SONUS PHARMACEUTICALS INC - 10-K Annual Report

Back to GetFilings.com

1

================================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

Or

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934 (NO FEE REQUIRED)

Commission File Number 0-26866

SONUS PHARMACEUTICALS, INC.
(Exact name of the registrant as specified in its charter)

DELAWARE 95-4343413
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

22026 20TH AVENUE SE, BOTHELL, WASHINGTON 98021
(Address of principal executive offices)

(425) 487-9500
(Registrant's telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Not Applicable

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, par value $0.001 per share

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 report), 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 the 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. [ ]

As of February 1, 2001, the aggregate market value of the registrant's Common
Stock held by non-affiliates of the Registrant was $13,152,388 based on the
closing sales price of $1.625 per share of the Common Stock as of such date, as
reported by The Nasdaq National Market. As of February 1, 2001, 9,603,520 shares
of the registrant's Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive Proxy Statement to be filed in
connection with the solicitation of proxies for its 2001 Annual meeting of
Stockholders to be held April 25, 2001 are incorporated by reference in Items
10, 11, 12, and 13 of part III hereof.

PAGE 1 OF 40 PAGES
EXHIBIT INDEX APPEARS ON PAGE 36

================================================================================

2

SONUS PHARMACEUTICALS, INC.
TABLE OF CONTENTS

PART I PAGE
----

Item 1. Business.............................................................................. 3
Overview............................................................................ 3
Technology Platform................................................................. 3
Products Under Development.......................................................... 3
Market Overview..................................................................... 4
Manufacturing....................................................................... 5
Research and Development............................................................ 5
Government Regulations.............................................................. 6
Competition......................................................................... 7
Patents and Proprietary Rights...................................................... 7
Product Liability................................................................... 9
Human Resources..................................................................... 9
Certain Factors that May Affect Our Business and Future Results..................... 9
Item 2. Properties............................................................................ 13
Item 3. Legal Proceedings..................................................................... 13
Item 4. Submissions of Matters to a Vote of Security Holders.................................. 14

PART II

Item 5. Market for Registrant's Common Stock.................................................. 15
Item 6. Selected Financial Data............................................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................... 16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................ 20
Item 8. Financial Statements and Supplementary Data........................................... 20
Item 9. Changes in and Disagreements with Accountants......................................... 20

PART III

Item 10. Directors and Executive Officers of the Registrant.................................... 35
Item 11. Executive Compensation................................................................ 35
Item 12. Security of Ownership of Certain Beneficial Owners and Management..................... 35
Item 13. Certain Relationships and Related Transactions........................................ 35

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K....................... 36
SIGNATURES ...................................................................................... 40

2
3

PART I

ITEM 1. BUSINESS

OVERVIEW

Our Company is engaged in the research and development of therapeutic
drug delivery and oxygen delivery products utilizing our core technology in
emulsion formulations and surfactant chemistry. Based on this proprietary core
technology, we have developed the TOCOSOL(TM) drug-delivery system to solubilize
therapeutic drugs that are poorly soluble in water. We are developing a cancer
therapy product and a cardiovascular therapy product using the TOCOSOL
technology. We are also developing an oxygen delivery product based on core
technology that utilizes stabilized fluorocarbon gas microbubbles to more
efficiently transport oxygen to body tissues. See "Products Under Development"
section below for further discussion of our current products.

TOCOSOL DRUG DELIVERY TECHNOLOGY PLATFORM

We have developed the TOCOSOL drug delivery technology to solubilize
therapeutic drugs that are poorly soluble in water with the goal of developing
products that can be administered more easily to the patient, with fewer side
effects and equivalent or higher efficacy. The TOCOSOL technology uses
tocopherol (vitamin E) and tocopherol-based surfactants. Our strategy for
development of the TOCOSOL drug delivery system has three parts:

- To develop proprietary new formulations of currently marketed
intravenous drugs that are generic or which are coming off patent
protection.

- To collaborate with other pharmaceutical companies to provide them
with drug delivery solutions for their new or existing drug substances
that have known formulation challenges or need life cycle extensions.

- To license the TOCOSOL technology to other drug delivery companies for
development of alternate dosage forms, such as oral, nasal, and
topical applications.

PRODUCTS UNDER DEVELOPMENT

S-8184 -- CANCER THERAPY

The first application of our TOCOSOL drug delivery technology is an
injectable paclitaxel emulsion formulation, S-8184. Paclitaxel is the active
ingredient in a highly successful cancer treatment currently on the market for
the treatment of breast, ovarian and non-small cell lung cancer. We filed an
Investigational New Drug Application, or IND, with the U.S. Food and Drug
Administration in late 2000 and initiated our Phase 1 human clinical study in
December 2000. The Phase 1 study will determine whether the S-8184 paclitaxel
emulsion can reduce side effects, reduce or eliminate the need for
premedications and be delivered in a single, quick injection in a matter of
minutes compared to the hours of infusion with existing formulations of
paclitaxel. We expect to complete patient enrollment in the S-8184 Phase 1 study
in the second half of 2001.

3
4

S-2646 -- CARDIOVASCULAR THERAPY

Consistent with our strategy to apply our TOCOSOL drug delivery
technology to intravenous marketed drugs that are generic and/or have patents
expiring, S-2646 is a reformulation of an intravenous cardiac drug, amiodarone,
that is marketed for the treatment of the life threatening cardiac rhythm
disturbances, ventricular fibrillation and unstable ventricular tachycardia. The
currently marketed form of the drug has side effects, namely hypotention (low
blood pressure) and venous irritation, that may limit the drug's effectiveness
when administered in emergency situations in the field. With the TOCOSOL drug
delivery system, S-2646 may have lower toxicity than the currently marketed
intravenous formulation, which could allow faster administration of the drug. We
expect to complete formulation development and pre-clinical studies with S-2646
by the end of 2001.

S-9156 -- OXYGEN DELIVERY

We are also developing an oxygen delivery product, S-9156 for use in
therapeutic applications. This product utilizes stabilized microbubbles, formed
from our flourocarbon emulsion technology, for transporting oxygen to the body's
tissues. In pre-clinical studies, S-9156 was shown to carry large volumes of
oxygen adequate to sustain life at doses that are many times lower than other
liquid fluorocarbon products that are currently under development by others.
This may present important clinical advantages because many of the side effects
associated with administration of large volumes of liquid fluorocarbons could be
minimized with S-9156. Potential applications for S-9156 include for use in
trauma situations to provide immediate tissue oxygenation when there is no
availability or time for typing and cross-matching blood for transfusion or for
oxygenation of solid tumors to increase the effectiveness of radiotherapy. We
expect to complete pre-clinical studies with S-9156 and file an IND with the
U.S. Food and Drug Administration by the end of 2001.

MARKET OVERVIEW

CANCER

According to the American Cancer Society, cancer is the second leading
cause of death in the United States and accounts for approximately one in every
four deaths. Since 1990, approximately 13 million new cases have been diagnosed
and about 5 million lives have been lost to cancer. The National Cancer
Institute estimated the total cost of cancer to be $107 billion in 2000. The
worldwide cancer drug market was estimated at $16 billion in 1998, representing
a 15% growth from 1997. Despite the resources spent on cancer and the many
advances that have been made to date, current treatments for many tumors are
often inadequate and improved cancer treatment drugs are still needed.

CARDIOVASCULAR

Since 1900, cardiovascular disease has been the number one killer in the
U.S. every year but one. Cardiovascular diseases will account for approximately
1 million deaths in the U.S. in 2001, or one of every 2.5 deaths. About 220,000
people a year will die from sudden deaths caused by cardiac arrest. Most of the
cardiac arrests that lead to sudden death occur when the electrical impulses in
the heart become rapid (ventricular tachycardia) or chaotic (ventricular
fibrillation) or both. This irregular rhythm causes the heart to stop beating
effectively. Early advanced cardiac life support (ACLS) can result in
significantly higher long-term survival rates for witnessed cardiac arrest. A
key component of ACLS is the early and fast administration of anti-arrhythmic
drugs, particularly intravenous (i.v.) amiodarone. In addition to sudden cardiac
arrest situations, i.v. amiodarone is used in the management of certain other

4
5

frequently recurring ventricular arrhythmias. The U.S. market for the one
current commercial formulation of i.v. amiodarone is estimated at $200 million
and growing.

OXYGEN DELIVERY/BLOOD SUBSTITUTES

The opportunity for an oxygen therapeutic product such as S-9156
includes applications where the product can be used as a blood substitute (e.g.
in hemorrhagic shock or transfusion applications) and applications where the
product can be used to augment the normal oxygen delivery function of blood
where normal oxygen transport is compromised (e.g. hypoxic tumors, carbon
monoxide poisoning).

The market for an artificial oxygen carrier is in the early stages of
development but can be estimated relative to the number of applicable
therapeutic procedures performed. For example, in the U.S., 2.5 million surgical
procedures are performed per year requiring a total of 8.2 million units of
transfused blood. Worldwide, the total demand is 35 million units per year. If
the availability of blood substitutes could reduce the requirement for 10
percent of the transfused units, at a cost of about $150 per unit, the market
opportunity would therefore be $350 million per year.

In the area of cancer therapeutics, approximately 600,000 patients
receive radiation therapy in the U.S. per year, involving 25-35 treatments per
patient for a total of 15-21 million treatments each year. If just 10 percent of
radiation treatments were augmented with oxygen diffusion enhancers, such as a
perfluorocarbon oxygen carrier, at an average cost of $150 per dose, the market
opportunity in the U.S. alone could exceed $300 million.

MANUFACTURING

We currently produce non-GMP batches of our products at our facilities
in Bothell, Washington as part of our ongoing research and development. We also
utilize an outside FDA-certified institution to manufacture our products under
current GMP requirements for our use in preclinical and clinical studies. In the
event that we receive FDA approval for one or more of our products, we
anticipate that we would either contract with one or more third parties to
manufacture our products or invest in the scale-up of our own manufacturing
facility.

RESEARCH AND DEVELOPMENT

We currently conduct research and development activities at our
facilities. We also engage in certain research, preclinical studies and clinical
development efforts at universities and other institutions. Our primary research
and development efforts are currently directed at the development and
application of S-8184, S-2646 and S-9156.

We incurred expenses of approximately $3.3 million, $5.6 million and
$10.5 million on research and development in fiscal 2000, 1999 and 1998,
respectively. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" for further discussion of research and
development spending trends.

5
6

GOVERNMENT REGULATIONS -- DRUG APPROVAL PROCESS

Regulation by governmental authorities in the U.S. and other countries
is a significant factor in our ongoing research and development activities and
in the production and marketing of our products. In order to undertake clinical
tests, to produce and market products for human diagnostic or therapeutic use,
mandatory procedures and safety standards established by the FDA in the U.S. and
comparable agencies in other countries must be followed.

The standard process required by the FDA before a pharmaceutical agent
may be marketed in the U.S. includes the following steps:

(i.) Preclinical studies including laboratory evaluation and animal studies
to test for initial safety and efficacy;

(ii.) Submission to the FDA of an Investigational New Drug Application, or
IND, which must become effective before human clinical trials may
commence;

(iii.) Adequate and well-controlled human clinical trials to establish the
safety and efficacy of the drug in its intended application;

(iv.) Submission to the FDA of a New Drug Application, or NDA, which
application is not automatically accepted by the FDA for consideration;
and

(v.) FDA approval of the NDA prior to any commercial sale or shipment of the
drug.

In addition to obtaining FDA approval for each product, each domestic
drug-manufacturing establishment must be registered or licensed by the FDA for
each product that is manufactured at that facility. U.S. manufacturing
establishments are subject to inspections by the FDA and by other Federal, State
and local agencies and must comply with Good Manufacturing Practices, or GMP
requirements applicable to the production of pharmaceutical drug products.

Preclinical studies include laboratory evaluation of product chemistry
and animal studies to assess the potential safety and efficacy of the product
and its formulation. The results of the preclinical studies are submitted to the
FDA as part of an IND, and unless the FDA objects, the IND will become effective
30 days following its receipt by the FDA.

Clinical trials involve the administration of the drug to healthy
volunteers and/or to patients under the supervision of a qualified principal
investigator. Clinical trials are conducted in accordance with protocols that
detail the objectives of the study, the parameters to be used to monitor safety
and the efficacy criteria to be evaluated. Each protocol is submitted to the FDA
as part of the IND. Each clinical study is approved and monitored by an
independent Institutional Review Board or Ethics Committee at each clinical site
who will consider, among other things, ethical factors, informed consents, the
safety of human subjects and the possible liability of the institution
conducting a clinical study.

Clinical trials typically are conducted in three sequential phases,
although the phases may overlap. In Phase 1, the initial introduction of the
drug to humans, the drug is tested for safety and clinical pharmacology such as
metabolism. Phase 2 involves detailed evaluation of safety and efficacy of the
drug in patients with the disease or condition being studied. Phase 3 trials
consist of larger scale evaluation of safety and efficacy and usually require
greater patient numbers and multiple clinical trial sites, depending on the
clinical indications for which marketing approval is sought.

The process of completing clinical testing and obtaining FDA approval
for a new product is likely to take a number of years and require the
expenditure of substantial resources. FDA may grant an

6
7

unconditional approval of a drug for a particular indication or may grant
approval conditioned on further post-marketing testing. The FDA also may
conclude that the submission is not adequate to support an approval and may
require further clinical and preclinical testing, re-submission of the NDA, and
further review. Even after initial FDA approval has been obtained, further
studies may be required to provide additional data on safety or to gain approval
for the use of a product for clinical indications other than those for which the
product was approved initially. Also, the FDA may require post-marketing testing
and surveillance programs to monitor the drug's efficacy and side effects.

Marketing of pharmaceutical products outside of the U.S. are subject to
regulatory requirements that vary widely from country to country. In the
European Union, the general trend has been towards coordination of the common
standards for clinical testing of new drugs. Centralized approval in the
European Union is coordinated through the European Medicines Evaluation Agency,
or EMEA.

The level of regulation jurisdictions outside of the U.S. varies widely.
The time required to obtain regulatory approval from comparable regulatory
agencies in each country may be longer or shorter than that required for FDA or
EMEA approval. In addition, in certain markets, reimbursement may be subject to
governmentally mandated prices.

We are and may be subject to regulations under state and Federal law
regarding occupational safety, laboratory practices, handling of chemicals,
environmental protection and hazardous substance control. We also will be
subject to other present and possible future local, state, federal and other
jurisdiction regulations.

COMPETITION

The health care industry is characterized by extensive research efforts
and rapid technological change. We believe that other pharmaceutical companies
will compete with us in areas of research and development, acquisition of
products and technology licenses, and the manufacturing and marketing of
products that could potentially compete with ours. We expect that competition
will be based primarily on safety, efficacy, ease of administration, breadth of
approved indications, reimbursement, and physician and patient acceptance. Many
of our competitors and potential competitors have substantially greater
financial, technical and human resources than we do and have substantially
greater experience in developing products, obtaining regulatory approvals and
marketing and manufacturing products. Accordingly, these competitors may succeed
in obtaining FDA or non-U.S. approval for their products more rapidly than us.
Generally, products that reach the market first have a market advantage. In
addition, other technologies or products may be developed that have an entirely
different approach that would render our technology and products noncompetitive
or obsolete. See "Certain Factors That May Affect Our Business and Future
Results -- Competition and Risk of Technological Obsolescence."

PATENTS AND PROPRIETARY RIGHTS

We consider the protection of our technology to be important to our
business. In addition to seeking U.S. patent protection for many of our
inventions, we are also seeking patent protection in other countries in order to
protect our proprietary rights to inventions. We also rely upon trade secrets,
know-how, continuing technological innovations and licensing opportunities to
develop and maintain our competitive position.

Our success will depend, in part, on our ability to obtain patents,
defend patents and protect trade secrets. We have filed patent applications in
the U.S. and in over 40 other countries relating to our principal technologies.
In the U.S., 12 patents have been issued to us, the claims of which are
primarily

7
8

directed to ultrasound contrast media that include fluorocarbon containing
chemicals as well as methods of making and using these media. The patent
position of medical and pharmaceutical companies is highly uncertain and
involves complex legal and factual questions. There can be no assurance that any
claims which are included in pending or future patent applications will be
issued, that any issued patents will provide us with competitive advantage or
will not be challenged by third parties, or that the existing or future patents
of third parties will not have an adverse effect on our ability to commercialize
our products. Furthermore, there can be no assurance that other companies will
not independently develop similar products, duplicate any of our products or
design around patents that may be issued to us. Litigation or administrative
proceedings may be necessary to enforce any patents issued to us or to determine
the scope and validity of others' proprietary rights in court or administrative
proceedings. Any litigation or administrative proceeding could result in
substantial costs to us and distraction of our management. An adverse ruling in
any litigation or administrative proceeding could have a material adverse effect
on our business, financial condition and results of operations. A significant
portion of our drug delivery products is based upon extending the effective
patent life of existing products through the use of our proprietary technology.
See "Legal Proceedings" and "Certain Factors That May Affect Our Business and
Future Results -- If we fail to secure adequate intellectual property protection
or become involved in an intellectual property dispute, it could significantly
harm our financial results and ability to compete."

Our commercial success will depend in part on not infringing patents
issued to competitors. There can be no assurance that patents belonging to
competitors or others will not require us to alter our products or processes,
pay licensing fees or cease development of our current or future products. Any
litigation regarding infringement could result in substantial costs to us and
distraction of our management, and any adverse ruling in any litigation could
have a material adverse effect on our business, financial condition and results
of operations. Further, there can be no assurance that we will be able to
license other technology that we may require at a reasonable cost or at all.
Failure by us to obtain a license to any technology that we may require to
commercialize our products could have a material adverse effect on our business,
financial condition and results of operations. In addition, to determine the
priority of inventions and the ultimate ownership of patents, we may participate
in interference, reissue or re-examination proceedings conducted by the U.S.
Patent and Trademark Office ("PTO") or in proceedings before other agencies with
respect to any of our existing patents or patent applications or any future
patents or applications, any of which could result in loss of ownership of
existing, issued patents, substantial costs to us and distraction of our
management. See "Legal Proceedings" and "Certain Factors That May Affect Our
Business and Future Results -- Our commercial success will depend in part on not
infringing patents issued to competitors."

In August 1999, we entered into an agreement with Nycomed Imaging AS
("Nycomed") for the cross-license of certain proprietary ultrasound contrast
agent technologies. Under the terms of the agreement, we provided Nycomed with
an exclusive license to our ultrasound contrast patents except as related to
perfluoropentane. Under the exclusive license to the patents, Nycomed also has
the right to freely sublicense to other companies with a portion of any
sublicense fees to be paid to us. In addition, we have a worldwide,
non-exclusive license to certain of Nycomed's ultrasound contrast agent patents.
We also have the right to sublicense these patents to our collaborative
partners. Under the agreement, Nycomed paid us a license fee of $10.0 million in
1999. In addition, Nycomed pays royalties to us based on the sales of licensed
products.

Also, under the agreement, we transferred to Nycomed the
responsibilities and legal costs associated with patent infringement litigation
with DuPont Pharmaceuticals Company, DuPont Contrast Imaging, Inc., E.I. DuPont
de Nemours & Co., Inc and DuPont Pharma, Inc. See "Legal Proceedings."

8
9

We have obtained a registered trademark for our corporate name and have
filed for the registration of our TOCOSOL trademark in the U.S. and certain
other countries. There can be no assurance that the registered or unregistered
trademarks or trade names of our company will not infringe upon third party
rights or will be acceptable to regulatory agencies. The requirement to change
our trademarks or trade name could entail significant expenses and could have a
material adverse effect on our business, financial condition and results of
operations.

We also rely on unpatented trade secrets, proprietary know-how and
continuing technological innovation which we seek to protect, in part, by
confidentiality agreements with our corporate partners, collaborators, employees
and consultants. There can be no assurance that these agreements will not be
breached, that we will have adequate remedies for any breach, or that our trade
secrets or know-how will not otherwise become known or be independently
discovered by competitors. Further, there can be no assurance that we will be
able to protect our trade secrets or that others will not independently develop
substantially equivalent proprietary information and techniques. See "Certain
Factors That May Affect Our Business and Future Results -- Dependence on patents
and proprietary rights."

PRODUCT LIABILITY

The clinical testing, manufacturing and marketing of our products may
expose us to product liability claims. We maintain liability insurance for
possible claims arising from the use of our products in clinical trials with
limits of $5.0 million per claim and in the aggregate. Although we have never
been subject to a product liability claim, there can be no assurance that the
coverage limits of our insurance policies will be adequate or that one or more
successful claims brought against us would not have a material adverse effect
upon our business, financial condition and results of operations. If any of our
products under development are approved by the FDA, there can be no assurance
that adequate product liability insurance will be available, or if available,
that it will be available at a reasonable cost. Any adverse outcome resulting
from a product liability claim could have a material adverse effect on our
business, financial condition and results of operations.

HUMAN RESOURCES

As of March 1, 2001, we had 30 employees, 20 engaged in research and
development, regulatory, clinical and manufacturing activities, and 10 in
business operations and administration, management, and business development. We
consider our relations with our employees to be good, and none of our employees
is a party to a collective bargaining agreement.

CERTAIN FACTORS THAT MAY AFFECT OUR BUSINESS AND FUTURE RESULTS

This report contains forward looking statements which are based upon
management's current beliefs and judgment. These statements and our business are
subject to a number of risks and uncertainties, some of which are discussed
below. Other risks are presented elsewhere in this report. You should consider
the following risks carefully in addition to the other information contained in
this report before purchasing shares of our common stock. If any of the
following risks actually occur, they could seriously harm our business,
financial conditions or results of operations. In such case, the trading price
of our common stock could decline, and you may lose all or part of your
investment.

If we fail to develop products, then we may never realize revenue from
product commercialization. A key element of our business strategy is to utilize
our technologies for the development and commercialization of drug delivery and
oxygen delivery products. Our drug delivery technology is a new approach to the
formulation of water insoluble compounds for therapeutic applications.
Significant

9
10

expenditures in additional research and development, clinical testing,
regulatory, manufacturing, and sales and marketing activities will be necessary
in order for us to commercialize any products developed with our technology.
Even if we are successful in developing our products, there is no assurance that
a commercially viable market will develop. While it is our strategy to develop
additional products under our drug delivery technology by entering into
feasibility study agreements with companies who own active compounds, there can
be no assurance that we will enter into any feasibility studies. Moreover, there
can be no assurance that these feasibility studies will result in development or
license agreements. Without feasibility studies or development or license
agreements, we may need to scale back or terminate our efforts to develop other
products using our drug delivery technology.

We have a history of operating losses, and we may never become
profitable. We have experienced significant accumulated losses since our
inception, and are expected to incur net losses for the foreseeable future.
These losses have resulted primarily from expenses associated with our research
and development activities, including preclinical and clinical trials, and
general and administrative expenses. We anticipate that our operating losses
will continue as we further invest in research and development for our products.
Even if we generate significant product revenues, there can be no assurance that
we will be able to sustain profitability. Our results of operations have varied
and will continue to vary significantly and depend on, among other factors:

- Entering into new collaborative or product license agreements;

- The timing of payments, if any, under collaborative partner
agreements;

- The timing and costs of clinical trials;

- Costs related to obtaining, defending and enforcing patents.

We may need additional capital in the future. If additional capital is
not available, we may have to curtail or cease operations. Our development
efforts to date have consumed substantial amounts of cash, and we have generated
only limited revenues from payments received from our contractual agreements.
Our future capital requirements depend on many factors including:

- Our ability to obtain and retain funding from third parties under
contractual agreements;

- The ability to maintain our bank line of credit;

- Our progress on research and development programs and clinical trials;

- The time and costs required to gain regulatory approvals;

- The costs of filing, prosecuting and enforcing patents, patent
applications, patent claims and trademarks;

- The costs of marketing and distribution of our products, if approved;

- The status of competing products; and

- The market acceptance and third-party reimbursement of our products,
if approved.

Additional capital may not be available on terms acceptable to us, or at
all. Any equity financing would likely result in substantial dilution to
existing stockholders, and debt financing, if available, may include restrictive
covenants. If we are unable to raise additional financing, we may have to reduce
our expenditures, scale back our development of new products or license to
others products that we otherwise would seek to commercialize ourselves.

We depend on third parties for funding, clinical development and
distribution. We are dependent on third parties for funding and performance of a
variety of activities including research, clinical development and manufacturing
our products. If we are unable to establish these arrangements with third
parties, if they are terminated or the collaborations are not successful, we
will be required to

10
11

identify alternative partners to fund or perform research, clinical development,
and/or manufacturing, which could have a material adverse effect on our
business, financial condition and results of operations. Our success depends in
part upon the performance by these collaborators of their responsibilities under
these arrangements. We have no control over the resources that any potential
partner may devote to the development and commercialization of products under
these collaborations and our partners may fail to conduct their collaborative
activities successfully or in a timely manner.

Governmental regulatory requirements are lengthy and expensive and
failure to obtain necessary approvals will prevent us or our collaborators from
commercializing a product. We are subject to uncertain governmental regulatory
requirements and a lengthy approval process for our products prior to any
commercial sales of our products. The development and commercial use of our
products are regulated by the U.S. Food and Drug Administration, or FDA, the
European Medicines Evaluation Agency, or EMEA, and comparable international
regulatory agencies. The regulatory approval process for new products is lengthy
and expensive. Before we can file an application with the FDA and comparable
international agencies, the product candidate must undergo extensive testing,
including animal studies and human clinical trials that can take many years and
may require substantial expenditures. Data obtained from such testing may be
susceptible to varying interpretations which could delay, limit or prevent
regulatory approval. In addition, changes in regulatory policy for product
approval may cause additional costs in our efforts to secure necessary
approvals. We cannot predict if or when any of our products under development
will be commercialized.

Future U.S. or international legislative or administrative actions also
could prevent or delay regulatory approval of our products. Even if regulatory
approvals are obtained, they may include significant limitations on the
indicated uses for which a product may be marketed. A marketed product also is
subject to continual FDA, EMEA and other regulatory agency review and
regulation. Later discovery of previously unknown problems or failure to comply
with the applicable regulatory requirements may result in restrictions on the
marketing of a product or withdrawal of the product from the market, as well as
possible civil or criminal sanctions. In addition, if marketing approval is
obtained, the FDA, EMEA or other regulatory agency may require post-marketing
testing and surveillance programs to monitor the product's efficacy and side
effects. Results of these post-marketing programs may prevent or limit the
further marketing of a product.

The markets for pharmaceutical products are highly competitive, and if
we fail to compete effectively, our revenues will decline. The health care
industry is characterized by extensive research efforts and rapid technological
change. Competition in the development of pharmaceutical products is intense and
expected to increase. We also believe that other medical and pharmaceutical
companies will compete with us in the areas of research and development,
acquisition of products and technology licenses, and the manufacturing and
marketing of our products. Success in these fields will be based primarily on:

- Efficacy;

- Safety;

- Ease of administration;

- Breadth of approved indications; and

- Physician, healthcare payer and patient acceptance.

Many of our competitors and potential competitors have substantially greater
financial, technical and human resources than we do and have substantially
greater experience in developing products, obtaining regulatory approvals and
marketing and manufacturing medical products. Accordingly, these competitors may
succeed in obtaining FDA approval for their products more rapidly than us. In

11
12

addition, other technologies or products may be developed that have an entirely
different approach that would render our technology and products noncompetitive
or obsolete.

We primarily rely on third party suppliers and manufacturers to produce
products that we develop and failure to retain such suppliers and manufacturers
would adversely impact our ability to commercialize our products. We currently
rely on third parties to supply the chemical ingredients necessary for our drug
delivery and oxygen delivery products. The chemical ingredients for our products
are manufactured by a limited number of vendors. The inability of these vendors
to supply medical-grade materials to us could delay the manufacturing of, or
cause us to cease the manufacturing of our products. We also rely on third
parties to manufacture our products for research and development and clinical
trials. Suppliers and manufacturers of our products must operate under GMP
regulations, as required by the FDA, and there are a limited number of contract
manufacturers that operate under GMP regulations. If we do not develop an
in-house manufacturing capability or we are not able to identify and qualify
alternative contract manufacturers, we may not be able to produce the required
amount of our products for research and development and clinical trials. Failure
to retain qualified suppliers and manufacturers will delay our research and
development efforts as well as the time it takes to commercialize our products,
which could materially adversely affect our operating results.

If we fail to secure adequate intellectual property protection or become
involved in an intellectual property dispute, it could significantly harm our
financial results and ability to compete. Our success will depend, in part, on
our ability to obtain and defend patents and protect trade secrets. The patent
position of medical and pharmaceutical companies is highly uncertain and
involves complex legal and factual questions. There can be no assurance that any
claims which are included in pending or future patent applications will be
issued, that any issued patents will provide us with competitive advantages or
will not be challenged by third parties, or that the existing or future patents
of third parties will not have an adverse effect on our ability to commercialize
our products. Furthermore, there can be no assurance that other companies will
not independently develop similar products, duplicate any of our products or
design around patents that may be issued to us. Litigation may be necessary to
enforce any patents issued to us or to determine the scope and validity of
others' proprietary rights in court or administrative proceedings. Any
litigation or administrative proceeding could result in substantial costs to us
and distraction of our management. An adverse ruling in any litigation or
administrative proceeding could have a material adverse effect on our business,
financial condition and results of operations.

Our commercial success will depend in part on not infringing patents
issued to competitors. There can be no assurance that patents belonging to
competitors will not require us to alter our products or processes, pay
licensing fees or cease development of our current or future products. Any
litigation regarding infringement could result in substantial costs to us and
distraction of our management, and any adverse ruling in any litigation could
have a material adverse effect on our business, financial condition and results
of operations. Further, there can be no assurance that we will be able to
license other technology that we may require at a reasonable cost or at all.
Failure by us to obtain a license to any technology that we may require to
commercialize our products would have a material adverse effect on our business,
financial condition and results of operations. In addition, to determine the
priority of inventions and the ultimate ownership of patents, we may participate
in interference, reissue or re-examination proceedings conducted by the U.S.
Patent and Trademark Office ("PTO") or in proceedings before international
agencies with respect to any of our existing patents or patent applications or
any future patents or applications, any of which could result in loss of
ownership of existing, issued patents, substantial costs to us and distraction
of our management.

The success of our products will depend, in part, on the acceptance of
our products by third party payers. Our ability to successfully commercialize
products that we develop will depend, in part, upon

12
13

the extent to which reimbursement of the cost of such products will be available
from domestic and international health administration authorities, private
health insurers and other payer organizations. Third party payers are
increasingly challenging the price of medical and pharmaceutical products and
services or restricting the use of certain procedures in an attempt to limit
costs. Further, significant uncertainty exists as to the reimbursement status of
newly approved health care products, and there can be no assurance that adequate
third party coverage will be available.

Failure to satisfy Nasdaq National Market Listing requirements may
result in our stock being delisted from the Nasdaq National Market. Our common
stock is currently listed on the Nasdaq National Market under the symbol "SNUS."
For continued inclusion on the Nasdaq National Market, we must maintain among
other requirements net tangible assets of at least $4.0 million, a minimum bid
price of $1.00 per share, and a market value of our public float of at least
$5.0 million. In the event that we fail to satisfy the listing standards on a
continuous basis, our common stock may be removed from listing on the Nasdaq
National Market. If our common stock is delisted from the Nasdaq National
Market, trading of our common stock, if any, would be conducted in the
over-the-counter market in the so-called "pink sheets" or, if available, the
NASD's "Electronic Bulletin Board." As a result, stockholders could find it more
difficult to dispose of, or to obtain accurate quotations as to the value of,
our common stock, and the trading price per share could be reduced.

If we lose our key personnel or are unable to attract and retain
qualified scientific and management personnel, we may be unable to become
profitable. We are highly dependent on our key executives. The loss of any of
these key executives or the inability to recruit and retain qualified scientific
personnel to perform research and development and qualified management personnel
could have a material adverse effect on our business, financial condition and
results of operations. There can be no assurance that we will be able to attract
and retain such personnel on acceptable terms, if at all, given the competition
for experienced scientists and other personnel among numerous medical and
pharmaceutical companies, universities and research institutions.

ITEM 2. PROPERTIES

We currently lease approximately 27,000 square feet of laboratory and
office space in a single facility near Seattle, Washington. The lease expires in
April 2002 and includes an option to extend the term of the lease for three
years. We believe that this facility will be adequate to meet our projected
needs for the foreseeable future.

ITEM 3. LEGAL PROCEEDINGS

In July 2000, DuPont Pharmaceuticals Company, DuPont Contrast Imaging,
Inc., E.I. DuPont de Nemours & Co., Inc. and DuPont Pharma, Inc. (collectively
"DuPont") filed a complaint in the United States District Court for the District
of Massachusetts against us and certain Nycomed Amersham-related entities.
DuPont's complaint seeks a declaratory judgment that certain ultrasound contrast
patents owned by us and licensed to Nycomed are invalid and not infringed by
DuPont. We and Nycomed believe DuPont's complaint is without merit and intend to
vigorously defend against the complaint. At the request of Nycomed and us, the
Massachusetts action has been transferred to the U.S. District Court for the
Western District of Washington.

Under our license agreement with Nycomed, Nycomed has the right to
enforce the patents in the field of non-perfluoropentane ultrasound contrast
agents on behalf of Nycomed and on our behalf, at Nycomed's expense. Pursuant to
this right, Nycomed and we also have filed against DuPont a patent infringement
action in the U.S. District Court for the Western District of Washington
alleging that

13
14

DuPont's contrast agent known as "Definity" infringes patents we own and have
licensed to Nycomed. The patent infringement action filed in Washington is based
on the same questions of patent infringement and validity that were raised in
the Massachusetts action. We believe it is likely that these actions, both of
which have been assigned to the same judge in the U.S. District Court for the
Western District of Washington, will be consolidated and effectively proceed as
one action. Pursuant to our license agreement with Nycomed, Nycomed will bear
all costs and expenses associated with the prosecution of the Washington action
and the defense of the Massachusetts action.

In 1998, various class action complaints were filed in the Superior
Court of Washington (the "State Action") and in the U.S. District Court for the
Western District of Washington (the "Federal Action") against us and certain of
our officers and directors, alleging violations of Washington State and U.S.
securities laws. In October 1998, we and the individual defendants moved to
dismiss and stay the State Action. The state law claims in the State Action were
subsequently re-filed in the Federal Action. In February 1999, plaintiffs filed
a consolidated and amended complaint in the Federal Action, alleging violations
of Washington State and U.S. securities laws. In March 1999, we and the
individual defendants filed a motion to dismiss the consolidated amended
complaint in the Federal Action. In July 1999, the Court entered an order
denying in part and granting in part the motion to dismiss the complaint in the
Federal Action. In November 1999, we filed motions for summary judgment and to
stay discovery.

In July 2000, with the consent of our insurance carrier, we entered into
a Memorandum of Understanding with plaintiffs to settle the Federal Action for
an amount within our directors and officers' insurance policy limits. In
November 2000, the parties filed with the Court a Stipulation of Settlement and
related exhibits. On February 20, 2001, the Court approved the Stipulation of
Settlement and entered an order dismissing with prejudice all claims against the
defendants. Given the uncertainties of litigation, we believe that this
settlement, which is covered by our insurance carrier, is in the best interests
of our shareholders.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the
fourth quarter of the year ended December 31, 2000.

14
15

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK

Our common stock first began trading on the Nasdaq National Market under
the symbol SNUS on October 12, 1995. No cash dividends have been paid on the
common stock, and we do not anticipate paying any cash dividends in the
foreseeable future. As of February 1, 2001, there were 148 stockholders of
record and approximately 6,500 beneficial stockholders of our company's Common
Stock. The high and low sales prices of our Common Stock as reported by Nasdaq
for the eight quarters ended December 31, 2000 are as follows:

HIGH LOW
------ -------

2000
First Quarter 11 1/4 2 27/64
Second Quarter 4 3/4 2 1/2
Third Quarter 4 3/4 3 5/32
Fourth Quarter 4 13/32

1999
First Quarter 10 7/8 4 7/8
Second Quarter 8 1/4 5
Third Quarter 7 1/8 3
Fourth Quarter 4 5/8 2 1/16

ITEM 6. SELECTED FINANCIAL DATA

YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
2000 1999 1998 1997 1996
------- ------- -------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

STATEMENT OF OPERATIONS DATA:
Revenues $ 408 $12,050 $ 5,100 $18,900 $16,600
Total operating expenses $ 7,641 $12,088 $ 17,012 $18,763 $14,988
Net income (loss) $(2,147) $ 435 $(11,173) $ 1,011 $ 1,722
Net income (loss) per share:
Basic $ (0.23) $ 0.05 $ (1.30) $ 0.12 $ 0.20
Diluted $ (0.23) $ 0.05 $ (1.30) $ 0.11 $ 0.19
Shares used in calculation of
net income (loss) per share
Basic 9,146 8,836 8,622 8,565 8,481
Diluted 9,146 8,969 8,622 9,580 9,064

AS OF DECEMBER 31,
-------------------------------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------- -------
(IN THOUSANDS)

BALANCE SHEET DATA:
Cash, cash equivalents and
marketable securities $13,462 $16,804 $16,955 $26,571 $25,131
Total assets $14,310 $18,089 $18,818 $28,946 $26,762
Long-term liabilities $ -- $ -- $ 2,049 $ 939 $ 240
Stockholders' equity $ 8,509 $10,048 $ 7,495 $18,505 $16,877

15
16

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

FORWARD-LOOKING STATEMENTS

This report contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, and we intend that such
forward-looking statements be subject to the safe harbors created thereby.
Examples of these forward-looking statements include, but are not limited to:

- Market acceptance of our products and the potential size of these
markets;

- Our anticipated future capital requirements and the terms of any
capital financing;

- The progress and results of clinical trials;

- The timing and amount of future contractual payments, product revenues
and operating expenses; and

- The anticipated outcome or financial impact of legal matters.

While these statements made by us are based on our current beliefs and
judgement, they are subject to risks and uncertainties that could cause actual
results to vary.

The discussion and analysis set forth below contains trend analysis,
discussions of regulatory status and other forward-looking statements. Actual
results could differ materially from those projected in the forward-looking
statement as a result of the following factors, among others:

- Dependence on the development and commercialization of products;

- History of operating losses and uncertainty of future financial
results;

- Future capital requirements and uncertainty of additional funding;

- Dependence on third parties for funding, clinical development and
distribution;

- Uncertainty of governmental regulatory requirements and lengthy
approval process;

- Uncertainty of U.S. or international legislative or administrative
actions;

- Competition and risk of technological obsolescence;

- Limited manufacturing experience and dependence on a limited number of
contract manufacturers and suppliers;

- Dependence on patents and proprietary rights;

- Limitations on third-party reimbursement for medical and
pharmaceutical products;

- Continued listing on the Nasdaq National Market; and

- Dependence on key employees.

See "Business -- Certain Factors That May Affect Our Business and Future
Results."

16
17

MD&A OVERVIEW

In Management's Discussion and Analysis we explain the general financial
condition and the results of operations for our Company, including:

- An overview of our business;

- Results of operations and why those results are different from the
prior year;

- The capital resources our Company currently has and possible sources
of additional funding for future capital requirements;

- Certain factors that may affect our business and future results.

BUSINESS OVERVIEW

Our Company is engaged in the research and development of therapeutic
drug delivery and oxygen delivery products utilizing our core technology in
emulsion formulations and surfactant chemistry. Based on this proprietary core
technology, we have developed the TOCOSOL drug delivery system to solubilize
therapeutic drugs that are poorly soluble in water. We are developing a cancer
therapy product, S-8184, and a cardiovascular therapy product, S-2646, under the
TOCOSOL technology. We are also developing an oxygen delivery product, S-9156,
which uses our core emulsion formulation technology and consists of stabilized
fluorocarbon gas microbubbles for transporting oxygen to body tissues. See Part
I, Item I -- Business for further review of our current products.

REFOCUS STRATEGY

Prior to October 2000, we focused the significant portion of our time
and resources on the development of a diagnostic ultrasound contrast agent,
EchoGen, using our proprietary core technology in emulsion formulations. In
October 2000, we announced a strategic decision to shift our focus from
diagnostic ultrasound contrast to the further development of our drug delivery
and oxygen delivery products. At that time, we withdrew the EchoGen NDA,
discontinued further clinical development of EchoGen, and decided not to pursue
commercialization of the product in Europe. These decisions were based on
several factors including the possibility of significant additional time and
investment to secure regulatory approval in the U.S., the limited market
opportunity of an echocardiography ultrasound contrast product, and the
potential opportunities to advance the development of our drug delivery and
oxygen delivery products.

RESULTS OF OPERATIONS

Our results of operations have varied and will continue to vary
significantly and depend on, among other factors:

- Timing of payments under contractual and license agreements;

- Entering into additional contractual agreements;

- Timing and costs of clinical trials, legal matters and expenses
related to product development;

- Timing of regulatory approvals.

YEARS ENDED DECEMBER 31, 2000 AND DECEMBER 31, 1999

To date, our reported revenues have been derived from payments received
under contractual and license agreements with third parties. Revenue was $0.4
million for the year ended December 31, 2000

17
18

compared with $12.1 million in the prior year. Revenues during 2000 were derived
from royalties received under our patent license agreement with Nycomed and from
payments received under drug feasibility study agreements. Revenue received in
the prior year consisted of the initial license fee payment of $10.0 million
under our patent license agreement with Nycomed and $2.1 million from Abbott
Laboratories under a prior agreement.

Research and development expenses were $3.3 million for the year ended
December 31, 2000 compared with $5.6 million in the prior year. The decrease
from the prior year was due to a reduction in clinical trials and associated
development activity for EchoGen as a result of our decision to discontinue
further development of this product. In addition, we terminated an ultrasound
contrast manufacturing and supply agreement which resulted in a one-time
favorable adjustment in research and development expenses of $1.3 million in
2000.

General and administrative expenses were $4.4 million for the year ended
December 31, 2000 compared with $6.5 million in the prior year. The decrease
from the prior year was primarily due to a reduction in legal costs as a result
of the favorable patent litigation settlement in May 2000 and also due to an
overall lower level of administrative expenses resulting from various expense
reductions achieved in 2000.

Total operating expenses in 2001 are expected to be consistent with or
slightly higher than 2000 levels as we maintain a relatively low fixed cost
structure while continuing to invest in the development plans for our drug
delivery and oxygen delivery products.

Other income in 2000 represents payments received in the second quarter
of $4.25 million from patent litigation and insurance settlements. As part of
the patent litigation settlement, we received a payment of $2.5 million from
Nycomed pursuant to our patent license agreement with Nycomed. In addition, we
reached an agreement on a pre-existing insurance coverage dispute and we
received a settlement payment of $1.75 million.

Interest income, net of interest expense, was $658,000 for the year
ended December 31, 2000 compared with $472,000 for the prior year. The increase
in net interest income was primarily due to higher levels of invested cash in
2000.

In the first quarter of 2000, we received a refund in the amount of
$176,939 for international withholding taxes paid in 1995.

YEARS ENDED DECEMBER 31, 1999 AND DECEMBER 31, 1998

Revenue was $12.1 million for the year ended December 31, 1999 compared
with $5.1 million in the prior year. Revenues during 1999 were derived from our
agreements with Nycomed ($10.0 million) and Abbott ($2.1 million). Revenue
received in 1998 was derived from payments received under our agreements with
Abbott.

Research and development expenses were $5.6 million for the year ended
December 31, 1999 compared with $10.5 million in the prior year. The decrease
from the prior year was primarily due to a reduction in clinical trials and
associated development activity for our previous ultrasound contrast product.

18
19

General and administrative expenses were $6.5 million for each of the
years ended December 31, 1999 and 1998. We had an increase in intellectual
property legal costs in 1999 offset by decreases in medical education and other
marketing expenses.

Interest income, net of interest expense, was $472,000 for the year
ended December 31, 1999 compared to $739,000 for the prior year. The decrease
was primarily due to the lower average levels of invested cash during 1999.

LIQUIDITY AND CAPITAL RESOURCES

We have historically financed operations with payments from contractual
agreements with third parties, proceeds from equity financing and a bank line of
credit. At December 31, 2000, we had cash, cash equivalents and marketable
securities of $13.5 million compared to $16.8 million at December 31, 1999. The
decrease was primarily due to cash used in operations during the year ended
December 31, 2000, offset in part by the $4.3 million of legal and insurance
settlements and $0.6 million of proceeds from the exercise of stock options.

We have a bank loan agreement which provides for a $5.0 million
revolving line of credit facility and bears interest at the prime rate plus 1.0%
per annum. At December 31, 2000, we had borrowings of $5.0 million outstanding
under the line of credit. The line of credit expires in August 2001 and is
secured by tangible assets. The company is required to maintain a minimum of
$5.0 million of cash in order to borrow under the line of credit, and the
borrowed funds are required to be held at the bank. We cannot give assurance
that we will be able to maintain the minimum balances necessary to borrow under
the line of credit.

We expect that our cash needs will increase in future periods due to
planned clinical trials and other product development costs associated with our
drug delivery and oxygen delivery products. Based on our current operating plan
for 2001, including planned clinical trials and other product development costs,
we estimate that existing cash and marketable securities will be sufficient to
meet our cash requirements through at least 2001. However, we may seek
additional funding through available means, which may include debt and/or equity
financing or funding under additional third party agreements. Our future capital
requirements depend on many factors including:

- The ability to attract and retain new collaborative agreement
partners;

- The ability to obtain funding under contractual and licensing
agreements;

- The ability to maintain our bank line of credit;

- The progress of our research and development programs and clinical
trials;

- The time and costs required to obtain regulatory approvals;

- The costs of filing, prosecuting and enforcing patents, patent
applications, patent claims and trademarks;

- The cost of defending, and any damages or settlement payments that may
be paid pursuant to legal proceedings.

We cannot give assurance that additional financing will be available on
acceptable terms, if at all. Any equity financing would likely result in
substantial dilution to our existing stockholders and debt financing, if
available, may include restrictive covenants. If we are unable to raise
additional financing, we may be required to curtail or delay the development of
our products and new product research and development, which could seriously
harm our business.

19
20

MARKET RISK

The market risk inherent in our short-term investment and debt portfolio
represents the potential loss arising from adverse changes in interest rates. If
market rates hypothetically increase immediately and uniformly by 100 basis
points from levels at December 31, 2000, the decline in the fair value of the
investment portfolio and increased interest expense on our short-term debt
portfolio would not be material. Because we have the ability to hold our fixed
income investments until maturity, we do not expect our operating results or
cash flows to be affected to any significant degree by a sudden change in market
interest rates.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Response to this item is included in "ITEM 7. MANAGEMENT'S DISCUSSION
AND ANALYSTS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Market Risk"

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS: PAGE
----

Report of Ernst & Young LLP, Independent Auditors................................................... 21
Balance Sheets as of December 31, 2000 and 1999...................................................... 22
Statements of Operations for the years ended December 31, 2000, 1999, and 1998....................... 23
Statements of Stockholders' Equity for the years ended December 31, 2000, 1999, and 1998............. 24
Statements of Cash Flows for the years ended December 31, 2000, 1999, and 1998....................... 25
Notes to the Financial Statements.................................................................... 26

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

20
21

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors
Sonus Pharmaceuticals, Inc.

We have audited the accompanying balance sheets of Sonus
Pharmaceuticals, Inc. as of December 31, 2000 and 1999, and the related
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2000. 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 auditing standards generally
accepted in the United States. 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 Sonus
Pharmaceuticals, Inc. at December 31, 2000 and 1999, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States.

ERNST & YOUNG LLP

Seattle, Washington
January 18, 2001

21
22

SONUS PHARMACEUTICALS, INC.
BALANCE SHEETS

YEAR ENDED DECEMBER 31,
---------------------------------
2000 1999
------------ ------------

ASSETS
Current assets:
Cash and cash equivalents ........................................... $ 6,696,610 $ 5,894,194
Marketable securities ............................................... 6,765,854 10,910,292
Other current assets ................................................ 345,696 422,851
------------ ------------
Total current assets ............................................... 13,808,160 17,227,337

Equipment, furniture and leasehold improvements, net ................... 501,660 861,434
------------ ------------
Total assets ........................................................... $ 14,309,820 $ 18,088,771
============ ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank line of credit ................................................. $ 5,000,000 $ 5,000,000
Accounts payable and accrued expenses ............................... 800,343 3,041,271
------------ ------------
Total current liabilities ........................................ 5,800,343 8,041,271

Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value:
5,000,000 shares authorized; no shares outstanding ............... -- --
Common stock, $001 par value:
30,000,000 shares authorized; 9,603,520 and 8,989,972
shares issued and outstanding in 2000 and 1999, respectively ..... 38,077,469 37,142,965
Notes receivable from officers ..................................... (350,000) --
Accumulated deficit ................................................ (29,219,041) (27,071,604)
Accumulated other comprehensive income (loss) ...................... 1,049 (23,861)
------------ ------------
Total stockholders' equity ....................................... 8,509,477 10,047,500
------------ ------------
Total liabilities and stockholders' equity ............................. $ 14,309,820 $ 18,088,771
============ ============

See accompanying notes.

22
23

SONUS PHARMACEUTICALS, INC.
STATEMENTS OF OPERATIONS

YEAR ENDED DECEMBER 31,
-----------------------------------------------------
2000 1999 1998
----------- ------------ ------------

Revenues:
Contract and licensing revenue ............................... $ 408,407 $ 12,050,000 $ 5,100,000

Operating expenses:
Research and development ...................................... 3,258,630 5,585,988 10,463,573
General and administrative .................................... 4,382,519 6,501,647 6,548,833
----------- ------------ ------------
Total operating expenses ............................. 7,641,149 12,087,635 17,012,406
----------- ------------ ------------

Operating loss .................................................. (7,232,742) (37,635) (11,912,406)

Other income (expense):
Interest income ............................................... 692,424 568,959 970,146
Interest expense .............................................. (34,058) (96,654) (231,024)
Other income .................................................. 4,250,000 -- --
----------- ------------ ------------
Total other income, net .............................. 4,908,366 472,305 739,122
----------- ------------ ------------

Income (loss) before income taxes ............................... (2,234,376) 434,670 (11,173,284)
Income tax benefit .............................................. (176,939) -- --
----------- ------------ ------------

Net income (loss) ............................................... $(2,147,437) $ 434,670 $(11,173,284)
=========== ============ ============

Net income (loss) per share:
Basic ......................................................... $ (0.23) $ 0.05 $ (1.30)
Diluted ....................................................... $ (0.23) $ 0.05 $ (1.30)

Shares used in calculation of net income (loss) per share:
Basic ......................................................... 9,146,374 8,836,406 8,621,759
Diluted ....................................................... 9,146,374 8,969,404 8,621,759

See accompanying notes.

23
24

SONUS PHARMACEUTICALS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY

Accumulated
Common Stock Other
--------------------------- Notes Accumulated Comprehensive
Shares Amount Receivable Deficit Income (Loss) Total
----------- ------------ ------------ ------------ ------------- ------------

Balance at January 1, 1998 ....... 8,611,376 $ 34,860,237 $ -- $(16,349,661) $ (5,959) $ 18,504,617
Comprehensive income (loss):

Net loss .................... -- -- -- (11,173,284) -- (11,173,284)

Unrealized losses on
investments .............. -- -- -- -- (2,449) (2,449)
------------

Comprehensive loss .......... (11,175,733)

Issuance of common stock ......... 20,849 149,131 -- -- -- 149,131

Amortization of stock
compensation .................. -- -- -- 16,671 -- 16,671
----------- ------------ --------- ------------ ----------- ------------

Balance at December 31, 1998 ..... 8,632,225 35,009,368 -- (27,506,274) (8,408) 7,494,686
Comprehensive income (loss):

Net income .................. -- -- -- 434,670 -- 434,670

Unrealized losses on
investments ............. -- -- -- -- (15,453) (15,453)
------------

Comprehensive income ........ 419,217

Issuance of common stock ......... 357,747 2,133,597 -- -- -- 2,133,597
----------- ------------ --------- ------------ ----------- ------------

Balance at December 31, 1999 ..... 8,989,972 37,142,965 -- (27,071,604) (23,861) 10,047,500
Comprehensive income (loss):

Net loss .................... -- -- -- (2,147,437) -- (2,147,437)

Unrealized gain on
investments ............. -- -- -- -- 24,910 24,910
------------

Comprehensive loss .......... (2,122,527)

Issuance of common stock ......... 613,548 934,504 (350,000) -- -- 584,504
----------- ------------ --------- ------------ ----------- ------------
Balance at December 31, 2000 ..... 9,603,520 $ 38,077,469 (350,000) $(29,219,041) $ 1,049 $ 8,509,477
=========== ============ ========= ============ =========== ============

See accompanying notes.

24

25

SONUS PHARMACEUTICALS, INC.
STATEMENTS OF CASH FLOWS

YEAR ENDED DECEMBER 31,
--------------------------------------------------
2000 1999 1998
------------ ------------ ------------

OPERATING ACTIVITIES:
Net income (loss) .............................................. $ (2,147,437) $ 434,670 $(11,173,284)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization ................................ 385,594 627,171 831,188
Gain on sale of equipment .................................... (20,419) -- --
Amortization of discount on marketable securities ............ (28,056) (34,852) (5,571)
Realized (gains) losses on marketable securities ............. -- 4,976 (13,952)
Changes in operating assets and liabilities:
Other current assets ......................................... 77,154 (3,832) 220,952
Accounts payable and accrued expenses ........................ (2,240,927) (1,139,594) (174,408)
------------ ------------ ------------
Net cash used in operating activities .......................... (3,974,091) (111,461) (10,315,075)

INVESTING ACTIVITIES:
Purchases of equipment, furniture and leasehold
Improvements ................................................... (38,666) (44,515) (523,870)
Proceeds from sale of equipment ................................ 33,265 -- --
Purchases of marketable securities ............................. (8,643,350) (20,758,859) (28,308,701)
Proceeds from sales of marketable securities ................... 499,995 14,564,759 24,600,104
Proceeds from maturities of marketable securities .............. 12,340,759 7,049,147 13,292,590
------------ ------------ ------------
Net cash provided by investing activities ...................... 4,192,003 810,532 9,060,123

FINANCING ACTIVITIES:
Proceeds from bank line of credit .............................. 20,000,000 20,000,000 20,000,000
Repayment of bank line of credit ............................... (20,000,000) (20,000,000) (20,000,000)
Increase in long-term debt ..................................... -- 30,783 1,203,282
Repayment of capital lease obligations ......................... -- (93,178) (146,762)
Proceeds from exercise of stock options ........................ 584,504 53,592 149,131
------------ ------------ ------------
Net cash provided by (used in) financing activities ............ 584,504 (8,803) 1,205,651
------------ ------------ ------------

Change in cash and cash equivalents for the period ............. 802,416 690,268 (49,301)
Cash and cash equivalents at beginning of period ............... 5,894,194 5,203,926 5,253,227
------------ ------------ ------------
Cash and cash equivalents at end of period ..................... 6,696,610 5,894,194 5,203,926
Marketable securities at end of period ......................... 6,765,854 10,910,292 11,750,916
------------ ------------ ------------
TOTAL CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES ....... $ 13,462,464 $ 16,804,486 $ 16,954,842
============ ============ ============

Supplemental cash flow information:
Interest paid ................................................ $ 33,958 $ 43,069 $ 64,531
Income taxes paid ............................................ $ -- $ -- $ 7,500

Supplemental disclosure of non-cash financing activity:
Conversion of long-term debt to common stock ................. $ -- $ 2,080,005 $ --

See accompanying notes.

25
26

SONUS PHARMACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS

1. DESCRIPTION OF BUSINESS AND SUMMARY OF ACCOUNTING POLICIES

BUSINESS OVERVIEW

Sonus Pharmaceuticals, Inc. (the Company) is engaged in the research and
development of therapeutic drug delivery and oxygen delivery products utilizing
our core technology in emulsion formulations. Based on this proprietary
technology, we have developed the TOCOSOL(TM) drug delivery system to solubilize
drugs that are poorly soluble in water. The Company is developing a cancer
therapy product and a cardiovascular therapy product with the TOCOSOL
technology. The Company is also developing an oxygen delivery product, which
uses our core emulsion formulation technology and consists of stabilized
fluorocarbon gas microbubbles for transporting oxygen.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents consist of highly liquid investments with a
maturity of three months or less at the date of purchase.

MARKETABLE SECURITIES

The Company classifies the marketable securities investment portfolio as
available-for-sale, and such securities are stated at fair value based on quoted
market prices, with the unrealized gains and losses included as a component of
accumulated other comprehensive loss. Interest earned on securities
available-for-sale is included in interest income. The cost of debt securities
in this category is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization and accretion are included in interest
income. Realized gains and losses and declines in value judged to be other than
temporary on securities available-for-sale also are included in interest income.
The cost of securities sold is based on the specific identification method.

CONCENTRATIONS OF CREDIT RISK

The Company invests its excess cash in accordance with investment
guidelines which limit the credit exposure to any one financial institution and
to any one type of investment, other than securities issued by the U.S.
government. The guidelines also specify that the financial instruments are
issued by institutions with strong credit ratings. These securities are
generally not collateralized and mature within one year.

REVENUE RECOGNITION

Payments under contractual agreements are recorded as revenue when
earned based upon the provisions of each agreement. Payments received which have
not met the appropriate revenue recognition criteria are recorded as deferred
revenue.

EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS

Equipment, furniture and leasehold improvements are stated at cost.
Depreciation of equipment is provided using the straight-line basis over three
to five years, the estimated useful life of the assets.

26
27

Leasehold improvements are amortized over the lesser of the economic useful
lives of the improvements or the term of the related lease.

STOCK-BASED COMPENSATION

In accordance with Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," the Company has elected to continue
to account for stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and related interpretations. Accordingly, compensation cost
for stock options is measured as the excess, if any, of the market price of the
Company's common stock at the date of grant over the stock option exercise
price. Under the Company's stock plans, stock options are generally granted at
fair market value.

COMPREHENSIVE INCOME

In accordance with Statement of Financial Accounting Standard No. 130,
"Reporting Comprehensive Income" (SFAS 130), the Company has reported
comprehensive income, defined as net income (loss) plus other comprehensive
income, in the Statements of Stockholders' Equity. The total of other
accumulated comprehensive income consists of unrealized gains and losses on
marketable securities.

PER SHARE DATA

In accordance with Statement of Financial Accounting Standards No. 128
"Earnings Per Share" the Company has presented both basic and diluted earnings
per share ("EPS"). Basic EPS is based on the weighted average number of common
shares outstanding. Diluted EPS is based on the weighted average number of
common shares and dilutive potential common shares. Dilutive potential common
shares are calculated under the treasury stock method and consist of unexercised
stock options and warrants.

USE OF ESTIMATES

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

2. MARKETABLE SECURITIES

Marketable securities consist of the following at December 31, 2000 and
1999:

UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
----------- -------- ------------ -----------

2000:
Corporate debt securities (principally
commercial paper) ...................... $ 6,759,992 $ 1,263 $ (214) $ 6,765,854
=========== ======== ============ ===========

1999:
Government obligations .................... $ 1,499,545 $ -- $ (1,772) $ 1,497,773
Corporate debt securities (principally
commercial paper) ...................... 9,426,200 1,189 (14,870) 9,412,519
----------- -------- ------------ -----------
$10,925,745 $ 1,189 $ (16,642) $10,910,292
=========== ======== ============ ===========

27
28

Total realized gains on sales of available-for-sale securities were not
material in the current year. Realized gains on the sales of available-for-sale
securities were $3,015 and $13,952 in 1999 and 1998, respectively. The realized
losses on sales of available for sale securities were $0, $7,991 and $0 in 2000,
1999 and 1998, respectively. All marketable securities at December 31, 2000
mature within one year.

3. EQUIPMENT, FURNITURE AND LEASEHOLD IMPROVEMENTS

Equipment, furniture and leasehold improvements consist of the
following:

2000 1999
---------- ----------

Laboratory equipment $2,204,009 $2,221,744
Office furniture and equipment 989,618 1,037,586
Leasehold improvements 782,060 782,060
---------- ----------
3,975,687 4,041,390
Less accumulated depreciation and amortization 3,474,027 3,179,956
---------- ----------
$ 501,660 $ 861,434
========== ==========

4. DEBT

The Company has a Loan Agreement with a bank which provides for a $5.0
million revolving line of credit facility. Borrowings bear interest at the prime
rate plus 1.0% per annum. At December 31, 2000 and December 31, 1999, there was
$5.0 million outstanding under the line of credit. The line of credit expires in
August 2001 and is secured by the tangible assets of the Company. The Company is
required to maintain a minimum of $5.0 million of cash in order to borrow under
the line of credit, and the borrowed funds are required to be held at the bank.

5. CONTRACTUAL AGREEMENTS

In 1996, the Company entered into agreements with Abbott Laboratories
("Abbott") for the development and commercialization of an ultrasound contrast
agent, EchoGen. Under these agreements, Abbott has paid the Company a total of
$37.7 million based on the achievement of certain milestones. The agreements
with Abbott were terminated in 2000. The Company made a strategic decision in
October 2000 to shift its focus from diagnostic ultrasound contrast to the
further development of its drug delivery and oxygen delivery products. At that
time, the Company withdrew the EchoGen application with the FDA and discontinued
further clinical development. In addition, the Company terminated the
manufacturing and supply agreement with Abbott for EchoGen which resulted in a
$1.3 million favorable adjustment that is included as a reduction in research
and development expenses in the Statement of Operations for the year ended
December 31, 2000.

In 1999, the Company entered into a license agreement with Nycomed
Imaging AS ("Nycomed") for the cross-license of certain proprietary ultrasound
contrast agent technologies and received a license fee of $10.0 million. Under
the terms of the agreement, the Company provided Nycomed with an exclusive
license to its ultrasound contrast patents except as related to
perfluoropentane. Under the exclusive license to the patents, Nycomed also has
the right to freely sublicense to other companies with a portion of any
sublicense fees to be paid to the Company. In addition, the Company has a
worldwide, non-exclusive license to certain of Nycomed's ultrasound contrast
agent patents. The Company also has the right to sublicense these patents to its
collaborative partners. In addition to the license fee, Nycomed pays the Company
a royalty based on sales of its licensed products.

28
29

6. INCOME TAXES

Income taxes consist of the following:

2000 1999 1998
---------- ------ ------

Federal -- current $ -- $-- $--
Foreign -- current (176,939) -- --
--------- --- ---
Total $(176,939) $-- $--
========= === ===

In the first quarter of 2000, the Company received a refund of $176,939
for international withholding taxes that were originally paid in 1995. Due to
the uncertainty of receipt of this refund, a valuation allowance had previously
been provided.

A reconciliation of the Federal Statutory tax rate of 34% to the
Company's effective income tax rate follows:

2000 1999 1998
-------- ------- --------

Statutory tax rate (34.00%) 34.00% (34.00%)
Utilization of net operating loss carry forwards -- (37.95) --
Permanent difference 0.89 3.95 (0.20)
Change in valuation allowance 33.11 -- 34.20
Foreign tax credit (8.24%) -- --
----- ----- -----

Effective tax rate (8.24%) --% --%
===== ===== =====

Significant components of the Company's net deferred tax assets and
liabilities as of December 31, 2000 and 1999 are as follows:

2000 1999
------------ ------------

Deferred tax assets:
Federal net operating loss carry forwards $ 9,311,000 $ 8,580,000
Accrued expenses 99,000 126,000
Research and development credits 1,449,000 1,347,000
Foreign tax credits 1,006,000 1,183,000
AMT tax credits 68,000 68,000
Book in excess of tax depreciation expense 170,000 149,000
------------ ------------
Gross deferred tax assets 12,103,000 11,453,000
Valuation allowance for net deferred tax assets (12,103,000) (11,453,000)
------------ ------------
Net deferred tax assets $ -- $ --
============ ============

Due to the uncertainty of the Company's ability to generate taxable
income to realize its net deferred tax assets at December 31, 2000 and 1999, a
valuation allowance has been recognized for financial reporting purposes. The
Company's valuation allowance for deferred tax assets increased $650,000 and
$87,000 for the years ended December 31, 2000 and 1999, respectively.

At December 31, 2000, the Company has federal net operating loss carry
forwards of approximately $27,386,000 for income tax reporting purposes and
research and development and AMT tax credit carry forwards of approximately
$1,517,000. The federal operating loss carry forwards and research and
development credits begin to expire in 2006.

29
30

The initial public offering of common stock by the Company in 1995
caused an ownership change pursuant to applicable regulations in effect under
the Internal Revenue Code of 1986. Therefore, the Company's use of losses
incurred through the date of ownership change will be limited during the carry
forward period and may result in the expiration of net operating loss carry
forwards before utilization.

7. STOCKHOLDERS' EQUITY

COMMON STOCK

At December 31, 2000, the Company had shares of common stock reserved
for possible future issuance as follows:

Stock options outstanding.................................... 2,515,945
Shares available for future grant under stock plans.......... 703,021
Warrants outstanding......................................... 500,000
---------
3,718,966
=========

STOCK OPTIONS

The Company has several stock option plans, including the 2000 Stock
Incentive Plan adopted in 2000, whereby shares of common stock are reserved for
future issuance pursuant to stock option grants or other issuances. Employee
stock options vest over a period of time determined by the Board of Directors,
generally four years, and director stock options are generally fully vested on
the date of grant. Stock options generally are granted at the fair market value
on the date of grant and expire ten years from the date of grant.

A summary of activity related to the Company's stock options follows:

EXERCISE
SHARES PRICE
----------- ---------------

Balance, January 1, 1998 .......................................... $1,044,919 $ .07 -- 44.00
Granted......................................................... 823,215 6.25 -- 38.63
Exercised....................................................... (11,765) .07 -- 24.13
Canceled........................................................ (545,278) 3.93 -- 44.00
----------
Balance, December 31, 1998......................................... 1,311,091 .20 -- 44.00
Granted......................................................... 814,026 3.69 -- 6.94
Exercised....................................................... (5,158) 3.93 -- 6.25
Canceled........................................................ (134,077) 5.94 -- 44.00
----------
Balance, December 31, 1999......................................... 1,985,88 .20 -- 44.00
Granted......................................................... 1,252,215 .63 -- 6.00
Exercised....................................................... (203,785) .66 -- 6.75
Canceled........................................................ (518,367) .88 -- 6.00
----------
Balance, December 31, 2000......................................... 2,515,945 .20 -- 44.00
==========

Options exercisable at December 31, 2000, 1999, and 1998, were 997,546,
990,462, and 757,775, respectively.

30
31

The following table summarizes information about stock options outstanding at
December 31, 2000:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ------------- ----------- ------------ -------- ----------- --------

$ 0.20-$ 0.88 660,613 9.83 years $ 0.80 613 $ 0.20
$ 3.63-$ 4.88 141,514 9.14 years $ 4.02 43,835 $ 3.96
$ 5.94-$ 8.19 1,165,580 8.11 years $ 6.21 411,981 $ 6.44
$10.13-$20.50 487,405 5.14 years $13.57 484,860 $13.59
$27.75-$44.00 60,834 6.55 years $34.21 56,257 $33.97
--------- -------
Total 2,515,945 8.01 years $ 6.77 997,546 $11.35
========= =======

ACCOUNTING FOR STOCK-BASED COMPENSATION

In accordance with Statement of Financial Accounting Standards No. 133,
"Accounting for Stock-Based Compensation (SFAS 123), the Company has elected to
continue following the intrinsic value method allowed under the statement for
its stock option plans and present pro forma disclosures of the fair value
method prescribed by SFAS 123. Had the Company elected to recognize compensation
cost based on the fair value of the options as prescribed by SFAS 123, the net
loss and associated basic net loss per share amounts would have been $3.6
million or $0.40 per share, $1.7 million or $0.19 per share and $13.5 million or
$1.57 per share for the years ended December 31, 2000, 1999 and 1998,
respectively. The fair value of each option is estimated using the Black-Scholes
option pricing model. The assumptions used in this model include (1) the stock
price at grant date, (2) the exercise price, (3) an estimated option life of
four years, (4) no expected dividends for each year presented, (5) an expected
stock price volatility factor of 1.14, 0.873, and 0.659 in 2000, 1999 and 1998,
respectively, and (6) a risk-free interest rate of 6.35%, 6.88% and 4.43% in
2000, 1999 and 1998, respectively. The weighted average fair value per share of
options granted during 2000, 1999 and 1998 was $2.38, $3.92 and $4.27,
respectively.

STOCK PURCHASE PLAN

The company has an employee stock purchase plan whereby employees may
contribute up to 15% of their compensation to purchase shares of the Company's
common stock at 85% of the stock's fair market value at the lower of the
beginning or end of each three-month offering period. Shares purchased under the
plan were 9,763, 8,787 and 9,698 in 2000, 1999 and 1998, respectively. At
December 31, 2000, 55,457 shares were reserved for future purchases by employees
under the plan.

WARRANTS

As of December 31, 2000, the Company had warrants outstanding to
purchase 500,000 shares of common stock. The warrants are exercisable at $16.00
per share and expire in May 2001.

NOTES RECEIVABLE

In October 2000, the Company entered into stock purchase agreements with
certain officers whereby the officers purchased 400,000 shares of common stock
at the fair market value of the stock on the date of purchase in exchange for
full-recourse notes totaling $350,000. Each of the notes is due in five years

31
32

with interest due annually at the rate of 6.09%. The shares are restricted and
subject to repurchase by the Company at the original purchase price for a period
of one year.

SHAREHOLDER RIGHTS PLAN

The Company has adopted a Shareholder Rights Plan ("Plan"). Under the
Plan, the Company's Board of Directors declared a dividend of one Preferred
Stock Purchase Right ("Right") for each outstanding common share of the Company.
The Rights have an exercise price of $140 per Right and provide the holders with
the right to purchase, in the event a person or group acquires 15% or more of
the Company's common stock, additional shares of the Company's common stock
having a market value equal to two times the exercise price of the Right. The
Rights expire in 2006.

8. NET INCOME (LOSS) PER SHARE

A reconciliation between basic and diluted net income (loss) per share follows:

2000 1999 1998
----------- ---------- ------------

BASIC NET INCOME (LOSS) PER SHARE:
Net income (loss) ......................... $(2,147,437) $ 434,670 $(11,173,284)
Weighted average common shares ............ 9,146,374 8,836,406 8,621,759
Basic net income (loss) per share ..... $ (0.23) $ 0.05 $ (1.30)

DILUTED NET INCOME (LOSS) PER SHARE:
Net income (loss) ......................... $(2,147,437) $ 434,670 $(11,173,284)
Weighted average common shares ............ 9,146,374 8,836,406 8,621,759
Dilutive potential common shares .......... -- 132,998 --
----------- ---------- ------------
Total shares .............................. 9,146,374 8,969,404 8,621,759
=========== ========== ============

Diluted net income (loss) per share ... $ (0.23) $ 0.05 $ (1.30)

As of December 31, 2000, 1999 and 1998, 2,502,105, 2,090,529 and
2,088,369 options and warrants, respectively, have not been included in the
calculation of potential common shares as their effect on diluted per share
amounts would have been anti-dilutive.

9. COMMITMENTS AND CONTINGENCIES

The Company has leased office space and equipment under two operating
lease agreements which expire in April 2002 and October 2004, respectively.
Under the office lease, the Company has the option to extend the lease for an
additional three years at the then fair market value of the leased premises.
Future minimum lease payments under these leases are as follows:

2001........................................ $597,836
2002........................................ 167,055
2003........................................ 19,320
2004........................................ 16,100
--------
$800,311
========

Rental expense for the years ended December 31, 2000, 1999 and 1998 was
$603,000, $613,000 and $564,000, respectively.

32
33

10. LEGAL PROCEEDINGS

In July 2000, DuPont Pharmaceuticals Company, DuPont Contrast Imaging,
Inc., E.I. DuPont de Nemours & Co., Inc. and DuPont Pharma, Inc. (collectively
"DuPont") filed a complaint in the United States District Court for the District
of Massachusetts against the Company and certain Nycomed Amersham-related
entities. DuPont's complaint seeks a declaratory judgement that certain
ultrasound contrast patents owned by the Company and licensed to Nycomed are
invalid and not infringed by DuPont. The Company and Nycomed believe Dupont's
complaint is without merit and intend to vigorously defend against the
complaint. At the request of Nycomed and the Company, the Massachusetts action
has been transferred to the U.S. District Court for the Western District of
Washington.

Under the Company's license agreement with Nycomed, Nycomed has the
right to enforce the patents in the field of non-perfluoropentane ultrasound
contrast agents on behalf of Nycomed and on the Company's behalf, at Nycomed's
expense. Pursuant to this right, Nycomed and the Company also have filed against
DuPont a patent infringement action in the U.S. District Court for the Western
District of Washington alleging that DuPont's contrast agent known as "Definity"
infringes patents the Company owns and have licensed to Nycomed. The patent
infringement action filed in Washington is based on the same questions of patent
infringement and validity that were raised in the Massachusetts action. It is
likely that of these actions, both of which have been assigned to the same judge
in the U.S. District Court for the Western District of Washington, will be
consolidated and effectively proceed as one action. Pursuant to the Company's
license agreement with Nycomed, Nycomed will bear all costs and expenses
associated with the prosecution of the Washington action and the defense of the
Massachusetts action.

In 1998, various class action complaints were filed in the Superior
Court of Washington (the "State Action") and in the U.S. District Court for the
Western District of Washington (the "Federal Action") against the Company and
certain of the Company's officers and directors, alleging violations of
Washington State and U.S. securities laws. In October 1998, the Company and the
individual defendants moved to dismiss and stay the State Action. The state law
claims in the State Action were subsequently re-filed in the Federal Action. In
February 1999, plaintiffs filed a consolidated and amended complaint in the
Federal Action, alleging violations of Washington State and U.S. securities
laws. In March 1999, the Company and the individual defendants filed a motion to
dismiss the consolidated amended complaint in the Federal Action. In July 1999,
the Court entered an order denying in part and granting in part the motion to
dismiss the complaint in the Federal Action. In November 1999, the Company filed
motions for summary judgment and to stay discovery.

In July 2000, with the consent of the Company's insurance carrier, the
Company entered into a Memorandum of Understanding with plaintiffs to settle the
Federal Action for an amount within its directors and officers' insurance policy
limits. In November 2000, the parties filed with the Court a Stipulation of
Settlement and related exhibits. On February 20, 2001, the Court approved the
Stipulation of Settlement and entered an order dismissing with prejudice all
claims against the defendants. The settlement is covered by the Company's
insurance policy.

Other income for the year ended December 31, 2000 represents payments
received in the second quarter of $4.25 million from patent litigation and
insurance settlements. As part of the patent litigation settlement, the Company
received a payment of $2.5 million from Nycomed pursuant to the Company's patent
license agreement with Nycomed. In addition, the Company reached an agreement on
a pre-existing insurance coverage dispute and received a settlement payment of
$1.75 million.

33
34

11. SUBSEQUENT EVENT

In January 2001, the Company entered into a patent licensing agreement
with Chugai Pharmaceutical, Co., Ltd. (Chugai) and Molecular Biosystems, Inc.,
(MBI). The agreement gives Chugai and MBI non-exclusive rights under certain
Sonus patents to manufacture and sell Optison, an ultrasound contrast agent, in
Japan, South Korea, and Taiwan.

The Company received in January 2001 an initial non-refundable license
fee of $1.0 million and will receive a second $1.0 million payment in June 2001.
The second $1.0 million payment will be considered non-refundable if any claims
of a Sonus Japanese patent application are allowed within a period of two years
from the signing of the agreement. If no claims are allowed on the Sonus
Japanese patent application within this two-year period, the Company will repay
the second $1.0 million payment without interest. In addition to the $2.0
million license fee payments, Chugai and MBI will pay royalties to the Company
on sales of Optison if and when the product is approved for marketing in the
territories covered under the patent license agreement.

34
35

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required hereunder is incorporated by reference from our
Proxy Statement to be filed in connection with its 2001 Annual Meeting of
Stockholders.

ITEM 11. EXECUTIVE COMPENSATION

The information required hereunder is incorporated by reference from our
Proxy Statement to be filed in connection with its 2001 Annual Meeting of
Stockholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required hereunder is incorporated by reference from our
Proxy Statement to be filed in connection with its 2001 Annual Meeting of
Stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required hereunder is incorporated by reference from our
Proxy Statement to be filed in connection with its 2001 Annual Meeting of
Stockholders.

35
36

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) (1) Financial Statements

The financial statements filed as a part of this Report are listed on
the "Index to Financial Statements" on Page 20.

(2) All schedules are omitted because they are not required or the
required information is included in the financial statements or notes
thereto.

(3) Exhibits

INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ------------------------------------------------------------------------ ---------

3.2 Amended and Restated Certificate of Incorporation of the Company. (1)
3.3 Certificate of Amendment of Certificate of Incorporation of the Company. (12)
3.4 Amended and Restated Bylaws of the Company. (1)
4.1 Specimen Certificate of Common Stock. (1)
4.2 Rights Agreement, dated as of August 23, 1996, between the Company and (3)
U.S. Stock Transfer Corporation.
10.14 Contrast Agent Development and Supply Agreement dated May 6, 1993 by and (1)
between the Company and Abbott Laboratories, Inc. (portions omitted
pursuant to Rule 406 of the 1933 Act).
10.14A Amendment to Contrast Agent Development and Supply Agreement dated (1)
August 22, 1995 by and between the Company and Abbott Laboratories, Inc.
(portions omitted pursuant to Rule 406 of the 1933 Act).
10.18 Lease Agreement dated January 17, 1994 between the Company and WRC (1)
Properties, Inc.
10.18A Amendment 2 dated October 28, 1997 to Lease Agreement dated January 17, (10)
1994.
10.18B Amendment 3 dated October 15, 1998 to Lease Agreement dated January 17, (10)
1994.
10.19 Form of Indemnification Agreement for Officers and Directors of the (1)
Company.
10.21 Loan and Security Agreement dated August 11, 1995 by and between the (1)
Company and Silicon Valley Bank.
10.21A Loan Modification Agreement dated September 10, 1997 to Loan and Security (10)
Agreement by and between the Company and Silicon Valley Bank.
10.21B Loan Modification Agreement dated August 31, 1998 to Loan and Security (10)
Agreement by and between the Company and Silicon Valley Bank.
10.21C Loan Modification Agreement dated August 30, 1999 to Loan and Security (14)
Agreement by and between the Company and Silicon Valley Bank.
10.25 Agreement between Abbott Laboratories, Inc. and the Company, dated May (5)
14, 1996 (portions omitted pursuant to Rule 24b-2).
10.26 Third Amended and Restated Registration Rights Agreement dated as of May (6)
15, 1996.
10.28 International License Agreement, dated October 1, 1996, by and between (7)
Abbott Laboratories, Inc. and the Company (portions omitted pursuant to
Rule 24b-2).

36
37

INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION LOCATION
- ----------- ------------------------------------------------------------------------ ---------

10.29 Commercial Supply Agreement dated March 6, 1998. (8)
10.33 First Amendment to Agreement by and between Abbott Laboratories and (11)
Sonus Pharmaceuticals, Inc. dated January 31, 1999.
10.34 First Amendment to International License Agreement by and between (11)
Abbott International, Ltd. and Sonus Pharmaceuticals, Inc. dated
January 31, 1999.
10.35 Securities Purchase Agreement between Abbott Laboratories and Sonus (11)
Pharmaceuticals, Inc. dated January 31, 1999.
10.36 License Agreement by and between Nycomed Amersham AS and the Company (13)
dated August 31, 1999.
10.38 Mutual Recission Agreement dated October 11, 1999 by and between the (14)
Company and Abbott International Ltd.
10.40 Amendment to the First Amendment to Agreement by and between Abbott (15)
Laboratories and the Company, dated February 3, 2000.
10.43 Loan and Security Agreement by between Sonus Pharmaceuticals, Inc. and (17)
Silicon Valley Bank, dated September 6, 2000.
10.45 License Agreement by and between Chugai Pharmaceutical Co. Ltd., (18)
Molecular Biosystems, Inc., and the Company, dated December 22, 2000.
10.46 Termination Agreement by and between Abbott Laboratories and the (18)
Company, dated December 14, 2000.
23.1 Consent of Ernst & Young LLP, Independent Auditors. (18)
24.1 Power of Attorney (included on the Signature Page of this Annual (18)
Report on Form 10-K).
COMPENSATION PLANS AND ARRANGEMENTS
10.1 Sonus Pharmaceuticals, Inc. Incentive Stock Option, Nonqualified Stock (1)
Option and Restricted Stock Purchase Plan -- 1991 (the "1991 Plan"),
as amended.
10.2 Form of Incentive Stock Option Agreement pertaining to the 1991 Plan. (1)
10.3 Form of Nonqualified Stock Option Agreement pertaining to the 1991 Plan (1)
10.4 Form of Restricted Stock Purchase Agreement pertaining to the 1991 (1)
Plan.
10.5 Sonus Pharmaceuticals, Inc. 1995 Stock Option Plan for Directors (the (1)
"Director Plan").
10.6 Form of Stock Option Agreement pertaining to the Director Plan. (1)
10.7 1999 Nonqualified Stock Incentive Plan (the "1999 Plan"). (12)
10.8 Form of Stock Option Agreement pertaining to the 1999 Plan. (12)
10.9 Form of Restricted Stock Purchase Agreement pertaining to the 1999 (12)
Plan.
10.22 Sonus Pharmaceuticals, Inc. Employee Stock Purchase Plan. (2)
10.24 Employment Agreement, effective as of January 16, 1996, by and between (12)
the Company and Steven C. Quay, M.D., Ph.D.
10.24A Employment Agreement, effective February 11, 1999, by and between the (12)
Company and Steven C. Quay, M.D., Ph.D.
10.31 Change in Control Agreement for Michael Martino. (9)
10.37 Agreement for Part-Time Employment and Mutual Release, effective (14)
August 25, 1999 by and between the Company and Steven C. Quay, M.D.,
Ph.D.
10.39 Change in Control Agreement for John T. Flaherty, M.D. (15)
10.41 2000 Stock Incentive Plan (the "2000 Plan"). (16)
10.42 Form of Stock Option Agreement pertaining to the 2000 Plan. (16)
10.44 Change in Control Agreement for Richard J. Klein. (17)

37
38

(1) Incorporated by reference to the referenced exhibit number to the
Company's Registration Statement on form S-1, Reg. No. 33-96112.

(2) Incorporated by reference to Exhibit 4.7 to the Company's Registration
Statement on form S-1, Reg. No. 33-80623.

(3) Incorporated by reference to the Company's Registration Statement on form
8-A, dated August 23, 1996.

(4) Incorporated by reference to the referenced exhibit number to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
March 31, 1996.

(5) Incorporated by reference to the referenced exhibit number to the
Company's Current Report on Form 8-K dated May 14, 1996.

(6) Incorporated by reference to the referenced exhibit number to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1996.

(7) Incorporated by reference to the referenced exhibit number to the
Company's Current Report on Form 8-K dated October 1, 1996.

(8) Incorporated by, reference to the referenced exhibit number to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
March 31, 1998.

(9) Incorporated by, reference to the referenced exhibit number to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1998.

(10) Incorporated by reference to the referenced exhibit number to the
Company's Annual Report on form 10-K for the period ended December 31,
1998.

(11) Incorporated by reference to the referenced exhibit number to the
Company's Current Report on Form 8-K dated February 3, 1999.

(12) Incorporated by reference to the referenced exhibit number to the
Company's Quarterly Report on form 10-Q for the quarterly period ended
March 31, 1999.

(13) Incorporated by reference to the referenced exhibit number to the
Company's Current Report on Form 8-K dated September 28, 1999.

(14) Incorporated by, reference to the referenced exhibit number to the
Company's Quarterly Report on Form 10-QA for the quarterly period ended
September 30, 1999.

(15) Incorporated by reference to the referenced exhibit number to the
Company's Annual Report on form 10-K for the period ended December 31,
1999.

(16) Incorporated by reference to the referenced exhibit number to the
Company's Quarterly Report on form 10-Q for the quarterly period ended
June 30, 2000.

38
39

(17) Incorporated by reference to the referenced exhibit number to the
Company's Quarterly Report on form 10-Q for the quarterly period ended
September 30, 2000.

(18) Filed herewith.

(b) Reports on Form 8-K

The Company filed the following report on Form 8-K during the quarter
ended December 31, 2000.

1. The Registrant filed a report on Form 8-K on October 19, 2000 in
connection with the announcement to refocus the Company on the
development of its drug delivery and blood substitute products. At the
same time, the Company announced that it had withdrawn the New Drug
Application for its ultrasound contrast product and discontinued
further clinical activity related to ultrasound contrast development.

39
40

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Bothell,
State of Washington, on March 7, 2001.

SONUS PHARMACEUTICALS, INC.

Dated: March 7, 2001 By: /s/ Michael A. Martino
---------------------------------
Michael A. Martino
President, Chief Executive
Officer and Director
(Principal Executive Officer)

We, the undersigned directors and officers of Sonus Pharmaceuticals,
Inc., do hereby constitute and appoint Michael A. Martino and Richard J. Klein,
or either of them, our true and lawful attorneys and agents, with full powers of
substitution to do any and all acts and things in our name and on behalf in our
capacities as directors and officers and to execute any and all instruments for
us and in our names in the capacities indicated below, which said attorneys and
agents may deem necessary or advisable to enable said corporation to comply with
the Securities Exchange Act of 1934, as amended, and any rules, regulations and
requirements of the Securities and Exchange Commission, in connection with this
Annual Report on Form 10-K, including specifically but without limitation, power
and authority to sign for us or any of us in our names in the capacities
indicated below, any and all amendments thereto; and we do hereby ratify and
confirm all that said attorneys and agents, shall do or cause to be done by
virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.

/s/ Michael A. Martino President, Chief Executive March 7, 2001
- --------------------------------------- Officer and Director (Principal
Michael A. Martino Executive Officer)

/s/ Richard J. Klein Vice President of Finance and March 7, 2001
- --------------------------------------- Chief Financial Officer
Richard J. Klein (Principal Financial and
Accounting Officer)

/s/ George W. Dunbar, Jr. Director, Co-Chairman of March 7, 2001
- ---------------------------------------- the Board of Directors
George W. Dunbar, Jr.

/s/ Christopher S. Henney, Ph.D., D. Sc. Director March 7, 2001
- ----------------------------------------
Christopher S. Henney, Ph.D, D. Sc.

/s/ Robert E. Ivy Director, Co-Chairman of March 7, 2001
- ---------------------------------------- the Board of Directors
Robert E. Ivy

/s/ Dwight Winstead Director March 7, 2001
- ----------------------------------------
Dwight Winstead