<PAGE>


                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-K/A
     (Mark One)

         [X]     Annual Report Pursuant to Section 13 or 15(d) of
                       the Securities Exchange Act of 1934

                    For the fiscal year ended March 31, 1999

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

                         Commission file number 0-12648

                           MOLECULAR BIOSYSTEMS, INC.
             (Exact name of registrant as specified in its charter)

            Delaware                                      36-3078632
  (State or other jurisdiction of                      (I.R.S. Employer
  incorporation or organization)                      Identification No.)

              10030 Barnes Canyon Road, San Diego, California 92121
               (Address of principal executive offices) (Zip Code)

       Registrant's telephone number, including area code: (619) 812-7200

           Securities registered pursuant to Section 12(b) of the Act:

    Title of each class                Name of each exchange on which registered
 Common Stock, $.01 par value                   New York Stock Exchange

           Securities registered pursuant to Section 12(g) of the Act:
                                      None


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

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

         The aggregate market value of voting stock held by non-affiliates of
the registrant was $42,706,156 as of June 15, 1999 (computed by reference to the
last sale price of a share of the registrant's Common Stock on that date as
reported on the New York Stock Exchange).

          There were 18,580,745 shares outstanding of the registrant's Common
Stock as of June 15, 1999.


<PAGE>


Molecular Biosystems, Inc. ("the Company") is filing this Form 10-K/A to expand
upon and clarify certain information included in the prior filing.


                                       2
<PAGE>


ITEM 6.           SELECTED FINANCIAL DATA


<TABLE>
<CAPTION>

Selected Financial Data
Fiscal Years Ended March 31,                           1995        1996         1997        1998        1999
----------------------------                     -------------------------------------------------------------
(In thousands, except per share data)
<S>                                              <C>             <C>          <C>         <C>         <C>
Consolidated Statement of Operations Data:

Revenues:

   Revenues under collaborative
      agreements                                    $  15,132    $  2,412     $  4,500    $  5,095    $  5,498

   Product and royalty revenues                         1,769         647          626       1,151       4,083

   Other                                                   40          25            -           -           -
                                                  -------------------------------------------------------------
      Total Revenues                                   16,941       3,084        5,126       6,246       9,581

Operating expenses:

   Research and development costs                      18,743      13,588        9,902      11,078       9,083

   Costs of products sold                               1,608       1,553        4,748       5,791       7,840

   Selling, general and
      administrative expenses                           5,864       5,862        8,052      11,912      14,191

   Other nonrecurring charges                           3,403       3,110            -           -           -

   Cost Reduction Measures:

            Asset disposals                                 -           -            -           -       3,143

            Severance costs                                 -           -            -           -       2,328

            Technology transfer                             -           -            -           -         265

             Exit costs                                     -           -            -           -         384
                                                  -------------------------------------------------------------
             Total operating expenses                  29,618      24,113       22,702      28,781      37,234

Other income (expenses):

Gain on disposal of asset held for sale                     -           -        2,725           -       6,993

Interest expense                                         (694)       (786)        (810)       (721)       (574)

Interest income                                         1,189       1,102        2,377       1,996       1,394

Foreign income tax provision                                -           -            -           -      (1,400)
                                                  -------------------------------------------------------------
              Total other income                          495         316        4,292       1,275       6,413
                                                  -------------------------------------------------------------
Net loss                                            $ (12,182)   $(20,713)    $(13,284)   $(21,260)   $(21,240)

                                                  ============================================================
Loss per common share - basic and diluted           $   (1.02)   $  (1.62)    $  (0.78)   $  (1.19)   $  (1.14)

                                                  ============================================================
Weighted average common
   shares outstanding                                  11,999      12,758       16,926      17,793      18,564
                                                  ============================================================

</TABLE>


                                       3
<PAGE>


<TABLE>
<CAPTION>

As of March 31,                                        1995        1996         1997        1998        1999
---------------                                     -----------------------------------------------------------
<S>                                                  <C>         <C>          <C>         <C>         <C>
Consolidated Balance Sheet Data:

Cash, cash equivalents and
   marketable securities                             $ 19,718    $ 20,570     $ 41,414    $ 21,338    $ 18,038

Working capital                                        20,927      18,601       43,843      21,066      10,693

Total assets                                           50,639      43,829       70,159      51,318      31,849

Long-term debt                                          8,408       8,610        7,349       6,082       4,804

Total stockholders' equity                             36,424      28,962       51,746      31,164      16,207

</TABLE>


     THE SELECTED FINANCIAL DATA SET FORTH ABOVE WITH RESPECT TO THE COMPANY'S
CONSOLIDATED FINANCIAL STATEMENTS HAS BEEN DERIVED FROM THE AUDITED FINANCIAL
STATEMENTS. THE DATA SET FORTH ABOVE SHOULD BE READ IN CONJUNCTION WITH
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" AND THE COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND RELATED
NOTES INCLUDED ELSEWHERE IN THIS FILING.




ITEM 7.           MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                  AND RESULTS OF OPERATIONS

     (REFERENCES TO YEARS ARE TO THE COMPANY'S FISCAL YEARS ENDED MARCH 31.)

     THIS ANNUAL REPORT ON FORM 10-K MAY CONTAIN PREDICTIONS, ESTIMATES AND
OTHER FORWARD-LOOKING STATEMENTS THAT INVOLVE A NUMBER OF RISKS AND
UNCERTAINTIES. THIS OUTLOOK REPRESENTS THE COMPANY'S CURRENT JUDGMENT ON THE
FUTURE DIRECTION OF ITS BUSINESS. ANY RISKS AND UNCERTAINTIES COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM ANY FUTURE PERFORMANCE SUGGESTED BELOW. THE
COMPANY UNDERTAKES NO OBLIGATION TO RELEASE PUBLICLY THE RESULTS OF ANY
REVISIONS TO THESE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES
ARISING AFTER THE DATE OF THIS ANNUAL REPORT.

OVERVIEW

    Molecular Biosystems, Inc. ("MBI" or the "Company") is a leader in the
development, manufacture and sale of ultrasound contrast imaging agents. These
contrast agents are used primarily to improve the real-time images ("moving
pictures") of organs and body structures, especially the heart, obtained through
ultrasound examinations. The Company has designed its products to increase the
diagnostic usefulness of ultrasound examinations through enhanced visualization
of structures and vasculature, and to reduce the need for diagnostic procedures
that may be more expensive, time-consuming, or invasive.

    The Company made key operational changes during fiscal year 1999. First, as
fiscal year 1999 was the first full year of OPTISON(R) sales, the Company made a
transition from being a product development company to a commercial enterprise.
In making this transition and in carefully evaluating cost reduction measures,
the Company announced on November 10, 1998 the initiation of a multi-phase
program to reduce expenses and preserve capital. This program included plans to
out-source the Company's manufacturing process.

    In April 1999, the Company and Mallinckrodt, Inc. ("Mallinckrodt") agreed to
transfer the manufacture of OPTISON, the only advanced generation cardiac
ultrasound imaging agent commercially available in the United States and Europe,
from MBI to Mallinckrodt under an amendment to their existing research support
and distribution agreement. In addition to the transfer of manufacturing, the
amended agreement will extend Mallinckrodt's responsibility for funding clinical
trials to include all cardiology, as well as radiology, clinical trials for
OPTISON in the United States. Under the terms of the agreement, MBI will
continue to conduct all cardiology trials for OPTISON and will assume
responsibility for conducting radiology trials in the United States. The parties
agreement will be incorporated into an amendment to ARDA.


                                       4
<PAGE>


    Under the terms of the amended agreement, which will be retroactive to March
1, 1999, Mallinckrodt would reimburse MBI for all manufacturing expenses,
including incremental costs related to the technology transfer. In exchange for
the transfer of manufacturing and increased financial support of clinical trials
for OPTISON, MBI would receive a reduced royalty rate on product sales of
OPTISON.

    The out-sourcing of the Company's manufacturing process is not only expected
to reduce the Company's expenditures, but also to better enable the Company to
focus on key research and development opportunities, including other indications
of OPTISON and its liver CT, imaging agent, MB-840.

    The Company is the first and only company to obtain marketing approval from
the United States Food and Drug Administration ("FDA") for ultrasound contrast
agents, having gained approvals for ALBUNEX(R) in 1994 and OPTISON (the
Company's second-generation agent) in 1997. In May 1998, OPTISON received final
marketing authorization by the European Agency for the Evaluation of Medicinal
Products ("EMEA") for use in patients with suspected or known cardiovascular
disease. The authorization covers all 15 member states of the European Union.

    OPTISON is used to detect heart disease by assessing blood flow within the
heart chambers and by identifying the location of the chamber borders and the
movement of the chamber walls ("cardiac function"). To increase the potential
applications of OPTISON, MBI is conducting Phase 2 clinical trials to evaluate
the product's efficacy in determining whether the heart muscle is receiving an
adequate blood supply ("myocardial perfusion"). The multiple Phase 2 trials
include use of OPTISON in the emergency room for patients presenting with chest
pain, and in various forms of stress echocardiography. Results using OPTISON in
each of these applications suggest a close agreement with nuclear imaging for
the detection of ischemia by wall motion and perfusion. Furthermore, the results
indicate that use of OPTISON could help to "rescue" a large proportion of
uninterpretable non-contrast studies, thereby reducing the need for additional,
more expensive and time consuming testing. The Company believes the information
regarding perfusion will enable cardiologists to diagnose heart attacks and
coronary artery disease more accurately and safely than is currently feasible.
MBI is also conducting Phase 2 clinical studies using OPTISON to detect
abnormalities in other organs, such as the liver.

      OPTISON is the Company's second generation contrast agent and is a
significant improvement over the Company's first generation contrast agent,
ALBUNEX, in terms of efficacy. The Company has replaced ALBUNEX with OPTISON.
Accordingly, the Company does not foresee any ALBUNEX product sales in the
future.

    Operating losses may occur for at least the next few years due to continued
requirements for research and development including preclinical testing and
clinical trials, regulatory activities and the costs of commercializing new
products. The magnitude of the losses and the time required by the Company to
achieve profitability are highly dependent on the market acceptance of OPTISON
and are therefore uncertain. There can be no assurance that the Company will be
able to achieve profitability on a sustained basis or at all. Results of
operations may vary significantly from quarter to quarter depending on, among
other things, the progress, if any, of the Company's research and development
efforts, the timing of milestone payments, the timing of certain expenses and
the establishment of collaborative research agreements.

REVENUE RECOGNITION

    Historically the Company has earned revenues from three primary sources:
revenues under collaborative agreements, milestone payments, and product
revenues.

    REVENUES UNDER COLLABORATIVE AGREEMENTS. Revenues under collaborative
agreements have been the primary source of revenues for the Company in the past.
They consist of payments received from Mallinckrodt under the Company's Amended
and Restated Distribution Agreement ("ARDA") to support clinical trials,
regulatory submissions and product development. Pursuant to ARDA, half of each
payment is designated for clinical development expenses and is recorded as
deferred revenue until such expenses are incurred, and the remaining half of
each payment is designated to fund ongoing research and development activities
and is recognized as research is performed.

    MILESTONE PAYMENT REVENUES. Milestone payment revenues are earned upon the
achievement of certain product development and territorial milestones. All
milestone payments to date consist of payments received from Chugai based on
Chugai commencing certain specified clinical trials in Japan.

    PRODUCT AND ROYALTY REVENUES. Product revenues are based upon the Company's
non-refundable sales to Mallinckrodt and are recognized upon shipment of the
product at which time ownership and title to the goods passes to Mallinckrodt.


                                       5
<PAGE>


Product revenues in 1997 also included sales to Shionogi & Co., Ltd.
("Shionogi"). The transfer prices for the Company's sales of ALBUNEX to
Mallinckrodt and Shionogi were determined under the respective agreements and
were approximately equal to 40% of Mallinckrodt's average net sales price to its
end users of the product and 30% of Shionogi's net sales to its end users.

     For fiscal year 1998 and fiscal year 1999, the transfer price for the
Company's sales of OPTISON to Mallinckrodt was approximately equal to 40% of
Mallinckrodt's average net sales price to its end users of the product for the
immediately preceding quarter. Pursuant to ARDA, the average net sales price to
end users is calculated by dividing the net sales for the preceding quarter by
the total number of units shipped to end users whether paid for or shipped as
samples. Consistent with industry practice, the Company considers samples a
marketing expense and as such the cost of samples is recorded as selling,
general and administrative expense.

     For fiscal year 2000, under the terms of the ARDA II agreement with
Mallinckrodt effective in March 1999, the Company receives a royalty rather that
a sales price on product sales of OPTISON.

    Royalty revenues during fiscal years 1997, 1998 and 1999 were pursuant to a
licensing agreement between the Company and Abbott Laboratories.


IMPACT OF THE YEAR 2000 ISSUE

         The Year 2000 problem is the result of computer programs being written
using two digits rather than four digits to define the applicable year. This
problem could create unforeseen risks to the Company from its internal computing
systems as well as from computer systems of third parties with which it deals.
The Company has conducted a comprehensive review of its internal computing
systems and of its vendors, service providers (including financial institutions
and insurance companies), and collaborative partners. As of the date of this
document, the Company has not experienced any significant costs or disruptions
associated with the Year 2000 problem.

RESULTS OF OPERATIONS

     FISCAL YEAR 1999 COMPARED TO FISCAL YEAR 1998. Revenues under collaborative
agreements were $5.5 million for the fiscal year ended March 31, 1999, compared
to $5.1 million for the fiscal year ended March 31, 1998. This increase is
primarily due to an increase in the quarterly payments from Mallinckrodt to $1.5
million for the last two quarters in fiscal year 1999 over $1.25 million in the
prior year. These revenues in both years consist of quarterly payments to
support clinical trials, regulatory submissions and product development received
from Mallinckrodt under ARDA.

    Product and royalty revenues were $4.1 million for fiscal year 1999,
compared to $1.2 million for the prior year. Product revenues in the current
year are based on the Company's sales to Mallinckrodt and are recognized upon
shipment of the product. The increase in product revenues for fiscal year 1999
as compared to 1998 results primarily from sales of OPTISON to Mallinckrodt
which were launched in the fourth quarter of fiscal year 1998. Royalty revenues
are pursuant to a license agreement between the Company and Abbott Laboratories
and totaled $123,000 in fiscal year 1999 and $132,000 in fiscal year 1998.

    Costs of products sold totaled $7.8 million for fiscal year 1999, resulting
in a negative gross profit margin. This negative gross profit margin was due to
the fact that the low levels of production were insufficient to cover the
Company's fixed manufacturing overhead expenses. For fiscal year 1998, costs of
products sold totaled $5.8 million. The increase over the prior year is
primarily due to two factors. First, the Company sold OPTISON throughout the
entire fiscal year 1999 as compared to only during the fourth quarter of fiscal
year 1998. Second, $1.1 million in inventories were expensed through cost of
sales as a result of the planned out-sourcing of manufacturing. The Company
anticipates an increase in gross profit margins if and when OPTISON sales
volumes increase as OPTISON obtains market acceptance and when the manufacturing
process is out-sourced pursuant to the anticipated terms of the April 1999
agreement with Mallinckrodt. During fiscal 1999, manufacturing fixed costs were
running at an annual rate of approximately $4.5 million.


    The Company's research and development costs totaled $9.1 million for fiscal
year 1999 as compared to $11.1 million for fiscal year 1998. The decrease of 18%
is due to previously announced cost reduction measures.

    Selling, general and administrative expenses totaled $14.2 million in fiscal
year 1999 as compared to $11.9 million in fiscal year 1998. This increase of 19%
is primarily due to continuing legal expenses, marketing costs associated with
the


                                       6
<PAGE>


launch of OPTISON, and severance costs. Additionally, a portion of the increase
is due to a licensing agreement between the Company and Schering AG ("Schering")
in which the Company licensed rights to certain Schering patents.


On November 10, 1998, as a result of the slower than planned ramp up of OPTISON
sales, the Company announced the initiation of a multi-phase program to reduce
expenses and preserve capital. The initial phase was a reduction principally in
administrative, development and support staff. Phase II was the out-sourcing of
the product packaging operations. Phase II will entail the out-sourcing of the
manufacture of bulk product. The initial phase of cost reduction affected
approximately 40 employees of the Company's 140-person workforce. The next
reduction in force, in April 1999, affected an additional 26 employees. In
addition, attrition since November 1998 has further reduced the current
workforce to approximately 56 employees. On March 30, 2000, the Company
announced plans to restructure and further reduced its workforce by 33
employees. The Company will implement an additional reduction in workforce when
the out-sourcing of manufacturing operations is complete, which is estimated to
occur in December 2001.All employees expected to be terminated as a result of
this program were notified of such termination and their estimated severance
benefits were accrued.

    The impact of the cost reduction measures on the Company's financial results
included a one-time charge of $7.2 million for the year ended March 31, 1999.
This charge included $6.1 million in nonrecurring charges and $1.1 million in
cost of sales. The $6.1 million nonrecurring charge included $3.1 million for
the full write off of fixed assets, principally building improvements of
abandoned facilities, capitalized license fees and capitalized patent costs that
will no longer be used by the Company as a result of the planned out-sourcing of
manufacturing operations and the discontinuation of certain projects, $2.3
million of severance costs, and approximately $265,000 of technology transfer
costs, primarily direct labor and travel costs associated with the transfer of
the manufacturing process, and $387,000 of lease exit costs related to the
Company's plan to out-source manufacturing.

    Additionally, approximately $2.8 million of fixed assets, principally
building improvements for the Company's remaining manufacturing facility, will
be written off to operations through accelerated depreciation over the term of
the out-sourcing. The Company wrote off $1.2 million in fixed assets through
accelerated depreciation during fiscal year 1999 and expects to write off
another $1.6 million in fixed assets through accelerated depreciation over the
period that the manufacturing process is out-sourced, which is estimated to be
completed by December 2001. As of March 31, 1999, the Company had approximately
$2.0 million in accrued liabilities related to the future costs of out-sourcing.

    A summary of the $8.4 million cost reduction measures charge reflected in
the accompanying statements of operations for the year ended March 31, 1999 is
as follows:


<TABLE>
<CAPTION>

                                                                                                        Amount
                                                                                                     -------------
                                                                                                     (in millions)
<S>                                                                                                   <C>
     Non cash charges:
              Accelerated depreciation, recorded prospectively in operations,
                   resulting from a change in estimates of the useful lives
                   of manufacturing assets.............................................................   $1.2
              Write off of abandoned fixed assets ($2.8) and other
                  capitalized assets ($0.3)............................................................    3.1
              Inventory disposed of....................................................................    1.1
                                                                                                         --------

                                                                                                          $5.4
                                                                                                         --------
      Cash charges:
              Severance...............................................................................     2.3
              Exit costs..............................................................................      .4
              Technology transfer.....................................................................      .3
                                                                                                         --------
                                                                                                          $3.0
                                                                                                         --------
      Less amounts paid through March 31, 1999:
              Severance...............................................................................     1.0
              All other...............................................................................       -
                                                                                                         --------

</TABLE>



                                       7
<PAGE>


<TABLE>

<S>                                                                                                       <C>
       Accrued at March 31, 1999......................................................................    $2.0
                                                                                                         ========

</TABLE>


    At March 31, 1999, $1.3 million of the cost reduction accrual is included in
compensation accruals and the remaining $0.7 million is included in accounts
payable and accrued liabilities in the accompanying balance sheet as of March
31, 1999.



    Gain on disposal of assets held for sale totaled $7.0 million for fiscal
1999. The Company resold territory rights to Chugai for $14.0 million, as well
as a $2.4 million premium received for the sale of the Company's common stock to
Chugai. This gain is net of these rights previously reacquired from Shionogi &
Co. for $8.5 million and related transaction fees of $878,000.

    Interest expense for fiscal years 1999 and 1998 amounted to $574,000 and
$721,000, respectively. Interest expense consists of mortgage interest on the
Company's manufacturing building and interest related to a note payable, secured
by the tangible assets of the Company, which bears interest at the prime rate
and is payable in monthly installments of principal plus interest over five
years. The interest rate on the note was 7.75% in March 1999. In September 1998,
the Company renegotiated its note payable to reduce the interest rate from prime
plus one to the prime rate and to release compensating balance requirements.

    Interest income for fiscal year 1999 was $1.4 million compared to $2.0
million in fiscal year 1998. This decrease is due to lower average cash balances
and marketable securities balances.

    No tax benefit has been recognized for fiscal years 1999 or 1998 as the
Company had fully utilized its operating loss carryback ability in 1993. As of
March 31, 1999, the Company had federal and state operating loss carryforwards
of approximately $121 million and $38.9 million, respectively. Realization of
future tax benefits from utilization of net operating loss carryforwards is
uncertain.

    FISCAL YEAR 1998 COMPARED TO FISCAL YEAR 1997. Revenues under collaborative
agreements were $5.1 million for the fiscal year ended March 31, 1998, compared
to $4.5 million for the fiscal year ended March 31, 1997. This increase was
primarily due to an increase in the quarterly payments from Mallinckrodt to
$1.25 million over $1.0 million in the prior year's first two quarters. These
revenues in both years consisted of quarterly payments to support clinical
trials, regulatory submissions and product development received from
Mallinckrodt under ARDA.

    Product and royalty revenues were $1.2 million for fiscal year 1998,
compared to $626,000 for fiscal year 1997. Product revenues in fiscal year 1998
were based on the Company's sales to Mallinckrodt and were recognized upon
shipment of the product. Product revenues in fiscal year 1997 also included
sales to Shionogi, also recognized upon shipment of the product. The increase in
product revenues for fiscal year 1998 as compared to fiscal year 1997 resulted
primarily from the market introduction of OPTISON in the fourth quarter which
added revenues of approximately $700,000. Royalty revenues were pursuant to a
license agreement between the Company and Abbott Laboratories and totaled
$132,000 in fiscal year 1998 and $113,000 in fiscal year 1997.

    Costs of products sold totaled $5.8 million for fiscal year 1998, resulting
in a negative gross profit margin. This negative gross profit margin was due to
the fact that low levels of production were insufficient to cover the Company's
fixed manufacturing overhead expenses. For fiscal year 1997, costs of products
sold totaled $4.7 million.

    The Company's research and development costs totaled $11.1 million for
fiscal year 1998 as compared to $9.9 million for fiscal year 1997. The increase
of 12% was due to additional research and development costs associated with the
Company's product development efforts.

    Selling, general and administrative expenses totaled $11.9 million in fiscal
year 1998 as compared to $8.1 million in fiscal year 1997. This increase of 47%
was primarily due to increased legal expenses.

    Gain on disposal of assets held for sale totaled $2.7 million in fiscal
1997. Pursuant to an amendment to ARDA, the Company resold territory rights
consisting of Europe, Africa, India and parts of Asia to Mallinckrodt for $5.7
million. This gain is net of the cost of these rights previously reacquired from
Nycomed for $3.0 million.


                                       8
<PAGE>


    Interest expense for fiscal years 1998 and 1997 amounted to $721,000 and
$810,000, respectively. Interest expense consisted of mortgage interest on the
Company's manufacturing building and interest related to a note payable, secured
by the tangible assets of the Company, which bore interest at the prime rate
plus 1% and was payable in monthly installments of principal plus interest over
five years. The interest rate on the note was 9.5% in March 1998.

    Interest income for fiscal year 1998 was $2.0 million compared to $2.4
million in fiscal year 1997. This decrease was due to lower average cash
balances and marketable securities balances.

    No tax benefit was recognized for fiscal years 1998 or 1997 as the Company
had fully utilized its operating loss carryback ability in 1993. As of March 31,
1998, the Company had federal and state operating loss carryforwards of
approximately $90.5 million and $27.2 million, respectively.


LIQUIDITY AND CAPITAL RESOURCES

    At March 31, 1999, the Company had net working capital of $10.7 million
compared to $21.1 million at March 31, 1998. Cash, cash equivalents and
marketable securities were $18.0 million at March 31, 1999 compared to $21.3
million at March 31, 1998.

    During fiscal year 1999, the Company used $26.5 million cash for operating
requirements, which was funded primarily by $6.4 million of marketable
securities that matured during fiscal 1999, $8.3 million in net proceeds from
the sale of common stock to Chugai, and 15.5 million from the sale of
territorial rights to Chugai. Other significant cash uses included purchases of
property and equipment of $791,000, $2.0 million for the reacquisition of
license rights from Shionogi and $1.3 million in principal payments on long term
debt.

    For the next several years, the Company expects to incur substantial
additional expenditures associated with product development. The Company
anticipates that its existing resources, including up-front license fees
received from Chugai, and interest thereon, plus payments under its
collaborative agreements with Mallinckrodt, will enable the Company to fund its
operations for at least the next fifteen months. The Company continually reviews
its product development activities in an effort to allocate its resources to
those products that the Company believes have the greatest commercial potential.
Factors considered by the Company in determining the products to pursue may
include, but are not limited to, the projected markets, potential for regulatory
approval, technical feasibility and estimated costs to bring the product to the
market. Based upon these factors, the Company may from time to time reallocate
its resources among its product development activities.

    The Company may pursue a number of options to raise additional funds,
including borrowings; lease arrangements; collaborative research and development
arrangements with pharmaceutical companies; the licensing of product rights to
third parties; or additional public and private financing, as capital
requirements change as a result of strategic, competitive, technological and
regulatory factors. There can be no assurance that funds from these sources will
be available on favorable terms, or at all.

    In an agreement dated March 31, 1998, the Company entered into a cooperative
development and marketing agreement with Chugai. The parties entered into this
strategic alliance which covers Japan, Taiwan and South Korea, to develop
OPTISON (which Chugai may be market under a different name) and ORALEX, as well
as related products. The Company granted Chugai an exclusive license to develop,
manufacture, and market these products in the subject territory, for which the
Company received $14.0 million during fiscal year 1999. With respect to licensed
products manufactured by Chugai, Chugai will pay the Company a royalty on net
sales. For licensed products manufactured by the Company, the Company will
receive royalties on net sales, the amount of which will depend upon the sales
volume, in addition to a transfer price based on average net sales per unit from
the previous quarter. Additionally, Chugai purchased 691,883 shares of the
Company's common stock at a premium of 40% over the then-prevailing market
price. The equity investment was valued at $8.3 million. The Company is also
eligible to receive milestone payments of up to $20.0 million based on Chugai's
achievement of certain Japanese product development and regulatory goals.

    On September 7, 1995, the Company entered into an Amended and Restated
Distribution Agreement ("ARDA") and a related investment agreement with
Mallinckrodt which will provide the Company with between $33.0 million and $42.5
million. Under the terms of the agreement, Mallinckrodt is obligated to make
payments to the Company totaling $20.0 million over four years to support
clinical trials, related regulatory submissions and associated product
development of the licensed products, which include, but are not limited to,
ALBUNEX and OPTISON. These payments will be made in 16 quarterly installments of
$1.0 million for the first four quarters, $1.25 million for the following eight
quarters and $1.5


                                       9
<PAGE>


million for the final four quarters. The payments may be accelerated in the
event that the Company's cumulative outlays for clinical trials are in excess of
the amounts received at any point in time. However, the quarterly payments may
not be postponed. The first 14 quarterly payments have been received by the
Company as of March 31, 1999.

     In April 1999, the Company and Mallinckrodt Inc. entered into an agreement
to transfer the manufacture of OPTISON from MBI to Mallinckrodt under an
amendment to ARDA. The terms of the agreement also extends Mallinckrodt's
responsibility for funding clinical trials to include all cardiology, as well as
radiology, clinical trials for OPTISON in the United States. MBI will continue
to conduct all cardiology trials for OPTISON and will assume responsibility for
conducting radiology trials in the United States. Under the terms of the
agreement, which is retroactive to March 1, 1999, Mallinckrodt will reimburse
MBI for all manufacturing expenses, including incremental costs related to the
technology transfer. In exchange for the transfer of manufacturing and increased
financial support of clinical trials for OPTISON, MBI will receive a royalty on
product sales of OPTISON.

     In September 1996, the Company entered into an agreement with Shionogi
pursuant to which the Company reacquired all rights to manufacture, market and
sell its ALBUNEX family of products in the territory, consisting of Japan,
Taiwan and South Korea, formerly exclusively licensed to Shionogi. Under the
agreement, the Company paid $3.0 million to Shionogi and agreed to pay an
additional $5.5 million over the next three years, of which $4.0 million had
been paid at March 31, 1999.

    Capital expenditures for facilities, laboratory equipment, furniture and
fixtures were $791,000, $1.4 million, and $726,000 for fiscal years 1999, 1998
and 1997, respectively. Expenditures in all three fiscal years consisted
primarily of building improvements and equipment for aseptic manufacturing
facilities being constructed for the manufacture of OPTISON and other products.
In June 1997, the Company entered into an equipment leasing agreement with
Mellon US Leasing for a lease line of $1.6 million with a term of 48 months. The
outstanding balance on this line of credit at March 31, 1999 was $1.0 million.

     The Company invests its excess cash in debt instruments of financial
institutions and corporations with strong credit ratings. The Company has
established guidelines relative to diversification and maturities that maintain
safety and liquidity. These guidelines are periodically reviewed and modified to
take advantage of trends in yields and interest rates.

    The Company believes that inflation and changing prices have not had a
material effect on operations for fiscal years 1999, 1998 and 1997 and that the
impact of government regulation on the Company is not materially different from
the impact on other similar enterprises.


                                       10
<PAGE>


ITEM 8.           FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>

                                                                                                                   PAGE
        <S>                                                                                                        <C>
        Report of Independent Public Accountants

        Consolidated Balance Sheets as of March 31, 1998 and 1999

        Consolidated Statements of Operations for the Fiscal Years Ended March 31, 1997, 1998 and 1999

        Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended March 31, 1997, 1998 and
        1999

        Consolidated Statements of Cash Flows for the Fiscal Years Ended March 31, 1997, 1998 and 1999

        Notes to Consolidated Financial Statements

</TABLE>



                                       11
<PAGE>


                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Molecular Biosystems, Inc.:

         We have audited the accompanying consolidated balance sheets of
Molecular Biosystems, Inc. (a Delaware corporation) and subsidiaries as of March
31, 1998 and 1999, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended March 31, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

         We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Molecular
Biosystems, Inc. and subsidiaries as of March 31, 1998 and 1999, and the results
of their operations and their cash flows for each of the three years in the
period ended March 31, 1999, in conformity with generally accepted accounting
principles.





                                                 ARTHUR ANDERSEN LLP



San Diego, California
April 30, 1999, except the second paragraph
of Note 12 as to which the date is May 3, 1999



                                       12
<PAGE>


                   MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>

                                                                                 March 31,       March 31,
                                                                                   1998             1999
<S>                                                                              <C>              <C>
                                   ASSETS
Current assets:
    Cash and cash equivalents                                                    $   1,064        $   1,056
    Marketable securities, available-for-sale (Note 4)                              20,274           16,982
    Accounts and notes receivable                                                    1,498            2,320
    License rights held for sale (Note 10)                                           8,500                -
    Inventories                                                                      1,902              748
    Prepaid expenses and other assets                                                  400              425
                                                                             --------------  ---------------
         Total current assets                                                       33,638           21,531
                                                                             --------------  ---------------

Property and equipment, at cost:
    Building and improvements                                                       14,412           11,113
    Equipment, furniture and fixtures                                                4,364            2,893
    Construction in progress                                                           471              930
                                                                             --------------  ---------------
                                                                                    19,247           14,936
    Less:  Accumulated depreciation and amortization                                 7,073            6,672
                                                                             --------------  ---------------
         Total property and equipment                                               12,174            8,264
                                                                             --------------  ---------------

Other assets:
    Patents and license rights, net of amortization of
        $87 in 1998  (Notes 7 and 10)                                                  320                -
    Certificate of deposit, pledged (Notes 4 and 6)                                  3,000                -
    Other assets, net                                                                2,186            2,054
                                                                             --------------  ---------------
         Total other assets                                                          5,506            2,054
                                                                             --------------  ---------------
                                                                                 $  51,318       $   31,849
                                                                             ==============  ===============

                    LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Current portion of long-term debt                                            $   1,272        $   1,278
    Accounts payable and accrued liabilities (Notes 1 and 7)                         7,498            7,395
    Compensation accruals                                                            2,227            2,165
    Deferred Contract Revenue                                                        1,575                -
                                                                             --------------  ---------------
         Total current liabilities                                                  12,572           10,838
                                                                             --------------  ---------------
Long-term debt, net of current portion (Note 6):                                     6,082            4,804
                                                                             --------------  ---------------
Other noncurrent liabilities                                                         1,500                -
                                                                             --------------  ---------------
Commitments and contingencies (Note 7):
Stockholders' equity (Note 8):
    Common Stock, $.01 par value, 40,000,000 shares
    authorized, 17,846,237 and 18,580,745 shares
      issued and outstanding, respectively                                             178              186
    Additional paid-in capital                                                     128,145          134,347
    Accumulated deficit                                                            (96,729)        (117,969)
    Unrealized loss on available-for-sale securities                                   (67)               6
    Less  40,470 shares of treasury stock, at cost                                    (363)            (363)
                                                                             --------------  ---------------
         Total stockholders' equity                                                 31,164           16,207
                                                                             --------------  ---------------
                                                                                 $  51,318       $   31,849
                                                                             ==============  ===============

</TABLE>

  The accompanying notes are an integral part of these consolidated statements.


                                       13
<PAGE>


                   MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)


<TABLE>
<CAPTION>

                                                                   FISCAL YEARS ENDED MARCH 31,
                                                           --------------------------------------------
                                                                1997             1998            1999
<S>                                                           <C>              <C>             <C>
Revenues (Note 9):
    Revenues under collaborative agreements                 $   4,500       $    5,095      $    5,498
    Product and royalty revenues                                  626            1,151           4,083
                                                           -----------     ------------    ------------
                                                                5,126            6,246           9,581
                                                           -----------     ------------    ------------

Operating expenses:
    Research and development costs (Note 9)                     9,902           11,078           9,083
    Costs of products sold                                      4,748            5,791           7,840
    Selling, general and administrative expenses                8,052           11,912          14,191
    Cost reduction measures (Note 2):
      Asset disposals                                               -                -           3,143
      Severance costs                                               -                -           2,328
      Technology transfer                                           -                -             265
      Exit costs                                                    -                -             384
                                                           -----------     ------------    ------------
                                                               22,702           28,781          37,234
                                                           -----------     ------------    ------------

    Loss from operations                                      (17,576)         (22,535)        (27,653)

Gain on disposals of assets held for sale (Note 10)             2,725                -           6,993
Interest expense                                                 (810)            (721)           (574)
Interest income                                                 2,377            1,996           1,394
                                                           -----------     ------------    ------------
Loss before income taxes                                      (13,284)         (21,260)        (19,840)
Foreign income tax provision                                        -                -          (1,400)
                                                           ===========     ============    ============
      Net Loss                                              $ (13,284)      $  (21,260)     $  (21,240)
                                                           ===========     ============    ============

Loss per common share - basic and diluted                   $   (0.78)      $    (1.19)     $    (1.14)
                                                           ===========     ============    ============

Weighted average common shares
    outstanding                                                16,926           17,793          18,564
                                                           ===========     ============    ============

</TABLE>

  The accompanying notes are an integral part of these consolidated statements.


                                       14
<PAGE>


                   MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>


                                                                                                           ACCUMULATED
                                               COMMON STOCK        ADDITIONAL                                 OTHER
                                         ------------------------    PAID-IN      ACCUMULATED   TREASURY  COMPREHENSIVE
                                            SHARES       AMOUNT      CAPITAL       DEFICIT       STOCK       INCOME
                                         -------------  ---------  ------------  -------------  --------- --------------
<S>                                      <C>            <C>        <C>           <C>            <C>       <C>
Balance at March 31, 1996                  13,296,186      $ 133      $ 91,468     $ (62,185)    $  (167)       $    (6)
    Comprehensive Loss
        Net loss                                    -          -             -       (13,284)          -              -
        Unrealized loss on available-
           for-sale securities                      -          -             -              -          -            (76)
    Proceeds from Public
      Offering                              4,140,000         41        34,045              -          -              -
    Purchase of treasury stock (Note 6)             -          -           (85)             -       (196)             -
    Exercise of stock options                 295,500          3         1,928              -          -              -
    Issuance of stock grants                   14,211          -           127              -          -              -
                                         -------------  ---------  ------------  -------------  --------- --------------
Balance at March 31, 1997                  17,745,897      $ 177     $ 127,483     $  (75,469)   $  (363)      $    (82)

    Comprehensive Loss
        Net loss                                    -          -             -        (21,260)         -              -
        Unrealized gain on available-
           for-sale securities                      -          -             -              -          -             15
    Exercise of stock options                 100,340          1           662              -          -              -
                                         -------------  ---------  ------------  -------------  --------- --------------
Balance at March 31, 1998                  17,846,237      $ 178     $ 128,145     $  (96,729)   $  (363)      $    (67)

    Comprehensive Loss
        Net loss                                                                      (21,240)
        Unrealized gain on available-
           for-sale securities                                                                                       73
    Sale of common stock to Chugai            691,883          7         5,922              -          -              -
    Exercise of stock options                  42,625          1           280
                                         -------------  ---------  ------------  -------------  --------- --------------
Balance at March 31, 1999                  18,580,745      $ 186     $ 134,347     $(117,969)    $ (363)        $     6
                                         =============  =========  ============  =============  ========= ==============

</TABLE>



<TABLE>
<CAPTION>

                                                              NOTES
                                                            RECEIVABLE
                                                             FROM SALE
                                                             OF COMMON                   COMPREHENSIVE
                                                               STOCK          TOTAL           LOSS
                                                          --------------   ------------  --------------
<S>                                                       <C>              <C>           <C>
Balance at March 31, 1996                                     $   (281)       $28,962
    Comprehensive Loss
        Net loss                                                      -
                                                                              (13,284)       (13,284)
        Unrealized loss on available-
           for-sale securities                                        -           (76)           (76)
    Proceeds from Public
      Offering                                                        -        34,086
    Purchase of treasury stock (Note 6)                             281             -
    Exercise of stock options                                         -         1,931
    Issuance of stock grants                                          -           127
                                                          --------------  ------------ --------------
Balance at March 31, 1997                                     $       -       $51,746     $  (13,360)
                                                                                       ==============
    Comprehensive Loss
        Net loss                                                      -       (21,260)       (21,260)
        Unrealized gain on available-
           for-sale securities                                        -            15             15
    Exercise of stock options                                         -           663
                                                          --------------  ------------ --------------
Balance at March 31, 1998                                     $       -       $31,164     $  (21,245)
                                                                                       ==============
    Comprehensive Loss
        Net loss                                                              (21,240)       (21,240)
        Unrealized gain on available-
           for-sale securities                                                     73             73
    Sale of common stock to Chugai                                    -         5,929
    Exercise of stock options                                                     281
                                                          --------------  ------------ --------------
Balance at March 31, 1999                                     $       -       $16,207     $ (21,167)
                                                          ==============  ============ ==============

</TABLE>

  The accompanying notes are an integral part of these consolidated statements.

                                       15
<PAGE>


                   MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>

                                                                                     FISCAL YEARS ENDED MARCH 31,
                                                                              -------------------------------------------
                                                                                   1997          1998            1999
<S>                                                                              <C>           <C>              <C>
Cash flows from operating activities:
    Net loss                                                                     ($13,284)     ($21,260)        ($21,240)
    Adjustments to reconcile net loss to net cash
      used in operating activities:
       Depreciation and amortization                                                1,435         1,085            1,915
       Loss on disposals/write-downs of tangible and intangible property                1            20            3,092
       Gain on sale of former Nycomed/Shionogi territory license rights            (2,725)            -           (6,993)
       Forgiveness of note receivable from sale of Common Stock                       109             -                -
       Premium received on Chugai Investment                                            -             -           (2,371)
       Changes in operating assets and liabilities:
        Receivables                                                                    29          (702)          (1,171)
        Inventories                                                                   280        (1,560)           1,154
        Prepaid expenses and other assets                                            (623)          (45)             326
        Accounts payable and accrued liabilities                                      721         2,814              397
        Deferred contract revenue                                                       -         1,575           (1,575)
        Compensation accruals                                                         582           614              (62)
                                                                              ------------  ------------  ---------------
              Cash used in operating activities                                   (13,475)      (17,459)         (26,528)
                                                                              ------------  ------------  ---------------

Cash flows from investing activities:
    Purchases of property and equipment                                              (726)       (1,387)            (791)
    Proceeds from sale of property and equipment                                        4             -               42
    Write off of patents and license rights                                             -            17                -
    Additions to patents and license rights                                          (226)          (32)             (30)
    Acquisition of license rights from Shionogi                                    (3,000)       (2,000)          (2,000)
    Acquisition of license rights from Nycomed                                     (2,000)            -                -
    Proceeds from sale of territorial license                                       5,725             -           15,493
    rights
    (Increase) decrease in other assets                                              (269)           37              132
     Purchases of marketable securities                                          (127,732)      (25,566)         (42,988)
     Maturities of marketable securities                                           94,856        46,135           49,353
                                                                              ------------  ------------  ---------------
              Cash provided by (used for) investing activities                    (33,368)       17,204           19,211

                                                                              ------------  ------------  ---------------
Cash flows from financing activities:
    Proceeds from sale/leaseback transaction                                            -         1,331                -
    Net proceeds from public offering of Common Stock                              34,086             -                -
    Net proceeds from sale of common stock to Chugai                                    -             -            8,300
    Net proceeds from issuance of Common Stock                                      2,058           663              281
    Principal payments on long-term debt                                           (1,256)       (1,262)          (1,272)
                                                                              ------------  ------------  ---------------
              Cash provided by financing activities                                34,888           732            7,309
                                                                              ------------  ------------  ---------------

Increase (decrease) in cash and cash equivalents                                  (11,955)           477              (8)
Cash and cash equivalents, beginning of year                                       12,542           587            1,064
                                                                              ------------  ------------  ---------------
Cash and cash equivalents, end of year                                            $   587       $ 1,064        $   1,056
                                                                              ============  ============  ===============
Supplemental cash flow disclosures:
    Interest income received                                                      $ 1,609       $ 2,101        $   1,744
                                                                              ============  ============  ===============
    Interest paid                                                                 $   804       $   715        $     568
                                                                              ============  ============  ===============

</TABLE>

  The accompanying notes are an integral part of these consolidated statements.

                                       16
<PAGE>


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



1.       ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

         DESCRIPTION OF BUSINESS-

         Molecular Biosystems, Inc. ("MBI" or the "Company") discovers, develops
         and manufactures proprietary diagnostic ultrasound imaging agents. The
         Company's annual continuing operations have been unprofitable since
         1992. The Company believes that operating losses may occur for at least
         the next several years due to continued requirements for research and
         development, including preclinical testing and clinical trials,
         regulatory activities and the high costs of commercialization
         activities. The magnitude of the losses and the time required by the
         Company to achieve profitability are highly dependent on the market
         acceptance of OPTISON-Registered Trademark- and other future products
         and are therefore uncertain. The Company has replaced its first
         generation product, ALBUNEX-Registered Trademark-, with OPTISON. There
         is no assurance that the Company will be able to achieve profitability
         with sales of OPTISON or other future products on a sustained basis or
         at all.

         PRINCIPLES OF CONSOLIDATION-

         The Consolidated Financial Statements include the accounts of the
         Company and its wholly owned subsidiaries. All significant intercompany
         accounts and transactions have been eliminated.

         Certain amounts in the prior years' financial statements and notes have
         been reclassified to conform with the current year presentation.

         USE OF ESTIMATES-

         The preparation of financial statements in conformity with generally
         accepted accounting principles requires management to make estimates
         and assumptions that affect the reported amounts of assets and
         liabilities and disclosure of contingent assets and liabilities at the
         date of the financial statements and the reported amounts of revenues
         and expenses during the reported period. Actual results could differ
         from those estimates.

         RESEARCH AND DEVELOPMENT COSTS-

         All research and development costs and related special purpose
         equipment costs are charged to expense as incurred.

         REVENUES UNDER COLLABORATIVE AGREEMENTS-

         Revenues under collaborative agreements, which have been the primary
         source of revenues for the Company, consist of two types of revenues.
         The first type, milestone payments, is earned in connection with
         research activities performed under the terms of research and
         development license agreements. Revenue is recognized on the
         achievement of certain milestones, some of which relate to obtaining
         regulatory approvals. Accordingly, the estimated dates of the milestone
         achievements are subject to revision based on periodic evaluations by
         the Company and its partners of the attainment of specified milestones,
         including the status of the regulatory approval process. Advance
         payments received in excess of amounts earned are classified as
         deferred contract revenues and the resulting revenues are recognized
         based on work performed at a predetermined rate or level of expense
         reimbursement.

         Additionally, under the terms of the Amended and Restated Distribution
         Agreement ("ARDA") entered into in September 1995, as restated in May
         1999, Mallinckrodt, Inc. ("Mallinckrodt") will pay the Company $20.0
         million over four years to further the development of OPTISON (the
         Company's second-generation product) and related products. These
         payments will be made in 16 quarterly installments starting at $1.0
         million for the first four quarters, $1.25 million for the following
         eight quarters and $1.5 million for the final four quarters. Pursuant
         to the agreement, half of each payment is designated for clinical
         development expenses and will be recorded as deferred revenue until
         such expenses are incurred, and the remaining half of each payment is
         designated to fund ongoing research and development activities and is
         recognized as research is performed.


                                       17
<PAGE>


         REVENUE RECOGNITION FOR PRODUCT SOLD-

         The Company recognizes revenue when goods are shipped to its customer,
         Mallinckrodt. For fiscal years 1998 and 1999, the transfer price for
         the Company's sales of OPTISON to Mallinckrodt was equal to 40% of
         Mallinckrodt's average net sales price to its end users of the product
         for the immediately preceding quarter. Pursuant to ARDA, the average
         net sales price to end users is calculated by dividing the net sales
         for the preceding quarter by the total number of units shipped to end
         users whether paid for or shipped as samples. Consistent with industry
         practice, the Company considers samples a marketing expense and as such
         the cost of samples is recorded as selling, general and administrative
         expense.

         Under the terms of the May 1999 amended agreement with Mallinckrodt,
         the Company will receive a receive a reduced royalty rate on product
         sales of OPTISON in exchange for the transfer of manufacturing of and
         increased financial support for clinical trials of OPTISON.

         The Company has not provided for potential uncollectible accounts,
         based on its collection history and credit worthiness of its one
         customer, Mallinckrodt.


         INCOME TAXES-

         The Company accounts for income taxes in accordance with Statement of
         Financial Accounting Standards No. 109 (SFAS No. 109), "Accounting for
         Income Taxes." SFAS No. 109 is an asset and liability approach that
         requires the recognition of deferred assets and liabilities for the
         expected future tax consequences of events that have been recognized
         differently in the Company's financial statements or tax returns.
         Deferred tax assets are reduced by a valuation allowance when, in the
         opinion of management, it is more likely than not that some portion or
         all of the deferred tax assets will not be realized.


         CASH EQUIVALENTS-

         Cash equivalents include marketable securities with original maturities
         of three months or less when acquired. The Company has not realized any
         losses on its cash equivalents.


         MARKETABLE SECURITIES

         In accordance with Statement of Financial Accounting Standards ("SFAS")
         No. 115, "Accounting for Certain Investments in Debt and Equity
         Securities," the Company's management has classified its investment
         securities as available-for-sale and records holding gains or losses as
         a separate component of stockholders' equity. The cost basis for
         determining realized gains and losses is based on specific
         identification.


         CONCENTRATION OF CREDIT RISK-

         The Company invests its excess cash in debt instruments of financial
         institutions and corporations with strong credit ratings. The Company
         has established guidelines relative to diversification and maturities
         that maintain safety and liquidity. These guidelines are periodically
         reviewed and modified to take advantage of trends in yields and
         interest rates.


         INVENTORIES-

         Inventories are stated at lower of cost (first-in, first-out) or
         market, and consist of the following major classes (in thousands):

<TABLE>
<CAPTION>

                                                         MARCH 31,
                                                   -----------------------
                                                      1998          1999
               <S>                                 <C>           <C>
               Raw materials and supplies            $ 1,639        $ 551
               Work in process                            74           92
               Finished goods                            189          105
                                                   ----------    ---------
                                                     $ 1,902        $ 748
                                                   ==========    =========

</TABLE>


                                       18
<PAGE>


         Work in process and finished goods include the cost of materials,
         direct labor and manufacturing overhead.


         PROPERTY AND EQUIPMENT-

         Property and equipment are stated at cost. Depreciation and
         amortization are provided using the straight-line method over estimated
         useful lives of five years for equipment, 31 years for buildings and
         improvements and the term of the lease for leasehold improvements.


         PATENTS AND LICENSE RIGHTS AND OTHER ASSETS-

         The Company periodically reevaluates the original assumptions and
         rationale utilized in the assessment of the carrying value and
         estimated lives of long-lived assets. The determinants used for this
         evaluation include management's estimate of the asset's ability to
         generate positive income and cash flow as well as the strategic
         significance of the respective assets.

         Patents and license rights are amortized on the straight-line method
         over their estimated useful lives of five to ten years. During fiscal
         year 1999, the Company reevaluated its patent estate and wrote off
         approximately $300,000 in capitalized patent and license rights that
         will no longer be used by the Company as a result of the planned
         out-sourcing of manufacturing operations and discontinuation of certain
         products.

         In June 1989, the Company prepaid $2.0 million in royalties on the
         first $66.6 million of sales of ALBUNEX and OPTISON in the United
         States. Included in other assets at March 31, 1999 is approximately
         $1.7 million which is the portion of this prepayment which has not yet
         been expensed. Additionally, other assets at March 31, 1998 and 1999
         include $300,000 of real estate investment related to an employment
         agreement with one of the Company's officers.


         IMPAIRMENT OF LONG-LIVED ASSETS-

         The Company accounts for long lived assets in accordance with Statement
         of Financial Accounting Standards No. 121, "Accounting for the
         Impairment of Long-Lived Assets and for Long-Lived Assets to be
         Disposed Of" (SFAS 121). The Company reviews its long-lived assets for
         impairment whenever events or changes in circumstances indicate that
         the carrying amount of the assets may not be fully recoverable. To
         determine recoverability of its long-lived assets, the Company
         evaluates the probability that future undiscounted net cash flows,
         without interest charges, will be less than the carrying amount of the
         assets. Impairment is measured at fair value. Fair value is determined
         by an evaluation of available price information at which assets could
         be bought or sold including quoted market prices, if available, or the
         present value of the estimated future discounted cash flows based on
         reasonable and supportable assumptions.

         During fiscal year 1999, the Company wrote off approximately $2.8
         million of fixed assets that will no longer be used by the company as a
         result of the planned out-sourcing of manufacturing operations and
         discontinuation of certain projects. These assets principally relate to
         tenant improvements at the Company's research facility not transferable
         to other facilities. This facility was abandoned in fiscal 1999.


         ACCOUNTS PAYABLE AND ACCRUED LIABILITIES-

         Accounts payable and accrued liabilities consist of the following major
         classes (in thousands):

<TABLE>
<CAPTION>

                                                                                    MARCH 31,
                                                                            -----------------------
                                                                                1998         1999
         <S>                                                                  <C>          <C>
         Accrued legal and professional fees                                  $ 1,540      $ 3,031
         License rights payable and related fees (Note 7)                       2,000        1,500
         Restructuring accruals                                                              1,041
         Accounts payable - trade                                               3,394        1,226

</TABLE>


                                       19
<PAGE>


<TABLE>

         <S>                                                                <C>          <C>
         Other miscellaneous accruals                                             564          597
                                                                            ----------   ----------
                                                                              $ 7,498      $ 7,395
                                                                            ==========   ==========

</TABLE>


         STOCK BASED COMPENSATION-

         The Company has elected to adopt the disclosure only provisions of
         Statement of Financial Accounting Standards No. 123, "Accounting for
         Stock-Based Compensation" (SFAS 123). Accordingly the Company accounts
         for its stock based compensation plans under the provisions of APB No.
         25.


         LOSS PER SHARE-

         In December 1997, the Company adopted Statement of Financial Accounting
         Standards No. 128, "Earnings Per Share" (SFAS 128). The statement
         specifies the computation, presentation, and disclosure requirements
         for earnings per share (EPS). SFAS 128 requires companies to compute
         net income (loss) per share under two different methods, basic and
         diluted per share data for all periods for which an income statement is
         presented. Basic earnings per share was computed by dividing net income
         (loss) by the weighted average number of common shares outstanding
         during the period. Diluted earnings per share reflects the potential
         dilution that could occur if net income were divided by the
         weighted-average number of common shares and potential common shares
         from outstanding stock options for the period. Potential common shares
         are calculated using the treasury stock method and represent
         incremental shares issuable upon exercise of the Company's outstanding
         options. For the years ended March 31, 1997, 1998, and 1999, the
         diluted loss per share calculation excludes effects of 2,685,000,
         3,139,000 and 3,855,000 outstanding stock options in fiscal years ended
         March 31, 1997, 1998, and 1999, respectively, as such inclusion would
         be anti-dilutive.

         COMPREHENSIVE LOSS-

         In June 1997, Statement of Financial Accounting Standards No. 130,
         "Reporting Comprehensive Income," was issued. The Company has adopted
         this standard which requires the display of comprehensive income or
         loss and its components in the financial statements. The Company has
         chosen to disclose Comprehensive Loss, which encompasses net loss and
         unrealized gains and losses on available-for-sale securities, in the
         Consolidated Statements of Stockholders' Equity. Prior years have been
         restated to conform to the SFAS No. 130 requirements.


         GEOGRAPHIC AND CUSTOMER INFORMATION-

         The Company derives all of its product revenues from sales in the
         United States to its sole customer Mallinckrodt. The Company operates
         out of one factory in San Diego, California, has one product which is
         an ultrasound imaging agent and is managed on an aggregate basis. Based
         on the above factors, the Company has determined that it operates in
         one reportable segment.


         SALES OF EQUIPMENT-

         During 1997 and 1999, the Company sold certain fully depreciated
         equipment. These sales resulted in gains of $4,000 and $42,000,
         respectively, which have been reflected in the accompanying statements
         of operations.


         FAIR VALUE OF FINANCIAL INSTRUMENTS-

         The carrying amounts of the Company's financial instruments, including
         cash, accounts receivable, and accounts payable and accrued liabilities
         approximate their fair values due to their short term nature. The
         Company's long term debts approximate fair value as they carry a
         variable market rate of interest. Financial instruments which
         potentially subject the Company to concentration of credit risk consist
         primarily of trade accounts receivable. The Company believes it is not
         exposed to any significant credit risk on its accounts receivable.


         NEW ACCOUNTING STANDARDS-


                                       20
<PAGE>


         In 1999, the Company adopted the provisions of AICPA Statement of
         Position 98-1, "Accounting for the Costs of Computer Software Developed
         or Obtained for Internal use" ("SOP 98-1"). This statement provides
         guidance on accounting for the costs of computer software developed or
         obtained for internal use and identifies characteristics of
         internal-use software as well as assists in determining when computer
         software is for internal use. The adoption had no material impact on
         the Company's financial statements or related disclosure thereto.

         In 1998, the Company adopted the provisions of AICPA Statement of
         Position 98-5, "Reporting on the Costs of Start-Up Activities" ("SOP
         98-5"). This Statement provides guidance on the financial reporting of
         start-up and organization costs and requires that such costs of
         start-up activities be expensed as incurred. The adoption had no
         material impact on the Company's Financial Statements or Related
         Disclosure thereto.

         In December 1999, the Securities and Exchange Commission issued the
         Staff Accounting Bulletin No. 101-Revenue Recognition in Financial
         Statements (SAB 101). The bulletin draws on existing accounting rules
         and provides specific guidance on how those accounting rules should be
         applied and specifically addresses revenue recognition for
         non-refundable technology access fees in the biotechnology industry.
         SAB 101 is effective for fiscal years beginning after December 15,
         1999. The Company has performed an evaluation of SAB101 and the effect
         that it may have on the Company's financial statements. The Company
         believes the application of the provisions of SAB 101 will not will
         have a material impact on its financial position or results of
         operations.

2.       COST REDUCTION MEASURES

         On November 10, 1998, as a result of the slower than planned ramp up of
         OPTISON sales, the Company announced the initiation of a multi-phase
         program to reduce expenses and preserve capital. The initial phase was
         a reduction principally in administrative, development and support
         staff. Phase II was the out-sourcing of the product packaging
         operations. Phase II will entail the out-sourcing of the manufacture of
         bulk product. The initial phase of cost reduction affected
         approximately 40 employees of the Company's 140-person workforce. The
         next reduction in force, in April 1999, affected an additional 26
         employees. In the future when the out-sourcing of the Company's
         manufacturing operations is complete, which is estimated to occur in
         December 2001, the Company will implement a further reduction in force
         of approximately 25 to 30 employees. All employees expected to be
         terminated as a result of this program were notified of such
         termination and their estimated severance benefits were accrued during
         the quarter ended December 31, 1998.

         The impact of the cost reduction measures on the Company's financial
         results included a one-time charge of $7.2 million for the year ended
         March 31, 1999. This charge included $6.1 million in nonrecurring
         charges and $1.1 million in cost of sales. The $6.1 million
         nonrecurring charge included $3.1 million for the full write off of
         fixed assets, principally building improvements of abandoned
         facilities, capitalized license fees and capitalized patent costs that
         will no longer be used by the Company as a result of the planned
         out-sourcing of manufacturing operations and the discontinuation of
         certain projects, $2.3 million of severance costs, and approximately
         $2650,000 of technology transfer costs, primarily direct labor and
         travel costs associated with the transfer of the manufacturing process,
         and $387,000 of lease exit costs related to the Company's plan to
         out-source manufacturing.

         Additionally, approximately $2.8 million of fixed assets, principally
         building improvements for the Company's remaining manufacturing
         facility, will be written off to operations through accelerated
         depreciation over the term of the out-sourcing. The Company wrote off
         $1.2 million in fixed assets through accelerated depreciation during
         fiscal year 1999 and expects to write off another $1.6 million in fixed
         assets through accelerated depreciation over the period that the
         manufacturing process is out-sourced, which is estimated to be
         completed by December 2001. As of March 31, 1999, the Company had
         approximately $1.0 million in accrued liabilities related to the future
         costs of out-sourcing.

         A summary of the $8.4 million cost reduction measures charge reflected
         in the accompanying statements op operations for the year ended March
         31, 1999 is as follows:


                                       21
<PAGE>


<TABLE>
<CAPTION>

                                                                                                         Amount
                                                                                                     -------------
                                                                                                     (in millions)
              <S>                                                                                    <C>
              Non cash charges:
                       Accelerated depreciation, recorded prospectively in operations,
                            resulting from a change in estimates of the useful lives of
                            manufacturing assets...............................................            $1.2
                       Write off of abandoned fixed assets ($2.8) and other
                           capitalized assets ($0.3)...........................................             3.1
                       Inventory disposed of...................................................             1.1

                                                                                                        ----------
                                                                                                           $5.4

                                                                                                        ----------
               Cash charges:

                       Severance..............................................................              2.3
                       Exit costs.............................................................               .4
                       Technology transfer....................................................               .3

                                                                                                        ----------

                                                                                                           $3.0

                                                                                                        ----------
               Less amounts paid through March 31, 1999:

                       Severance..............................................................              1.0
                       All other..............................................................                -

                                                                                                        -----------
                Accrued at March 31, 1999.....................................................             $2.0

                                                                                                        ===========

</TABLE>

         At March 31, 1999, $1.3 million of the cost reduction accrual is
         included in compensation accruals and the remaining $0.7 million is
         included in accounts payable and accrued liabilities in the
         accompanying balance sheet as of March 31, 1999.



3.           THE CHUGAI AGREEMENT

         In April, 1998, the Company entered into a cooperative development and
         marketing agreement with Chugai Pharmaceutical Co., Ltd. ("Chugai") of
         Japan. The parties entered into this strategic alliance which covers
         Japan, Taiwan and South Korea, to develop OPTISON (which may be
         marketed under a different name) and ORALEX-Registered Trademark-, as
         well as related products. The Company granted Chugai an exclusive
         license to develop, manufacture, and market these products in the
         subject territory, for which the Company received $14.0 million (See
         Note 10) in fiscal year 1999. With respect to licensed products
         manufactured by Chugai, Chugai will pay the Company a royalty on net
         sales. For licensed products manufactured by the Company, the Company
         will receive royalties on net sales, the amount of which will depend
         upon the sales volume, in addition to a transfer price based on average
         net sales per unit from the previous quarter. The Company has satisfied
         all existing contractual obligations related to the license granted to
         Chugai.

         Additionally, Chugai purchased 691,883 shares of the Company's common
         stock at a premium of 40% over the then-prevailing market price. This
         premium was equal to $2.4 million and is included in "Gain on disposal
         of asset" (See Note 10) in the first quarter of fiscal year 1999. The
         equity investment was valued at $8.3 million. The Company is also
         eligible to receive milestone payments of up to $20.0 million based on
         Chugai's achievement of certain Japanese product development and
         regulatory goals. As of March 31, 1999, the Company has not received
         any milestone payments from Chugai.


                                       22
<PAGE>


4.       MARKETABLE SECURITIES

         Investments are recorded at estimated fair market value, and consist
         primarily of treasury securities, government agency securities and
         corporate obligations. The Company has classified all of its
         investments as available-for-sale securities. The following table
         summarizes available-for-sale securities at March 31, 1998 (in
         thousands):

<TABLE>
<CAPTION>

                                                         COST NET OF
                                                          PREMIUMS/       GROSS         GROSS        ESTIMATED
                                                          DISCOUNTS    UNREALIZED     UNREALIZED       FAIR
                                                          AMORTIZED       GAINS         LOSSES         VALUE
                                                         ------------  ------------  -------------  ------------
<S>                                                      <C>           <C>            <C>           <C>
         U.S. treasury securities and obligations
             of U.S. government agencies                    $  4,501       $     -        $   (6)      $  4,495

         Corporate obligations                                15,840             -           (61)        15,779
                                                         ------------  ------------  -------------  ------------

         Marketable securities available-for-sale           $ 20,341       $     -        $  (67)      $ 20,274
                                                         ============  ============  =============  ============

</TABLE>


         THE FOLLOWING TABLE SUMMARIZES AVAILABLE-FOR-SALE SECURITIES AT MARCH
         31, 1999 (IN THOUSANDS):

<TABLE>
<CAPTION>

                                                         COST NET OF
                                                          PREMIUMS/       GROSS         GROSS        ESTIMATED
                                                          DISCOUNTS    UNREALIZED     UNREALIZED       FAIR
                                                          AMORTIZED       GAINS         LOSSES         VALUE
                                                         ------------  ------------  -------------  ------------
         <S>                                             <C>           <C>           <C>            <C>
         Money market                                       $  2,682        $    -         $    -      $  2,682

         Certificate of Deposit                                3,000             -              -         3,000

         U.S. treasury securities and obligations
             of U.S. government agencies                       1,500             -              -         1,500

         Corporate obligations                                 9,794             6              -         9,800
                                                         ------------  ------------  -------------  ------------
         Marketable securities available-for-sale           $ 16,976        $    6         $    -      $ 16,982
                                                         ============  ============  =============  ============

</TABLE>


         There were no gross realized gains or losses on sales of
         available-for-sale securities for the years ended March 31, 1999, 1998
         or 1997.

         The amortized cost and estimated fair value of debt and marketable
         securities at March 31, 1999, by contractual maturity, are shown below.
         Expected maturities may differ from contractual maturities because the
         issuers of the securities may have the right to prepay obligations
         without prepayment penalties.

<TABLE>
<CAPTION>

                                                                 COST LESS
                                                                  PREMIUMS/      ESTIMATED
                                                                  DISCOUNTS        FAIR
                                                                  AMORTIZED        VALUE
                                                                 -------------  ------------
                      <S>                                        <C>            <C>
                      Due in one year or less                        $ 16,599      $ 16,605

</TABLE>



                                       23
<PAGE>


<TABLE>

                      <S>                                        <C>            <C>
                      Due after one year through three years              377           377
                                                                 -------------  ------------
                                                                     $ 16,976      $ 16,982
                                                                 =============  ============

</TABLE>


         At March 31, 1998, a $3.0 million certificate of deposit was held as a
         compensating balance under the Company's debt agreement. In September
         1998, this loan was renegotiated and the compensating balance
         requirement was removed (see note 6). Accordingly, the certificate of
         deposit was included in the marketable securities balances for the
         fiscal year March 31, 1999, but not for the fiscal year ended March 31,
         1998.



5.       INCOME TAXES

         As described in Note 1, the Company uses the asset and liability method
         of computing deferred income taxes in accordance with Statement of
         Financial Accounting Standards No. 109, "Accounting for Income Taxes."

         The effective income tax rate on the loss before income taxes differs
         from the statutory U.S. federal income tax rate as follows (in
         thousands):

<TABLE>
<CAPTION>

                                                      FISCAL YEARS ENDED MARCH 31,
                                                     -------------------------------
                                                       1997       1998       1999
                  <S>                                <C>         <C>         <C>
                  Computed statutory tax             $  (4,517)  $  (7,342)  $  (7,221)
                  State income taxes                      (843)     (1,275)     (1,274)
                  Tax exempt interest                      (29)        (64)        (23)
                  Losses without income tax benefit      5,362       8,634       8,508
                  Other                                     27          47          10
                                                     ---------   ---------   ---------
                  Provision for income taxes         $       -   $       -   $       -
                                                     =========   =========   =========

</TABLE>

         At March 31, 1999, the Company has deferred tax assets of approximately
         $48.9 million relating to the following tax loss carryforwards for
         income tax purposes (in thousands):

<TABLE>
<CAPTION>

                                                                                       EXPIRATION
                                                                          AMOUNT          DATES
                                                                       -------------  --------------
         <S>                                                           <C>            <C>
         Federal ($120,975) and state ($38,855) net operating losses   $159,830         1999-2019
         Research and development credit - federal                        2,572         1999-2014
         Research and development credit - state                          1,328         1999-2014
         Alternative minimum tax credit                                     300         Indefinite

</TABLE>

         For financial reporting purposes, a valuation allowance has been
         recognized to offset the deferred tax assets related to the
         carryforwards. If realized, approximately $1.1 million of the tax
         benefit for those items will be applied directly to paid-in capital,
         related to deductible expenses reported as a reduction of the proceeds
         from issuing common stock in connection with the exercise of stock
         options.

         The foreign income tax provision of $1.4 million included in the
         Company's fiscal 1999 net loss represents foreign taxes paid during the
         year related to the Chugai transaction.


6.       LONG-TERM DEBT

         Long-term debt consists of the following (in thousands):

<TABLE>
<CAPTION>

                                                                                     MARCH 31,
                                                                            -----------------------------
                                                                                1998            1999
                 <S>                                                        <C>            <C>


</TABLE>



                                       24
<PAGE>


<TABLE>

                 <S>                                                        <C>             <C>
                 Note payable - due 2004                                         $ 3,754        $  3,682
                 Note payable - due 2001                                           3,600           2,400
                                                                            -------------   -------------
                                                                                   7,354           6,082
                 Less - current portion                                            1,272           1,278
                                                                            -------------   -------------
                                                                                 $ 6,082        $  4,804
                                                                            =============   =============

</TABLE>

         The note payable due in 2004 bears interest at a variable rate based
         upon the weighted average Federal Reserve Eleventh District cost of
         funds as quoted in The Wall Street Journal plus 2.35 percent. The
         interest rate on this note is adjusted semi-annually and was 8 percent
         at March 31, 1998 and 1999. The note is secured by the Company's
         manufacturing facility and certain of the equipment contained therein
         and is payable in monthly installments of principal and interest. As of
         March 31, 1999, maturities of this note in each of the next five fiscal
         years are: $79,000, $85,000, $92,000, $100,000 and $3,326,000.

         The note payable due in April, 2001 bears interest at the prime rate
         (7.75 percent at March 31, 1999) and is payable in monthly installments
         of $100,000 plus accrued interest through March 2001. The loan contains
         covenants relating to cashflow coverage and minimum cash balances. The
         Company is in compliance with the loan covenants. In September 1998,
         the terms of the loan were renegotiated which lowered the interest rate
         from prime plus one percent to the prime rate and released a
         compensating balance requirement. The loan is secured primarily by
         equipment and fixtures in addition to all other tangible assets of the
         Company.


         Irrespective of the fixed asset disposals and manufacturing out
         sourcing plans, the Company believes that the fair market value of the
         equipment and buildings that the Company will continue to own will meet
         the collateral requirements under the notes maturing in 2001 and 2004.



7.       COMMITMENTS AND CONTINGENCIES

         LEASES-

         The Company conducts certain of its operations in leased premises and
         also leases equipment through lease financing. Terms of the leases,
         including renewal options, vary by lease. Future minimum rental
         commitments for all noncancelable operating leases that have initial or
         remaining lease terms in excess of one year are as follows (in
         thousands):

<TABLE>
<CAPTION>

                  FISCAL YEAR ENDED MARCH 31,                     AMOUNT
                  <S>                                            <C>
                  2000                                              $  703
                  2001                                                 379
                  2002                                                 234
                  2003                                                   9
                  2004                                                   -
                                                                 ----------
                  Total minimum lease payments                      $1,325
                                                                 ==========

</TABLE>

         In fiscal 1998, the Company entered into a lease for its corporate
         headquarters. The lease expires in February 2000. The Company is
         obligated to pay real estate taxes, insurance and utilities on its
         portion of the leased property. Rental expense for the years ended
         March 31, 1997, 1998 and 1999 was $194,000, $245,000, and $297,000,
         respectively. As part of the cost reduction measures implemented in
         fiscal year 1999, the Company consolidated facilities and no longer
         occupies the building that had become its corporate headquarters in
         fiscal year 1998. As a result of this move, the Company recognized
         approximately $370,000 of the remaining rent expense through the end of
         the lease term as exit costs in fiscal year 1999. The remaining lease
         payments are included in the schedule above.


                                       25
<PAGE>


         In June 1997, the Company entered into an equipment leasing agreement
         with Mellon US Leasing ("Mellon") for a lease line of $1.6 million with
         a term of 48 months. The outstanding balance on this line of credit at
         March 31, 1999 was $1.0 million.



         LICENSE AGREEMENTS-

         The Company has entered into license agreements requiring future
         royalty payments ranging from 1 1/4% to 3% of specified product sales
         relating to the licensed technologies. Additionally, there is a minimum
         royalty payment of up to $600,000 due to one licensor in each calendar
         year, depending on the level of OPTISON sales.

         In April 1998, the Company and Chugai Pharmaceutical Co., Ltd.
         ("Chugai") entered into a strategic alliance to develop and
         commercialize OPTISON (which may be marketed under a different name)
         and ORALEX-Registered Trademark- in Japan, Taiwan and South Korea. In
         exchange for granting to Chugai a royalty-based license to market these
         products in the named countries, the Company received $14.0 million
         from Chugai. In addition, Chugai made an equity investment in MBI
         common stock. The Company is eligible to receive milestone payments of
         up to $20.0 million based on the achievement of certain product
         development goals and will receive royalties from Chugai from the sale
         of commercialized products in the territory. The Company has satisfied
         all existing contractual obligations related to the license granted to
         Chugai.

         PATENT MATTERS-

         The Company considers the protection of its proprietary technologies to
         be material to its business prospects. The Company pursues a
         comprehensive program of patent and trademark prosecution for its
         products both in the United States and in other countries where the
         Company believes that significant market opportunities exist.

         The Company has an exclusive license to certain United States and
         foreign patents relating to gas-filled sonicated albumin microspheres
         from Steven B. Feinstein, M.D. (see - Business - Marketing and
         Licensing Agreements - Feinstein License) The Company itself owns
         additional United States and foreign patents covering ALBUNEX and
         OPTISON that broaden the product coverage of its license. Certain of
         these additional patents cover the Company's continuous flow sonication
         manufacturing process. The European equivalents of these manufacturing
         patents were challenged in an opposition proceeding brought by Andaris
         Ltd. which was decided in the Company's favor in January 1996. Andaris
         has appealed the decision. Andaris has also filed an opposition against
         the Company's ALBUNEX composition patent in Europe, and Andaris and two
         other parties have filed a similar opposition in Japan. No hearing date
         has been set in these latter two oppositions.

         The Company has received patents covering its method of manufacturing
         gas-filled albumin microspheres using a milling process. The Company
         believes that this process may be more reliable and efficient than the
         sonication process that the Company currently uses. The Company has
         also received patents on other perfluorocarbon-based technology
         relating to ultrasound contrast agents.

         The Company owns a United States patent covering ORALEX and has several
         foreign applications pending. The Company has also filed patent
         applications relating to several early-stage development products. The
         Company is uncertain whether these applications will result in issued
         patents or whether the covered products can or will be commercialized.

         The last-to-expire of the Company's key United States patents covering
         ALBUNEX and OPTISON expires in 2008, and subject to the outcome of the
         oppositions previously described, the last-to-expire of the Company's
         key European patents covering ALBUNEX and OPTISON expires in 2009.

         The patent position of medical and pharmaceutical companies is highly
         uncertain and involves complex legal and factual questions. There can
         be no assurance that the Company will receive patents for all or any of
         the claims included in its pending or future patent applications, that
         any issued patents will provide the Company with competitive advantages
         or will not be challenged by third parties, or that


                                       26
<PAGE>


         existing or future patents of third parties will not have an adverse
         effect on the Company's ability to commercialize its products.
         Moreover, there can be no assurance that third parties will not
         independently develop similar products, duplicate one or more of the
         Company's products or design around the Company's patents.

         The Company's commercial success also will depend in part upon the
         Company not infringing patents issued to third parties. There can be no
         assurance that patents issued to third parties will not require the
         Company to alter its products or manufacturing processes, pay licensing
         fees, or cease development of its current or future products.

         Litigation or administrative proceedings may be necessary to enforce
         the Company's patents, to defend the Company against infringement
         claims or to determine the priority, scope and validity of the
         proprietary rights of third parties. Any such litigation or
         administrative proceedings could result in substantial costs to the
         Company, and an unfavorable outcome could have a material adverse
         effect on the Company's business, financial condition and results of
         operations. Moreover, there can be no assurance that, in the event of
         an unfavorable outcome in any litigation or administrative proceedings
         involving infringement claims against the Company, the Company would be
         able to license any proprietary rights that it requires on acceptable
         terms or at all. The Company's failure to obtain a license that it
         requires to commercialize one of its products could have a material
         adverse effect on the Company's business, financial condition and
         results of operations.

         The Company has become aware of several United States patents issued to
         other companies purportedly covering various attributes of
         perfluorocarbon-containing imaging agents such as OPTISON. Certain of
         these companies also are pursuing foreign patent protection. Some of
         these companies are developing or may be developing ultrasound contrast
         imaging agents that would compete with OPTISON. The patents and patent
         applications of these other companies involve a number of complex legal
         and factual issues that are currently unresolved. The Company believes
         that there may be a substantial overlap among many of the claims in
         their patents and is currently involved in various administrative
         proceedings and litigation in the United States and Europe to
         adjudicate their conflicting rights.

         The Company believes that, for a variety of reasons, its
         commercialization of OPTISON will not infringe any valid patent held by
         any of these other companies. Depending upon the particular patent
         claim, these reasons include, but are not limited to, (i) differences
         between OPTISON and the subject of the claim, (ii) the invalidity of
         the claim due to the existence of prior art, (iii) the inadequacy of
         the claim's specifications, (iv) lack of enablement, (v) inequitable
         conduct by patentee, and (vi) various other defenses as allowed by law.
         The Company intends to challenge the validity of any such patent
         granted to one of the other companies if the patent is asserted against
         the Company, and the Company will enforce its own patents if any
         product of one of the other companies infringes the Company's patent
         claims.

         The Company has obtained registered trademarks for "ALBUNEX" and
         "ORALEX" in the United States and in selected foreign countries.
         Additionally Mallinckrodt has filed for the trademark for "OPTISON" in
         various countries throughout the world. There can be no assurance that
         the Company's registered or unregistered trademarks and trade names
         will not infringe on the proprietary rights of third parties.

         The Company also relies on unpatented trade secrets, proprietary
         know-how and continuing technological innovation which it seeks to
         protect by, in part, confidentiality agreements with its employees,
         consultants, investigators and others. There can be no assurance that
         these agreements will not be breached, that the Company would have an
         adequate remedy for any breach or that the Company's trade secrets or
         know-how will not otherwise become known or independently discovered by
         third parties.

         OTHER-

         The Company is periodically a defendant in other legal actions
         incidental to its business activities. While any litigation has an
         element of uncertainty, the Company believes that the outcome of any of


                                       27
<PAGE>


         these actions or all of them combined will not have a materially
         adverse effect on its financial condition or results of operations.



8.       STOCKHOLDERS' EQUITY

         Mallinckrodt has certain registration rights with respect to the Common
         Stock issued and issuable to them.

         In April 1998, the Company entered into a Common Stock Purchase
         Agreement with Chugai. Under this agreement, the Company sold to Chugai
         691,883 shares of common stock for $12.00 per share which represented a
         40% premium over the then-prevailing market price for a total equity
         investment of $8.3 million. These shares are subject to certain
         covenants and restrictions, including "standstill" rights of the
         Company, a market stand-off provision and restrictions on
         transferability.



         COMMON SHARES RESERVED

         Common shares were reserved for the following purposes (in thousands):

<TABLE>
<CAPTION>

                                                                     MARCH 31,
                                                              -----------------------
                                                                  1998         1999
                  <S>                                         <C>          <C>
                  Options granted                                 3,139        3,855
                  Future grants of options                          488        1,699
                                                              ----------   ----------
                                                                  3,627        5,554
                                                              ==========   ==========

</TABLE>



         STOCK OPTIONS-

         1998 PLAN

         In fiscal 1999, the Board of Directors and the shareholders of the
         Company approved the 1998 Stock Option Plan as the sucessor to the
         Company's 1993 and 1997 Plans. All outstanding options under the 1993
         and 1997 Plans were incorporated into the 1998 Plan plus an additional
         2.0 million shares. The 1998 Plan provides for the grant of both
         qualified incentive stock options and nonstatutory stock options to
         purchase Common Stock to employees, non-employee directors, independent
         consultants and advisors of the Company under four separate equity
         incentive programs. The exercise price per share may be either 85% of
         the fair value on the date of grant or fair market value of the stock
         on date of grant depending on the program. Options granted under this
         plan are exercisable per the terms specified in each individual option,
         but not before one year (unless the option exercisability is
         accelerated by the Company's Board of Directors), or later than ten
         years from the date of grant. Additionally, the 1998 Plan permits
         certain senior executives, as defined, to reduce their compensation and
         receive options with an intrinsic value equal to that reduction in
         compensation. In 1999, the Company's chief executive officer elected to
         reduce his compensation by $20,000 and receive options to purchase
         10,613 shares at $0.93 per share when the fair market value was $2.18
         per share. The compensation expense related to the grant of these
         options is included in operation for fiscal 1999. On April 1, 1999, the
         Company's chief executive officer elected to receive an additional
         grant of 11,662 shares at $0.89 per share when the fair market value
         was $2.69 per share. The compensation related to this grant will be
         included in operations for fiscal 2000.

         1997 OUTSIDE DIRECTORS' PLAN

         IN FISCAL 1998, THE BOARD OF DIRECTORS AND THE SHAREHOLDERS OF THE
         COMPANY APPROVED THE 1997 DIRECTORS' OPTION PLAN AND AUTHORIZED THE
         ISSUANCE OF OPTIONS FOR 300,000 SHARES PURSUANT TO THE PLAN. THE PLAN
         PROVIDES FOR THE GRANT OF BOTH QUALIFIED INCENTIVE STOCK OPTIONS AND
         NONSTATUTORY STOCK OPTIONS TO PURCHASE COMMON STOCK TO NON-EMPLOYEE
         DIRECTORS OF THE COMPANY AT NO LESS THAN THE FAIR VALUE OF THE STOCK ON
         THE DATE OF GRANT. OPTIONS GRANTED UNDER THIS PLAN ARE EXERCISABLE PER
         THE TERMS SPECIFIED IN EACH INDIVIDUAL


                                       28
<PAGE>


         OPTION, BUT NOT BEFORE ONE YEAR (UNLESS THE OPTION EXERCISABILITY IS
         ACCELERATED BY THE COMPANY'S BOARD OF DIRECTORS), OR LATER THAN TEN
         YEARS FROM THE DATE OF GRANT.

         1993 PLANS

         In 1993 both the Board of Directors and the shareholders of the Company
         approved the 1993 Stock Option Plan and the 1993 Outside Directors
         Stock Option Plan (together, the 1993 Plans). The 1993 Plans were
         intended to replace the Company's 1984 Incentive Stock Option Plan and
         the 1984 Nonstatutory Stock Option Plan (together, the 1984 Plan),
         under which all of the options authorized to be granted have been
         granted. The 1993 Plans provide for the grant of both qualified
         incentive stock options and nonstatutory stock options to purchase
         Common Stock to employees (1993 Stock Option Plan) or non-employee
         directors of the Company (1993 Outside Directors Stock Option Plan) at
         no less than the fair value of the stock on the date of grant. Options
         granted under these plans are exercisable per the terms specified in
         each individual option, but not before one year (unless the option
         exercisability is accelerated by the Company's Board of Directors), or
         later than ten years from the date of grant.

         During fiscal 1997, the shareholders approved the Company's Board of
         Directors recommendation to amend the Company's 1993 Stock Option Plan
         to increase the maximum number of shares from 2,500,000 shares to
         3,250,000 shares.

         1984 PLAN

         The Company had an Incentive Stock Option Plan and Nonstatutory Stock
         Option Plan (together, the 1984 Plan) which provided for the grant of
         options to purchase Common Stock to employees or non-employee directors
         of the Company at no less than the fair value of the stock on the date
         of grant. Options granted under the 1984 Plan were exercisable per the
         terms specified in each individual option, but not before one year
         (unless the option exercisability was accelerated by the Company's
         Board of Directors) or later than five years from the date of grant.
         The 1984 Plan expired in July 1994 and there are no shares reserved for
         future grants.

         On May 11, 1995, the Board of Directors voted to offer the Company's
         non-executive employees the opportunity to reprice certain stock
         options which were originally granted under the 1984 Plan to the
         closing price on May 31, 1995. The Board approved this repricing
         because it believed retaining key employees was in the best interests
         of the stockholders and the Company. During the fourth quarter of
         fiscal 1995, following a decline in the stock price and a restructuring
         which included a twenty-five percent staff reduction, key employees
         were being contacted by other companies and agencies about employment
         opportunities elsewhere. The Board believed the repricing of the
         options was the most effective employment retention tool available.

         OTHER OPTION GRANTS



         The Company has granted to employees, consultants and scientific
         advisors options to purchase shares of common stock. These options are
         exercisable per the terms specified in each individual option and lapse
         pursuant to the terms in the applicable plan. The options were granted
         at amounts per share which were not less than the fair market value at
         the date of grant.

         Additional information with respect to the Company's option plans is as
         follows:


<TABLE>
<CAPTION>

                                                           EMPLOYEE OPTION PLANS             DIRECTORS' OPTION PLAN
                                                    -------------------------------- ------------------------------------
                                                                      OPTION PRICE                      OPTION PRICE
                                                       SHARES           PER SHARE        SHARES          PER SHARE
                                                    ------------  ------------------ -------------- ---------------------
         <S>                                        <C>           <C>                <C>            <C>
         Options Outstanding at March 31, 1996         2,167,955       6.00 -  31.13        60,000       8.13 -   17.00
         Granted                                         914,375       6.50 -  11.13        15,000       6.88
         Exercised                                     (295,500)       6.00 -  10.63             -
         Expired or lapsed                             (176,760)       6.00 -  31.13             -
                                                    ------------  ------------------ -------------- ---------------------

</TABLE>



                                       29
<PAGE>


<TABLE>

         <S>                                        <C>           <C>                <C>            <C>
         Options Outstanding at March 31, 1997         2,610,070       6.00 -  22.25        75,000       6.88 -   17.00
                                                    ------------  ------------------ -------------- ---------------------
         Granted                                         724,100       6.63 -  10.38        78,000       9.13      9.25
         Exercised                                     (100,340)       6.00 -   8.63             -
         Expired or lapsed                             (248,250)       6.25 -  22.25             -
                                                    ------------  ------------------ -------------- ---------------------
         Options Outstanding at March 31, 1998         2,985,580       6.00 -  22.25       153,000       6.88  -  17.00
                                                    ------------  ------------------ -------------- ---------------------
         Granted                                       1,194,288       0.93 -   9.69             -
         Exercised                                      (42,625)       6.00 -  10.13             -
         Expired or lapsed                             (434,912)       3.31 -  22.00             -
                                                    ------------  ------------------ -------------- ---------------------
         Options Outstanding at March 31, 1999         3,702,331       0.93 -  22.25       153,000       6.88  -  17.00
                                                    ------------  ------------------ -------------- ---------------------
         Options exercisable at March 31, 1999         2,402,807                           153,000
                                                    -------------                       ----------
         Reserved for future grants at March 31,       1,674,404                            25,000
         1999
                                                    -------------                       ----------

</TABLE>



         THE FOLLOWING TABLE SUMMARIZES INFORMATION ABOUT FIXED STOCK OPTIONS
         OUTSTANDING AT MARCH 31, 1999:

<TABLE>
<CAPTION>

                          OPTIONS OUTSTANDING                             OPTIONS EXERCISABLE
                      -------------------------------------------     ----------------------------
                                      Weighted-Avg    Weighted-                       Weighted-
                        Number         Remaining       Average           Number        Average
       Range of       Outstanding   Contractual Life  Exercise        Exercisable      Exercise
       Exercise       at 3/31/99         Life           Price          at 3/31/99       Price
        Prices                          (years)
    ---------------   ------------    ------------   ------------     -------------  -------------
    <S>               <C>             <C>            <C>              <C>            <C>
    0.9281 - 7.00       1,339,880            8.34         4.8179           580,116         6.4920
    7.125 - 9.6875      1,610,068            8.04         8.2301         1,151,306         8.0887
    9.875 - 22.25         905,383            6.16        14.2934           824,385        14.5654
                      ------------    ------------   ------------     -------------  -------------
    0.9281 - 22.25      3,855,331            7.70         8.4682         2,555,807         9.8153

</TABLE>



         As permitted, the Company has adopted the disclosure only provisions of
         SFAS 123 effective April 1, 1996. Accordingly, no compensation expense
         has been recognized for the stock option plans. Had compensation cost
         for the Company's 1999 grants for stock-based compensation plans been
         determined consistent with SFAS 123, the Company's net loss, net loss
         applicable to common share owners, and net loss per common share for
         March 31, 1997, 1998 and 1999 would approximate the pro forma amounts
         below (in thousands, except per share amounts).

<TABLE>
<CAPTION>

                                                                  Fiscal Years Ended, March 31,
                                                            ----------------------------------------
                                                                  1997          1998         1999
         <S>                                                    <C>          <C>          <C>
         Net income (loss) - as reported                        $(13,284)    $(21,260)    $(21,240)
         Net income (loss) - pro forma                          $(14,559)    $(23,877)    $(26,429)
         Earning per share (loss) - as reported                 $  (0.78)    $  (1.19)    $  (1.14)
         Earning per share (loss) - pro forma                   $  (0.86)    $  (1.34)    $  (1.42)

</TABLE>

         BECAUSE THE SFAS 123 METHOD OF ACCOUNTING HAS NOT BEEN APPLIED TO
         OPTIONS GRANTED PRIOR TO APRIL 1, 1995, THE RESULTING PRO FORMA
         COMPENSATION COST MAY NOT BE REPRESENTATIVE OF THAT TO BE EXPECTED IN
         FUTURE YEARS. THE FAIR VALUE OF EACH OPTION GRANT WAS ESTIMATED ON THE
         DATE OF GRANT USING THE BLACK SCHOLES OPTION-PRICING MODEL WITH THE
         FOLLOWING WEIGHTED AVERAGE ASSUMPTIONS USED FOR GRANTS IN FISCAL YEAR
         1999: RISK FREE RATE OF 4.75%, EXPECTED OPTION LIFE OF 4 YEARS,
         EXPECTED VOLATILITY OF 65% AND A DIVIDEND RATE OF ZERO. THE WEIGHTED
         AVERAGE FAIR VALUE OF OPTIONS GRANTED FROM THE EMPLOYEE STOCK OPTION
         PLANS DURING FISCAL 1997, 1998 AND 1999 WAS $9.29, $7.85 AND $5.43,
         RESPECTIVELY. THE WEIGHTED AVERAGE FAIR VALUE OF


                                       30
<PAGE>


         OPTIONS GRANTED FROM THE OUTSIDE DIRECTOR STOCK OPTION PLAN DURING
         FISCAL 1997 AND 1998 WAS $6.88 AND $9.19, RESPECTIVELY.

         NOTES RECEIVABLE FROM SALE OF COMMON STOCK-

         During fiscal year 1997, the Company repurchased 21,500 shares of
         Common Stock and forgave notes receivable from related parties of
         approximately $390,000 relating to the exercise of options to purchase
         common stock of the Company by officers and other employees. Of this
         amount, approximately $109,000 was included in accounts and notes
         receivable and represents taxes payable by the individuals at the time
         of these option exercises plus accrued interest thereon, as well as
         accrued interest on purchase price notes. The amounts relating to the
         purchase price of the common stock are recorded as a reduction to
         stockholders' equity.



9.       SIGNIFICANT RESEARCH CONTRACTS

         The Company conducts all of its research and development activities on
         its own behalf. Under the terms of its collaborative research
         agreements, the Company retains all ownership rights to its proprietary
         technologies, subject to licensing arrangements made with its
         licensees.

         In December 1987, December 1988 and March 1989, the Company entered
         into respective agreements (the Original Agreements) with Nycomed A.S.
         (Nycomed), a Norwegian corporation, Mallinckrodt, Inc. (Mallinckrodt),
         of St. Louis, Missouri and Shionogi & Co., Ltd. (Shionogi), a Japanese
         corporation, under which the Company granted exclusive licenses,
         restricted to certain geographic areas, to test, evaluate, develop and
         sell products covered by specified patents of the Company relating
         directly to the design, manufacture or use of microspheres for
         ultrasound imaging in vascular applications. The Company also granted
         rights to sublicense, use, make and sell the licensed products under
         specified royalty arrangements.

         Under the terms of the Original Agreements, as amended, the Company
         earned and received license fees of $6.5 million. The Original
         Agreements also provide for total payments to the Company aggregating
         up to $66.5 million, to continue product development, clinical trials,
         preproduction and premarketing activities relating to the Company's
         ultrasound imaging contrast agents for vascular applications. These
         amounts are to be received in installments based on the achievement of
         certain milestones by the Company.

         In September 1995, the Company entered into an Amended and Restated
         Distribution Agreement ("ARDA"), as well as a related investment
         agreement, with Mallinckrodt. Under ARDA, the geographical scope of
         Mallinckrodt's exclusive right was expanded to include all of the
         countries of the world other than those covered by the Company's
         license agreements with Shionogi and Nycomed. Additionally, the
         duration of Mallinckrodt's exclusive right was also extended from
         October 1999 until the later of July 1, 2003 or three years after the
         date that the Company obtains approval from the United States Food and
         Drug Administration ("FDA") to market OPTISON for an intravenous
         myocardial perfusion indication.

         The agreement provides the Company with between $33.0 million and $42.5
         million in financing (including the $13.0 million common stock
         investment discussed below). Under the terms of the agreement,
         Mallinckrodt must make guaranteed payments to the Company totaling
         $20.0 million over four years to support clinical trials, related
         regulatory submissions and associated product development of the
         licensed products, which include but are not limited to ALBUNEX and
         OPTISON. These payments will be made in 16 quarterly installments of
         $1.0 million for the first four quarters, $1.25 million for the
         following eight quarters and $1.5 million for the final four quarters.
         The payments may be accelerated in the event that the Company's
         cumulative outlays for clinical trials are in excess of the amounts
         received at any point in time. However, the quarterly payments may not
         be postponed. As of March 31, 1999 the first 14 quarterly payments had
         been received by the Company.

         ARDA requires the Company to spend at least $10.0 million of the $20.0
         million it receives over four years on clinical trials to support
         regulatory filings with the FDA for cardiac indications of the licensed
         products. The Company's expenditure of this $10.0 million will be made
         in accordance with the directions of a joint steering committee which
         the Company and Mallinckrodt established in order to


                                       31
<PAGE>


         expedite the development and regulatory approval of OPTISON by enabling
         the parties to share their expertise relating to clinical trials and
         the regulatory approval process. The Company and Mallinckrodt have each
         appointed three of the six members of the joint steering committee.

         In connection with ARDA, the Company also entered into an investment
         agreement whereby the Company sold 1,118,761 unregistered shares of its
         common stock to Mallinckrodt for $13.0 million, or a price of $11.62
         per share before related costs. Combined with the 181,818 shares of the
         Company's common stock that Mallinckrodt acquired in December 1988,
         Mallinckrodt currently owns approximately 7.3% of the Company's issued
         and outstanding shares.

         In addition, ARDA grants the Company the option (at its own discretion)
         to repurchase all of the shares of the Company's common stock that
         Mallinckrodt purchased under the investment agreement for $45.0
         million, subject to various price adjustments. This option is
         exercisable beginning the later of July 1, 2000 or the date that the
         Company obtains approval from the FDA to market OPTISON for an
         intravenous myocardial perfusion indication and ending on the later of
         June 30, 2003 or three years after the date that the Company obtains
         approval from the FDA to market OPTISON for an intravenous myocardial
         perfusion. If the Company exercises this option, the Company may
         co-market ALBUNEX, OPTISON and related products in all of the countries
         covered by the amended distribution agreement.

         In December 1996, the Company and Mallinckrodt amended ARDA to expand
         the geographical scope of Mallinckrodt's exclusive marketing and
         distribution rights for ALBUNEX, OPTISON and related products. The
         amendment extended Mallinckrodt's exclusive territory to include the
         territory that the Company had formerly licensed to Nycomed consisting
         of Europe, Africa, India and parts of Asia. Under the amendment to
         ARDA, Mallinckrodt agreed to pay fees up to $12.9 million plus 40
         percent of product sales to cover royalties and manufacturing.
         Mallinckrodt made an initial payment of $7.1 million, consisting of
         reimbursement to the Company of $2.7 million that the Company paid to
         Nycomed to reacquire the exclusive product rights in Nycomed's
         territory, payment of $3.0 million to the Company under the terms of
         ARDA upon the extension of Mallinckrodt's exclusive rights to Nycomed's
         former territory, and payment of $1.4 million to Nycomed in
         satisfaction of the Company's obligation to pay 45 percent of any
         amounts that the Company receives in excess of $2.7 million upon the
         licensing of the former Nycomed territory to a third party. Of the
         remaining $5.8 million that may be paid, Mallinckrodt will pay $4.0
         million to the Company (upon the achievement of the specified product
         development milestone) and $1.8 million to Nycomed (representing 45% of
         the $4.0 million payment to the Company). There can be no assurance,
         however, that this milestone will be satisfied. Of these costs,
         approximately $1.0 million was paid in fiscal 1996 and the remainder
         was paid in fiscal 1997.

         In April 1999, the Company and Mallinckrodt agreed to transfer the
         manufacture of OPTISON from MBI to Mallinckrodt. The parties agreement
         will be incorporated into an amendment to ARDA. In addition to the
         transfer of manufacturing, the amended agreement will extend
         Mallinckrodt's responsibility for funding clinical trials to include
         all cardiology, as well as radiology, clinical trials for OPTISON in
         the United States. MBI will continue to conduct all cardiology trials
         for OPTISON and will assume responsibility for conducting radiology
         trials in the United States. Under the amended agreement, which will be
         retroactive to March 1, 1999, Mallinckrodt will reimburse MBI for all
         manufacturing expenses, including incremental costs related to the
         technology transfer. In exchange for the transfer of manufacturing and
         increased financial support of clinical trials for OPTISON, MBI will
         receive a royalty on product sales of OPTISON.

         Mallinckrodt is the Company's principal strategic marketing partner for
         its ALBUNEX and OPTISON ultrasound contrast agents for all areas of the
         world except Japan, Taiwan and South Korea, which are exclusively
         licensed to Chugai. Under the Company's arrangements with Mallinckrodt,
         Mallinckrodt has substantial control over all aspects of marketing the
         Company's product in its territories.

         In October 1995, the Company entered into an agreement whereby it
         reacquired all rights to INFOSON (the European designation for
         ALBUNEX), OPTISON and related products from Nycomed, the Company's
         European licensee. The Company agreed to pay Nycomed $2.7 million and
         45% of any amounts in excess of $2.7 million that the Company receives
         in payment for the transfer of marketing rights in the former Nycomed
         territory to a third party. The Company also agreed to pay


                                       32
<PAGE>


         Nycomed a royalty based on future sales, as defined in the agreement.
         As stated above, the license rights were resold to Mallinckrodt for
         amounts stipulated in the amendment to ARDA.

         In September 1996, the Company entered into an agreement with Shionogi
         pursuant to which the Company reacquired all rights to manufacture,
         market and sell its ALBUNEX family of products in the territory
         consisting of Japan, Taiwan and South Korea, formerly exclusively
         licensed to Shionogi. This agreement settled an outstanding dispute
         between the two companies concerning the license and distribution
         agreement for ALBUNEX and resulted in the dismissal of all claims
         raised by the companies against each other. Under the agreement, the
         Company paid $3.0 million to Shionogi and agreed to pay an additional
         $5.5 million over the next three years, of which $4.0 million had been
         paid at March 31, 1999.

         In April 1998, the Company and Chugai entered into a strategic alliance
         to develop and commercialize OPTISON (which may be marketed under a
         different name) and ORALEX in Japan, Taiwan and South Korea in exchange
         for granting to Chugai a royalty-based license to market these products
         in the named countries. In addition, Chugai made an equity investment
         in the Company's common stock. The Company is eligible to receive
         milestone payments of up to $20 million based on the achievement of
         certain product development goals and will receive royalties from
         Chugai from the sale of commercialized products in the territory.



10.      GAIN ON DISPOSALS OF ASSETS HELD FOR SALE

         The accompanying 1999 and 1997 financial statements reflect gains on
         the disposals of assets held for sale. These gains result from the
         resale of territorial rights which had been reacquired from licensees
         in prior periods as follows:

         In the Company's fiscal 1989, Shionogi & Co. Ltd. (Shionogi) acquired
         from MBI the rights to develop, market, manufacture and sell certain of
         the Company's contrast agent products in specified territories (Japan,
         Korea, Taiwan). In fiscal 1997, as a result of a change of strategic
         focus at Shionogi, Shionogi sold these territorial rights back to the
         Company for $8.5 million. MBI accounted for this transaction as the
         purchase of an asset held for sale in the amount of $8.5 million, as
         reflected in the Company's balance sheets as of March 31, 1997 and
         1998. Effective April 1, 1998, the Company entered into an agreement to
         resell the above rights to Chugai. The key terms of that agreement are
         as follows:

         The Company granted Chugai an exclusive license under the Company's
         patents and technology related to FS069 (OPTISON) and ORALEX to sell,
         distribute, develop, have developed, make and have made licensed
         products in Japan, Korea and Taiwan. Chugai also granted the Company a
         license to any improvements made by Chugai to the products. Under the
         agreement, any further development as well as the attainment of any
         regulatory approvals within the subject territory are the sole
         responsibility of Chugai.

         At the time of this agreement, OPTISON was an FDA approved product and
         was being sold in the U.S., and further development of ORALEX was
         terminated by the Company in 1999.

         I.   Chugai paid the Company a non refundable license fee of $14.0
              million payable in a series of payments with the full amount paid
              within 300 days of the effective date of the agreement.

         II.  Chugai shall also pay the Company non refundable milestone
              payments of $20 million if and when various clinical and
              regulatory milestones are achieved by Chugai.

              These above payments are contingent upon Chugai attaining the
              above milestones. The Company has no obligation to and does not
              participate in the development activities or clinical trials of
              Chugai.

         III. Chugai shall also pay to the Company earned royalties on
              Chugai's sales of the products and minimum royalties for certain
              years of sales after the launch of the products. The previous
              agreement with Shionogi also provided for a royalty on sales of
              the product at a rate which closely approximated the Chugai
              royalty rate.


                                       33
<PAGE>


         IV.  Chugai also made an equity investment in the form of a common
              stock purchase of 691,883 MBI shares at a premium of $2.4 million

         V.   Term of the agreement is 15 years from the effective date of March
              31, 1998.

         VI.  MBI has an ongoing indemnification obligation to Chugai to protect
              its Japanese patents, if and when challenged.

              Accordingly, MBI has recorded this asset sale to Chugai as a gain
              on disposal of assets held for sale in its fiscal 1999 statement
              of operations, as follows:


<TABLE>
<CAPTION>

                                                                                      Amount in
                                                                                       millions
                                                                                      ---------
                     <S>                                                              <C>
                     Up-front non-refundable payment received by MBI                    $14.0
                     Premium on sale of equity                                            2.4
                     Less asset held for sale                                            (8.5)
                      Less transaction fee                                               (0.9)
                                                                                      ---------
                     Net gain on disposal.                                              $ 7.0

                                                                                      =========

</TABLE>

         In fiscal 1996, as a result of Nycomed's (MBI's former licensee in
         Europe) decision to develop its own contrast agent, MBI reacquired the
         marketing, manufacturing and distribution rights to the European
         territory for its products from Nycomed for $3.0 million, including
         transaction expenses. Such amount was capitalized by MBI as an asset
         held for sale in the amount of $3.0 million. In fiscal 1997, MBI sold
         these reacquired rights to Mallinckrodt for $5.7 million. At that time,
         MBI and Mallinckrodt had various collaborative research and
         distribution agreements in place. However, the sale of these European
         territory rights to Mallinckrodt did not modify any existing agreements
         of other contractual obligations between MBI and Mallinckrodt.

         The $5.7 million payment received by MBI from Mallinckrodt was
         non-refundable. Prior to this transaction, MBI had received no up-front
         fees from Mallinckrodt on any agreements. Furthermore, this transaction
         with Mallinckrodt contained no royalty provisions. Accordingly, MBI has
         reflected this asset sale as a gain on disposal of assets held for sale
         in its fiscal 1997 statement of operations, as follows:

<TABLE>
<CAPTION>

                                                                                    Amount in
                                                                                     millions
                                                                                    ---------
              <S>                                                                   <C>
              Up-front non-refundable payment received by MBI                         $ 5.7
              Less asset held for sale                                                 (3.0)
                                                                                    ---------
              Net gain on disposal.                                                   $ 2.7

                                                                                    =========

</TABLE>



11.      SUMMARY OF UNAUDITED QUARTERLY FINANCIAL INFORMATION

         The following is a summary of the unaudited quarterly results of
         operations for the years ended March 31, 1999 and 1998 (in thousands,
         except per share amounts):


<TABLE>
<CAPTION>

         Quarter Ended:                                                   Jun 30     Sep 30     Dec 31     Mar 31
         --------------                                                   ------     ------     ------     ------
         <S>                                                             <C>        <C>        <C>        <C>
         Fiscal 1999

</TABLE>


                                       34
<PAGE>


<TABLE>

         <S>                                                             <C>        <C>        <C>        <C>
         Revenues                                                        $ 2,617    $ 2,666    $ 2,185    $ 2,113
         Research and Development Costs                                    2,227      2,409      2,358      2,089
         Total Operating Costs and Expenses                                7,735      9,950     14,238      5,311
         Net Income/(Loss)                                                   740     (7,068)   (11,870)    (3,042)
         Income/(Loss) Per Common Share                                     0.04      (0.38)     (0.64)     (0.16)
         Weighted Average Common Shares Outstanding                       18,843     18,581     18,581     18,581

</TABLE>


<TABLE>
<CAPTION>

         Quarter Ended:                                                   Jun 30     Sep 30     Dec 31     Mar 31
         --------------                                                   ------     ------     ------     ------
         <S>                                                             <C>        <C>        <C>        <C>
         Fiscal 1998
         Revenues                                                        $ 1,474    $ 1,426    $ 1,373    $ 1,973
         Research and Development Costs                                    2,185      2,680      2,939      3,274
         Total Operating Costs and Expenses                                6,736      6,401      7,517      8,127
         Net Income/(Loss)                                                (4,799)    (4,621)    (5,903)    (5,937)
         Income/(Loss) Per Common Share                                    (0.27)     (0.26)     (0.33)     (0.33)
         Weighted Average Common Shares Outstanding                       17,752     17,768     17,813     17,793

</TABLE>



12.      SUBSEQUENT EVENTS

         In April 1999, the Company and Mallinckrodt agreed to transfer the
         manufacture of OPTISON, the only advanced generation cardiac ultrasound
         imaging agent commercially available in the United States and Europe,
         from MBI to Mallinckrodt. The parties agreement will be incorporated
         into an amendment to ARDA. In addition to the transfer of
         manufacturing, the amended agreement will extend Mallinckrodt's
         responsibility for funding clinical trials to include all cardiology,
         as well as radiology, clinical trials for OPTISON in the United States.
         MBI will continue to conduct all cardiology trials for OPTISON and will
         assume responsibility for conducting radiology trials in the United
         States. Under the terms of the amended agreement, which will be
         retroactive to March 1, 1999, Mallinckrodt will reimburse MBI for all
         manufacturing expenses, including incremental costs related to the
         technology transfer. In exchange for the transfer of manufacturing and
         increased financial support of clinical trials for OPTISON, MBI will
         receive a royalty on product sales of OPTISON.

         In May and June 1999, the Company received correspondence from the PTO
         with respect to the ImaRx patents involved in the reexamination
         proceedings. The PTO indicated that all claims of U.S. Patent No.
         5,547,656 (`656) and U.S. Patent No. 5,527,521(`521) will be allowed in
         their original form.

         On May 3, 1999, the Company and Mallinckrodt received notice of a
         lawsuit filed against them by DuPont Pharmaceuticals Company ("DuPont)
         and ImaRx in the United States District Court for the District of
         Delaware (the "DuPont Case"). The lawsuit alleges that the manufacture
         and sale of OPTISON infringes the `656 patent owned by ImaRx and
         exclusively licensed to DuPont. MBI has counterclaimed for a
         declaration of invalidity and non-infringement with respect to the `656
         patent. In June 1999, DuPont and ImaRx amended their complaint in the
         DuPont case to add allegations that the manufacture and sale of OPTISON
         also infringes the `521 patent owned by ImaRx and exclusively licensed
         to DuPont.

         Litigation or administrative proceedings relating to these matters
         could result in a substantial cost to the Company; and given the
         complexity of the legal and factual issues, the inherent vicissitudes
         and uncertainty of litigation, and other factors, there can be no
         assurance of a favorable outcome. An unfavorable outcome could have a
         material adverse effect on the Company's business, financial condition
         and results of operations. Moreover, there can be no assurance that, in
         the event of an unfavorable outcome, the Company would be able to
         obtain a license to any proprietary rights that may be necessary to
         commercialize OPTISON, either on acceptable terms or at all. If the
         Company were


                                       35
<PAGE>


         required to obtain a license necessary to commercialize OPTISON, the
         Company's failure or inability to do so would have a material adverse
         effect on the Company's business, financial condition and results of
         operations.


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<PAGE>


SIGNATURES

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


MOLECULAR BIOSYSTEMS, INC.





   /s/ BOBBA VENKATADRI
--------------------------
Bobba Venkatadri
President and Chief Executive Officer



5/22/00
--------------------------
Date




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