FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from............... to ............... Commission file number 1-10546 MOLECULAR BIOSYSTEMS, INC. (Exact name of registrant as specified in its charter) Delaware 36-3078632 (State of Incorporation) (I.R.S. Identification No.) 10030 Barnes Canyon Road San Diego, California 92121 (858) 812-7001 (Address, including zip code, and telephone number, including area code, of principal executive offices) 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. X Yes No --- --- The number of shares outstanding of the issuer's common stock, $.01 par value, as of July 31, 1999 was 18,731,917 shares. INDEX PAGE PART I - FINANCIAL INFORMATION Item 1 - Financial Statements 1. Consolidated Balance Sheets 3 March 31, 1999 and June 30, 1999 2. Consolidated Statements of Operations 4 Three Months Ended June 30, 1998 and 1999 3. Consolidated Statements of Cash Flows 5 Three Months Ended June 30, 1998 and 1999 4. Notes to Financial Statements 6 Item 2 - Management's Discussion and Analysis of 9 Financial Condition and Results of Operations Item 3 - Quantitative and Qualitative Disclosure of 13 Market Risk PART II - OTHER INFORMATION Item 1 - Legal Proceedings 13 Item 2 - Changes in Securities 13 Item 3 - Defaults Upon Senior Securities 13 Item 4 - Submission of Matters to a Vote of Securities Holders 13 Item 5 - Other Information 14 Item 6 - Exhibits and Reports on Form 8-K 14 (a) Exhibits (b) Reports on Form 8-K Signatures 14 PART I - FINANCIAL INFORMATION Item 1 - FINANCIAL STATEMENTS MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share amounts) MARCH 31, JUNE 30, 1999 1999 --------- --------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents $ 1,056 $ 726 Marketable securities, available-for-sale 16,982 14,809 Accounts and notes receivable 2,320 3,109 Inventories 748 631 Prepaid expenses and other assets 425 402 --------- --------- Total current assets 21,531 19,677 --------- --------- Property and equipment, at cost: Building and improvements 11,113 11,113 Equipment, furniture and fixtures 2,893 2,959 Construction in progress 930 668 --------- --------- 14,936 14,740 Less: Accumulated depreciation and amortization 6,672 6,973 --------- --------- Total property and equipment 8,264 7,767 --------- --------- Other assets, net 2,054 2,052 --------- --------- $ 31,849 $ 29,496 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 1,278 $ 1,278 Accounts payable and accrued liabilities 7,395 7,410 Compensation accruals 2,165 1,535 --------- --------- Total current liabilities 10,838 10,223 --------- --------- Long-term debt, net of current portion 4,804 4,485 Commitments and contingencies (Note 2) Stockholders' equity: Common Stock, $.01 par value, 40,000,000 shares authorized, 18,580,745 and 18,731,917 shares issued and outstanding, respectively 186 186 Additional paid-in capital 134,347 134,347 Accumulated deficit (117,969) (119,372) Unrealized gain on available-for-sale securities 6 6 Less notes receivable from sale of Common Stock -- -- Less 40,470 and 42,298 shares of treasury stock, at cost, respectively (363) (379) --------- --------- Total stockholders' equity 16,207 14,788 --------- --------- $ 31,849 $ 29,496 ========= ========= See accompanying notes. 3 MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per share amounts) THREE MONTHS ENDED JUNE 30, 1998 1999 -------- -------- (UNAUDITED) Revenues: Revenues under collaborative agreements $ 1,250 $ 1,500 Product and royalty revenues 1,367 160 License Fees 16,371 -- -------- -------- 18,988 1,660 -------- -------- Operating expenses: Research and development costs 2,227 1,412 Costs of products sold 1,639 (645) Selling, general and administrative expenses 3,869 2,393 Other Nonrecurring Charges 9,378 -- -------- -------- 17,113 3,160 -------- -------- Income (loss) from operations 1,875 (1,500) Interest expense (160) (120) Interest income 425 218 -------- -------- Income (loss) before income taxes 2,140 (1,402) Foreign income tax provision (1,400) -- -------- -------- Net income (loss) $ 740 $ (1,402) ======== ======== Net income (loss) per share - basic: $ 0.04 $ (0.07) ======== ======== Weighted average common shares outstanding 18,512 18,730 ======== ======== Net income (loss) per share - diluted (Note 3): $ 0.04 $ (0.07) ======== ======== Weighted average common and common equivalent shares 18,843 18,730 outstanding ======== ======== See accompanying notes. 4 MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) THREE MONTHS ENDED JUNE 30, 1998 1999 -------- -------- (UNAUDITED) Cash flows from operating activities: Net income (loss) $ 740 $ (1,402) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 244 427 Loss on disposals/write-downs of tangible and intangible property -- 3 Write-off of former Shionogi territory license rights 8,500 -- Premium received on Chugai equity investment (2,371) -- Changes in operating assets and liabilities: Receivables (11,745) (942) Inventories (469) 117 Prepaid expenses and other assets 136 175 Accounts payable and accrued liabilities 3,895 99 Deferred contract revenue (1,575) -- Compensation accruals (1,496) (630) -------- -------- Cash used in operating activities (4,141) (2,153) -------- -------- Cash flows from investing activities: Purchases of property and equipment (489) (20) Proceeds from sale of property and equipment 0 0 Proceeds from sales of property and equipment -- 4 Additions to patents and license rights (50) -- Decrease in other assets 26 2 Change in marketable securities (4,275) 2,173 -------- -------- Cash provided by (used in) investing activities (4,788) 2,159 -------- -------- Cash flows from financing activities: Proceeds from sale of common stock to Chugai 8,300 -- Net proceeds from stock options exercised 242 -- Principal payments on long-term debt (318) (319) Purchase of treasury stock -- (16) -------- -------- Cash provided by (used in) financing activities 8,224 (335) -------- -------- Decrease in cash and cash equivalents (705) (329) Cash and cash equivalents, beginning of period 1,064 1,055 -------- -------- Cash and cash equivalents, end of period $ 359 $ 726 ======== ======== Supplemental cash flow disclosures: Interest income received $ 575 $ 370 ======== ======== Interest paid $ 159 $ 120 ======== ======== See accompanying notes. 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) BASIS OF PRESENTATION- These interim Consolidated Financial Statements of Molecular Biosystems, Inc. and Subsidiaries (the "Company") should be read in conjunction with the Consolidated Financial Statements of the Company and related Notes filed with the Company's Annual Report on Form 10-K for the year ended March 31, 1999. These interim Consolidated Financial Statements of the Company have not been audited by independent public accountants. However, in the opinion of the Company, all adjustments required for a fair presentation of the financial position of the Company as of June 30, 1999, and the results of its operations for the three-months ended June 30, 1998 and 1999, and its cash flows for the three-months ended June 30, 1998 and 1999, have been made. The results of operations for these interim periods are not necessarily indicative of the operating results for the full year. (2) COMMITMENTS AND CONTINGENCIES- In July, 1997 the Company and its marketing partner, Mallinckrodt Inc. ("Mallinckrodt") filed suit (the "MBI Case") in United States District Court for the District of Columbia against four potential competitors -- Sonus Pharmaceuticals, Inc. ("Sonus"), Nycomed Imaging AS ("Nycomed"), ImaRx Pharmaceutical Corp. ("ImaRx") and its marketing partner DuPont Merck and Bracco - -- seeking declarations that certain of their ultrasound contrast agent patents are invalid. The complaint alleges that each of the defendants' patents is invalid on a variety of independent grounds under U.S. patent law. In addition to requesting that all of the patents in question be declared invalid, the complaint requests a declaration that, contrary to defendants' contentions, the Company and Mallinckrodt do not infringe the defendants' patents, and asks that defendants be enjoined from proceeding against the Company and Mallinckrodt for infringement until the status of defendants' patents has been determined by the court or the U.S. Patent and Trademark Office ("PTO"). The complaint alleges that each defendant has claimed or is likely to claim that its patent or patents cover OPTISON(R), the Company's advance-generation ultrasound contrast agent, and will attempt to prevent its commercialization. All of the defendants except Nycomed filed motions to dismiss the complaint on jurisdictional grounds. In January 1998, the court dismissed each of the defendants except Nycomed, ruling that the court lacked jurisdiction over those defendants with respect to the Company's claims of patent invalidity and non-infringement. The court's ruling does not purport to rule on the merits of the Company's claims; the dismissal was based solely on jurisdictional grounds. Following Sonus's dismissal as a defendant in the MBI Case, Sonus activated a patent infringement lawsuit (the "Sonus Case") which it had filed in August 1997 against the Company and Mallinckrodt in the United States District Court for the Western District of Washington. Although the complaint was filed in August 1997, Sonus had agreed not to proceed with the Sonus Case until the jurisdictional motions were decided in the MBI Case. Sonus's complaint alleges that the manufacture and sale of OPTISON by the Company and Mallinckrodt infringe two patents owned by Sonus. MBI counterclaimed for a declaration of invalidity and non- 6 infringement with respect to the Sonus patents. These two patents are the same patents for which the Company was seeking a declaration of invalidity in the MBI Case. Beginning in July 1997, the Company received the first of five notices from the PTO granting the Company's petitions for reexamination which it had filed with respect to five patents held by three potential competitors, Sonus, Nycomed and ImaRx. Each of the five notices stated there was a substantial new question of patentability raised by the Company's petitions with respect to all claims of the patents. Each of the patents in the reexamination process is related to the use of perfluorocarbon gases in ultrasound contrast agents and is included among the patents for which the Company was seeking a declaration of invalidity in the MBI Case (and for which the Company is continuing to seek a declaration of invalidity in the case of Nycomed's patents). In late 1997 and early 1998, the PTO issued office actions in connection with the Company's patent reexamination petitions filed against Sonus, Nycomed and ImaRx. The PTO office actions rejected all relevant claims of these patents based on prior art not previously disclosed to the PTO by Sonus, Nycomed or ImaRx during prosecution of their patent applications. In June 1998, the PTO issued a final rejection of all claims of the two Sonus patents involved in the Sonus Case. In December 1998, the Company received correspondence from the PTO with respect to the two Sonus patents involved in the reexamination proceedings. On the basis of amendments after final rejection, the PTO has indicated that certain claims in Sonus' U.S. Patent No. 5,558,094 (`094) are allowable by the agency. According to the PTO correspondence, none of the original `094 patent claims which Sonus had asserted against MBI will be allowed by the PTO without amendment. The PTO has also indicated that certain claims of Sonus' U.S. Patent 5,573,751 (`751) are allowable by the agency. According to the PTO correspondence, certain of the `751 patent claims which Sonus has asserted against the Company will be allowed in their original form. In January 1999, the PTO issued reexamination certificates for the `094 and `751 patents. In August 1998, the PTO issued a final rejection of all relevant claims of the Nycomed patent involved in the MBI Case. If the PTO rejection is maintained on any appeal subsequently filed by Nycomed, the patent Nycomed is attempting to assert against the Company and Mallinckrodt to block the manufacture and sale of OPTISON will be invalidated. 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 5, 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 counterclaimed for a declaration of invalidity and noninfringement 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. 7 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 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. (3) EARNINGS PER SHARE- The Company follows 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 quarter ended June 30, 1998. Potential common shares were calculated using the treasury stock method and represent incremental shares issuable upon exercise of the Company's outstanding options. For the quarter ended June 30, 1999, the diluted loss per share calculation excludes effects of outstanding stock options as such inclusion would be anti-dilutive. The following table provides a reconciliation of the numerators and denominators used in calculating basic and diluted earnings per share for the quarters ended June 30, 1998 and June 30, 1999. Quarter Ended June 30, 1998 1999 --------- ---------- NET INCOME (LOSS) $ 740 $ (1,402) BASIC EARNINGS (LOSS) PER SHARE: Income (loss) available to common stockholders 740 (1,402) Weighted average common shares outstanding 18,512 18,730 --------- ---------- BASIC EARNINGS (LOSS) PER SHARE $ 0.04 $ (0.07) ========= ========== DILUTED EARNINGS (LOSS) PER SHARE: Income (loss) available to common stockholders $ 740 $ (1,402) Weighted average common shares outstanding 18,512 18,730 Common stock options outstanding (unless anti-dilutive) 331 -- Total weighted average common shares and equivalents 18,843 18,730 --------- ---------- DILUTED EARNINGS (LOSS) PER SHARE $ 0.04 $ (0.07) ========= ========== 8 (4) 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 of cost reduction affected approximately 40 employees of the Company's 140-person workforce. The second reduction in force occurred in April 1999 and affected an additional 26 employees. The Company will implement a further reduction in force in the future when out-sourcing of the Company's manufacturing operations is complete. (5) AMENDMENT TO MALLINCKRODT AGREEMENT- 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 the Amended and Restated Distribution Agreement ("ARDA") entered into in September 1995 between the Company and Mallinckrodt. Under the terms of the amended ARDA, which is retroactive to March 1, 1999, Mallinckrodt has agreed to 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 reduced royalty rate on product sales of OPTISON. Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following management discussion and analysis should be read in conjunction with (1) the current Consolidated Financial Statements and (2) the Company's Consolidated Financial Statements and related Notes and Management's Discussion and Analysis of Financial Condition and Results of Operations in its Annual Report on Form 10-K for the year ended March 31, 1999. From time to time, the Company may publish forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, regulatory approval, research and development activities and similar matters. A variety of factors could cause the Company's actual results and experience to differ materially from the Company's anticipated results or other expectations. The risks and uncertainties that may affect the operations, performance, development and results of the Company's business include the expense and uncertain outcome of the litigation described in the Notes to the Financial Statements in Item 1 above, including the possibility of injunctive relief to competitors prohibiting the sale of OPTISON? , a ruling by the Patent and Trademark Office ("PTO") in the pending patent reexamination proceedings favoring competitors' patents; delays or an inability to bring OPTISON to market in Europe as a result of regulatory delays or patent litigation; difficulties and delays with respect to the performance of clinical trials; delays by regulatory authorities in approving additional indications for OPTISON, including the evaluation of myocardial perfusion; manufacturing problems; difficulties and delays with respect to marketing and sales activities; general uncertainties accompanying the development and introduction of new products; and other risk factors reported from time to time in the Company's reports filed with the Securities and Exchange Commission. 9 RECENT 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 the Amended and Restated Distribution Agreement ("ARDA") entered into in September 1995 between the Company and Mallinckrodt. In addition to the transfer of manufacturing, the amended ARDA will extend Mallinckrodt's responsibility for funding clinical trials to include all cardiology, as well as radiology and 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 ARDA, which is retroactive to March 1, 1999, Mallinckrodt has agreed to 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 reduced royalty rate on product sales of OPTISON. LIQUIDITY AND CAPITAL RESOURCES At June 30, 1999, the Company had net working capital of $9.5 million compared to $10.7 million at March 31, 1999. Cash, cash equivalents and marketable securities were $15.5 million at June 30, 1999 compared to $18.0 million at March 31, 1999. For the next several years, the Company expects to incur substantial additional expenditures associated with product development. The Company anticipates that its existing resources, plus payments under its collaborative agreement with Mallinckrodt, will enable the Company to fund its operations for at least the next twelve 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. RESULTS OF OPERATIONS REVENUES UNDER COLLABORATIVE AGREEMENTS. Revenues under collaborative agreements were $1.5 million for the quarter ended June 30, 1999 compared to $1.3 million for the same quarter in the prior year. These revenues in both years consist solely of quarterly payments to support clinical trials, regulatory submissions and product development received from Mallinckrodt under the ARDA. 10 PRODUCT AND ROYALTY REVENUES. Revenues from product sales and royalties were $160,000 for the quarter ended June 30, 1999, compared to $1.4 million for the same quarter in the prior year. In the quarter ended June 30, 1998, product revenues came from the Company's sales of OPTISON to Mallinckrodt and were recognized upon shipment of the product. 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 was 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 considered samples a marketing expense and as such the cost of samples was recorded as selling, general and administrative expense. MBI's quarterly revenues at June 30, 1999 did not reflect the benefits of increased OPTISON end-user sales due to the fact that a majority of these sales were made from Mallinckrodt inventory purchased from MBI prior to MBI's and Mallinckrodt's agreement to amend the ARDA described in Note 5 to the Financial Statements under Item 1 above. LICENSE FEES. Revenues for the quarter ended June 30, 1998 include $16.4 million recognized in connection with MBI's partnership with Chugai Pharmaceutical Co., Ltd., announced on April 8, 1998. COSTS OF PRODUCTS SOLD. Cost of products sold totaled ($645,000) for the quarter ended June 30, 1999. Under the terms of the amended ARDA, which is retroactive to March 1, 1999, Mallinckrodt has agreed to reimburse MBI for all fully allocated manufacturing expenses, including incremental costs related to the technology transfer. The Company has accrued a receivable from Mallinckrodt for manufacturing expenses incurred during the period March 1, 1999 through June 30, 1999. The manufacturing expenses from March 1999 were included in the prior fiscal year. As a result, the recoupment of these expenses is reflected as a negative expense in the current fiscal year. For the quarter ended June 30, 1998, cost of products sold totaled $1.6 million resulting in a negative gross profit margin. This negative gross profit margin was due to the fact that the current low levels of production were insufficient to cover the Company's fixed manufacturing overhead expenses. RESEARCH AND DEVELOPMENT COSTS. For the quarter ended June 30, 1999, the Company's research and development costs totaled $1.4 million, as compared to $2.2 million for the same period in 1998. The decrease is due to previously announced cost reduction measures and MBI's and Mallinckrodt's agreement to amend the ARDA described in Note 5 to the Financial Statements under Item 1 above. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. For the quarter ended June 30, 1999, the Company's selling, general and administrative expenses totaled $2.4 million, as compared to $3.9 million for the same quarter in 1998. The decrease in the current year is due to previously announced cost reduction measures. Also, a portion of the higher expenses for the same period in 1998 was due to continuing legal expenses and marketing costs associated with the launch of OPTISON. 11 OTHER NONRECURRING CHARGES AND FOREIGN INCOME TAXES. For the quarter ended June 30, 1999 the Company had no nonrecurring charges as compared to $9.4 million for the same period ended June 30, 1998. The charge in the first quarter of 1998 was primarily due to a non-cash, non-recurring expense of $8.5 million related to the sale to Chugai of territory rights previously reacquired from Shionogi & Co., Ltd. Additionally, the company paid $1.4 million in foreign taxes related to the Chugai alliance during the quarter ended June 30, 1998. INTEREST EXPENSE AND INTEREST INCOME. Interest expense for the quarter ended June 30, 1999 amounted to $120,000, compared to $160,000 for the same period in the prior year, and consisted of mortgage interest on the Company's manufacturing building and interest on a note payable which is secured by the tangible assets of the Company. The interest rate on the mortgage was 8% in June 1999. The note payable bears interest at the prime rate and is payable in monthly installments of principal plus interest over five years. The decrease is primarily due to the renegotiation of the note payable in September 1998 which lowered the interest rate from prime plus one to the prime rate and released a compensating balance requirement. The interest rate on the note was 7.75% in June 1999. Interest income for the quarter ended June 30, 1999 was $218,000 compared to $425,000 for the same quarter in the prior year. The decrease in interest income in the current year is due to lower average cash and marketable securities balances. The Company's cash is invested primarily in short-term, fixed principal investments, such as U.S. Government agency issues, corporate bonds, certificates of deposit and commercial paper. YEAR 2000 READINESS. The Year 2000 problem is the result of computer programs being written using two digits rather than four digits to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations, which could disrupt operations, including product development, manufacturing, the processing of transactions and other normal business activities. The Year 2000 problem may also 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 information technology ("IT") and non information technology ("Non-IT") systems to identify the systems that could be affected by the "Year 2000" issue and has developed a plan to assess and resolve Year 2000 problems with its IT and Non-IT systems. The plan includes five phases: inventory, assessment, evaluation, implementation and testing. The Company has completed the inventory phase on its IT systems and has identified all IT systems that the Company believes are at risk. The Company is in the process of inventorying its Non-IT systems and expects to have identified all Non-IT systems that are at risk within the next few months. The Company completed the assessment phase (in which systems that were inventoried are prioritized) for all systems in March 1999. The Company has begun the evaluation phase which involves testing systems and determining which IT and Non-IT systems need to be replaced, repaired or retired. The evaluation phase is expected to take approximately 3 months. Once the evaluation phase is complete, the Company will begin the implementation phase and repair/replace all noncompliant systems (both IT and Non-IT), convert data as necessary, and obtain compliance statements. The implementation phase is expected to take three months to complete. Finally, the Company will test and validate the repaired noncompliant 12 IT and Non-IT systems for compliance. This final phase of the process should take 1-2 months and should be complete by November 1999. In addition, the Company is in the process of conducting a comprehensive review of its vendors, service providers (including financial institutions and insurance companies), and collaborative partners. Although this assessment is not yet complete, the Company is not currently aware of any material Year 2000 issues with respect to its dealings with such third parties. However, if the Company discovers Year 2000 problems with such third parties' systems, the Company will be unable to control whether its current and future suppliers', service providers' or collaborative partners' systems are Year 2000 compliant. To the extent that such third parties would be hindered by Year 2000 problems, the Company's operations could be materially adversely affected. The Company anticipates that its assessment of both internal and third party IT and Non-IT systems will be complete by November 1999. At this time, the Company believes that the Year 2000 problem will not pose significant operational problems for the Company's computer systems. The Company also expects that the total costs required to fix the Year 2000 problem will not be material. To date, the Company has not used, and does not plan to use, any independent verification and validation process to assess the reliability of the Company's risk and cost estimates. Since no significant issues have arisen, the Company does not have a contingency plan to address any material Year 2000 issues. If significant Year 2000 issues arise, the Company may not be able to timely develop and implement a contingency plan and the Company's operations could be adversely affected. PROSPECTIVE INFORMATION The Company is involved in several legal and administrative proceedings which could result in a substantial cost to the Company. Given the complexity of the legal and factual issues and the uncertainty of litigation, 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. For a detailed discussion of these matters, see Note 2 in Notes to the Financial Statements under Item 1 above. Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK The information called for by this item is provided under the caption "Interest Expense and Interest Income" under Item 2 above. PART II - OTHER INFORMATION Item 1 - LEGAL PROCEEDINGS See Note 2 in Notes to the Financial Statements, which is incorporated by reference in this response. Item 2-4 - The Company has nothing to report with respect to these items during the quarter ended June 30, 1999. 13 Item 5 - OTHER INFORMATION Dates for Submission of Stockholder Proposals: Any stockholder of the Company who wishes to present a proposal to be considered at the 2000 Annual Meeting of Stockholders and who, pursuant to Rule 14a-8 of the Securities and Exchange Commission, wishes to have the proposal included in the Company's proxy statement and form of proxy for that meeting, must submit the proposal in writing to the Company at 10030 Barnes Canyon Road, San Diego, California 92121, so that it is received by April 4, 2000. Item 6 - EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - None (b) Reports on Form 8-K A Current Report on Form 8-K dated May 3, 1999 was filed on May 12, 1999, reporting that DuPont Pharmaceuticals Company and ImaRx Pharmaceutical Corporation filed a lawsuit in the United States District Court for the District of Delaware against the Company and Mallinckrodt. 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/ Elizabeth Hougen - ------------------------------------------ Elizabeth Hougen Executive Director, Finance and Chief Financial Officer (Principal Financial and Accounting Officer) 8/12/99 - ----------------------------- Date