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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, 1996

or

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

For the transition period from __________ to __________

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, S.E., SUITE 102, BOTHELL, WASHINGTON 98021
(Address of principal executive offices)

(206) 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 28, 1997, the aggregate market value of the registrant's Common
Stock held by non-affiliates of the Registrant was $180,109,227 based on the
closing sales price of $28.875 per share of the Common Stock as of such date, as
reported by The Nasdaq National Market. As of February 28, 1997, 8,531,157
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 1997 Annual Meeting of
Stockholders to be held June 18, 1997 are incorporated by reference in Items 10,
11, 12, and 13 of Part III hereof.





Page 1 of 48 Pages
Exhibit Index appears on Page 43
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PART I
ITEM 1. BUSINESS

SONUS Pharmaceuticals, Inc. ("SONUS" or the "Company")is engaged in the
research and development of proprietary contrast agents for use in ultrasound
imaging. Ultrasound imaging is a widely used, non-invasive, cost-effective
technique to examine soft tissues, internal body organs and blood flow in the
body. In contrast to other imaging modalities, ultrasound imaging is currently
largely performed without the use of a contrast agent. The Company's principal
product under development, EchoGen(R) Emulsion, is a contrast agent designed to
be administered to a patient prior to performing ultrasound studies to improve
image quality. Based upon the Company's clinical trials to date involving over
1,000 people, the Company believes that EchoGen will significantly improve the
effectiveness of ultrasound imaging by increasing the reflectivity differential
between the bloodstream which carries the contrast agent and the surrounding
soft tissue being imaged. A New Drug Application ("NDA") was submitted to the
U.S. Food and Drug Administration ("FDA") in August 1996 and a Marketing
Authorization Application ("MAA") was submitted to the European Medicines
Evaluation Agency ("EMEA") in November 1996 for the approval to market EchoGen
in the U.S. and the European Union ("E.U."), respectively. See "Certain Factors
That May Affect the Company's Business and Future Results."

EchoGen is a stable, liquid emulsion, based on the Company's proprietary
PhaseShift(TM) technology, which changes from microscopic liquid droplets of
dodecafluoropentane ("DDFP") to gas microbubbles during administration. The
Company believes EchoGen offers significant benefits as a contrast agent
including (i) small bubble size which allows EchoGen to pass through capillaries
in the lungs and other organs, (ii) a long half-life which will allow physicians
sufficient time to complete an EchoGen-enhanced ultrasound study, and (iii)
intensity of the sound wave reflectivity or echogenicity providing for better
quality images.

OVERVIEW

Medical imaging to diagnose and treat disease states and conditions has been
an important element of medical treatment since the introduction of x-ray
technology. As imaging technology has advanced in recent decades, applications
of medical imaging have expanded to address increasingly complex disease states
and conditions involving soft tissues and internal body organs. For example,
medical imaging currently plays an important role in the diagnosis and treatment
of disease states and conditions affecting the vascular and nervous systems and
major organs such as the heart, kidney and liver. In 1994, over 100 million soft
tissue and organ imaging studies were performed in the United States.

The most widely used imaging modalities for soft tissues and organs include
computed tomography ("CT"), magnetic resonance imaging ("MRI"), nuclear
medicine, x-ray angiography and ultrasound. Each medical imaging modality
requires specialized equipment and has different patterns of use and
applications. The imaging modality to be used is selected based on a variety of
factors, including the particular disease state or condition to be studied,
image quality, the cost of the study and the status of the patient in the
patient management cycle. The use of image-enhancing contrast agents is crucial
to some imaging modalities, and has greatly clarified images in others, and in


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general has broadened the number of imaging applications. A contrast agent is
a substance that is administered to the patient, either orally, intravenously or
by other routes of injection, to enhance the image by increasing the visibility
of the blood vessels or body cavities, as well as other tissues and organs
containing the contrast agent. In 1994, 36 million imaging studies utilizing
contrast agents were performed in the United States with an estimated cost of
$1.6 billion attributable to the contrast agents.

ULTRASOUND IMAGING

Ultrasound was introduced for medical imaging purposes in the late 1950s as
a safe, non-invasive and relatively inexpensive method to provide images of most
major soft tissues and organs. Initially, ultrasound was used to image the
general shape, size and structure of internal soft tissues and organs. With
advances in technology, ultrasound imaging has been used to image blood flow in
soft tissues, organs and the vascular system as a means of determining the
presence of a disease state or condition. Based on published reports, the
Company believes that over 50 million ultrasound imaging procedures are
performed annually in the United States, of which a majority are for radiology
and cardiology indications. Approximately 18 million radiology ultrasound
studies were performed in the United States in 1994 at a typical cost to payors
of approximately $100 per study to image abdominal tissues and organs. In an
ultrasound study for radiology indications, the physician attempts to image soft
tissues and organs and to identify abnormalities and obstructions of the major
veins and arteries of the body. In addition, approximately 14 million ultrasound
studies were performed in the United States in 1994 for cardiac function
indications at a typical cost to payors of approximately $200. In an ultrasound
study for cardiac function indications, otherwise known as echocardiography, the
physician attempts to obtain an enhanced image of the internal heart structure,
including the valves and chambers, to diagnose coronary artery disease, valvular
disease and congenital heart defects. The average cost of an ultrasound system
is approximately $110,000, and there are approximately 43,000 ultrasound systems
installed in the United States in substantially all hospitals and clinics and in
many physicians' offices.

Ultrasound systems use low-power, high-frequency sound waves to produce
real-time images. The sound waves emitted by the ultrasound transducer, which is
placed on the skin or in a body cavity near the targeted area, are reflected by
tissues and fluids, thus allowing the physician to view, characterize and define
tissues and organs. The reflected sound waves, or echoes, are received and
processed by the ultrasound system and displayed in real-time on the system's
monitor. The intensity of the echoes received by the ultrasound system is
proportional to the acoustical reflectivity of the tissue or fluid. In standard
ultrasound imaging, known as grayscale for radiology applications or
two-dimensional ("2D") for cardiology applications, the physician can diagnose,
treat and monitor disease states and conditions by analyzing the relative
shading of tissues or organs.

In 1984, color Doppler ultrasound system enhancements were introduced that
utilize the principle that the frequency of sound waves reflected by moving
objects is altered in proportion to their velocity (a Doppler frequency shift).
These enhancements allow physicians to make a hemodynamic assessment (the study
of blood circulation through the body) of the patient based on the direction and
speed of blood flow through the body as well as in the chambers and valves of
the heart. However, since the velocity of blood flow measured by the Doppler
ultrasound transducer is


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dependent upon the angle of the blood vessel in relation to skin surface, the
use of Doppler enhancements for certain applications, such as the imaging of the
renal artery, which is parallel to the skin, has been limited. More recently,
the use of newly introduced "power" Doppler systems, which are capable of
measuring the variation of the intensity of signals that have undergone a
Doppler frequency shift, has improved the diagnostic utility of ultrasound
imaging systems by reducing much of the angle dependence of earlier generation
Doppler systems and by allowing the imaging of certain vessels and tissues that
could not be imaged effectively with earlier systems.

Despite such advancements in ultrasound equipment, ultrasound imaging
produces images that are less defined and more difficult to interpret than
images produced by other imaging modalities such as CT and MRI. For example, the
depth and angle of certain organs or arterial vessels within the body limit the
use of ultrasound imaging because of the inability to receive echoes from deep
within the body and the inability to see the entire length of certain arterial
vessels such as the renal artery. In addition, the low acoustic density and
reflectivity of blood also limits the use of ultrasound imaging for vascular or
perfusion imaging. Accordingly, while anatomical structures may be viewed
effectively using ultrasound imaging, physiologic functions of the body, such as
blood flow, are not monitored easily. As a further limitation, the lower
velocity of blood flow in certain vessels of the body makes it difficult for
ultrasound systems to detect Doppler frequency shift signals. For example,
infections (absesses) and tumors, which are characterized by lower velocity
blood flow, may not be detected by today's ultrasound systems. As a result, many
ultrasound procedures are non-diagnostic for technical reasons because the
physician is not able to make a definitive diagnosis with the information that
is provided by the ultrasound image.

ULTRASOUND CONTRAST AGENTS

While the use of contrast agents in diagnostic imaging is well established
and broadly utilized in other imaging modalities, there has been a lack of
commercially available ultrasound contrast agents. For many years, scientists
have attempted to develop such agents focusing primarily on methods to
encapsulate air microbubbles that reflect the sound waves generated by the
ultrasound system. To date, the development of an effective contrast agent has
been hampered by the lack of persistence of the microbubbles, or by the
challenge that microbubbles were too fragile to pass through the lungs or too
large to pass through small blood vessels. Persistence, size and stability of
microbubbles are important characteristics given that, once injected in the
bloodstream, the contrast agent must pass through the lungs, where gas exchange
can eliminate the microbubbles, before reaching the left chambers of the heart
and before circulating throughout the vascular system.

Radiology Indications. The Company believes that the development of an
effective ultrasound contrast agent could improve the capabilities of ultrasound
imaging for radiology indications, including diagnostic imaging of kidney, liver
and peripheral vascular diseases, by increasing the visibility of blood flow and
blood flow patterns, and by improving the detection of small lesions or
structures deep within the body, where acoustic energy is lost as the
transmitted acoustical beam passes through the body. The Company is developing
EchoGen for both macrovascular and microvascular indications. In macrovascular
indications (the diagnosis of disease states and conditions of the major
arteries and veins of the body), an effective ultrasound contrast agent may aid
in the detection of strokes and pre-stroke conditions through visualization of
intracranial (within


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the skull) blood vessels, atherosclerosis, vascular graft patency and peripheral
vascular thrombosis, a major cause of pulmonary emboli (blood clots in the
pulmonary artery and the lungs). For microvascular indications (the diagnosis of
disease states and conditions through the analysis of patterns of small vessel
blood flow), ultrasound contrast agents may allow the physician to identify
lesions, tumors or other diseases in the liver (e.g., adenomas and hemangiomas),
kidneys and other tissues and organs. There are no FDA approved ultrasound
contrast agents for radiology indications although the Company believes that
several are in clinical trials.

Cardiology Indications. For cardiology indications, the Company believes
that an effective ultrasound contrast agent could enable physicians to assess
the function of the cardiovascular system as well as myocardial perfusion. An
effective ultrasound contrast agent could improve echocardiography by allowing
physicians to use left ventricular chamber opacification to assist cardiac
function analysis regionally, through wall motion analysis and globally, through
ejection fraction measurements. Further, an ultrasound contrast agent, which is
persistent and able to pass through small blood vessels, could allow physicians
to assess myocardial perfusion to differentiate functioning cardiac tissue from
ischemic (blood deficient) and infarcted (dead) tissue. The use of exercise
stress to increase the work load of the heart before contrast-enhanced
echocardiography could also assist the differentiation of ischemia from
infarction. In 1994, the FDA approved the first ultrasound contrast agent for
use as an aid for the enhancement of images of ventricular chambers and improved
endocardial (inner heart chamber) border definition in patients with suboptimal
echoes undergoing certain cardiac function studies. There are no other FDA
approved ultrasound contrast agents for cardiac function and none for myocardial
perfusion indications, although the Company is aware of one other agent has been
submitted to the FDA for approval for cardiac function indications which has
received a recommendation for approval from the FDA's Radiological Devices Panel
and several others are in clinical trials.

TECHNOLOGY AND PRODUCTS

The Company has focused its research and development efforts on the
development of EchoGen, which produces small microbubbles in the bloodstream
that persist long enough to permit completion of diagnostic studies and which
can be manufactured and packaged with an acceptable shelf life. To develop
EchoGen, the Company initially focused its efforts on identifying a chemical
agent that exhibited the desired properties of high persistence and the ability
to form small microbubbles when injected. The Company measures the persistence
of microbubbles by a standard the Company has defined as a "Q factor." By
definition, a Q factor of one equals the length of time an air bubble three
microns in diameter remains undissolved in the blood. After studying over 400
chemicals, primarily fluorocarbons, the Company selected dodecafluoropentane
("DDFP") to develop as a potential contrast agent. DDFP has a Q factor of
approximately 200,000, which permits it to persist in the blood for over 10
minutes. In addition, DDFP has a boiling point of 28.5(0) C (approximately 83(0)
F), which allows it to exist as a liquid at room temperature or below but change
into a gas when administered to a patient. This process, which the Company calls
the PhaseShift process, leads to microbubbles in the patient's bloodstream.
Through its research and development efforts, and utilizing its proprietary
technology, the Company developed EchoGen. EchoGen is a stable, 2% emulsion of
DDFP, that through the PhaseShift process creates microbubbles that are small
enough to pass through the lungs and circulate in the vascular system. EchoGen
is packaged


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in vials and easily administered by the physician with a single peripheral
venous injection prior to or during the ultrasound study. Based on studies
conducted to date, the Company believes that EchoGen could have a useful shelf
life in excess of twelve months at room temperature.

The Company believes that EchoGen has the following characteristics, which
the Company believes will provide it with an advantage over competing ultrasound
contrast agents:

- Long Persistence. Based on results from clinical trials, the Company
believes that EchoGen is sufficiently persistent to complete typical
radiology and cardiology studies. The period of persistence of EchoGen
varies widely depending upon numerous factors. In radiology indications
where Doppler is the primary imaging modality, based on Phase 3 clinical
trials, EchoGen persisted on average for approximately fifteen minutes.
In Phase 3 studies of cardiac function, where 2D is the preferred
imaging modality, EchoGen persisted on average for approximately four
minutes.

- Small Microbubble Size. Following administration, EchoGen microbubbles
are small enough to pass through the lungs and circulate in the vascular
system, enabling imaging of small blood vessels and tissues. In
addition, the small microbubble size may enable EchoGen to penetrate the
microvasculature of the heart facilitating myocardial perfusion imaging.

- Sound Wave Reflectivity. EchoGen exhibits significant sound wave
reflectivity, thereby improving image quality and allowing imaging of
vessels or organs that are deep within the body.

- Safety. Results from preclinical and clinical trials conducted to date
indicate that DDFP, the active ingredient of EchoGen, is substantially
excreted from the body through the lungs within 25 minutes of
administration without metabolic changes. Some patients experience
transient side effects such feeling of warmth, headache and taste
perversion.

STATUS OF CLINICAL TRIALS

The Company submitted an Investigational New Drug application ("IND") to the
FDA in September 1993 and commenced clinical trials in January 1994. The Company
uses academic institutions and clinical research organizations to conduct and
monitor its clinical trials for radiology and cardiology indications. Under the
Company's agreements with Abbott Laboratories ("Abbott"), SONUS is responsible
for conducting clinical trials and obtaining regulatory clearances in the U.S.
and E.U. Abbott is responsible for conducting clinical trials and obtaining all
regulatory clearances in all other countries of the world, excluding Japan and
nine other countries in the Pacific Rim. As part of the Company's agreement with
Daiichi Pharmaceutical Co., Ltd ("Daiichi"), Daiichi is responsible for
conducting clinical trials and obtaining all regulatory clearances in Japan and
nine other countries in the Pacific Rim.




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RADIOLOGY INDICATIONS

In 1995, the Company performed a pivotal, 253 patient Phase 3 clinical
study in the United States at 18 sites to evaluate radiology indications for
EchoGen, specifically contrast enhancement and facilitated visualization of
anatomic structures, lesions and blood flow during studies of the liver, kidney
and peripheral vasculature. The study design included a placebo-control,
randomized single administration and a dosage of 0.05 mL/kg with the results of
the study also read by blinded investigators. In the study, based on 152
patients who were studied using the final formulation, EchoGen-enhanced or
facilitated visualization of abnormal structures, lesions or blood flow patterns
in 94% of the patients. The average duration of contrast enhancement provided by
EchoGen in color Doppler studies was over 15 minutes. In addition, EchoGen
increased diagnostic confidence in 54% of the studies; reduced non-diagnostic
studies by 46%; provided the primary information needed for the diagnosis in 31%
of patients; and changed the diagnosis in 12% of patients. Over 42% of the
examinations were completed more quickly with EchoGen. EchoGen prevented further
studies in 13% of patients and assisted in the therapeutic management of
patients 18% of the time.

CARDIOLOGY INDICATIONS

From late 1995 to early 1996, the Company performed a pivotal 258 patient Phase
3 clinical study at 19 sites in the United States to evaluate the efficacy of
EchoGen in improving the use of echocardiography to assess cardiac disease in
patients who previously had a suboptimal (non-diagnostic) echo exam. EchoGen
provided blood pool enhancement or left ventricular opacification in 90% of
patients, improved endocardial border delineation in 88% of patients, and
improved wall motion assessment in 88% of patients. These results lead to an
increased diagnostic confidence in 76% of the patients, disclosed findings not
present at baseline in 63% and prevented the need for further studies in 19% of
patients. EchoGen salvaged suboptimal echoes in 50% of the patients.

SAFETY RESULTS

In clinical trials in 560 patients utilizing the current formulation, there
were no findings that the Company believes would suggest a toxicologic or
pharmacologic response to the administration of EchoGen. There were no effects
on organ function, blood chemistry, hematologic or urinalysis results. Adverse
events that were considered possibly, probably or definitely related to EchoGen
administration were experienced by 6.3% of patients. Those events occurring in
greater than 1% of patients include feeling of warmth (2.5%), headache (1.3%)
and taste perversion (1.1%). The events were usually mild (90%), occurred within
30 minutes of injection, generally required no treatment and left no sequelae.

ADDITIONAL STUDIES

In 1996, the Company performed a Phase 2 trial in Europe that enrolled 20
patients who underwent contrast enhanced ultrasound studies of the breast. The
results suggest that EchoGen-enhanced ultrasound appears to be useful in
distinguishing malignant from benign breast lesions after suspicious lumps are
discovered by mammography examination.



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In October 1996, the Company initiated a Phase 2 trial aimed at improving
the detection of prostate cancer by contrast ultrasound. Patients with elevated
PSA (prostate specific antigen) levels and/or abnormal rectal examinations who
have been referred for biopsy will receive a contrast transrectal ultrasound
examination ("TRUS") using EchoGen. The purpose of the trial will be to assess
whether EchoGen enhanced TRUS can aid in the diagnosis of prostate cancer. Up to
70 patients are expected to be enrolled in this study; 50 have been enrolled to
date.

In January 1997, the Company initiated a multicenter, randomized, blinded
Phase 3 trial which will compare the discriminatory power of contrast
echocardiography with EchoGen and nuclear medicine scans in diagnosing
myocardial infarction by assessing perfusion deficits in the myocardium. The
success of this trial may foster new options for the non-invasive diagnosis of
coronary artery disease and potentially open up a new patient population for
echocardiography. It is planned to enroll a minimum of 200 patients at 10
participating institutions.

In February 1997, a Phase 1 trial in healthy volunteers undergoing stress
echocardiography with EchoGen was commenced in the U.K. This study will evaluate
the safety and contrast effect of EchoGen when used in conjunction with both
exercise stress and pharmacologic stress in a total of 36 volunteers.

The commercialization of EchoGen for new indications, beyond those
contained in the NDA, will require approval of separate regulatory submissions
based on extensive additional clinical testing. There can be no assurance that
future clinical trial results will demonstrate any efficacy or will be adequate
for regulatory approval. See "Certain Factors That May Affect the Company's
Business and Future Results".

MARKETING AND DISTRIBUTION

The Company's strategy is to market EchoGen through arrangements with third
parties in the United States and the rest of the world.

The Company and Abbott have formed a strategic alliance for the marketing,
manufacturing and distribution of EchoGen in the U.S., Europe, Latin America,
Canada, Africa, Middle East and certain countries in the Pacific Rim. Under the
Abbott alliance the Company has the responsibility to provide technical
marketing support during the launch and commercialization of EchoGen in the U.S.
The Company and Daiichi have formed a strategic alliance for the marketing,
manufacturing and distribution of EchoGen in Japan and nine other countries in
the Pacific Rim. See "Strategic Alliances." There can be no assurance that the
Company's strategic relationships will be successful.

MANUFACTURING

The Company has utilized three outside FDA-certified organizations to
manufacture EchoGen under current Good Manufacturing Practices ("GMP")
requirements for the Company's use in preclinical and clinical studies and
produces non-GMP batches of EchoGen at its facilities in Bothell, Washington as
part of the Company's ongoing development of the product.



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The Company has entered into an agreement with Abbott pursuant to which
Abbott has agreed to scale-up, manufacture and sell EchoGen to the Company at a
fixed price, subject to increases in the producer's price index, packaged in
final dosage form for a period of five years from the date of FDA approval,
subject to automatic renewal unless otherwise terminated by either party with 12
months' prior notice. Abbott has produced EchoGen in commercial-scale lots for
use by the Company in its Phase 3 clinical trials in the United States. The
product is manufactured from raw materials supplied to Abbott by the Company.
Under the agreement, the Company must purchase minimum annual quantities of
EchoGen if FDA approval is received, and the Company has retained the right to
manufacture or to have a third party manufacture a portion of its requirements.
The inability of Abbott or any alternative contract manufacturer to manufacture
and supply the Company with EchoGen would have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Strategic Alliances" and "Certain Factors That May Affect the Company's
Business and Future Results."

The active chemical ingredient in EchoGen, DDFP, is manufactured by a
limited number of vendors worldwide. The Company has entered into supply
agreements with two such vendors. The inability of these vendors to supply
medical-grade DDFP to the Company could delay the Company's manufacture of, or
cause the Company to cease the manufacturing of, EchoGen. Any such delay or
cessation could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company believes the other
raw materials of EchoGen are readily available from various suppliers.

RESEARCH AND DEVELOPMENT

The Company currently conducts research and development activities at its
facilities in Bothell, Washington. The Company also funds certain research,
preclinical studies and clinical development efforts at universities and other
institutions. The Company's primary research and development efforts are
directed at the development and application of EchoGen, including clinical
trials. In addition, the Company is conducting research in additional ultrasound
imaging agents and in other applications of its proprietary technology including
pulmonary and intravascular drug delivery. None of the Company's products other
than EchoGen have reached the human clinical phase of development and there can
be no assurance that the Company will be successful in advancing such products
to the human clinical phase. The Company incurred expenses of approximately
$11.2 million, $7.2 million and $5.8 million on research and development in
fiscal 1996, 1995 and 1994, respectively.

STRATEGIC ALLIANCES

The Company's strategy is to enter into strategic alliances to facilitate
the development, manufacture and distribution of EchoGen. To date, the Company
has entered into a collaborative agreement with Daiichi with respect to the
marketing and distribution of EchoGen in certain Pacific Rim countries and
agreements with Abbott for the manufacturing, marketing and distribution of
EchoGen in the rest of the world.




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ABBOTT LABORATORIES

In May 1993, the Company and Abbott, a worldwide manufacturer of health
care products, entered into a supply agreement relating to EchoGen. Under this
agreement, Abbott has agreed to develop the manufacturing process, assist the
Company in FDA submissions and manufacture and sell the product to the Company
for an initial five-year period after FDA approval, subject to automatic renewal
unless otherwise terminated by either party with one year's prior notice. Abbott
is supplying the Company with most of its requirements for EchoGen clinical
trials. The Company has agreed to purchase a portion of the United States
commercial requirements of EchoGen upon receipt of FDA approval, subject to
certain annual minimum purchase requirements at a fixed price, subject to
increases in the producer's price index.

In May 1996, the Company entered into additional agreements with Abbott for
the marketing and sale of EchoGen in the U.S. The Company has primary
responsibility for clinical development, regulatory affairs, and medical and
technical marketing support of EchoGen, and Abbott has primary responsibility
for manufacturing and U.S. marketing and sales. The Company has retained certain
co-promotion rights to EchoGen in the U.S. Under the agreements, Abbott has
agreed to pay the Company $31.0 million in license, clinical support and
milestone payments, of which the Company had received $11.0 million as of
December 31, 1996. After the FDA has approved the marketing of EchoGen, for
which there can be no assurance, the Company will receive 47 percent of net
EchoGen revenues in the U.S. - a portion of which the Company must use to fund
its responsibilities under the agreement. Subject to early termination, the
agreement spans the later of the life of the patents relating to EchoGen or the
introduction of a generic equivalent by a third party. Abbott can acquire the
rights to certain additional indications for EchoGen by making additional
clinical support payments. In addition, Abbott paid $4.0 million for five year
warrants to acquire 500,000 shares of the Company's common stock at an exercise
price of $16.00 per share.

In October 1996, the Company expanded its strategic alliance with Abbott by
signing an agreement for EchoGen that extends Abbott's licensed territory to
include Europe, Latin America, Canada, Middle East, Africa and certain
Asia/Pacific Rim countries. Under the agreement, Abbott has agreed to pay the
Company $34.6 million in payments conditioned upon the achievement of certain
regulatory and commercialization milestones, of which $12.6 million may be
offset against future royalty payments. As of December 31, 1996, the Company had
received $2.0 million under the agreement. After applicable regulatory agencies
have approved the marketing of EchoGen, for which there can be no assurance, the
Company will receive a royalty that ranges from 36% to 42% of EchoGen net sales
based on aggregate annual sales in the territory. Subject to early termination,
the agreement spans the later of the life of the patents relating to EchoGen in
the countries of the territory, ten years from the date of the agreement, or the
introduction of a generic equivalent by a third party.





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DAIICHI PHARMACEUTICAL CO., LTD.

In April 1993, the Company and Daiichi entered into an option agreement
pursuant to which Daiichi was granted an option to exclusive marketing and
distribution rights to EchoGen in the Pacific Rim countries of Japan, Taiwan,
The Peoples Republic of China, South Korea, Hong Kong, Thailand, Indonesia,
Singapore, Malaysia and the Philippines. Daiichi is a market leader in Japan in
the sale of contrast agents for medical imaging. Under the option agreement, the
exercise of the option was contingent upon, among other factors, the receipt by
Daiichi of certain clinical trial data related to EchoGen. In March 1995,
Daiichi exercised its option and entered into a license agreement with the
Company. Under these agreements, as of December 31, 1996, Daiichi has paid the
Company option and license fees totaling $12.4 million and has agreed to pay an
additional $19.6 million mainly in the form of milestone payments conditioned on
the achievement of certain clinical development, regulatory and
commercialization milestones in Japan. Daiichi is responsible for conducting
clinical trials and obtaining all regulatory clearances in the licensed
territory and has agreed to pay royalties to the Company on sales of the
product. The Company may be required to share with Daiichi any technical
advances relating to EchoGen. To date, Daiichi has only conducted preclinical
studies for EchoGen. Daiichi has the option to manufacture EchoGen, with raw
materials supplied by the Company, for sales in Japan and Taiwan. The term of
the license shall expire upon the later of the expiration of the last to expire
patents or 10 years after the first commercial sale of the EchoGen in the
licensed territory. Daiichi has the right to terminate the license agreement at
any time, in which case all rights to EchoGen revert to the Company and the
Company retains all payments made through the date of termination. In addition,
in November 1993, the Company issued a convertible subordinated debenture to
Daiichi in the principal amount of $3.0 million, which was converted into
462,857 shares of common stock concurrently with the closing of the Company's
initial public offering. There can be no assurance that the Company will receive
any further funding of milestone payments from Daiichi. If this collaboration is
terminated or unsuccessful, it would have a material adverse effect on the
Company's business, financial condition and results of operations.

GOVERNMENT REGULATION

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

The standard process required by the FDA before a pharmaceutical agent may
be marketed in the United States includes (i) preclinical studies, (ii)
submission to the FDA of an application for an 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 an NDA with respect to the
drug, 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


11

12
be registered or licensed by the FDA. Domestic manufacturing establishments are
subject to inspections by the FDA and by other Federal, state and local agencies
and must comply with GMP requirements applicable to the production of
pharmaceutical agents.

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 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 ("IRB") at the institution at which the study will be conducted. The IRB
will consider, among other things, ethical factors, informed consents, the
safety of human subjects and the possible liability of the institution.

Clinical trials typically are conducted in three sequential phases, but the
phases may overlap. In Phase 1, the initial introduction of the drug to humans
or the first studies involving new routes of administration or unusual
conditions, such as stress echocardiography, the drug is tested for safety,
dosage tolerance, metabolism, distribution, excretion and clinical pharmacology
in healthy adult subjects. Phase 2 involves detailed evaluation of safety and
efficacy of the drug in a range of doses in patients with the disease or
condition being studied. Phase 3 trials consist of larger scale evaluation of
safety and efficacy and may require greater patient numbers, 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. The FDA may grant an 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, resubmission of the NDA, and further time consuming 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
as a treatment 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. Results
of these post-marketing programs may prevent or limit the further marketing of
the drug.

In August 1996, the Company submitted an NDA for EchoGen with the FDA based
on the data from the Phase 3 clinical trials for radiology and cardiology
indications. The FDA accepted the NDA as filed in September 1996 and has
scheduled a meeting of Medical Imaging Drugs Advisory Committee for June 30,
1997 to review the NDA. However, no assurance can be given that the Medical
Advisory Committee will recommend that the FDA approve EchoGen or that the FDA
will ultimately approve the NDA.



12

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Sales of pharmaceutical products outside of the United States are subject to
regulatory requirements that vary widely from country to country. In the
E.U., the general trend has been towards coordination of common
standards for clinical testing of new drugs, leading to changes in various
requirements imposed by each EU country.

In November 1996, the Company submitted a Marketing Authorization
Application to the European Medicines Evaluation Agency for EchoGen under the
new centralized "fast track" application procedures whereby a generally binding
approval, valid for all 15 nations of the E.U., is obtained by a single
application. With the single EMEA review, EchoGen may gain approval in the
United Kingdom, Ireland, France, Germany, Italy, Spain, Portugal, Sweden,
Finland, Denmark, Belgium, Luxembourg, the Netherlands, Greece and Austria.

The Committee for Proprietary Medicinal Products ("CPMP") accepted the
application as valid at its December, 1996 meeting. Acceptance means a
preliminary review of the EchoGen MAA determined that the filing contains the
information and studies required by the regulations. However, there can be no
assurance that the CPMP will recommend that EchoGen be approved or that
Marketing Authorization will be granted by the European Agencies.

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

The Company is and may be subject to regulation under state and Federal law
regarding occupational safety, laboratory practices, handling of chemicals,
environmental protection and hazardous substance control. The Company also will
be subject to other present and possible future local, state, federal and
foreign regulation.

COMPETITION

The health care industry is characterized by extensive research efforts and
rapid technological change. Competition in the development of ultrasound imaging
contrast agents is intense and expected to increase. Although there is currently
only one commercially available ultrasound imaging contrast agent in the U.S.
for certain cardiology applications and, to the knowledge of the Company, only
one other ultrasound imaging agent that has been submitted to the FDA for
approval, the Company believes that other medical and pharmaceutical companies
are in clinical trials with ultrasound contrast agents. In addition, there is
one ultrasound contrast agent approved for marketing in certain countries in
Europe for certain cardiology and radiology indications and the Company believes
that several others are in clinical trials. The Company also believes that other
medical and pharmaceutical companies will compete with the Company in areas of
research and development, acquisition of products and technology licenses, and
the manufacturing and marketing of ultrasound contrast agents. The Company
expects that competition in the ultrasound contrast imaging agent field will be
based primarily on efficacy, safety, ease of administration, breadth of approved
indications and physician, healthcare payor and patient acceptance. Although the
Company believes that if and when EchoGen is approved for commercial sale
EchoGen will be well positioned


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to compete successfully, there can be no assurance that the Company will be able
to do so. Many of the Company's competitors and potential competitors have
substantially greater financial, technical and human resources than the Company
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 or foreign
jurisdictional approval for their products more rapidly than the Company. In
addition, other technologies or products may be developed that have an entirely
different approach or means of accomplishing the enhancement of ultrasound
imaging or other imaging modalities that would render the Company's technology
and products uncompetitive or obsolete.

PATENTS AND PROPRIETARY RIGHTS

The Company considers the protection of its technology to be material to its
business. In addition to seeking United States patent protection for many of its
inventions, the Company is seeking patent protection in certain foreign
countries in order to protect its proprietary rights to inventions. The Company
also relies upon trade secrets, know-how, continuing technological innovations
and licensing opportunities to develop and maintain its competitive position.

The Company's success will depend, in part, on its ability to obtain
patents, defend patents and protect trade secrets. The Company has filed patent
applications in the U.S. and 43 foreign countries relating to its principal
technologies. In the United States, eight patents have been issued to the
Company, the claims of which are directed to EchoGen and other ultrasound
contrast media which include gaseous fluorine-containing chemicals. 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 the Company 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 the ability
of the Company to commercialize its products. Furthermore, there can be no
assurance that other companies will not independently develop similar products,
duplicate any of the Company's products or design around patents that may be
issued to the Company. Litigation may be necessary to enforce any patents issued
to the Company 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 the Company and distraction of
the Company's management. An adverse ruling in any litigation or administrative
proceeding could have a material adverse effect on the Company's business,
financial condition and results of operations.

The commercial success of the Company also will depend in part on not
infringing patents issued to competitors. There can be no assurance that patents
belonging to competitors will not require the Company to alter its products or
processes, pay licensing fees or cease development of its current or future
products. Any litigation regarding infringement could result in substantial
costs to the Company and distraction of the Company's management, and any
adverse ruling in any litigation could have a material adverse effect on the
Company's business, financial condition and results of operations. Further,
there can be no assurance that the Company will be able to license other
technology that it may require at a reasonable cost or at all. Failure by the
Company to obtain a license to any technology that it may require to
commercialize its products would have a material


14

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adverse effect on the Company's business, financial condition and results of
operations. In addition, to determine the priority of inventions and the
ultimate ownership of patents, the Company may participate in interference
proceedings conducted by the United States Patent and Trademark Office ("PTO")
or in proceedings before foreign agencies with respect to any of its 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 the Company and distraction of the Company's management.

The Company has obtained registered trademarks for its corporate name and
for EchoGen in the U.S. and certain foreign countries. There can be no assurance
that the registered or unregistered trademarks or trade names of the Company may
not infringe upon third party rights. The requirement to change the trademarks
or trade name of the Company could entail significant expenses and could have a
material adverse effect on the Company's business, financial condition and
results of operations.

The Company also relies on unpatented trade secrets, proprietary know-how
and continuing technological innovation which it seeks to protect, in part, by
confidentiality agreements with its corporate partners, collaborators, employees
and consultants. There can be no assurance that these agreements will not be
breached, that the Company would have adequate remedies for any breach, or that
the Company's trade secrets or know how will not otherwise become known or be
independently discovered by competitors. Further, there can be no assurance that
the Company will be able to protect its trade secrets or that others will not
independently develop substantially equivalent proprietary information and
techniques.

PRODUCT LIABILITY INSURANCE

The clinical testing, manufacturing and marketing of the Company's products
may expose the Company to product liability claims. The Company maintains
liability insurance for claims arising from the use of its products in clinical
trials with limits of $5.0 million per claim and in the aggregate. Although the
Company has never been subject to a product liability claim, there can be no
assurance that the coverage limits of the Company's insurance policies will be
adequate or that one or more successful claims brought against the Company would
not have a material adverse effect upon the Company's business, financial
condition and results of operations. Further, if EchoGen is approved by the FDA
for marketing, 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 the Company's business, financial
condition and results of operations.

HUMAN RESOURCES

At March 1, 1997, the Company had 40 employees, 31 engaged in research,
development, clinical development and manufacturing activities, and 9 in
marketing and administration. The Company considers its relations with its
employees to be good, and none of its employees is a party to a collective
bargaining agreement.




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CERTAIN FACTORS THAT MAY AFFECT THE COMPANY'S BUSINESS AND FUTURE RESULTS

FORWARD-LOOKING STATEMENTS. THIS ANNUAL 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, THAT INVOLVE RISKS AND UNCERTAINTIES. IN ADDITION, THE COMPANY MAY
FROM TIME TO TIME MAKE ORAL FORWARD-LOOKING STATEMENTS. ACTUAL RESULTS ARE
UNCERTAIN AND MAY BE IMPACTED BY THE FOLLOWING FACTORS, AMONG OTHERS, WHICH MAY
CAUSE THE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED IN THE
FORWARD-LOOKING STATEMENT. BECAUSE OF THESE AND OTHER FACTORS THAT MAY AFFECT
THE COMPANY'S OPERATING RESULTS, PAST PERFORMANCE SHOULD NOT BE CONSIDERED AN
INDICATOR OF FUTURE PERFORMANCE AND INVESTORS SHOULD NOT USE HISTORICAL RESULTS
TO ANTICIPATE RESULTS OR TRENDS IN FUTURE PERIODS.

Uncertainty of Governmental Regulatory Requirements; Lengthy Approval
Process. The Company is subject to uncertain governmental regulatory
requirements and a lengthy approval process for its products prior to any
commercial sales of its products. The development and commercial use of the
Company's products is regulated by the FDA, EMEA and comparable foreign
regulatory agencies. The regulatory approval process for new ultrasound contrast
agents, including required preclinical studies and clinical trials, is lengthy
and expensive. The Company has filed for approval of only one product, EchoGen,
with the FDA and the EMEA. The Company's collaborative partners are responsible
for regulatory filings in all other jurisdictions, none of which have been
filed. The Company and its collaborative partners may encounter significant
delays or excessive costs in its efforts to secure necessary approvals. There
can be no assurance that the necessary FDA and EMEA clearances and other foreign
regulatory approvals will be obtained in a timely manner, if at all. The Company
cannot predict if or when any of its products under development will be
commercialized. See "Government Regulations."

Unproven Safety and Efficacy; Uncertainty of Clinical Trials. The Company
currently has only one product, EchoGen, in human clinical trials. Although the
Company has completed the necessary pivotal clinical trials it believes will
satisfy the requirements for approval of EchoGen by the FDA and the EMEA, there
can be no assurance that there will not be the need for additional clinical
trials or that such trials if begun, will demonstrate any efficacy or will be
completed successfully in a timely manner, if at all. See "Status of Clinical
Trials" and "Government Regulations." In addition, the initial filings for
approval of EchoGen covers only certain cardiology and radiology applications.
The Company believes EchoGen may be used in other applications, such as
myocardial perfusion, stress echocardiography, breast and prostate cancer and
has begun clinical studies in those applications. Failure to complete
successfully any of its clinical trials on a timely basis or at all would have a
material adverse effect on the Company's business, financial condition and
results of operations. In clinical trials in humans to date adverse events
related to the final formulation of EchoGen have been infrequent, mild and
transient, including feeling of warmth, headache and taste perversion. There can
be no assurance that more serious side effects will not be encountered in future
trials.

The regulatory requirements for EchoGen are uncertain because the use of
contrast agents for ultrasound imaging is new and has not been extensively
tested in humans. In addition, during the development and clinical testing of
EchoGen, the Company investigated a number of techniques to improve the
administration of EchoGen. Initially, EchoGen was administered by injection
through a medical grade filter to facilitate microbubble formation, and certain
of the Company's Phase 1 and Phase 2 clinical trials were conducted using this
technique. In April 1995, the Company selected an


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administration technique that utilizes hypobaric effects to activate EchoGen
prior to injection. There can be no assurance that the FDA will not require
further extensive testing of EchoGen with this administration technique beyond
the current scope of clinical trials which the Company is performing or
contemplating performing. Such additional clinical testing could entail
regulatory delays, which could have a material adverse effect on the Company's
business, results of operations and financial condition.

Future United States or foreign legislative or administrative actions also
could prevent or delay regulatory approval of the Company's 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 drug's efficacy and side
effects. Results of these post-marketing programs may prevent or limit the
further marketing of the monitored drug.

History of Operating Losses; Uncertainty of Future Financial Results. The
Company's future financial results are uncertain. Although the Company reported
net income for the year ended December 31, 1996, the Company has experienced
significant losses since its inception in 1991, accumulating approximately $17.4
million as of December 31, 1996, and may incur net losses in the foreseeable
future. These losses have resulted primarily from expenses associated with the
Company's research and development activities, including preclinical and
clinical trials, and general and administrative expenses. The Company
anticipates that its operating expenses will increase significantly in the
future as the Company prepares for the anticipated commercialization of EchoGen
and increases its research and development expenditures on new products.
However, there can be no assurance that the Company will obtain regulatory
approvals in order to generate product revenues. If the Company is unable to
generate significant product revenues, it may incur substantial losses.
Moreover, even if the Company generates significant product revenues, there can
be no assurance that the Company will be able to sustain profitability. The
Company's results of operations have varied and will continue to vary
significantly from quarter to quarter and depend on, among other factors, the
timing of fees and milestone payments made by collaborative partners, the
entering into of new product license agreements by the Company and the timing
and costs of clinical trials conducted by the Company.

Uncertainty of Market Acceptance. To date, only one contrast agent for use
in ultrasound imaging has received FDA approval, and the general market
acceptance of contrast agents for ultrasound imaging is uncertain. Market
acceptance of EchoGen may depend upon a number of factors, including efficacy,
safety, price and ease of administration. In addition, market acceptance may
depend upon the Company's ability to educate the medical community on the
diagnostic and clinical efficacy of ultrasound contrast agents in general and
EchoGen in particular and the ability to obtain reimbursement from third party
payors. Market acceptance may also depend upon the clinical utility and cost
effectiveness of EchoGen. There can be no assurance that EchoGen, if
successfully developed and commercialized, will gain market acceptance. Failure
of EchoGen to gain market acceptance would have a material adverse effect on the
Company's business, financial condition and results of operations.

Future Capital Requirements and Uncertainty of Additional Funding. The
Company's development efforts to date have consumed substantial amounts of cash
and the Company has generated only limited revenues from payments received from
its collaborative partners. There can be no assurance that the Company will
continue to receive such payments in the future. The Company expects that its
cash requirements will increase significantly in the future, and there can be no
assurance that such cash requirements will be met on satisfactory terms, if at
all. The Company's capital requirements will depend on numerous factors,
including: the progress of the Company's research and development programs;
progress with preclinical testing and clinical trials; the time and costs
required to gain regulatory approvals; the resources the Company devotes to



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product development; the costs of filing, prosecuting and enforcing patents,
patent applications, patent claims and trademarks; and the costs of developing
the technical marketing support capabilities required under the Company's
agreements with Abbott. The Company may be required to seek additional funds
through debt or equity financing. Issuance of additional equity securities by
the Company could result in substantial dilution to stockholders. If adequate
funds are not available on acceptable terms, the Company will be required to
delay or scale back its product development programs or obtain funds through
arrangements with collaborative partners or others that may require the Company
to relinquish rights to certain of its technologies or products. The Company's
inability to fund its capital requirements would have a material adverse effect
on the Company's business, financial condition and results of operations.

Dependence on Third Parties for Funding, Clinical Development and
Distribution. The Company is dependent on collaborative partners for a variety
of activities, including conducting foreign clinical trials, obtaining required
foreign regulatory approvals and manufacturing, marketing and distributing its
products. The Company has entered into a number of agreements with Abbott for
the manufacturing, marketing and distribution of EchoGen in all territories of
the world except for Japan and nine other Pacific Rim countries. The Company is
dependant on Abbott to fund a substantial portion of the Company's operating
expenses, to manufacture EchoGen for clinical trials and for commercial sale, if
approved, to conduct clinical trials and obtain regulatory approval in its
territories outside of the U.S. and the E.U., and to market and distribute
EchoGen in its territories. There can be no assurance that the collaboration
will continue or be successful. Abbott has the right, in its sole discretion, to
terminate the marketing collaboration at any time with one year's notice to the
Company. The Company has entered into a license agreement with Daiichi to market
and distribute EchoGen throughout the Pacific Rim. The Company is dependent on
Daiichi to fund a portion of the Company's operating expenses and to conduct
clinical trials, make required regulatory filings, obtain regulatory approval
for EchoGen and distribute EchoGen in the Pacific Rim. There can be no assurance
that the collaboration will continue or be successful. Daiichi has the right, in
its sole discretion, to terminate the collaboration at any time upon notice to
the Company. If the agreements with Abbott or Daiichi are terminated or the
collaborations are not successful, the Company will not receive scheduled
milestone and funding payments and will be required to identify an alternative
collaborative partner(s), which would have a material adverse effect on the
Company's business, financial condition and results of operations.




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Dependence on Patents and Proprietary Rights. The Company's success will
depend, in part, on its ability to obtain patents and protect trade secrets. The
Company has filed patent applications in the U.S. and 43 foreign countries
relating to its principal technologies. In the United States, eight patents have
issued to the Company, the claims of which are directed to EchoGen and other
ultrasound contrast media which include gaseous fluorine-containing chemicals.
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 the Company with competitive
advantages or will not be challenged by third parties, that the ownership of any
issued patents will be changed through interference proceedings or that the
existing or future patents of third parties will not have an adverse effect on
the ability of the Company to commercialize its products. Furthermore, there can
be no assurance that other companies will not independently develop similar
products, duplicate any of the Company's products or design around patents that
may be issued to the Company. Litigation may be necessary to enforce any patents
issued to the Company 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 the Company and
distraction of the Company's management. An adverse ruling in any litigation or
administrative proceeding could have a material adverse effect on the Company's
business, financial condition and results of operations.

The commercial success of the Company also will depend in part on not
infringing patents issued to competitors. There can be no assurance that
existing patents or pending patents which issue at or later date belonging to
competitors will not require the Company to alter its products or processes, pay
licensing fees or cease development of its current or future products. Any
litigation regarding infringement could result in substantial costs to the
Company and distraction of the Company's management, and any adverse ruling in
any litigation could have a material adverse effect on the Company's business,
financial condition and results of operations. Further, there can be no
assurance that the Company will be able to license other technology that it may
require at a reasonable cost or at all. Failure by the Company to obtain a
license to any technology that it may require to commercialize its products
would have a material adverse effect on the Company's business, financial
condition and results of operations.

Competition and Risk of Technological Obsolescence. The health care industry
is characterized by extensive research efforts and rapid technological change.
Competition in the development of ultrasound imaging contrast agents is intense
and expected to increase. Although, there is currently only one commercially
available ultrasound imaging contrast agent in the U.S. for certain cardiology
applications, and, to the knowledge of the Company, only one other ultrasound
imaging agent that has been submitted to the FDA for approval, the Company
believes that other medical and pharmaceutical companies are in clinical trials
with ultrasound contrast agents. The Company also believes that other medical
and pharmaceutical companies will compete with the Company in the areas of
research and development, acquisition of products and technology licenses, and
the manufacturing and marketing of ultrasound contrast agents. The Company
expects that competition in the ultrasound contrast imaging agent field will be
based primarily on efficacy, safety, ease of administration, breadth of approved
indications and physician, healthcare payor and patient acceptance. Although the
Company believes that if and when EchoGen is approved for commercial sale
EchoGen will be well positioned to compete successfully, there can be no
assurance that the Company will be able to do so. Many of the Company's
competitors and potential competitors have substantially greater financial,
technical and human resources than the Company 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 the Company. In
addition, other technologies or products may be developed that have an entirely
different approach or means of accomplishing the enhancement of ultrasound
imaging or other imaging modalities that would render the Company's technology
and products uncompetitive or obsolete.

Limited Manufacturing Experience; Dependence on Limited Contract
manufacturers and Suppliers. The Company currently relies primarily on Abbott to
produce EchoGen for research and development and preclinical and clinical
trials. Abbott's manufacturing site is subject to routine FDA and other
regulatory inspections of its manufacturing practices. In addition there are a
limited number of contract manufacturers that operate under GMP regulations, as
required by the FDA. Unless the Company develops an in-house manufacturing
capability or is able to identify and qualify alternative contract
manufacturers, it will be entirely dependent on Abbott for the manufacture of
EchoGen. There can be no assurance that the Company's reliance on Abbott for the
manufacture of its products will not result in interruptions, delays or
stoppages in the supply of EchoGen. The active chemical ingredient in EchoGen,
DDFP, is manufactured by a limited number of vendors worldwide. The Company has
entered into supply agreements with two such vendors. The inability of these
vendors to supply medical-grade DDFP to the Company could delay the Company's
manufacture of, or cause the Company to cease the manufacturing of, EchoGen. Any
such delay or cessation could have a material adverse effect on the


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Company's business, financial condition and results of operations. The Company
believes the other raw materials of EchoGen are readily available from various
suppliers.

Lack of Marketing and Sales Experience. The Company has no experience in
marketing, sales and distribution. The Company's strategy is to market EchoGen
through its established strategic alliances and distribution arrangements with
Abbott and Daiichi. There can be no assurance that the Company will be
successful in maintaining these arrangements or that its collaborative partners
in these arrangements will be successful in marketing and selling the Company's
products. The Company's agreement with Abbott requires the Company to provide
technical marketing support to Abbott's sales, marketing and distribution
activities in the U.S. The Company is in the very early stages in recruiting the
staff which will provide such technical support. There can be no assurance that
the Company will be successful in establishing technical support capability. If
the Company does not provide adequate technical support, Abbott can choose to
take over the technical support responsibilities and SONUS would be required to
negotiate a lower royalty rate with Abbott to reflect the reduced
responsibilities.

Limitations on Third-Party Reimbursement. The Company's ability to
successfully commercialize EchoGen will depend in part upon the extent to which
reimbursement of the cost of EchoGen and related treatments will be available
from domestic and foreign health administration authorities, private health
insurers and other payor organizations. Third party payors are increasingly
challenging the price of medical 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


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newly approved health care products, and there can be no assurance that adequate
third party coverage will be available. In certain foreign markets, the Company
may be subject to governmentally mandated prices for EchoGen. If adequate
reimbursement is not provided by governments and third party payors for the
Company's potential products or if adverse pricing is mandated by foreign
governments, the Company's business, financial condition and results of
operations would be materially adversely affected.

ITEM 2. PROPERTIES

The Company currently leases approximately 19,000 square feet of laboratory
and office space in a single facility in Bothell, Washington. The lease expires
in April 1999 and includes an option to extend the term of the lease for three
years. In addition, the Company has an option to lease approximately 8,900
square feet of space contiguous with its current facility. The Company believes
that this facility will be adequate to meet its projected needs for the
foreseeable future.

ITEM 3. LEGAL PROCEEDINGS

The Company is not a party to any material legal proceedings.

ITEM 4. SUBMISSION OF MATTER 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, 1996.




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PART II


ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK

The Company's 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 the Company does not anticipate paying any cash
dividends in the foreseeable future. As of February 28, 1997, there were 130
stockholders of record of the Company's common stock. The high and low sales
prices of the Company's common stock as reported by Nasdaq are as follows:



1995 High Low
- ---- ---- ---

Fourth Quarter 13 6 3/4

1996
- ----
First Quarter 19 10 3/4
Second Quarter 23 1/4 15 7/8
Third Quarter 21 5/8 16 1/4
Fourth Quarter 30 19 3/8


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ITEM 6. SELECTED FINANCIAL DATA




Year Ended December 31,
---------------------------------------------------------
1996 1995 1994 1993 1992
------ ------ ------- ------- ------
(in thousands, except per share data)

Statement of Operations Data:
Revenues ................................... $16,600 $ 4,500 $ 1,053 $ 3,300 $ --
Total operating expenses ................... 14,988 9,416 9,259 5,491 1,650
Net income (loss) .......................... 1,722 (5,939) (8,897) (2,589) (1,622)
Net income (loss) per share (1) ............ 0.19 (1.77) (4.19) (1.23)
Shares used in computation of net
income (loss) per share (1) ............. 8,999 3,354 2,122 2,111
Pro forma net income (loss) per share (1)(2) -- (0.99) (1.80) (0.58)
Shares used in computation of pro
forma net income (loss) per share (2) ... -- 5,981 4,928 4,472





December 31,
--------------------------------------------------------
1996 1995 1994 1993 1992
------- ------- ------- ------- -------
(in thousands)

Balance Sheet Data:
Cash, cash equivalents and marketable
securities .............................. $25,131 $18,221 $ 1,644 $ 2,307 $ 1,293
Total assets ............................... 26,762 19,646 3,195 3,411 2,059
Total long term liabilities and convertible,
redeemable preferred stock .............. 240 468 7,403 6,479 3,282
Total stockholders' equity (deficit) ....... $16,877 $10,947 $(13,041) $(4,222) $(1,636)


- ----------
(1) Such amounts for 1992 are not considered meaningful.

(2) See Note 1 of Notes to Financial Statements for a description of the
computation of pro forma per share amounts.




23

24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The discussion and analysis set forth below contains trend analysis 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: uncertainty of governmental regulatory requirements in
the U.S. and foreign countries; lengthy regulatory approval process;
uncertainty of safety and efficacy; uncertainty of clinical trials; uncertainty
of market acceptance; competitive products; future capital requirements and
uncertainty of additional funding and dependence on third parties for
manufacturing, marketing and sales. See "Business -- Certain Factors That May
Affect the Company's Business and Future Results."

OVERVIEW

Since its inception in October 1991, the Company has been engaged in the
research and development of proprietary contrast agents for use in ultrasound
imaging. The Company has financed its research and development and clinical
trials through payments received under agreements with its collaborative
partners, private equity and debt financings, and an initial public offering of
common stock completed in October 1995. As of December 31, 1996 the Company had
accumulated net losses of approximately $17.4 million since inception. Clinical
trials of the Company's principal product under development, EchoGen(R)
Emulsion, began in January 1994. The Company has completed various Phase 1, 2
and Phase 3 clinical trials of EchoGen since 1994 and in August 1996 submitted a
New Drug Application ("NDA") with the U.S. Food and Drug Administration
("FDA"). In November 1996, the Company filed a Marketing Authorization
Application ("MAA") for EchoGen with the European Medicines Evaluation Agency
("EMEA").

The Company will not be able to commence sales of EchoGen unless and until
it receives the appropriate regulatory approvals in the United States and the
various international markets. To date, all of the Company's revenues have been
derived from option and license payments that have been received under
agreements for the collaborative development of EchoGen worldwide.

In May 1996, the Company formed a strategic alliance with Abbott
Laboratories ("Abbott") for the marketing and sale of EchoGen in the United
States. Under the agreement, Abbott has agreed to pay the Company $31.0 million
in license, clinical support and milestone payments. In addition, Abbott
purchased, for $4.0 million, warrants to acquire 500,000 shares of the Company's
common stock. The warrants are exercisable over five years at $16.00 per share.
In October 1996, the Company and Abbott entered into an agreement expanding
Abbott's licensed territory to include Europe, Latin America, Canada, Middle
East, Africa, and certain Asia/Pacific countries. Under the October 1996
agreement, Abbott has agreed to pay the Company $34.6 million in license and
milestone payments, a portion of which will be credited against future royalties
once EchoGen is approved for commercial sale.

In April 1993, the Company granted Daiichi Pharmaceutical Co., Ltd.
("Daiichi") an option to acquire exclusive marketing and distribution rights to
EchoGen in Japan and nine other Pacific Rim countries. In March 1995, Daiichi
exercised the option and entered into a license agreement with the Company.
Under the option and license agreements, Daiichi agreed to pay the Company $32.0
million of option and license fees and milestone payments conditioned on the
achievement of certain clinical development, regulatory and commercialization
milestones. In addition to the option and license agreements, Daiichi entered
into a convertible subordinated debenture purchase agreement with the Company in
November 1993 under which the Company issued a convertible subordinated
debenture to Daiichi in the principal amount of $3.0 million, which was
converted into 462,857 shares of common stock concurrently with the closing of
the Company's initial public offering.



24

25
In October 1994, the Company granted Guerbet S.A. ("Guerbet") an option to
acquire exclusive marketing and distribution rights to EchoGen in Europe. In
exchange for such option, the Company received payments totaling approximately
$4.7 million, of which $3.6 million, plus accrued interest ($245,875 at the time
of conversion), was converted into 549,410 shares of Common Stock of the Company
concurrently with the closing of the Company's initial public offering. In
August 1996, Guerbet elected not to exercise its licensing option and the
Company subsequently entered into the October 1996 agreement with Abbott for
European rights to EchoGen.

The Company's results of operations have varied and will continue to vary
significantly from quarter to quarter and are affected by, among other factors,
the timing of fees and milestone payments made by collaborative partners, the
entering into product license agreements by the Company and the timing and costs
of the clinical trials conducted by the Company. The Company's current
collaborative partners can terminate their agreements on short notice, and there
can be no assurance that the Company will receive any additional funding or
milestone payments.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 1996 AND DECEMBER 31, 1995

Revenue from collaborative agreements increased to $16.6 million for the
year ended December 31, 1996 as compared to $4.5 million for the year ended
December 31, 1995. Revenue in 1996 consisted of $12.0 and $4.6 million of
payments received from Abbott and Daiichi, respectively. The increase reflects
the achievement of certain clinical trial and regulatory milestones which
trigger payments from collaborative partners. Milestone payments in 1996 related
primarily to the EchoGen NDA filing in the United States and the marketing
authorization filing with EMEA in Europe.

Research and development expenses increased to $11.2 million in 1996
compared to $7.2 million in 1995 primarily due to increased clinical trial costs
associated with EchoGen, preparation of the NDA and MAA filings with the FDA and
EMEA, respectively, and additional investment in the development of new
products.

General and administrative expenses were $3.8 million in 1996 compared to
$2.2 million in 1995. The higher level of expenses was primarily the result of
the increase in business development activities and associated revenue related
to corporate alliances, the implementation of marketing programs in anticipation
of FDA approval and planned product launch, costs of filing new patent and
trademark applications and, to a lesser extent, the additional activities of
being a publicly-held company including investor and shareholder relations and
SEC reporting and compliance.

Interest income increased to $0.8 million in 1996 from $0.3 million in
1995. The increase was primarily due to the larger cash and marketable
securities balances in 1996 resulting from the Company's initial public offering
in October 1995 and proceeds from the warrant purchased by Abbott in May 1996.
Interest expense decreased to $0.2 million in 1996 compared to $0.8 million in
1995 primarily due to the repayment of notes to stockholders and the conversion
of certain debts into common stock at the time of the initial public offering.


25

26
Income taxes of $0.5 million for the year ended December 31, 1996 were
primarily attributable to withholding taxes related to collaborative payments
received from Daiichi.

YEARS ENDED DECEMBER 31, 1995 AND DECEMBER 31, 1994

Revenue from collaborative agreements increased to $4.5 million for the year
ended December 31, 1995 as compared to $1.1 million for the year ended December
31, 1994 due to the timing of the license and license option fees received from
Daiichi and Guerbet, respectively.

Research and development expenses increased to $7.2 million for the year
ended December 31, 1995 from $5.8 million for the year ended December 31, 1994
primarily due to increased clinical trial costs of EchoGen.

General and administrative expenses increased to $2.2 million for the year
ended December 31, 1995 from $1.5 million for the year ended December 31, 1994,
reflecting increased staffing, the filing and prosecution of patent and
trademark applications and severance costs.

Relocation expenses were $2.0 million for the year ended December 31, 1994
due to the relocation of the Company's executive offices and laboratory
facilities from Southern California to Bothell, Washington to facilitate the
recruitment and retention of key personnel and to access resources available in
the Seattle area in the medical imaging industry and academic institutions. In
connection with the relocation, the Company incurred expenses for reimbursing
costs of employees who relocated, the moving of assets, accruing of lease costs
for vacated space and the write-down of assets related to the California
facility.

Interest income increased to $261,000 for the year ended December 31, 1995
from $60,000 for the year ended December 31, 1994 as a result of larger average
invested cash balances resulting from the initial public offering. Interest
expense was $752,000 for the year ended December 31, 1995 compared to $598,000
for the year ended December 31, 1994. The increase resulted primarily from
interest accrued on Guerbet option fees and interest incurred under the line of
credit offset by a decrease in interest accrued on the Daiichi convertible debt
and the reversal of interest accrued on a license advance from Daiichi.

Income taxes of $532,000 for the year ended December 31, 1995 were primarily
attributable to withholding taxes paid in Japan relating to the collaborative
payments received from Daiichi.

LIQUIDITY AND CAPITAL RESOURCES

The Company has financed its operations with payments from collaborative
agreements, proceeds from an initial public offering, proceeds from the issuance
of convertible, redeemable preferred stock (which converted into common stock at
the closing of the Company's initial public offering) and a $5.0 million line of
credit. At December 31, 1996, the Company had cash, cash equivalents and
marketable securities of $25.1 million, compared to $18.2 million at December
31, 1995. Cash provided by operations for the year ended December 31, 1996 was
$3.5 million compared to cash used in operations of $7.8 million for the
comparable period in fiscal 1995.


26

27
In August 1995, the Company entered into a loan agreement with Silicon
Valley Bank which provides for a $5.0 million revolving line of credit facility,
which bears interest at the prime rate plus 1.0% per annum. At December 31,
1996, there was $5.0 million outstanding under the line of credit. The line of
credit expires in August 1997 and is secured by the tangible assets of the
Company. The Company is required to maintain certain minimum balances of cash,
cash equivalents and marketable securities in order to borrow under the line of
credit.

At December 31, 1996, the Company had federal net operating loss
carryforwards of approximately $15.8 million. These carryforwards will expire
beginning in the year 2006. The initial public offering of common stock by the
Company 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 this ownership change will be limited during the
carryforward period and may result in the expiration of net operating loss
carryforwards.

The Company expects that its cash needs will increase significantly in
future periods due to pending and planned clinical trials and higher
administrative and marketing expenses as the Company prepares for
commercialization of EchoGen. The Company estimates that existing cash, cash
equivalents and marketable securities will be sufficient to meet the Company's
capital requirements for at least the next 12 months. The Company's future
capital requirements will, however, depend on many factors, including the
progress of the Company's research and development programs, clinical trials,
the time and costs required to gain regulatory approvals, the ability of the
Company to obtain and retain continued funding from third parties under
collaborative agreements, the costs of filing, prosecuting and enforcing
patents, patent applications, patent claims and trademarks, the costs of
marketing and distribution, the status of competing products and the market
acceptance of the Company's products, if and when approved. The Company may have
to raise substantial additional funds to complete development of any product or
to commercialize any products if and when approved by the FDA. There can be no
assurance that additional financing will be available on acceptable terms, if at
all.




27

28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA




INDEX TO FINANCIAL STATEMENTS: PAGE
----

Report of Independent Public Accountants 29
Balance Sheets as of December 31, 1996 and 1995 30
Statements of Operations for the years ended December
31, 1996, 1995 and 1994 31
Statements of Stockholders' Equity for the years ended
December 31, 1996, 1995 and 1994 32
Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994 33
Notes to the Financial Statements 34


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

Not applicable.




28

29
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, 1996 and 1995, and the related statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of SONUS Pharmaceuticals, Inc.
at December 31, 1996 and 1995, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles.

ERNST & YOUNG LLP

Seattle, Washington
January 31, 1997





29

30
SONUS PHARMACEUTICALS, INC.

BALANCE SHEETS






DECEMBER 31,
1996 1995
------------ ------------

Assets
Current assets:
Cash and cash equivalents ........................................ $ 7,236,615 $ 5,656,620
Marketable securities ............................................ 17,894,450 12,564,513
Prepaid expenses and other current assets ........................ 397,733 243,269
------------ ------------
Total current assets ....................................... 25,528,798 18,358,286
Equipment, furniture, and leasehold improvements, net .............. 1,168,503 1,123,089
Other assets ....................................................... 64,878 58,639
------------ ------------
Total assets ....................................................... $ 26,762,179 $ 19,646,130
============ ============

Liabilities and Stockholders' Equity
Current liabilities:
Bank line of credit .............................................. $ 5,000,000 $ 5,000,000
Accounts payable and accrued expenses ............................ 2,203,806 1,454,607
Accrued clinical trial expenses .................................. 1,213,563 1,568,992
Deferred revenue ................................................. 1,000,000 --
Current portion of capitalized lease obligations ................. 228,049 207,247
------------ ------------
Total current liabilities ..................................... 9,645,418 8,230,846
Capitalized lease obligations, less current portion ................ 239,511 467,989
Commitments
Stockholders' equity:
Preferred stock, $.001 par value:
5,000,000 shares authorized; no shares outstanding ......... -- --
Common stock, $.001 par value:
20,000,000 shares authorized; 8,530,911 and 8,448,082 shares
outstanding in 1996 and 1995, respectively ................. 34,275,015 30,106,638
Accumulated deficit ............................................. (17,355,374) (19,066,414)
Deferred compensation ........................................... (42,391) (92,929)
------------ ------------
Total stockholders' equity .................................... 16,877,250 10,947,295
------------ ------------
Total liabilities and stockholders' equity ......................... $ 26,762,179 $ 19,646,130
============ ============



See accompanying notes.




30

31
SONUS PHARMACEUTICALS, INC.

STATEMENTS OF OPERATIONS







YEAR ENDED DECEMBER 31,
1996 1995 1994
------------ ------------ ------------

Revenues:
Collaborative agreements ................................. $ 16,600,000 $ 4,500,000 $ 1,052,631

Operating expenses:
Research and development ................................. 11,181,468 7,189,478 5,775,214
General and administrative ............................... 3,806,858 2,226,345 1,532,387
Relocation expenses ...................................... -- -- 1,951,107
------------ ------------ ------------
14,988,326 9,415,823 9,258,708
------------ ------------ ------------

Operating income (loss) .................................... 1,611,674 (4,915,823) (8,206,077)

Other income (expense):
Interest income .......................................... 832,936 260,860 59,965
Interest expense ......................................... (212,465) (752,334) (597,717)
------------ ------------ ------------
Income (loss) before income taxes .......................... 2,232,145 (5,407,297) (8,743,829)
Income taxes ............................................... 510,000 531,644 153,446
------------ ------------ ------------
Net income (loss) .......................................... $ 1,722,145 $ (5,938,941) $ (8,897,275)
============ ============ ============

Net income (loss) per share ................................ $ 0.19 $ (1.77) $ (4.19)
============ ============ ============
Shares used in computation of net income (loss) per share .. 8,998,530 3,354,225 2,122,422
============ ============ ============

Pro forma, assuming conversions into common stock:
Net loss per share ....................................... $ (0.99) $ (1.80)
============ ============
Shares used in computation of pro forma net loss per share 5,981,021 4,927,643
============ ============




See accompanying notes.



31

32
SONUS PHARMACEUTICALS, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY



Common Stock
---------------------------- Accumulated Deferred
Shares Amount Deficit Compensation Total
------------ ------------ ------------ ------------ ------------

Balance at December 31, 1993 .............. 1,774,045 $ 12,582 $ (4,235,019) $ -- $ (4,222,437)
Exercise of stock options ............... 254,875 72,314 -- -- 72,314
Issuance of warrants .................... -- 1,000 -- -- 1,000
Net loss ................................ -- -- (8,897,275) -- (8,897,275)
Deferred compensation ................... -- 54,500 (54,500) --
Amortization of deferred
compensation .......................... -- -- -- 6,510 6,510
Unrealized losses on marketable
securities ............................ -- -- (1,013) -- (1,013)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1994 .............. 2,028,920 140,396 (13,133,307) (47,990) (13,040,901)
Initial public offering of common
stock net of offering costs of
$2,476,938 ............................ 3,063,750 18,969,313 -- -- 18,969,313
Conversion of redeemable preferred
stock into common stock ............... 2,325,219 3,995,000 -- -- 3,995,000
Conversion of refundable option fees into
common stock .......................... 549,410 3,845,875 -- -- 3,845,875
Conversion of convertible subordinated
debenture into common stock ........... 462,857 3,000,000 -- -- 3,000,000
Issuance of common stock ................ 97,840 49,651 -- -- 49,651
Repurchase of common stock .............. (79,914) (26,172) -- -- (26,172)
Net loss ................................ -- -- (5,938,941) -- (5,938,941)
Deferred compensation ................... -- 132,575 -- (132,575) --
Amortization of deferred
compensation .......................... -- -- -- 87,636 87,636
Unrealized gains on marketable
securities ........................... -- -- 5,834 -- 5,834
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1995 .............. 8,448,082 30,106,638 (19,066,414) (92,929) 10,947,295
Issuance of common stock ................ 82,829 168,377 -- -- 168,377
Proceeds from issuance of warrants ...... -- 4,000,000 -- -- 4,000,000
Net income .............................. -- -- 1,722,145 -- 1,722,145
Amortization of deferred
compensation .......................... -- -- -- 50,538 50,538
Unrealized losses on marketable
securities ............................ -- -- (11,105) -- (11,105)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1996 .............. 8,530,911 $ 34,275,015 $(17,355,374) $ (42,391) $ 16,877,250
============ ============ ============ ============ ============



See accompanying notes.




32

33
SONUS PHARMACEUTICALS, INC.

STATEMENTS OF CASH FLOWS



Year Ended December 31,
1996 1995 1994
------------ ------------ ------------

Operating activities:
Net income (loss) .......................................................... $ 1,722,145 $ (5,938,941) $ (8,897,275)
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization .......................................... 421,098 352,311 306,817
Amortization of discount on marketable securities ...................... (11,105) (12,662) (14,950)
Loss on asset retirements .............................................. 53,958 -- 110,122
Deferred taxes ......................................................... -- 200,000 (200,000)
Amortization of deferred compensation .................................. 50,538 87,636 6,510
Changes in operating assets and liabilities:
Prepaid expenses and other assets .................................... (160,703) (142,871) 38,031
Accounts payable and accrued expenses ................................ 749,199 829,339 478,781
Accrued clinical trial expenses ...................................... (355,429) 1,404,729 --
Accrued relocation expenses .......................................... -- (563,670) 662,224
Deferred revenue ..................................................... 1,000,000 (4,000,000) 4,000,000
------------ ------------ ------------
Net cash provided by (used in) operating activities ........................ 3,469,701 (7,784,129) (3,509,740)

Investing activities:
Purchases of equipment, furniture, and leasehold improvements .............. (520,470) (283,674) (702,163)
Purchases of marketable securities ......................................... (74,256,557) (49,907,612) (18,651,010)
Proceeds from sales of marketable securities ............................... 62,529,763 38,429,216 18,407,621
Proceeds from maturities of marketable securities .......................... 6,396,857 541,720 806,375
------------ ------------ ------------
Net cash used in investing activities ...................................... (5,850,407) (11,220,350) (139,177)

Financing activities:
Proceeds from line of credit borrowings .................................... 21,400,000 10,000,000 --
Repayment of line of credit borrowings ..................................... (21,400,000) (5,000,000) --
Notes payable to stockholders .............................................. -- -- 2,500,005
Repayment of notes payable to stockholders ................................. -- (2,927,005) (73,198)
Proceeds from capitalized lease obligations ................................ -- 274,560 282,096
Repayment of capitalized lease obligations ................................. (207,676) (313,967) (247,611)
Refundable option fees converted into common stock ......................... -- 3,600,000 --
Proceeds from issuance of common stock ..................................... 168,377 18,992,792 73,314
Proceeds from issuance of warrants ......................................... 4,000,000 -- --
Proceeds from sale of preferred stock ...................................... -- -- 1,000,000
------------ ------------ ------------
Net cash provided by financing activities .................................. 3,960,701 24,626,380 3,534,606
------------ ------------ ------------

Change in cash and equivalents for the period .............................. 1,579,995 5,621,901 (114,311)
Cash and equivalents at beginning of period ................................ 5,656,620 34,719 149,030
------------ ------------ ------------
Cash and equivalents at end of period ...................................... 7,236,615 5,656,620 34,719
Marketable securities ...................................................... 17,894,450 12,564,513 1,609,341
------------ ------------ ------------
Total cash and marketable securities ....................................... $ 25,131,065 $ 18,221,133 $ 1,644,060
============ ============ ============

Supplemental cash flow information:
Interest paid .............................................................. $ 198,934 $ 694,677 $ 431,263
Income taxes paid .......................................................... $ 460,000 $ 331,644 $ 353,446



See accompanying notes





33

34
SONUS PHARMACEUTICALS, INC.

NOTES TO FINANCIAL STATEMENTS


1. DESCRIPTION OF BUSINESS AND SUMMARY OF ACCOUNTING POLICIES

DESCRIPTION OF BUSINESS

SONUS Pharmaceuticals, Inc. (the "Company") is primarily engaged in the
research and development of proprietary contrast agents for use in ultrasound
imaging.

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 deficit. 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 are also 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 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 primarily mature within one year.

REVENUES FROM COLLABORATIVE AGREEMENTS

Option, license and milestone payments under collaborative agreements are
recorded as earned based upon the provisions of each agreement. Payments
received which have not met the appropriate 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. Leasehold improvements
are amortized over the lesser of the economic useful lives of the improvements
or the term of the related lease.

STOCK COMPENSATION

In 1996, the Company implemented the provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS
123). In accordance with the provisions of SFAS 123, 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 plans, stock options are generally
granted at fair market value.


34

35

PER SHARE DATA

Per share data is based on the weighted average number of common shares and
dilutive common share equivalents outstanding. Common share equivalents are
calculated under the treasury stock method and consist of unexercised stock
options and warrants. In accordance with the Securities and Exchange Commission
requirements, common and common equivalent shares issued during the 12-month
period prior to the filing of the Company's initial public offering (IPO) in
October 1995, have been included in the calculation as if they were outstanding
for all periods prior to the IPO using the treasury stock method and the IPO
price of $7.00 per share, even though the effect of their inclusion is
antidilutive.

The pro forma unaudited per share data are based on the number of shares
calculated above, plus the following adjustments:

- All shares of convertible, redeemable preferred stock outstanding prior
to the October 1995 IPO are assumed to have been converted to common
stock at the time of issuance.

- The convertible subordinated debenture is assumed to have been converted
to common stock at the time of issuance at a conversion price equal to
the IPO price of $7.00 per share divided by 1.08.

- The $3.6 million of deferred revenue from the time of receipt plus
accrued interest, is assumed to have been converted into common stock at
a conversion price equal to the IPO price of $7.00 per share.

USE OF ESTIMATES

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

RECLASSIFICATIONS

Certain balance sheet amounts reported in the prior year have been
reclassified to conform to current year presentation.

2. MARKETABLE SECURITIES

Marketable securities consist of the following at December 31, 1996:




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

U.S. Government Obligations .......... $ 11,996,089 $ 7,406 $ (8,470) $ 11,995,025
Corporate Debt Securities (principally
commercial paper) ................. 5,904,645 1,363 (6,583) 5,899,425
------------ ------------ ------------ ------------
$ 17,900,734 8,769 (15,053) 17,894,450
============ ============ ============ ============



Marketable securities consist of the following at December 31, 1995:


35

36


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

U.S. Government Obligations .......... $ 4,774,029 $ 4,821 $ -- $ 4,778,850
Corporate Debt Securities (principally
commercial paper) ................. 7,785,663 -- -- 7,785,663
----------- ----------- ----------- -----------
$12,559,692 $ 4,821 $ -- $12,564,513
=========== =========== =========== ===========


All marketable securities at December 31, 1996 and 1995 mature within one
year.

3. EQUIPMENT, FURNITURE, AND LEASEHOLD IMPROVEMENTS

Equipment, furniture, and leasehold improvements consist of the following:




DECEMBER 31,
--------------------------
1996 1995
----------- -----------

Laboratory equipment................................. $ 1,388,738 $ 1,115,123
Office furniture and equipment....................... 491,561 428,762
Leasehold improvements............................... 432,925 373,568
----------- -----------
2,313,224 1,917,453
Less accumulated depreciation and amortization....... 1,144,721 794,364
----------- -----------
$ 1,168,503 $ 1,123,089
=========== ===========


4. DEBT

The Company has a Loan Agreement with Silicon Valley 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, 1996 and December 31,
1995, there was $5.0 million outstanding under the line of credit. The line of
credit expires in August 1997 and is secured by the tangible assets of the
Company. The Company is required to maintain a minimum balance of cash, cash
equivalents and marketable securities in order to borrow under the line of
credit.

In November 1993, the Company issued a $3.0 million convertible
subordinated debenture to Daiichi Pharmaceutical Co., Ltd. ("Daiichi") with
interest at 10% per annum payable on the anniversary date of issuance. The
debenture converted into 462,857 shares of common stock upon closing of the
initial public offering in October 1995.

Prior to 1996, substantially all of the Company's equipment and furniture
was financed through a capital lease agreement. In the aggregate, the Company
has borrowed approximately $1.4 million under the lease agreement. The
obligations bear interest at rates ranging from 15.8% to 17.1%, with principal
and interest payable monthly at approximately $39,000 per month. Future minimum
payments under these leases are as follows:


Year ending December 31:


1997...................................................... $ 295,390
1998...................................................... 172,576
1999...................................................... 67,387
-----------
Total minimum lease payments.............................. 535,353
Less amounts representing interest........................ 67,793
-----------
Present value of minimum lease payments................... 467,560
Less current portion...................................... 228,049
-----------
Capitalized lease obligations, less current portion....... $ 239,511
===========


5. COLLABORATIVE AGREEMENTS

36

37
In May 1996, the Company formed a strategic alliance with Abbott
Laboratories ("Abbott") for the marketing and sale of EchoGen(R) Emulsion in the
United States. The Company has primary responsibility for clinical development,
regulatory affairs, and medical and technical marketing support of EchoGen, and
Abbott has primary responsibility for manufacturing and United States marketing
and sales. The Company has retained certain co-promotion rights to EchoGen in
the United States. Under the agreement, Abbott has agreed to pay the Company
$31.0 million in license, clinical support and milestone payments, of which the
Company had received $11.0 million as of December 31, 1996. After the United
States Food and Drug Administration ("FDA") has approved the marketing of
EchoGen, for which there can be no assurance, the Company will receive 47
percent of net EchoGen revenues in the United States -- a portion of which the
Company must use to fund its responsibilities under the agreement. Subject to
early termination, the agreement spans the later of the life of the patents
relating to EchoGen or the introduction of a generic equivalent by a third
party. Abbott can acquire the rights to certain additional indications for
EchoGen by making additional clinical support payments. In addition, Abbott paid
$4.0 million for five year warrants to acquire 500,000 shares of the Company's
common stock at an exercise price of $16.00 per share.

In October 1996, the Company expanded its strategic alliance with Abbott by
signing a second agreement for EchoGen that extends Abbott's licensed territory
to include: Europe, Latin America, Canada, Middle East, Africa and certain
Asia/Pacific Rim countries. Under the agreement, Abbott has agreed to pay the
Company $34.6 million in payments conditioned upon the achievement of certain
regulatory and commercialization milestones, of which $12.6 million may be
offset against future royalty payments. As of December 31, 1996, the Company had
received $2.0 million under the agreement. After applicable regulatory agencies
have approved the marketing of EchoGen, for which there can be no assurance, the
Company will receive a royalty that ranges from 36% to 42% of EchoGen net sales
based on aggregate annual sales in the territory. Subject to early termination,
the agreement spans the later of the life of the patents relating to EchoGen in
the countries of the territory, ten years from the date of the agreement, or the
introduction of a generic equivalent by a third party.

In April 1993, the Company entered into an option agreement with Daiichi
and received a $3.3 million nonrefundable payment. The agreement provided
Daiichi the option to obtain an exclusive license to distribute the Company's
first product to several Pacific Rim countries including Japan, Taiwan, China,
and Korea (the "Territory"). Daiichi paid $2.0 million to the Company in May
1994 as a license fee advance. Daiichi exercised its option and entered into a
license agreement with the Company in March 1995, and at which time the $2.0
million advance was recognized as revenue and the Company received an additional
$1.3 million of non-refundable license fees. Daiichi is required to pay
specified amounts to the Company to maintain its product license rights,
including regular quarterly payments of $400,000, which began in the second
quarter of 1995, over a period of two years, and additional payments upon
achievement of certain clinical development and regulatory milestones. Total
payments from Daiichi if the Company achieves the agreed-upon milestones will be
$32.0 million. As of December 31, 1996, the Company had received $12.4 million
under the agreement. Subject to early termination, the term of the license shall
expire upon the later of the expiration of the last to expire patents or 10
years after the first commercial sale of the Company's first product in the
Territory. The license agreement also includes product supply and royalty
provisions. For all areas in the Territory outside Japan and Taiwan, Daiichi is
obligated to purchase the finished product from the Company at a fixed unit
price. For Japan and Taiwan, Daiichi has the option of obtaining finished goods
directly from the Company or obtaining raw materials from the Company and
manufacturing the product.

In October 1994, the Company entered into a letter agreement with Guerbet
S.A. ("Guerbet") under which Guerbet received an option to license the Company's
first product. The Company received approximately $3.1 million as the initial
option fee of which $2.0 million (plus interest) was refundable. The Company
also received additional refundable option fees totaling $1.6 million during
1995. In August 1995, the letter agreement with Guerbet was amended to provide
that the $3.6 million in refundable option fees (plus interest) would be
converted into shares of common stock upon the consummation of an initial public
offering. At the time of the IPO in October 1995, the refundable option fees of
$3.6 million and accrued interest of $245,875 were converted into 549,410 shares
of common stock. In August 1996, Guerbet elected not to exercise its licensing
option and the Company subsequently entered into the October 1996 agreement with
Abbott for European rights to EchoGen.



37

38
6. INCOME TAXES

Income tax expense consists of the following:






YEAR ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
--------- --------- ---------

Current:
Federal ............... $ 50,000 $ -- $ --
State ................. -- 1,644 800
Foreign ............... 460,000 330,000 352,646
--------- --------- ---------
510,000 331,644 353,446
Deferred:
Federal ............... -- -- --
State ................. -- -- --
Foreign ............... -- 200,000 (200,000)
--------- --------- ---------
-- 200,000 (200,000)
--------- --------- ---------
Total ................... $ 510,000 $ 531,644 $ 153,446
========= ========= =========


The Company's foreign income tax expense is for withholding taxes paid in
Japan and France, relating to the collaborative payments made by Daiichi and
Guerbet, respectively (see Note 5).

Significant components of the Company's net deferred tax assets and
liabilities as of December 31, 1996 and 1995 are as follows:





December 31,
----------------------------
1996 1995
----------- -----------

Deferred tax assets:
Federal net operating loss carryforwards ...... $ 5,355,000 $ 6,190,000
Relocation expenses ........................... 32,000 34,000
Accrued expenses and other .................... 133,000 40,000
Research and development credits .............. 691,000 530,000
Foreign tax credits ........................... 1,143,000 683,000
Deferred compensation ......................... 112,000 (32,000)
----------- -----------
Total deferred tax assets ....................... 7,466,000 7,445,000
Deferred tax liabilities:
Tax in excess of book depreciation expense .... (107,000) (64,000)
----------- -----------
Gross deferred tax assets ....................... 7,359,000 7,381,000
Valuation allowance for net deferred tax assets (7,359,000) (7,381,000)
----------- -----------
Net deferred tax assets ........................ $ -- $ --
=========== ===========


Due to the uncertainty of the Company's ability to continue to generate
taxable income to realize its net deferred tax assets at December 31, 1996 and
1995, a valuation allowance has been recognized for financial reporting
purposes. The Company's valuation allowance for deferred tax assets decreased
$22,000 and increased $2,489,000 for the years ended December 31, 1996 and 1995,
respectively.

The Company has federal net operating loss carryforwards of approximately
$15,800,000 at December 31, 1996, for income tax reporting purposes and research
and development tax credit carryforwards of approximately $691,000 at December
31, 1996. The federal operating loss carryforwards begin to expire in 2006. The
research and development credits begin to expire in 1998.

The initial offering of common stock by the Company 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 carryforward period and may
result in the expiration of net operating loss carryforwards before utilization.

7. STOCKHOLDERS' EQUITY

38

39
COMMON STOCK

In October 1995, the Company sold 3,063,750 shares of common stock in an
initial public offering resulting in net proceeds of approximately $19.0
million. Upon the completion of the public offering, all of the convertible
redeemable preferred stock outstanding converted into 2,325,219 shares of common
stock, and the convertible subordinated debenture converted into 462,857 shares
of common stock. In addition, based on an August 1995 amendment to the Company's
agreement with Guerbet, the $3.6 million refundable option fees, plus accrued
interest ($245,875 at the time of conversion), were converted into 549,410
shares of common stock.

At December 31, 1996, the Company has reserved shares of common stock for
the following purposes:




Stock Option and Restricted Stock Plans........... 986,830
Warrants.......................................... 813,590
Other Stock Options............................... 76,335
Employee Stock Purchase Plan...................... 37,628
---------
1,914,383
=========


STOCK OPTION AND RESTRICTED STOCK PURCHASE PLANS

The Company has adopted two plans which provide for the granting of
incentive and nonqualified stock options and the purchase of restricted common
stock. 1,200,000 shares were reserved for issuance under the employee plan and
122,137 shares were reserved under the director plan. As of December 31, 1996,
there were 239,901 shares available for future grant under the plans. Employee
stock options vest over a period of time determined by the Board of Directors,
generally four years, and director options are fully vested at the date of
grant. All options expire ten years from the date of grant. A summary of
activity related to the Company's stock option plans follow:




WEIGHTED
AVERAGE
EXERCISE EXERCISE
SHARES PRICE PRICE
------ ----- -----

Balance, December 31, 1993 ............. 228,380 .07 -- .33
Granted .............................. 213,201 .33 -- .66
Exercised ............................ (254,875) .07 -- .33
Canceled ............................. (11,164) .07 -- .33
--------
Balance, December 31, 1994 ............. 175,542 .07 -- .66
Granted .............................. 149,656 .66 -- 8.19
Exercised ............................ (91,578) .07 -- .33
Canceled ............................. (33,604) .07 -- 8.19
--------
Balance, December 31, 1995 ............. 200,016 .07 -- 8.19 1.94
Granted .............................. 649,955 13.00 -- 23.00 14.49
Exercised ............................ (68,766) .07 -- 7.86 0.45
Canceled ............................. (34,276) .07 -- 20.00 11.77
--------
Balance, December 31, 1996 ............. 746,929 .07 -- 23.00 12.66
========

Options exercisable at December 31, 1996 333,119 .07 -- 20.00 12.38


The weighted-average remaining contractual life for options outstanding at
December 31, 1996 was 9.01 years.

The Company is recognizing as compensation expense the excess of the deemed
fair value for financial reporting purposes of the common stock issuable over
the exercise price of certain options granted between December 1994 and
September 1995. Amortization of deferred compensation expense for the year ended
December 31, 1996, 1995 and 1994 was $50,538, $87,636 and $6,510, respectively.


39

40
Of the shares issued upon exercise of options through December 31, 1996,
62,020 common shares are subject to reconveyance at the Company's option at the
original exercise price. The reconveyance restriction lapses over a four-year
period of employment for each individual.

STOCK PURCHASE PLAN

In 1995, the Company established an employee stock purchase plan. Under the
plan, 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 6,111 and 6,261 in 1996 and 1995, respectively. At
December 31, 1996, 37,628 shares were reserved for future purchase by employees
under the plan.

OTHER OPTIONS AND WARRANTS

In connection with the Abbott Agreement signed in May 1996, Abbott
purchased, for $4.0 million, warrants to acquire 500,000 shares of common stock.
The warrants are exercisable for five years at $16.00 per share.

In connection with bridge financing prior to the IPO, the Company issued
warrants to purchase an aggregate of 303,590 shares of common stock at exercise
prices ranging from $5.24 to $7.05 per share. The warrants expire at various
times from October 1998 through July 2000. In 1996, 5,361 warrants were
exercised at $7.05 per share.

In September 1994, the Board of Directors granted an option, expiring in
2004, to purchase 76,335 shares of common stock to the Company's President and
Chief Executive Officer. The option is exercisable at $.66 per share. In
connection with the grant, the Company recorded deferred compensation of
$50,000, representing the excess of the deemed fair value for financial
reporting purposes of the common stock issuable over the exercise price, which
amount is being amortized over the vesting period of the option.

In connection with the deferral of the payment of reimbursements related to
the relocation of the Company's executive offices (see Note 9), the Company, in
November 1994, issued warrants to purchase an aggregate of 17,949 shares of
Common Stock to three executive officers of the Company at an exercise price of
$6.55 per share, which warrants expire in November 1999. In 1996, 2,588 warrants
were exercised.

SHAREHOLDER RIGHTS PLAN

In 1996, the Board of Directors of the Company adopted a Shareholder Rights
Plan ("Plan"). Under the Plan, the Board 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.

ACCOUNTING FOR STOCK-BASED COMPENSATION

In 1996, the Company implemented the provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS
123). In accordance with the provisions of 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 using the fair value
method.

Had the Company elected to recognize compensation cost based on the fair
value of the options as prescribed by SFAS 123, the pro forma amounts for net
income (loss) and associated per share amounts would have been $0.3 million or
$.03 per share for the year ended December 31, 1996 and ($6.0) million or
$(1.78) per share for the year ended December 31, 1995. The fair value of each
option is estimated using the Black-Scholes option pricing model. The
assumptions used in this model include an estimated option life of 4 years,
expected stock price volatility of .645, and

40

41
a risk-free interest rate at the grant date ranging from 5.32% to 7.70%. The
weighted average fair value of option granted during 1996 and 1995 was $6.72 and
$4.43, respectively, per share.

8. COMMITMENTS

The Company has leased office and laboratory space under an operating lease
agreement which expires in May 1999. The Company has the option to extend this
lease for an additional three years at 95% of the then fair market value of the
premises. Future minimum lease payments are as follows:



1997......................................... $ 314,000
1998......................................... 321,000
1999......................................... 107,000
----------
$ 742,000
==========


Rental expense for the years ended December 31, 1996, 1995 and 1994 was
approximately $340,000, $328,000 and $292,000, respectively.

In May 1993, the Company entered into a manufacturing and supply agreement
with Abbott. In the event that EchoGen is approved by the United States Food &
Drug Administration, the Company is obligated to purchase certain minimum
quantities of materials from Abbott or make cash payments for the shortages from
the predetermined purchase level over a five-year period.

9. RELOCATION EXPENSES

In May 1994, the Company moved its offices and laboratories from California
to Washington. Relocation expenses of approximately $2.0 million were recognized
in 1994 relating to the move. The expenses include the direct costs of moving
the Company's people and assets, reimbursement of employees who relocated under
the Company's relocation program and an accrual for lease costs and asset
write-offs relating to the California facility.



41

42
PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required hereunder is incorporated by reference from the
sections of the Company's Proxy Statement to be filed in connection with its
1997 Annual Meeting of Stockholders entitled "Nominees" and "Other Executive
Officers."

ITEM 11. EXECUTIVE COMPENSATION

The information required hereunder is incorporated by reference from the
sections of the Company's Proxy Statement to be filed in connection with its
1997 Annual Meeting of Stockholders entitled "Executive Compensation."

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required hereunder is incorporated by reference from the
sections of the Company's Proxy Statement to be filed in connection with its
1997 Annual Meeting of Stockholders entitled "Security Ownership of Management
and Certain Beneficial Owners."

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required hereunder is incorporated by reference from the
sections of the Company's Proxy Statement to be filed in connection with its
1997 Annual Meeting of Stockholders entitled "Executive Compensation" and
"Compensation Committee Interlocks and
Insider Participation."




42

43
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 28.

(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. *

3.4 Amended and Restated Bylaws of the Company. *

4.1 Specimen Certificate of Common Stock. *

4.2 Rights Agreement, dated as of August 23, 1996, between the ***
Company and U.S. Stock Transfer Corporation.

10.1 SONUS Pharmaceuticals, Inc. Incentive Stock Option, Nonqualified
Stock 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. *

10.3 Form of Nonqualified Stock Option Agreement pertaining to
the 1991 Plan. *

10.4 Form of Restricted Stock Purchase Agreement pertaining to the
1991 Plan. *



43

44


10.5 SONUS Pharmaceuticals, Inc. 1995 Stock Option Plan for Directors
(the "Director Plan"). *

10.6 Form of Stock Option Agreement pertaining to the Director Plan. *

10.12 License Agreement dated as of March 31, 1995 by and between the
Company and Daiichi Company (portions omitted pursuant to Rule 406
of the Securities Act of 1933, as amended (the "1933 Act")). *




44

45


10.14 Contrast Agent Development and Supply Agreement dated May 6, 1993
by and 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 August 22, 1995 by and between the Company and Abbott
Laboratories, Inc. (portions omitted pursuant to Rule 406 of the
1933 Act). *

10.15 Lease Agreement dated February 26, 1992 by and between the Company
and Cambridge Park Partners, L.P. *

10.16 First Amendment to Lease dated December 15, 1994 by and between
the Company and Cambridge Park Partners, L.P. *

10.17 Sublease dated December 15, 1994 by and between the Company and
McGaw, Inc. *

10.18 Lease Agreement dated January 17, 1994 between the Company and WRC
Properties, Inc. *

10.19 Form of Indemnification Agreement for Officers and Directors of
the Company. *

10.20 Manufacturing Agreement dated August 2, 1995 by and between the
Company and Pharmaceutical Education and Development Foundation of
the Medical University of South Carolina (portions omitted pursuant
to Rule 406 of the 1933 Act). *



45

46


10.21 Loan and Security Agreement dated August 11, 1995 by and between
the Company and Silicon Valley Bank. *

10.22 SONUS Pharmaceuticals, Inc. Employee Stock Purchase Plan. **

10.24 Employment Agreement, effective as of January 16, 1996, #
by and between the Company and Steven C. Quay, M.D., Ph.D.

10.25 Agreement between Abbott Laboratories, Inc. and the Company, ##
dated May 14, 1996 (portions omitted pursuant to Rule 24b-2).

10.26 Third Amended and Restated Registration Rights Agreement ###
dated as of May 15, 1996.

10.28 International License Agreement, dated October 1, 1996, by and ####
between Abbott Laboratories, Inc. and the Company (portions
omitted pursuant to Rule 24b-2).

11.1 Computation of pro forma net loss per share. +

11.2 Computation of historical net income (loss) per share. +

23.1 Consent of Ernst & Young LLP, Independent Auditors +

24.1 Power of Attorney (included on the Signature Page of this
Annual Report on Form 10-K).

27.1 Financial Data Schedule. +


Executive Compensation Plans and Arrangements



Exhibit No. Description Location
----------- ----------- --------


10.1 1991 Plan. *

10.2 Form of Incentive Stock Option Agreement pertaining to
the 1991 Plan. *

10.3 Form of Nonqualified Stock Option Agreement pertaining
to the 1991 Plan. *

10.4 Form of Restricted Stock Purchase Agreement pertaining to
the 1991 Plan. *

10.5 Director Plan. *



46

47


10.6 Form of Stock Option Agreement pertaining to the Director
Plan. *

10.22 SONUS Pharmaceuticals, Inc. Employee Stock Purchase Plan. **

10.24 Employment Agreement, effective as of January 16, 1996, #
by and between the Company and Steven C. Quay, M.D.,
Ph.D.


- ----------

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

** Incorporated by reference to Exhibit 4.7 to the Company's Registration
Statement on Form S-8, Registration No. 33-80623.

*** Incorporated by reference to the Company's Registration Statement on Form
8-A, dated August 23, 1996.

# 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.

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

### 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.

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

+ Filed herewith

(b) Reports on Form 8-K

The Company filed the following report on Form 8-K during the quarter
ended December 31 1996:

1. The Registrant filed a report on Form 8-K on October 8, 1996 in
connection with the International License Agreement between Abbott
Laboratories and SONUS Pharmaceuticals, Inc. dated October 1, 1996.


EchoGen(R) is a registered trademark and High-Q Factor(TM) and
PhaseShift(TM) are trademarks of SONUS Pharmaceuticals, Inc.


47

48
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 18, 1997.

SONUS PHARMACEUTICALS, INC.

Dated: March 18, 1997 By: /s/ Steven C. Quay, M.D., Ph.D.
-------------- -------------------------------
Steven C. Quay, M.D., Ph.D.
President, Chief Executive
Officer and Director

We, the undersigned directors and officers of SONUS Pharmaceuticals, Inc.,
do hereby constitute and appoint Steven C. Quay, M.D., Ph.D. and Gregory Sessler
our true and lawful attorneys and agents, with full powers of substitution to do
any and all acts and things in our name and 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 hereto; 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/ Steven C. Quay, M.D., Ph.D. President, Chief Executive March 18, 1997
- ------------------------------------- Officer and Director
Steven C. Quay, M.D., Ph.D. (Principal Executive Officer)


/s/ Gregory Sessler Chief Financial Officer March 18, 1997
- ------------------------------------- (Principal Financial and
Gregory Sessler Principal Accounting Officer)


/s/ Donald B. Milder Director March 18, 1997
- -------------------------------------
Donald B. Milder

/s/ Harry A. Shoff Director March 18, 1997
- -------------------------------------
Harry A. Shoff


- ------------------------------------- Director March , 1997
Dwight Winstead



48