MOLECULAR BIOSYSTEMS INC, 10-Q, 2000-02-11

MOLECULAR BIOSYSTEMS INC
10-Q, 2000-02-11
IN VITRO & IN VIVO DIAGNOSTIC SUBSTANCES

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<PAGE>

FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 1999

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from............... to ...............

Commission file number 1-10546

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

Delaware 36-3078632
(State of Incorporation) (I.R.S. Identification No.)

10030 Barnes Canyon Road
San Diego, California 92121
(858) 812-7001
(Address, including zip code, and telephone number,
including area code, of principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

X Yes No
--- ---
The number of shares outstanding of the issuer's common stock, $.01 par value,
as of February 1, 2000 was 18,724,017 shares.
<PAGE>

INDEX

MOLECULAR BIOSYSTEMS, INC.

Part I. Financial Information

Item 1. Financial Statements (Unaudited)

Consolidated Balance Sheets
-December 31, 1999 and March 31, 1999

Consolidated Statements of Operations
-Three months ended December 31, 1998 and 1999
-Nine months ended December 31, 1998 and 1999

Consolidated Statements of Cash Flows
-Nine months ended December 31, 1998 and 1999

Notes to Financial Statements
-December 31, 1999

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

Part II. Other Information

Item 1. Legal Proceedings

Item 2. Changes in Securities

Item 3. Defaults Upon Senior Securities

Item 4. Submission of Matters to a Vote of Securities Holders

Item 5. Other Information

Item 6. Exhibits and Reports on Form 8-K

Signatures

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<PAGE>

MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(DOLLARS IN THOUSANDS)

MARCH 31, DECEMBER 31,
1999 1999
----------- ------------
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,056 $ 1,755
Marketable securities, available-for-sale 16,982 10,895
Accounts and notes receivable 2,320 2,617
Inventories 748 331
Prepaid expenses and other assets 425 254
--------- ---------
Total current assets 21,531 15,852
--------- ---------

Property and equipment, at cost:
Building and improvements 11,113 11,113
Equipment, furniture and fixtures 2,893 2,982
Construction in progress 930 497
--------- ---------
14,936 14,592
Less: Accumulated depreciation and amortization 6,672 7,382
--------- ---------
Total property and equipment 8,264 7,210
--------- ---------

Other assets, net 2,054 1,877
--------- ---------

$ 31,849 $ 24,939
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 1,278 $ 1,288
Accounts payable and accrued liabilities 7,395 6,000
Compensation accruals 2,165 1,191
--------- ---------
Total current liabilities 10,838 8,479
--------- ---------

Long-term debt, net of current portion 4,804 3,835

Commitments and contingencies

Stockholders' equity:
Common Stock, $.01 par value, 40,000,000 shares
authorized, 18,580,745 and 18,724,017 shares
issued and outstanding, respectively 186 186
Additional paid-in capital 134,347 134,388
Accumulated deficit (117,969) (121,591)
Unrealized gain on available-for-sale securities 6 21
Less 40,470 and 42,298 shares of treasury stock,
at cost, respectively (363) (379)
--------- ---------
Total stockholders' equity 16,207 12,625
--------- ---------

$ 31,849 $ 24,939
========= =========
</TABLE>

See accompanying notes.
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MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

Three Months Ended Nine Months Ended
December 31, December 31,
1998 1999 1998 1999
----------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Revenues:
Revenues under collaborative agreements $ 1,500 $ - $ 3,998 $ 3,000
Product and royalty revenues 685 433 3,471 950
Milestone payments - 2,000 - 2,000
License fees - 60 16,371 60
-------- -------- -------- --------
2,185 2,493 23,840 6,010
-------- -------- -------- --------
Operating expenses:
Research and development costs 2,358 839 6,995 3,287
Cost of products sold 2,668 183 6,108 (346)
Cost of licenses - - 9,378 -
Selling, general and administrative expenses 3,092 2,605 12,701 6,703
Cost reduction measures:
Asset disposals 3,143 - 3,143 -
Severance costs 2,328 - 2,328 -
Technology transfer 265 - 265 -
Exit costs 384 - 384 -
-------- -------- -------- --------
14,238 3,627 41,302 9,644
-------- -------- -------- --------

Loss from operations (12,053) (1,134) (17,462) (3,634)

Interest expense (142) (110) (456) (344)
Interest income 325 154 1,120 556
-------- -------- -------- --------

Loss before income taxes (11,870) (1,090) (16,798) (3,422)
Foreign income tax provision - (200) (1,400) (200)
-------- -------- -------- --------

Net Loss $(11,870) $ (1,290) $(18,198) $ (3,622)
======== ======== ======== ========

Loss per common share - basic and diluted $ (0.64) $ (0.07) $ (0.98) $ (0.19)
======== ======== ======== ========

Weighted average common shares outstanding 18,581 18,724 18,558 18,727
======== ======== ======== ========
</TABLE>

See accompanying notes.
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MOLECULAR BIOSYSTEMS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>

NINE MONTHS ENDED
DECEMBER 31,
1998 1999
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(18,198) $ (3,622)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 988 887
Write-off of patents and license fees 295 -
Disposals/write-downs of property and equipment 2,824 139
Write-off of former Shionogi territory license rights 8,500 -
Premium received on Chugai Investment (2,371) -
Changes in operating assets and liabilities:
Receivables (5,284) (622)
Inventories 223 416
Prepaid expenses and other assets 297 497
Accounts payable and accrued liabilities 2,876 188
Deferred contract revenues (1,575) -
Compensation accruals 761 (974)
-------- --------

Cash used in operating activities (10,664) (3,091)
-------- --------

Cash flows from investing activities:
Purchases of property and equipment (846) (68)
Proceeds from sale of property and equipment 3 12
Additions to patents and license rights (30) -
Purchase of license rights from Shionogi (2,000) (1,500)
Decrease in other assets 98 177
Purchases of marketable securities (35,703) (14,745)
Maturities of marketable securities 40,953 20,847
-------- --------

Cash provided by investing activities 2,475 4,723
-------- --------

Cash flows from financing activities:
Net proceeds from sale of Common Stock to Chugai 8,300 -
Net proceeds from stock options exercised 281 41
Purchase of treasury stock - (16)
Principal payments on long-term debt (954) (958)
-------- --------

Cash provided by (used in) financing activities 7,627 (933)
-------- --------

Increase (decrease) in cash and cash equivalents (562) 699

Cash and cash equivalents, beginning of period 1,064 1,056
-------- --------

Cash and cash equivalents, end of period $ 502 $ 1,755
======== ========

Supplemental cash flow disclosures:

Interest income received $ 1,401 $ 702
======== ========

Interest paid $ 454 $ 344
======== ========
</TABLE>

See accompanying notes.
5
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) BASIS OF PRESENTATION-

These interim Consolidated Financial Statements of Molecular
Biosystems, Inc. and Subsidiaries (the "Company") should be read in conjunction
with the Consolidated Financial Statements of the Company and related Notes
filed with the Company's Annual Report on Form 10-K for the year ended March 31,
1999. Certain reclassifications have been made to the prior year to conform to
the current year presentation.

These interim Consolidated Financial Statements of the Company have not
been audited by independent public accountants. However, in the opinion of the
Company, all adjustments required for a fair presentation of the financial
position of the Company as of December 31, 1999, and the results of its
operations for the nine-months ended December 31, 1998 and 1999, and its cash
flows for the nine-months ended December 31, 1998 and 1999, have been made. The
results of operations for these interim periods are not necessarily indicative
of the operating results for the full year.

(2) COMMITMENTS AND CONTINGENCIES-

In July, 1997 the Company and its marketing partner, Mallinckrodt Inc.
("Mallinckrodt") filed suit (the "MBI Case") in United States District Court for
the District of Columbia against four potential competitors - Sonus
Pharmaceuticals, Inc. ("Sonus"), Nycomed Imaging AS ("Nycomed"), ImaRx
Pharmaceutical Corp. ("ImaRx") and its marketing partner DuPont Merck and Bracco
- - seeking declarations that certain of their ultrasound contrast agent patents
are invalid.

The complaint alleges that each of the defendants' patents is
invalid on a variety of independent grounds under U.S. patent law. In
addition to requesting that all of the patents in question be declared
invalid, the complaint requests a declaration that, contrary to defendants'
contentions, the Company and Mallinckrodt do not infringe the defendants'
patents, and asks that defendants be enjoined from proceeding against the
Company and Mallinckrodt for infringement until the status of defendants'
patents has been determined by the court or the U.S. Patent and Trademark
Office ("PTO"). The complaint alleges that each defendant has claimed or is
likely to claim that its patent or patents cover OPTISON-Registered
Trademark-, the Company's advance-generation ultrasound contrast agent, and
will attempt to prevent its commercialization.

All of the defendants except Nycomed filed motions to dismiss the
complaint on jurisdictional grounds. In January 1998, the court dismissed each
of the defendants except Nycomed, ruling that the court lacked jurisdiction over
those defendants with respect to the Company's claims of patent invalidity and
non-infringement. The court's ruling does not purport to rule on the merits of
the Company's claims; the dismissal was based solely on jurisdictional grounds.

Following Sonus's dismissal as a defendant in the MBI Case, Sonus
activated a patent infringement lawsuit (the "Sonus Case") which it had filed in
August 1997 against the Company and Mallinckrodt in the United States District
Court for the Western District of Washington. Although the complaint was filed
in August 1997, Sonus had agreed not to proceed with the Sonus Case until the
jurisdictional motions were decided in the MBI Case. Sonus's complaint alleges
that the manufacture and sale of OPTISON by the Company and Mallinckrodt
infringe

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two patents owned by Sonus. MBI counterclaimed for a declaration of invalidity
and non-infringement with respect to the Sonus patents. These two patents are
the same patents for which the Company was seeking a declaration of invalidity
in the MBI Case.

Beginning in July 1997, the Company received the first of five notices
from the PTO granting the Company's petitions for reexamination which it had
filed with respect to five patents held by three potential competitors, Sonus,
Nycomed and ImaRx. Each of the five notices stated there was a substantial new
question of patentability raised by the Company's petitions with respect to all
claims of the patents. Each of the patents in the reexamination process is
related to the use of perfluorocarbon gases in ultrasound contrast agents and is
included among the patents for which the Company was seeking a declaration of
invalidity in the MBI Case (and for which the Company is continuing to seek a
declaration of invalidity in the case of Nycomed's patents).

In late 1997 and early 1998, the PTO issued office actions in
connection with the Company's patent reexamination petitions filed against
Sonus, Nycomed and ImaRx. The PTO office actions rejected all relevant claims of
these patents based on prior art not previously disclosed to the PTO by Sonus,
Nycomed or ImaRx during prosecution of their patent applications.

In June 1998, the PTO issued a final rejection of all claims of the
two Sonus patents involved in the Sonus Case. In December 1998, the Company
received correspondence from the PTO with respect to the two Sonus patents
involved in the reexamination proceedings. On the basis of amendments after
final rejection, the PTO has indicated that certain claims in Sonus' U.S. Patent
No. 5,558,094 (`094) are allowable by the agency. According to the PTO
correspondence, none of the original `094 patent claims which Sonus had asserted
against MBI will be allowed by the PTO without amendment. The PTO has also
indicated that certain claims of Sonus' U.S. Patent 5,573,751 (`751) are
allowable by the agency. According to the PTO correspondence, certain of the
`751 patent claims which Sonus has asserted against the Company will be allowed
in their original form. In January 1999, the PTO issued reexamination
certificates for the `094 and `751 patents.

In August 1998, the PTO issued a final rejection of all relevant claims
of the Nycomed patent involved in the MBI Case. If the PTO rejection is
maintained on any appeal subsequently filed by Nycomed, the patent Nycomed is
attempting to assert against the Company and Mallinckrodt to block the
manufacture and sale of OPTISON will be invalidated.

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

On May 5, 1999, the Company and Mallinckrodt received notice of a
lawsuit filed against them by DuPont Pharmaceuticals Company ("DuPont") and
ImaRx in the United States District Court for the District of Delaware (the
"DuPont Case"). The lawsuit alleges that the manufacture and sale of OPTISON
infringes the `656 patent owned by ImaRx and exclusively licensed to DuPont. MBI
counterclaimed for a declaration of invalidity and noninfringement with respect
to the `656 patent. In June 1999, DuPont and ImaRx amended their complaint in
the

7
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DuPont Case to add allegations that the manufacture and sale of OPTISON also
infringes the `521 patent owned by ImaRx and exclusively licensed to DuPont.

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

(3) EARNINGS PER SHARE-

The Company follows Statement of Financial Accounting Standards No.
128, "Earnings Per Share" (SFAS 128). The statement specifies the computation,
presentation, and disclosure requirements for earnings per share (EPS). SFAS 128
requires companies to compute net income (loss) per share under two different
methods, basic and diluted per share data for all periods for which an income
statement is presented. Basic earnings per share was computed by dividing net
income (loss) by the weighted average number of common shares outstanding during
the period. Diluted earnings per share reflects the potential dilution that
could occur if net income were divided by the weighted-average number of common
shares and potential common shares from outstanding stock options for the
period. Potential common shares were calculated using the treasury stock method
and represent incremental shares issuable upon exercise of the Company's
outstanding options. For the quarters and the nine months ended December 31,
1998 and 1999, the diluted loss per share calculation excludes effects of
outstanding stock options of 3,662,368 and 3,878,870, respectively, as such
inclusion would be anti-dilutive.

(4) COST REDUCTION MEASURES-

On November 10, 1998, as a result of the slower than planned ramp up of
OPTISON sales, the Company announced the initiation of a multi-phase program to
reduce expenses and preserve capital. The initial phase of cost reduction
occurred in November 1998 and affected approximately 40 employees of the
Company's 140-person workforce. The second reduction in force occurred in April
1999 and affected an additional 26 employees. In addition, attrition since
November 1998 has further reduced the current workforce to approximately 60
employees. The Company will implement an additional reduction in workforce of
approximately 25 employees when the out-sourcing of manufacturing operations is
complete.

The impact of the cost reduction measures on the Company's financial
statements for the nine months ended December 31, 1999 included a write-off of
$600,000 in fixed assets through accelerated depreciation. For the nine months
ended December 31, 1998, the impact included $3.1 million in asset disposals,
$2.3 million in severance costs, $300,000 in costs related to technology
transfer and $400,000 in exit costs. In addition, $1.1 million of inventories
were expensed through cost of sales as a result of the planned out-sourcing of
manufacturing. The Company expects to write off an additional $1.0 million in
accelerated depreciation over the next 24 months as the manufacturing process is
out-sourced.

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A summary of the nine-month period activity related to the accrual for
cost reduction measures is provided below.

<TABLE>

<S> <C>
Accrued at March 31, 1999 . . . . . . . . . . . . . . . . . . . . . $2,000,000

Severance . . . . . . . . . . . . . . . . . . . . . . . . . . . (500,000)

Exit costs . . . . . . . . . . . . . . . . . . . . . . . . . . (400,000)

Technology transfer . . . . . . . . . . . . . . . . . . . . . . (300,000)
----------

Accrued at December 31, 1999 . . . . . . . . . . . . . . . . . . . $ 800,000
==========

</TABLE>

(5) AMENDMENT TO MALLINCKRODT AGREEMENT-

In September 1995, the Company and Mallinckrodt entered into an Amended
and Restated Distribution Agreement ("ARDA"). ARDA grants Mallinckrodt exclusive
rights to market licensed products in certain countries of the world in exchange
for supporting clinical trials of OPTISON, related regulatory submissions and
associated product development. ARDA also calls for additional funding upon the
satisfaction of certain territorial and product development milestones and
requires the Company to spend at a set minimum for clinical trials to support
regulatory filings with the FDA for cardiac indications of OPTISON.

In April 1999, the Company and Mallinckrodt agreed to transfer the
manufacture of OPTISON from MBI to Mallinckrodt. The parties' agreement has been
incorporated into the Second Amended and Restated License and Distribution
Agreement ("ARDA II"). Under the terms of ARDA II, which were retroactive to
March 1, 1999, Mallinckrodt reimburses MBI for all manufacturing expenses,
including incremental costs related to the technology transfer. In addition to
the transfer of manufacturing, ARDA II extends Mallinckrodt's responsibility for
funding clinical trials to include all cardiology and radiology clinical trials
for OPTISON in the United States. MBI will continue to conduct all cardiology
trials for OPTISON and will assume responsibility for conducting radiology
trials in the United States. In exchange for the transfer of manufacturing and
increased financial support of clinical trials for OPTISON, MBI will receive a
reduced royalty rate on product sales of OPTISON.

(6) STOCK EXCHANGE LISTING-

In August 1999, the Company received notice that the New York Stock
Exchange (NYSE) had revised its continued listing standards and that the Company
was no longer in compliance with the revised standards. These listing standards
are threefold and include: total market capitalization and stockholders' equity
of not less than $50 million each; total market capitalization of not less than
$15 million over a 30 trading-day period; and a minimum share price of $1 over a
30 trading-day period. The Company submitted a plan to meet the revised
standards, which was rejected by the NYSE. As a result, the Company was delisted
by the NYSE effective after the close of trading on January 4, 2000.

Effective January 5, 2000, trading of the Company's common stock was
moved to the NASD Over-The-Counter Bulletin Board. A new trading symbol of
"MBIO" was assigned to the Company by NASD. The Company's common stock traded on
the New York Stock Exchange under the symbol "MB" through the close of business
January 4, 2000.

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(7) MERGER WITH PALATIN TECHNOLOGIES, INC.-

On November 12, 1999, the Company and Palatin Technologies of
Princeton, New Jersey jointly announced that they had signed a definitive
agreement to merge. Under the agreement, stockholders of the Company will
receive 0.525 shares of common stock of Palatin in exchange for their MBI common
stock. The exchange ratio under the merger agreement will result in shareholders
of each company owning approximately 50% of the merged entity, which will
operate under the name Palatin Technologies and will be headquartered in
Princeton. The merger is subject to shareholder approval. The stock exchange
will be accounted for using purchase accounting. A registration statement on
Form S-4 has been filed and is currently under review by the Securities and
Exchange Commission.

Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following management discussion and analysis should be read in
conjunction with (1) the current Consolidated Financial Statements and (2) the
Company's Consolidated Financial Statements and related Notes and Management's
Discussion and Analysis of Financial Condition and Results of Operations in its
Annual Report on Form 10-K for the year ended March 31, 1999.

From time to time, the Company may publish forward-looking
statements relating to such matters as anticipated financial performance,
business prospects, technological developments, new products, regulatory
approval, research and development activities and similar matters. A variety
of factors could cause the Company's actual results and experience to differ
materially from the Company's anticipated results or other expectations. The
risks and uncertainties that may affect the operations, performance,
development and results of the Company's business include the expense and
uncertain outcome of the litigation described in Note 2 to the Financial
Statements in Item 1 above, including the possibility of injunctive relief to
competitors prohibiting the sale of OPTISON-Registered Trademark-, a ruling
by the Patent and Trademark Office ("PTO") in the pending patent
reexamination proceedings favoring competitors' patents; difficulties and
delays with respect to the performance of clinical trials; delays by
regulatory authorities in approving additional indications for OPTISON,
including the evaluation of myocardial perfusion; inability to successfully
transfer OPTISON manufacturing to Mallinckrodt; difficulties and delays with
respect to marketing and sales activities; general uncertainties accompanying
the development and introduction of new products; and other risk factors
reported from time to time in the Company's reports filed with the Securities
and Exchange Commission.

RECENT EVENTS

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funding clinical trials to include all cardiology, as well as radiology and
clinical trials for OPTISON in the United States. MBI will continue to conduct
all cardiology trials for OPTISON and will assume responsibility for conducting
radiology trials in the United States. In exchange for the transfer of
manufacturing and increased financial support of clinical trials for OPTISON,
MBI will receive a royalty on end-user product sales of OPTISON.

Effective January 5, 2000, trading of the Company common stock was
moved to the NASD Over-The-Counter Bulletin Board. A new trading symbol of
"MBIO" was assigned to the Company by NASD. The Company common stock traded on
the New York Stock Exchange under the symbol "MB" through the close of business
January 4, 2000.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 1999, the Company had net working capital of $7.4
million compared to $10.7 million at March 31, 1999. Cash, cash equivalents and
marketable securities were $12.6 million at December 31, 1999 compared to $18.0
million at March 31, 1999. The Company expects to write off an additional $1.0
million in accelerated depreciation over the next 24 months as the manufacturing
process is out-sourced.

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

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

RESULTS OF OPERATIONS

REVENUES UNDER COLLABORATIVE AGREEMENTS. Revenues under collaborative
agreements were $3.0 million for the nine-month period ended December 31, 1999
compared to $4.0 million for the same period in the prior year. These revenues
in both years consisted solely of quarterly payments to support clinical trials,
regulatory submissions and product development received from Mallinckrodt under
the Amended and Restated Distribution Agreement ("ARDA"). As of September 30,
1999, these payments were completed. Therefore, there were no revenues under
collaborative agreements for the three-month period ended December 31, 1999
compared to $1.5 million for the same period in the prior year.

PRODUCT AND ROYALTY REVENUES. Revenues from product sales and royalties
were $433,000 and $950,000 for the three-month and nine-month periods ended
December 31, 1999 compared to $700,000 and $3.5 million for the same periods in
the prior year.

In the nine months ended December 31, 1999, royalty revenues amounted
to $886,000 from Mallinckrodt and $64,000 from Abbott Laboratories. Royalties
from Mallinckrodt were calculated by applying a royalty rate to end-user sales
under the terms of ARDA II as described in Note 5 of the Notes to the Financial
Statements under Item 1 above. ARDA II changed the nature of revenues recognized
by the Company from product revenues recognized upon shipment to royalty
revenues recognized as a percentage of end-user sales. As a result, there were
no product sales for the nine months ended December 31, 1999.

In the nine months ended December 31, 1998, product and royalty
revenues were $3.5 million. Royalty revenues amounted to $122,000 from Abbott
Laboratories. Product revenues came from the Company's sales of OPTISON to
Mallinckrodt and were recognized upon shipment of the product. The transfer
price for the Company's sales of OPTISON to Mallinckrodt was approximately equal
to 40% of Mallinckrodt's average net sales price to its end users of the product
for the immediately preceding quarter. Pursuant to ARDA, the average net sales
price to end users was calculated by dividing the net sales for the preceding
quarter by the total number of units shipped to end users whether paid for or
shipped as samples. Consistent with industry practice, the Company considered
samples a marketing expense and as such the cost of samples was recorded as
selling, general and administrative expense.

MILESTONE PAYMENTS. Revenues from milestone payments were $2.0 million
for the nine-month period ended December 31, 1999. There were no milestone
payments during the same period in the prior year. Revenues in the current year
represent a $2.0 million milestone payment from Chugai Pharmaceutical Co., Ltd.
(Chugai) which was received during the third quarter for the initiation of
pivotal trials in Japan for OPTISON.

LICENSE FEES. Revenues from license fees were $60,000 for the
nine-month period ended December 31, 1999 compared to $16.4 million for the same
period in the prior year. Revenues in the current year represent a $60,000
license fee from ISIS Pharmaceuticals. Revenues in the

12
<PAGE>

prior year include a $14 million license fee recognized in connection with the
sale of territorial rights to Chugai, as well as a $2.4 million premium received
for the sale of MBI common stock to Chugai.

COST OF PRODUCTS SOLD. Cost of products sold totaled $183,000 and
($346,000) for the three-month and nine-month periods ended December 31, 1999
compared to $2.7 million and $6.1 million for the same periods in the prior
year. Under the terms of ARDA II, which were retroactive to March 1, 1999,
Mallinckrodt has agreed to reimburse MBI for all fully allocated manufacturing
expenses, including incremental costs related to the technology transfer. The
manufacturing expenses from March 1999 were included in the prior fiscal year.
As a result, the recoupment of these expenses is reflected as a negative expense
in the current fiscal year.

COST OF LICENSES. Cost of licenses totalled $9.4 million for the nine
months ended December 31, 1998 and included a non-cash expense of $8.5 million
related to the sale to Chugai of territory rights previously reacquired from
Shionogi & Co., Ltd., plus related transaction fees of $878,000.

RESEARCH AND DEVELOPMENT COSTS. For the three-month and nine-month
periods ended December 31, 1999, the Company's research and development costs
totaled $840,000 and $3.3 million, as compared to $2.4 million and $7.0 million
for the same periods in the prior year. The decrease is due to previously
announced cost reduction measures and the extension of Mallinckrodt's
responsibility for funding clinical trials under ARDA II as described in Note 5
of the Notes to the Financial Statements under Item 1 above.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. For the three-month and
nine-month periods ended December 31, 1999, the Company's selling, general and
administrative costs totaled $2.6 million and $6.7 million, as compared to $3.1
million and $12.7 million for the same periods in the prior year. The higher
expenses for the same period in the prior year were due primarily to continuing
legal expenses and marketing costs associated with the launch of OPTISON. In
addition, current year expense decreased due to previously announced cost
reduction measures.

COST REDUCTION MEASURES. On November 10, 1998, as a result of the
slower than planned ramp up of OPTISON sales, the Company announced the
initiation of a multi-phase program to reduce expenses and preserve capital. The
initial phase of cost reduction occurred in November 1998 and affected
approximately 40 employees of the Company's 140-person workforce. The second
reduction in force occurred in April 1999 and affected an additional 26
employees. In addition, attrition since November 1998 has further reduced the
current workforce to approximately 60 employees. The Company will implement an
additional reduction in workforce of approximately 25 employees when the
out-sourcing of manufacturing operations is complete.

13
<PAGE>

A summary of the nine-month period activity related to the accrual for
cost reduction measures is provided below.

<S> <C>
Accrued at March 31, 1999 . . . . . . . . . . . . . . . . . . . . . . $2,000,000

Severance . . . . . . . . . . . . . . . . . . . . . . . . . . . . (500,000)

Exit costs . . . . . . . . . . . . . . . . . . . . . . . . . . . (400,000)

Technology transfer . . . . . . . . . . . . . . . . . . . . . . . (300,000)
----------

Accrued at December 31, 1999 . . . . . . . . . . . . . . . . . . . . $ 800,000
==========
</TABLE>

INTEREST EXPENSE AND INTEREST INCOME. Interest expense for the
three-month and nine-month periods ended December 31, 1999 amounted to $110,000
and $344,000, compared to $142,000 and $456,000 for the same period in the prior
year, and consisted of mortgage interest on the Company's manufacturing building
and interest on a note payable which is secured by the tangible assets of the
Company. The interest rate on the mortgage was 8% in December 1999. The note
payable bears interest at the prime rate and is payable in monthly installments
of principal plus interest over five years. The note payable was renegotiated in
September 1998 lowering the interest rate from prime plus one to the prime rate
and releasing a compensating balance requirement. The interest rate on the note
was 8.5% in December 1999.

Interest income for the three-month and nine-month periods ended
December 31, 1999 amounted to $154,000 and $556,000, compared to $325,000 and
$1.1 million for the same period in the prior year. The decrease in interest
income in the current year is due to lower average cash and marketable
securities balances. The Company's cash is invested primarily in short-term,
fixed principal investments, such as U.S. Government agency issues, corporate
bonds, certificates of deposit and commercial paper.

FOREIGN INCOME TAX PROVISION. The company paid $200,000 in foreign
taxes during the quarter ended December 31, 1999 related to a milestone payment
received from Chugai and $1.4 million in foreign taxes related to the Chugai
alliance during the quarter ended June 30, 1998.

YEAR 2000 READINESS. The Year 2000 problem is the result of computer
programs being written using two digits rather than four digits to define the
applicable year. This problem could create unforeseen risks to the Company from
its internal computing systems as well as from computer systems of third parties
with which it deals. The Company has completed a comprehensive review of its
internal computing systems and of its vendors, service providers (including
financial institutions and insurance companies), and collaborative partners.
Subsequent to December 31, 1999, the Company had not experienced any significant
costs or disruptions associated with the Year 2000 problem.

PROSPECTIVE INFORMATION

14
<PAGE>

The Company is involved in several legal and administrative proceedings
which could result in a substantial cost to the Company. Given the complexity of
the legal and factual issues and the uncertainty of litigation, there can be no
assurance of a favorable outcome. An unfavorable outcome could have a material
adverse effect on the Company's business, financial condition and results of
operations. For a detailed discussion of these matters, see Note 2 in Notes to
the Financial Statements under Item 1 above.

Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK

The information called for by this item is provided under the caption
"Interest Expense and Interest Income" under Item 2 - Management's Discussion
and Analysis of Financial Condition and Results of Operations.
The Company does not hedge its market risk.

PART II - OTHER INFORMATION

Item 1 - LEGAL PROCEEDINGS

See Note 2 in Notes to the Financial Statements, which is incorporated
by reference in this response.

Item 2-4 - The Company has nothing to report with respect to these items during
the quarter ended December 31, 1999.

Item 5 - OTHER INFORMATION

DATES FOR SUBMISSION OF STOCKHOLDER PROPOSALS

Any stockholder of the Company who wishes to present a proposal to be
considered at the 2000 Annual Meeting of Stockholders and who, pursuant to Rule
14a-8 of the Securities and Exchange Commission, wishes to have the proposal
included in the Company's proxy statement and form of proxy for that meeting,
must submit the proposal in writing to the Company at 10030 Barnes Canyon Road,
San Diego, California 92121, so that it is received by April 4, 2000.

SUBSEQUENT EVENT - LISTING ON NASD OVER-THE-COUNTER BULLETIN BOARD

Effective January 5, 2000, trading of the Company common stock was
moved to the NASD Over-The-Counter Bulletin Board. A new trading symbol of
"MBIO" was assigned to the Company by NASD. The Company traded on the New York
Stock Exchange under the symbol "MB" through the close of business January 4,
2000.

Item 6 - EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits -

10.1 Employment Agreement between the Company and Bobba Venkatadri,
effective as of January 21, 1999.

15
<PAGE>

10.2 Employment Agreement between the Company and Howard Dittrich,
M.D., effective as of January 21, 1999.

10.3 Employment Agreement between the Company and Joni Harvey,
effective as of January 21, 1999.

10.4 Employment Agreement between the Company and Elizabeth Hougen,
effective as of January 21, 1999.

(b) Reports on Form 8-K

A Current Report on Form 8-K dated November 11, 1999 was filed on
November 26, 1999 reporting that the Company had signed a definitive
agreement to merge with Palatin Technologies of Princeton, New Jersey.

A Current Report on Form 8-K dated January 5, 2000 was filed on January
11, 2000 reporting that trading of the Company common stock was moved
from the New York Stock Exchange to the NASD Over-The-Counter Bulletin
Board under the symbol "MBIO".

16
<PAGE>

SIGNATURES

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

MOLECULAR BIOSYSTEMS, INC.

/s/ ELIZABETH HOUGEN
- ----------------------------
Elizabeth Hougen
Executive Director, Finance and Chief Financial Officer
(Principal Financial and Accounting Officer)

2/11/00
- ---------
Date

<PAGE>

EXHIBIT 10.1

EMPLOYMENT AGREEMENT

This is an EMPLOYMENT AGREEMENT "Agreement" effective as of
January 21, 1999 ("Effective Date"), between BOBBA VENKATADRI, an individual
("Employee"), and MOLECULAR BIOSYSTEMS, INC., a Delaware corporation ("the
Company").

1. EMPLOYMENT.

a. POSITION. The Company agrees to employ Employee
as its CHIEF EXECUTIVE OFFICER AND PRESIDENT.

b. DUTIES. Employee shall diligently, and to the
best of his ability, perform all such duties incident to his position and use
his best efforts to promote the interests of the Company.

c. TIME TO BE DEVOTED TO EMPLOYMENT. Employee shall
devote his full time and energy to the business of the Company and shall not be
engaged in any competitive business activity without the express written consent
of the Company except Employee may serve on the Board of Directors of no more
than two (2) other corporations (other than family businesses in India to which
Employee does not devote substantial time) with the prior written approval of
the Board of Directors. Employee hereby represents that he is not a party to any
agreement which would be an impediment to entering into this Employment
Agreement and that he is permitted to enter into this Employment Agreement and
perform the obligations hereunder.

d. AT-WILL EMPLOYMENT. Employee shall be employed
on an at-will basis and may terminate his employment and may be terminated from
his employment at any time with or without cause, subject to the severance
payment provisions set forth in paragraphs 14 and 16 below.

2. COMPENSATION AND BENEFITS.

a. ANNUAL SALARY. In consideration of and as
compensation for the services agreed to be performed by Employee hereunder, the
Company agrees to pay Employee, as of the Effective Date of this Agreement, an
annual Base Salary of $315,000, payable in accordance with the Company's regular
payroll schedule, less applicable withholdings and deductions. Employee's
annual Base Salary is subject to being increased as part of the Company's annual
salary review process. Changes to Employee's annual Base Salary, as well as
other terms and conditions of his compensation, must be approved by the Board of
Directors of the Company (the "Board").
<PAGE>

b. ANNUAL BONUS. Employee may be paid an annual
bonus to be determined by the Company's Board of Directors based on Employee's
performance, the Company's performance, and any other reasonable factors
determined by the Board of Directors.

c. STOCK OPTIONS. Employee shall be eligible for
additional stock option awards at the discretion of the Board of Directors. In
the event of a termination Without Cause or a Constructive Termination not
following a Change of Control, Employee shall have two years from the date of
termination to exercise options vested as of the termination date, or any lesser
period as mandated by law.

d. PARTICIPATION IN BENEFIT PLANS. Employee shall be
eligible for family medical, dental, short and long term disability, life
insurance coverages, eligibility in the Corporation's 401(k) plan, vacation and
any other such benefits as are made available to the executives of the
Corporation, all on such terms and conditions (including, where applicable,
cost-sharing with the Employee) as are applicable to participants generally. The
Company reserves the right to amend, modify or terminate any employee benefits
at any time for any reason.

e. REIMBURSEMENT OF EXPENSES. The Company shall
reimburse Employee for all reasonable business expenses incurred by Executive on
behalf of the Company provided that: (i) such reasonable expenses are ordinary
and necessary business expenses incurred on behalf of the Company, and (ii)
Employee provides the Company with itemized accounts, receipts and other
documentation for such reasonable expenses as are reasonably required by the
Company.

3. DEFINITIONS. The following definitions shall apply with
respect to this agreement.

a. BASE SALARY means the Employee's annual salary;
it shall not include overtime pay, commissions or any other benefits and special
allowances for which the Employee is eligible (e.g., bonuses). If Employee's
annual salary is adjusted following the Effective Date of this Agreement, the
adjusted annual salary would then represent Employee's Base Salary. "Weekly
Salary" shall mean the Base Salary divided by fifty-two. "Monthly Salary" shall
mean Base Salary divided by 12.

b. CHANGE OF CONTROL shall mean a change in
ownership or control of the Company effected through any of the following
transactions:

(1) a merger, consolidation or
reorganization approved by the Company's stockholders, unless securities
representing more than fifty percent (50%) of the total combined voting power of
the voting securities of the successor corporation are immediately thereafter
beneficially owned, directly or indirectly and in substantially the same
proportion, by the persons who beneficially owned the Company's outstanding
voting securities immediately prior to such transaction, or

(2) any stockholder-approved transfer or
other disposition of all or substantially all of the Company's assets, or

2
<PAGE>

(3) the acquisition, directly or indirectly
by any person or related group of persons (other than the Company or a person
that directly or indirectly controls, is controlled by, or is under common
control with, the Company), of beneficial ownership (within the meaning of Rule
13d3 of the 1934 Act) of securities possessing more than fifty percent (50%) of
the total combined voting power of the Company's outstanding securities pursuant
to a tender or exchange offer made directly to the Company's stockholders, or

(4) a change in the composition of the Board
over a period of thirty-six (36) consecutive months or less such that a majority
of the Board members ceases, by reason of one or more contested elections for
Board membership, to be comprised of individuals who either (A) have been Board
members continuously since the beginning of such period or (B) have been elected
or nominated for election as Board members during such period by at least a
majority of the Board members described in clause (A) who were still in office
at the time the Board approved such election or nomination.

c. CONSTRUCTIVE TERMINATION shall occur if Employee
resigns his employment within ninety (90) days of the occurrence of any of the
following events: (i) any reduction in the Base Salary of the Employee; (ii) a
relocation (or demand for relocation) of Employee's place of employment to a
location more than thirty-five (35) miles from Employee's current place of
employment; or (iii) a significant or material reduction in Employee's job
duties or level of responsibility or the imposition of significant or material
limitations on Employee's autonomy in his position.

d. 1934 ACT means the Securities Exchange Act of
1934, as amended, and the rules and regulations promulgated thereunder.

e. TERMINATION FOR CAUSE means a termination of
Employee's employment by the Company due to the Employee's:

(1) Willful misconduct that has a material
adverse effect on the Company's operations, prospects, reputation or business;

(2) Conviction of a felony;

(3) Act of fraud against, or theft of
property belonging to, the Company.

f. TERMINATION WITHOUT CAUSE means a termination of
Employee's employment by the Company for any reason other than those specified
in subparagraph 3.e.(1) through (3) above.

g. DISABILITY shall mean a determination by the
Company's Board of Directors that as a result of any physical or mental injury
or disability, Employee has been unable to perform the essential functions of
his job, with or without reasonable accommodation, for a period of six
consecutive months or for eight months out of any twelve-month period. If such
circumstances have occurred, then the Board of Directors may give written notice
to Employee of a termination due to Disability.

3
<PAGE>

4. EMPLOYMENT. The Company shall be entitled to all of the
benefits and profits arising from or incident to the work, services and advice
rendered by the Employee relating to the work performed for the Company. The
Employee shall make all information available to the Company that relates to the
Company's business of which he has any knowledge and shall not use any such
information or the benefits of any such information for his personal profit or
that of any third party. The Employee agrees to use his best efforts to promote
the interests of the Company including, where appropriate, the publication of
articles in medical and scientific journals and the participation in medical and
scientific seminars and symposiums relating to the business and affairs of the
Company and/or his research efforts performed for and on behalf of the Company.

5. DISCLOSURES. Employee shall promptly disclose in writing to
the officials designated by the Company to receive such disclosures, complete
information concerning each and every invention, discovery, improvement, device,
design, apparatus, practice, process, method or product (hereinafter referred to
as "Inventions"), whether Employee considers them patentable or not, made,
developed, perfected, devised, conceived or reduced to practice by Employee,
either solely or in collaboration with others, during the period of Employee's
employment by the Company, and up to and including a period of twelve (12)
months after termination of employment, whether or not during regular working
hours, relating either directly or indirectly to the business, products,
practices or techniques of the Company or to the Company's actual or
demonstrably anticipated research or development, or resulting from any work
performed by Employee for the Company or with the equipment, supplies,
facilities or confidential information of the Company.

6. CONFIDENTIALITY. Employee recognizes that his employment
with the Company will involve contact with information of substantial value to
the Company, which is not generally known in the trade and which gives the
Company an advantage over its competitors who do not know or use it, including
but not limited to techniques, designs, drawings, processes, inventions,
developments, equipment, prototypes, sales and customer information, and
business and financial information, relating to the business, products,
practices or techniques of the Company (hereinafter referred to as "Confidential
Information"). Employee shall at all times regard and preserve as confidential
such Confidential Information obtained by Employee from whatever source and
shall not, either during Employee's employment or thereafter, publish or
disclose any part of such Confidential Information in any manner, or use the
same except on behalf of the Company, without the prior written consent of the
Company. Further, Employee shall, during his employment and thereafter, refrain
from any acts or omissions that would reduce the value of such Confidential
Information to the Company.

7. ASSIGNMENT OF RIGHTS. Employee hereby agrees that any
Inventions made, developed, perfected, devised, conceived or reduced to practice
by Employee during the period of his employment by the Company, and any other
Inventions made, developed, perfected, devised, conceived or reduced to practice
by Employee during said period of twelve (12) months after termination of his
employment if based upon the Confidential Information of the Company, relating
either directly or indirectly to the business, products, practices or techniques
of the Company or to the Company's actual or demonstrably anticipated research
or development, or resulting from any work performed by Employee for the Company
or with the equipment, supplies, facilities or Confidential Information of the
Company, are the sole property of the

4
<PAGE>

Company, and hereby assigns and agrees to assign to the Company, its successors
and assigns, all of my right, title and interest in and to said Inventions, and
any patent applications or Letters Patent thereon.

NOTIFICATION

THIS AGREEMENT DOES NOT APPLY TO AN INVENTION FOR WHICH NO
EQUIPMENT, SUPPLIES, FACILITY, OR TRADE SECRET INFORMATION OF THE COMPANY WAS
USED AND WHICH WAS DEVELOPED ENTIRELY ON EMPLOYEE'S OWN TIME, AND (a) WHICH DOES
NOT RELATE (1) TO THE BUSINESS OF THE COMPANY OR (2) TO THE COMPANY'S ACTUAL OR
DEMONSTRABLY ANTICIPATED RESEARCH OR DEVELOPMENT, OR (b) WHICH DOES NOT RESULT
FROM ANY WORK PERFORMED BY EMPLOYEE FOR THE COMPANY, AS DEFINED AND PROVIDED BY
SECTION 2870 OF THE CALIFORNIA LABOR CODE.

8. COVENANT OF COOPERATION. Employee shall, at any time during
employment or thereafter, upon request and without further compensation
therefor, but with all reasonable expenses incurred by Employee to be
reimbursed, do all lawful acts, including but not limited to the execution of
papers and oaths, the giving of testimony, and the obtaining of evidence that in
the opinion of the Company, its successors or assigns, may be necessary or
desirable for obtaining, sustaining, reissuing or enforcing Letters Patent in
the United States and throughout the world for said Inventions, and for
perfecting, recording or maintaining the title of the Company, its successors
and assigns, to said Inventions and to any patent applications made and any
Letters Patent granted for said Inventions in the United States and throughout
the world.

9. PATENT ENFORCEMENT. The Company shall have the sole
discretion whether to obtain, maintain, modify or enforce any domestic or
foreign patent for said Inventions assigned to the Company pursuant to this
Agreement. The Company is free to enter into any licensing or assignment
agreement with any third party or to use whatever means it deems best to
develop, promote or market said Inventions assigned to the Company pursuant to
this Agreement or any domestic or foreign patent thereof.

10. CLAIMS BY THIRD PARTY. As to any Inventions which were
made, developed, perfected, devised, conceived or reduced to practice by
Employee during the period of his employment by the Company, and up to and
including a period of twelve (12) months after termination of his employment,
but which are claimed for any reason to belong to an entity or person other than
the Company, Employee will promptly disclose the same in writing to the Company
and shall not disclose the same to others if the Company, within twenty (20)
days thereafter, shall claim ownership of such Inventions under the terms of
this Agreement.

11. RECORD KEEPING. Employee shall keep complete, accurate and
authentic accounts, notes, data and records of any and all of said Inventions in
the manner and form requested by the Company. Such accounts, notes, data and
records, including all copies thereof, shall be the property of the Company, and
upon its request, Employee will promptly surrender the same to it, or if not
previously surrendered, Employee will promptly surrender the same to the Company
at the conclusion of his employment.

5
<PAGE>

12. RECORDS ARE PROPERTY OF COMPANY. Employee agrees that all
accounts, notes, data sketches, drawings and other documents and records, and
all material and physical items of any kind, including all reproductions and
copies thereof, which relate in any way to the business, products, practices or
techniques of the Company or contain Confidential Information, made by Employee
or that come into Employee's possession by reason of his employment are the
property of the Company and shall be promptly surrendered to the Company at the
conclusion of Employee's employment.

13. NON-SOLICITATION. Employee shall not, for a period of one
(1) year from the date of termination of employment with the Company, directly
or indirectly solicit the services of any employee or induce or attempt to
induce current employees of the Company to terminate their employment with the
Company. However, this obligation shall not affect any responsibility Employee
may have as an employee of the Company with respect to the bona fide hiring and
firing of Company personnel.

14. SEVERANCE PAYMENTS AND OTHER BENEFITS IN THE EVENT OF
TERMINATION OF EMPLOYMENT FOLLOWING A CHANGE OF CONTROL.

a. In the event that either of the following two
events occur within two years after a Change of Control, the Company will
provide the following payment and benefits to Employee (or his estate): (i)
Employee's employment is terminated by the Company Without Cause, or (ii)
Employee's employment terminates as a result of a Constructive Termination:

(1) The Company shall make the following
payments to Employee:

(A) ACCRUED SALARY AND BENEFITS.
The Company shall pay Employee's Base Salary through the effective date of
termination of Employee's Employment. In addition to the Severance Payments
payable to an eligible employee as described below, such employee shall receive
the following: (i) payment for accrued but unused vacation time; and (ii) group
health coverage, including eligible medical, dental and vision insurance through
the last day of the calendar month during which the termination occurs (group
health coverage after such date being governed by COBRA.)

(B) SEVERANCE PAYMENTS. The Company
shall pay to Employee three (3) times the sum of (a) his annual Base Salary in
effect immediately prior to the Change of Control and (b) a payment equal to the
higher of (x) 100% of Employee's target bonus as determined under the Company's
incentive compensation plan or (y) an average of the last three actual bonuses
awarded to Employee. If an annual incentive compensation plan has not been
implemented, then the determination in (y) will govern.

(C) MANNER OF PAYMENT. Severance
Payments may be paid in accordance with regular payroll periods, in a single
lump sum payment, or any combination thereof, as deemed appropriate by the
Company. Taxes and other appropriate deductions will be withheld; however, 401k
contributions will not be allowed.

(2) The Company shall provide the following
benefits to Employee:

6
<PAGE>

(A) COBRA. An eligible Employee's
existing coverage under the Company's group health plan (and, if applicable, the
existing group health coverage for eligible dependents) will end on the last day
of the month in which the eligible Employee's employment terminates. The
eligible Employee and his eligible dependents may then be eligible to elect
temporary continuation coverage under the Company's group health plan in
accordance with the Consolidated Omnibus Budget Reconciliation Act of 1985, as
amended ("COBRA"). The eligible Employee (and, if applicable, his eligible
dependents) will be provided with a COBRA election form and notice which
describe his rights to continuation coverage under COBRA. If an eligible
Employee elects COBRA continuation coverage, then the Company will pay for COBRA
coverage (such payments shall not include COBRA coverage with respect to the
Company's Section 125 health care reimbursement plan) for (i) eighteen (18)
months, or (ii) the maximum period permitted under COBRA. If Employee does
exhaust the applicable COBRA period, the Company will reimburse Employee for the
cost of an individual health insurance policy in an amount not to exceed the
amount of the monthly COBRA premium previously paid by the Company pursuant to
this paragraph for the remainder of the three year period following Employee's
termination of employment. After such period of Company-paid coverage, the
eligible employee (and, if applicable, his eligible dependents) may continue
coverage at his own expense in accordance with COBRA or other applicable laws.
No provision of this agreement will affect the continuation coverage rules under
COBRA. Therefore, the period during which the eligible employee must elect to
continue the Company's group health plan coverage under COBRA, the length of
time during which COBRA coverage will be made available to the eligible
employee, and all the eligible employee's other rights and obligations under
COBRA will be applied in the same manner that such rules would apply in the
absence of this Plan. In the event, however, an Employee becomes eligible for
benefits under another plan prior to the expiration of the period in which the
Company is paying benefit premiums, the Company shall no longer be obligated to
pay such benefit premiums. The Employee is required to notify the Company of
eligibility for benefits under another plan and is expected to enroll in the new
group plan at the first eligible opportunity unless Employee chooses, at
Employee's sole expense, to continue COBRA benefits through the Company. If
Employee fails to notify the Company of Employee's eligibility for alternative
benefits, the Company shall have the right to discontinue payment of COBRA
premiums upon thirty (30) days notice to Employee. In no event shall a cash
payment be made to Employee in lieu of the payment of COBRA premiums. The
payment of COBRA premiums by the Company shall not extend the maximum eligible
COBRA coverage period.

(B) OUTPLACEMENT SERVICES. The
Company will make available to Employee, upon his request, outplacement services
provided by a reputable outplacement counselor selected by the Company for a
period of nine months following termination. The Company will assume the cost of
all such outplacement services. In no event will a cash payment be made in lieu
of outplacement benefits.

15. ACCELERATION OF STOCK OPTIONS IN THE EVENT OF A CHANGE OF
CONTROL. In the event of a Change of Control (whether or not followed by
termination of Employee's employment), all stock options under any Company stock
option plan which Employee holds at the time of such Change of Control shall
become fully "vested" (i.e., immediately exercisable). The Company shall also
extend the period of exercisability of those stock options to the maximum of
four years, or the natural expiration of the stock options, whichever is
earlier.

7
<PAGE>

16. SEVERANCE PAYMENTS AND OTHER BENEFITS IN THE EVENT OF
TERMINATION OTHER THAN FOLLOWING A CHANGE OF CONTROL.

a. In the event Employee's employment is terminated
Without Cause or there is a Constructive Termination other than within two (2)
years following a Change in Control, the Company shall provide the payments and
other benefits specified below to Employee:

(1) The Company shall make the following
payments to Employee:

(A) ACCRUED SALARY AND BENEFITS.
The Company shall pay Employee's Base Salary through the effective date of
termination of Employee's Employment. In addition, Employee shall receive the
following: (i) payment for accrued but unused vacation time; and (ii) group
health coverage, including eligible medical, dental and vision insurance through
the last day of the calendar month during which the termination occurs (group
health coverage after such date being governed by COBRA.)

(B) SEVERANCE PAYMENTS. The Company
shall pay to Employee a severance payment equal to eighteen (18) months of
Employee's Monthly Salary in effect immediately prior to the termination. This
eighteen-month period will be referred to as the "Severance Period".

(C) MANNER OF PAYMENT. These
Severance Payments may be paid in accordance with regular payroll periods over
the duration of the Severance Period, in a single lump sum, or any combination
thereof, as deemed appropriate by the Company. Taxes and other appropriate
deductions will be withheld however, 401(k) contributions will not be allowed.

(2) The Company shall provide the following
benefits to Employee:

8
<PAGE>

group health plan coverage under COBRA, the length of time during which COBRA
coverage will be made available to the eligible employee, and all the eligible
employee's other rights and obligations under COBRA will be applied in the same
manner that such rules would apply in the absence of this Plan. In the event,
however, an Employee becomes eligible for benefits under another plan prior to
the expiration of the period in which the Company is paying benefit premiums,
the Company shall no longer be obligated to pay such benefit premiums. The
Employee is required to notify the Company of eligibility for benefits under
another plan and is expected to enroll in the new group plan at the first
eligible opportunity unless Employee chooses, at Employee's sole expense, to
continue COBRA benefits through the Company. If the Employee fails to notify the
Company of Employee's eligibility for alternative benefits, the Company shall
have the right to discontinue payment of COBRA premiums upon thirty (30) days
notice to Employee. In no event shall a cash payment be made to eligible
employees in lieu of the payment of COBRA premiums. The payment of COBRA
premiums by the Company shall not extend the maximum eligible COBRA coverage
period.

(B) OUTPLACEMENT. The Company will
make available to Employee, upon his request, outplacement services provided by
a reputable outplacement counselor selected by the Company for a period of nine
months following termination. The Company will assume the cost of all such
outplacement services. In no event will a cash payment be made in lieu of
outplacement benefits.

IN NO EVENT SHALL EMPLOYEE BE ENTITLED TO OR RECEIVE SEVERANCE BENEFITS UNDER
BOTH THIS PARAGRAPH 16 AND PARAGRAPH 14. Similarly, if Employee is eligible to
receive severance benefits under any other severance plan created by the Company
then it will reduce dollar for dollar any benefit due under this Agreement.

17. SECTION 280G LIMITATION ON SEVERANCE PAYMENTS. The
Severance Payments as described in Paragraph 14(1)(B) of this Agreement shall be
reduced as necessary so that the present value, as determined in accordance
Section 280G(d)(4) of the Internal Revenue Code, of the sum of (i) the Severance
Payments and (ii) all other payments, if any, that must be taken into account
for purposes of computation under Section 280G(b)(2)(A)(ii) of the Internal
Revenue Code in respect of Employee does not exceed 2.99 times Employee's base
amount, as "base amount" is defined in Section 280G(b)(3) of the Internal
Revenue Code .

18. RETENTION BONUS PROGRAM. Employee will continue to
participate in the Retention Package program as explained in the memorandum to
Employee dated December 3, 1998.

19. REAL ESTATE. Employee and Company jointly own Employee's
principal residence as tenants in common with respective percentage undivided
interests determined as follows: The Company's interest shall be calculated by
dividing $300,000 by the purchase price of the Property, the result to be
expressed as a percentage; Employee's interest shall be 100 percent minus the
Company's interest. These respective percentage interests shall remain constant
unless otherwise agreed by the Company and Employee or unless recalculated as
provided below. Notwithstanding the foregoing, (1) Employee shall maintain the
Property and pay all expenses associated with the Property, including but not
limited to all mortgage payments; upkeep; taxes; insurance; homeowner
association fees, if any; repairs and

9
<PAGE>

improvements (improvements shall be at Employee's option), and utilities; and
(2) Employee shall not alienate his interest in the Property without the
Company's consent. If the Employee fails or refuses for any reason to perform
the obligations and make the payments called for in clause (1) of the foregoing
sentence, the Company may cause the obligations to be performed and/or make the
payments and, at its option, (x) deduct any expenditures from the payment of any
compensation to Employee called for by this Agreement on any reasonable basis,
or (y) add the full amount of any expenditures directly to its $300,000 initial
equity and, using the sum as the new numerator, recalculate the respective
percentage undivided interests of the parties using as a denominator the same
purchase price of the property. Employee shall execute and cooperate in the
recording of all documents necessary to evidence the parties' agreement
contained in this paragraph.

Within 30 days of termination of Employee's employment for any
reason, the parties shall agree on a valuation of the Property. If they cannot
agree within that time, each party shall select a certified appraiser to perform
an appraisal of the property at each selecting party's expense, and the
appraisal shall be the average of the two appraisals. The valuation reached by
either method shall be called the Agreed Valuation. Within (a) three years from
the date of termination of Employee's employment due to death or Disability, (b)
two years from the date of termination of Employee's employment in the event of
a Termination for Cause or Constructive Termination, or (c) one year from the
date of termination of Employee's employment in the event of a resignation by
Employee (other than a Constructive Termination), Employee (or his estate) shall
take such actions as are necessary to purchase the Company's interest in the
Property for a purchase price equal to the Company's percentage interest in the
property at the date of appraisal times the Agreed Valuation. The Company shall
cooperate with Employee to sell the Property under such circumstances if the
Employee is unwilling or unable to purchase the Company's interest, and Employee
shall be deemed to have complied with his purchase obligation under this
Subparagraph if a purchasing third party pays the Company the purchase price.

If the Employee is deemed to receive taxable income for any
payment or reimbursement under this subparagraph, such payments will be grossed
up to account for all applicable income taxes.

20. RESIGNATION, DEATH OR DISABILITY. Employee will not be
entitled to any Severance Benefits or Severance Payments under Paragraphs 14 or
16, or under any other plan, or any other provision of this Agreement, if his
employment is terminated by the Company for Cause or if his employment
terminates due to disability, death or resignation (other than a resignation
which constitutes a CONSTRUCTIVE TERMINATION).

21. EXCLUSIVITY. Employee shall not, while employed by the
Company engage in any other employment or business venture for his account or on
behalf of others that relates, directly or indirectly, to the business and
affairs of the Company without the prior written consent of the Company.

10
<PAGE>

or any other person claiming under Employee by virtue of this Agreement and
shall not be subject to execution, attachment or similar process. Any attempt to
assign, transfer, pledge or hypothecate or otherwise dispose of this Agreement
or of such rights, interests and benefits contrary to the foregoing provisions,
or the levy of any attachment or similar process thereon shall be null and void
and without effect and shall relieve the Company of any and all liability
hereunder.

23. NOTICE. Any and all notices, designations, consents,
offers, acceptances or any other communication provided for herein shall be
given in writing by registered or certified mail, return receipt requested,
which shall be addressed, in the case of the Company, to its office in San
Diego, California, and in Employee's case to his last known place of residence
as reflected on the Company's records.

24. ENTIRE AGREEMENT. This Agreement, and any stock option or
stock purchase agreements that Employee has with the Company, constitute the
entire agreement between Employee and the Company and contains all of the
agreements between the parties with respect to the subject matter hereof; this
Agreement supersedes any and all other agreements, either oral or in writing,
between the parties with respect to the subject matter hereof.

25. BINDING EFFECT. This Agreement shall be binding upon and
inure to the benefit of Employee and the Company and their respective heirs,
legal representatives, executors, administrators, and successors.

26. NO OTHER AGREEMENTS. Employee affirms that Employee has no
agreement with any other party that would preclude his compliance with his
obligations under this Agreement as set forth above.

27. GOVERNING LAW. This Agreement shall be subject to and
governed by the laws of the State of California.

28. AMENDMENT OF AGREEMENT. No change or modification of this
Agreement shall be valid unless the same is in writing and signed by Employee
and the Company. No waiver of any provision of this Agreement shall be valid
unless in writing and signed by the person or party to be charged.

29. SEVERABILITY. If any portion or portions of this Agreement
shall be, for any reason, deemed to be invalid or unenforceable, the remaining
portion or portions shall nevertheless be valid, enforceable and carried into
effect, unless to do so would clearly violate the present legal and valid
intention of the parties hereto.

30. BREACH. In the event either party breaches this Agreement
and the other party prevails in an action to enforce the terms of this
Agreement, the losing party agrees to pay to the prevailing party all reasonable
attorneys' fees and costs incurred by the prevailing party in prosecuting such
action, and all damages suffered by the prevailing party.

11
<PAGE>

31. HEADINGS. The headings of this Agreement are inserted for
convenience only and are not to be considered in construction of the provisions
hereof.

32. WAIVER OR BREACH. The waiver by either of the parties
hereto of any breach of any provision hereof shall not be construed to be a
waiver of any succeeding breach of that provision or a waiver of any other
provision of this Agreement.

33. ARBITRATION OF DISPUTES. Any dispute arising under this
Agreement shall be resolved through final and binding arbitration conducted
pursuant to the rules of the American Arbitration Association. This shall be in
lieu of any right to a jury trial, which right is expressly waived.

34. GENERIC DRUG ENFORCEMENT ACT CERTIFICATION. The
undersigned, certifies that he (1) has never been charged with or convicted of a
federal felony for conduct relating to the development, approval, or regulation
of any drug product or device regulated by the United States Food and Drug
Administration, and (2) has never been debarred or subject to a debarment
proceeding under the Generic Drug Enforcement Act of 1992.

(THIS SECTION HAS BEEN INTENTIONALLY LEFT BLANK FOR FORMATTING REASONS.)

12
<PAGE>

WHEREAS, the parties have executed this Agreement as of the
date first above written.

MOLECULAR BIOSYSTEMS, INC.

By:
----------------------------------
Director, Board of Directors,
Molecular Biosystems, Inc.

By:
----------------------------------
Bobba Venkatadri

<PAGE>

EXHIBIT 10.2

EMPLOYMENT AGREEMENT

This is an EMPLOYMENT AGREEMENT "Agreement" effective as of
January 21, 1999 ("Effective Date"), between HOWARD DITTRICH, M.D., an
individual ("Employee"), and MOLECULAR BIOSYSTEMS, INC., a Delaware corporation
("the Company").

1. EMPLOYMENT.

a. POSITION. The Company agrees to employ Employee
as its EXECUTIVE VICE PRESIDENT.

b. DUTIES. Employee shall diligently, and to the
best of his ability, perform all such duties incident to his position and use
his best efforts to promote the interests of the Company.

c. TIME TO BE DEVOTED TO EMPLOYMENT. Employee shall
devote his full time and energy to the business of the Company and shall not be
engaged in any competitive business activity without the express written consent
of the Company. However, it is understood and agreed that Employee will be
entitled to at least ten paid days off each year to attend any continuing
medical education classes or courses that he chooses. In addition, Employee will
be entitled to at least one half paid day off each week for purposes of carrying
out clinical activities at the University of California, San Diego hospitals and
clinics as part of his status as a clinical professor of medicine. Employee
hereby represents that he is not a party to any agreement which would be an
impediment to entering into this Employment Agreement and that he is permitted
to enter into this Employment Agreement and perform the obligations hereunder.

2. COMPENSATION AND BENEFITS.

a. ANNUAL SALARY. In consideration of and as
compensation for the services agreed to be performed by Employee hereunder, the
Company agrees to pay Employee, as of the Effective Date of this Agreement, an
annual Base Salary of $250,000, payable in accordance with the Company's regular
payroll schedule, less applicable withholdings and deductions. Employee`s
annual Base Salary is subject to being increased as part of the Company's annual
salary review process. If Employee is an Officer of the Company, changes to
Base Salary must be approved by the Board of Directors of the Company (the
"Board").
<PAGE>

b. PARTICIPATION IN BENEFIT PLANS. Employee shall
be entitled to participate in any vacation or other benefit plan, to the extent
eligible, that is generally available to the other employees of the Company at
the same level as Employee. The Company reserves the right to amend, modify or
terminate any employee benefits at any time for any reason.

c. REIMBURSEMENT OF EXPENSES. The Company shall
reimburse Employee for all reasonable business expenses incurred by Employee on
behalf of the Company provided that: (i) such reasonable expenses are ordinary
and necessary business expenses incurred on behalf of the Company, and (ii)
Employee provides the Company with itemized accounts, receipts and other
documentation for such reasonable expenses as are reasonably required by the
Company. In addition, the Company will pay on Employee's behalf the following
professional license fees and memberships: California Physician and Surgeon,
Drug Enforcement Agency ("DEA"), American College of Cardiology, American Heart
Association, American Society of Echocardiography, American College of Medicine,
and the American Medical Association (local, state and national).

d. EDUCATION BENEFIT. The Company agrees to pay on
behalf of the Employee reasonable tuition/enrollment costs associated with an
executive development/training. The Company must approve all training
costs/expenses associated with the course/training and the course curriculum, in
advance. The training/development should require no more than a two-week period
away from the job.

3. DEFINITIONS. The following definitions shall apply with
respect to this agreement.

b. CHANGE OF CONTROL shall mean a change in ownership
or control of the Company effected through any of the following transactions:

(2) any stockholder-approved transfer or
other disposition of all or substantially all of the Company's assets, or

2
<PAGE>

the meaning of Rule 13d3 of the 1934 Act) of securities possessing more than
fifty percent (50%) of the total combined voting power of the Company's
outstanding securities pursuant to a tender or exchange offer made directly to
the Company's stockholders, or

c. CONSTRUCTIVE TERMINATION means within two years
after a Change of Control during which two-year period any of the following
events take place AND Employee gives written notice of his intent to resign his
employment with the Company and said resignation is submitted within thirty (30)
days of the event: (i) a reduction in the Base Salary of the Employee of more
than fifteen percent (15%); (ii) a relocation (or demand for relocation) of
Employee's place of employment to a location more than fifty (50) miles from
Employee's current place of employment; (iii) a significant or material
reduction in Employee's job duties or level of responsibility.

d. 1934 ACT means the Securities Exchange Act of
1934, as amended, and the rules and regulations promulgated thereunder.

e. TERMINATION FOR CAUSE means a termination of
Employee's employment by the Company due to the Employee's:

(1) Misconduct that has a material adverse
effect on the Company's operations, prospects, reputation or business;

(2) Conviction of a felony;

(3) Act of fraud against, or theft of
property belonging to, the Company; or

(4) Gross negligence or the repeated failure
of Employee to perform his duties and responsibilities to the reasonable
satisfaction of the Board or superior after written notice of such failure, or
any breach by Employee of his fiduciary duties to the Company or any breach by
Employee of his confidentiality or proprietary information agreement with the
Company.

f. TERMINATION WITHOUT CAUSE means a termination of
Employee's employment by the Company for any reason other than those specified
in subparagraph 3.e.(1) through (4) above.

g. DISABILITY means that as a result of any physical
or mental injury or disability, Employee is unable to perform the essential
functions of his job, with or without reasonable accommodation. A notice will be
issued when the Company has reasonably

3
<PAGE>

determined that Employee has become unable to perform substantially his services
and duties hereunder with or without reasonable accommodation because of any
physical or mental injury or disability, and that it is reasonably likely that
he will not be able to resume substantially performing his services and duties
on substantially the terms and conditions as set forth in this Employment
Agreement.

4
<PAGE>

NOTIFICATION

THIS AGREEMENT DOES NOT APPLY TO AN INVENTION FOR WHICH NO
EQUIPMENT, SUPPLIES, FACILITY, OR TRADE SECRET INFORMATION OF THE COMPANY WAS
USED AND WHICH WAS DEVELOPED ENTIRELY ON EMPLOYEE'S OWN TIME, AND (A) WHICH DOES
NOT RELATE (1) TO THE BUSINESS OF THE COMPANY OR (2) TO THE COMPANY'S ACTUAL OR
DEMONSTRABLY ANTICIPATED RESEARCH OR DEVELOPMENT, OR (B) WHICH DOES NOT RESULT
FROM ANY WORK PERFORMED BY EMPLOYEE FOR THE COMPANY, AS DEFINED AND PROVIDED BY
SECTION 2870 OF THE CALIFORNIA LABOR CODE.

5
<PAGE>

12. RECORDS PROPERTY OF COMPANY. Employee agrees that all
accounts, notes, data sketches, drawings and other documents and records, and
all material and physical items of any kind, including all reproductions and
copies thereof, which relate in any way to the business, products, practices or
techniques of the Company or contain Confidential Information, made by Employee
or that come into Employee's possession by reason of his employment are the
property of the Company and shall be promptly surrendered to the Company at the
conclusion of Employee's employment.

13. NON-SOLICITATION. During Employee's employment with the
Company and for one (1) year thereafter, Employee will not solicit any employee
of the Company to leave the Company for any reason or to accept employment with
any other company. As part of this restriction, Employee will not interview any
employee of the Company or provide any input to any third party regarding any
such person for the purpose of offering such person employment elsewhere during
the period in question. However, this obligation shall not affect any
responsibility Employee may have as an employee of the Company with respect to
the bona fide hiring and firing of Company personnel.

14. SEVERANCE. PAYMENTS AND OTHER BENEFITS IN THE EVENT OF
TERMINATION OF EMPLOYMENT FOLLOWING A CHANGE OF CONTROL.

a. In the event that either of the following two
events occur within two years after a Change of Control, the Company will
provide the following payment and benefits to Employee: (i) Employee's
employment is terminated by the Company Without Cause, or (ii) Employee's
employment terminates as a result of a Constructive Termination:

(1) The Company shall make the following
payments to Employee:

(B) SEVERANCE PAYMENTS. The Company
shall pay to Employee two times the sum of (a) his Base Salary in effect
immediately prior to the Change of Control and (b) a payment equal to the higher
of (x) 100% Employee's annual target bonus as determined under the Company's
incentive compensation plan or (y) an average of the last three

6
<PAGE>

actual bonuses accorded to Employee. If an incentive compensation plan has not
been implemented, then the determination in (y) will govern.

(2) The Company shall provide the following
benefits to Employee:

(A) COBRA. An eligible Employee's
existing coverage under the Company's group health plan (and, if applicable, the
existing group health coverage for eligible dependents) will end on the last day
of the month in which the eligible Employee's employment terminates. The
eligible Employee and his eligible dependents may then be eligible to elect
temporary continuation coverage under the Company's group health plan in
accordance with the Consolidated Omnibus Budget Reconciliation Act of 1985, as
amended ("COBRA"). The eligible Employee (and, if applicable, his eligible
dependents) will be provided with a COBRA election form and notice which
describe his rights to continuation coverage under COBRA. If an eligible
Employee elects COBRA continuation coverage, then the Company will pay for COBRA
coverage (such payments shall not include COBRA coverage with respect to the
Company's Section 125 health care reimbursement plan) for (i) eighteen (18)
months, or (ii) the maximum period permitted under COBRA guidelines, but not to
exceed 24 months. If Employee does exhaust the COBRA period, the Company will
reimburse Employee for the cost of an individual health insurance policy in an
amount not to exceed the amount of the monthly COBRA premium previously paid by
the Company pursuant to this paragraph for the remainder of the two year period
following Employee's termination of employment. After such period of
Company-paid coverage, the eligible employee (and, if applicable, his eligible
dependents) may continue coverage at his own expense in accordance with COBRA or
other applicable laws. No provision of this agreement will affect the
continuation coverage rules under COBRA. Therefore, the period during which the
eligible employee must elect to continue the Company's group health plan
coverage under COBRA, the length of time during which COBRA coverage will be
made available to the eligible employee, and all the eligible employee's other
rights and obligations under COBRA will be applied in the same manner that such
rules would apply in the absence of this Plan. In the event, however, an
Employee becomes eligible for benefits under another plan prior to the
expiration of the period in which the Company is paying benefit premiums, the
Company shall no longer be obligated to pay such benefit premiums. The Employee
is required to notify the Company of eligibility for benefits under another plan
and is expected to enroll in the new group plan at the first eligible
opportunity unless Employee chooses, at Employee's sole expense, to continue
COBRA benefits through the Company. If Employee fails to notify the Company of
Employee's eligibility for alternative benefits, the Company shall have the
right to discontinue payment of COBRA premiums upon thirty (30) days notice to
Employee. In no event shall a cash payment be made to Employee in lieu of the
payment of COBRA premiums. The payment of COBRA premiums by the Company shall
not extend the maximum eligible COBRA coverage period.

7
<PAGE>

16. SEVERANCE PAYMENTS AND OTHER BENEFITS IN THE EVENT OF
TERMINATION OTHER THAN FOLLOWING A CHANGE OF CONTROL.

a. In the event Employee's employment is terminated
Without Cause other than within two (2) years following a Change in Control, the
Company shall provide the payments and other benefits specified below to
Employee:

(1) The Company shall make the following
payments to Employee:

(A) ACCRUED SALARY AND BENEFITS.
The Company shall pay Employee's Base Salary through the effective date of
termination of Employee's Employment. In addition, employee shall receive the
following: (i) payment for accrued but unused vacation time; and (ii) group
health coverage, including eligible medical, dental and vision insurance through
the last day of the calendar month during which the termination occurs (group
health coverage after such date being governed by COBRA.)

(B) SEVERANCE PAYMENTS. If such
termination of employment occurs on or before December 31, 2000, then the
Company shall pay to Employee a severance payment equal to his Monthly Salary,
in effect immediately prior to termination, for twelve (12) months. If such
termination of employment occurs after December 31, 2000, then the Company shall
pay to Employee a severance payment equal to his Monthly Salary in effect
immediately prior to termination, for fifteen (15) months. In either event, the
period during which the severance benefits are paid will be referred to as the
"Severance Period."

(2) The Company shall provide the following
benefits to Employee:

8
<PAGE>

(A) COBRA. An eligible Employee's
existing coverage under the Company's group health plan (and, if applicable, the
existing group health coverage for eligible dependents) will end on the last day
of the month in which the eligible Employee's employment terminates. The
eligible Employee and his or her eligible dependents may then be eligible to
elect temporary continuation coverage under the Company's group health plan in
accordance with the Consolidated Omnibus Budget Reconciliation Act of 1985, as
amended ("COBRA"). The eligible Employee (and, if applicable, his or her
eligible dependents) will be provided with a COBRA election form and notice
which describe his or her rights to continuation coverage under COBRA. If an
eligible Employee elects COBRA continuation coverage, then the Company will pay
for COBRA coverage (such payments shall not include COBRA coverage with respect
to the Company's Section 125 health care reimbursement plan) for the Severance
Period. After such period of Company-paid coverage, the eligible employee (and,
if applicable, his eligible dependents) may continue coverage at his own expense
in accordance with COBRA or other applicable laws. No provision of this
agreement will affect the continuation coverage rules under COBRA. Therefore,
the period during which the eligible employee must elect to continue the
Company's group health plan coverage under COBRA, the length of time during
which COBRA coverage will be made available to the eligible employee, and all
the eligible employee's other rights and obligations under COBRA will be applied
in the same manner that such rules would apply in the absence of this Plan. In
the event, however, an Employee becomes eligible for benefits under another plan
prior to the expiration of the period in which the Company is paying benefit
premiums, the Company shall no longer be obligated to pay such benefit premiums.
The Employee is required to notify the Company of eligibility for benefits under
another plan and is expected to enroll in the new group plan at the first
eligible opportunity unless Employee chooses, at Employee's sole expense, to
continue COBRA benefits through the Company. If Employee fails to notify the
Company of Employee's eligibility for alternative benefits, the Company shall
have the right to discontinue payment of COBRA premiums upon thirty (30) days
notice to Employee. In no event shall a cash payment be made to Employee.

9
<PAGE>

18. RETENTION BONUS PROGRAM. Employee will continue to
participate in the Retention Package program as explained in the memorandum to
Employee dated December 3, 1998.

19. RETENTION BONUS. Employee has been paid a retention bonus
by the Company in the amount of $62,500. This payment has not yet been earned by
the Employee and will not be earned unless and until Employee remains employed
through December 31, 2000. If employee resigns his employment for any reason or
there is a Termination for Cause, either of which occurs prior to December 31,
2000, then Employee will repay the full $62,500 within thirty days of the date
of termination of his employment. If Employee's employment terminates as a
result of a Termination Without Cause, then the entire retention bonus will be
forgiven.

22. PROHIBITION AGAINST ASSIGNMENT. Employee agrees that this
Agreement and the rights, interests and benefits hereunder shall not be
assigned, transferred, pledged or hypothecated in any way by Employee or any
executor, administrator, heir, legatee, distributee or any other person claiming
under Employee by virtue of this Agreement and shall not be subject to
execution, attachment or similar process. Any attempt to assign, transfer,
pledge or hypothecate or otherwise dispose of this Agreement or of such rights,
interests and benefits contrary to the foregoing provisions, or the levy of any
attachment or similar process thereon shall be null and void and without effect
and shall relieve the Company of any and all liability hereunder.

24. ENTIRE AGREEMENT. This Agreement, and any stock option or
stock purchase agreements between the Employee and Company, constitute the
entire agreement between Employee and the Company and contains all of the
agreements between the parties with respect to the subject matter hereof; this
Agreement supersedes any and all other agreements, either oral or in writing,
between the parties with respect to the subject matter hereof.

10
<PAGE>

26. NO OTHER AGREEMENTS. Employee affirms that Employee has no
agreement with any other party that would preclude his compliance with his
obligations under this Agreement as set forth above.

27. GOVERNING LAW. This Agreement shall be subject to and
governed by the laws of the State of California.

31. HEADINGS. The headings of this Agreement are inserted for
convenience only and are not to be considered in construction of the provisions
hereof.

11
<PAGE>

WHEREAS, the parties have executed this Agreement as of the
date first above written.

MOLECULAR BIOSYSTEMS, INC.

By:
------------------------------------
Officer of Molecular Biosystems, Inc.

By:
------------------------------------
Howard Dittrich. M.D.

<PAGE>

EXHIBIT 10.3

EMPLOYMENT AGREEMENT

This is an EMPLOYMENT AGREEMENT "Agreement" effective as of
January 21, 1999 ("Effective Date"), between JONI HARVEY, an individual
("Employee"), and MOLECULAR BIOSYSTEMS, INC., a Delaware corporation ("the
Company").

1. EMPLOYMENT.

a. POSITION. The Company agrees to employ
Employee as its VICE PRESIDENT OF OPERATIONS.

b. DUTIES. Employee shall diligently, and to
the best of her ability, perform all such duties incident to her position and
use her best efforts to promote the interests of the Company.

c. TIME TO BE DEVOTED TO EMPLOYMENT. Employee shall
devote her full time and energy to the business of the Company and shall not be
engaged in any competitive business activity without the express written consent
of the Company. Employee hereby represents that she is not a party to any
agreement which would be an impediment to entering into this Employment
Agreement and that she is permitted to enter into this Employment Agreement and
perform the obligations hereunder.

d. AT-WILL EMPLOYMENT. Employee shall be
employed on an at-will basis and may terminate her employment and may be
terminated from her employment at any time with or without cause, subject to the
severance payment provisions set forth in paragraphs 14 and 16 below.

2. COMPENSATION AND BENEFITS.

a. ANNUAL SALARY. In consideration of and as
compensation for the services agreed to be performed by Employee hereunder, the
Company agrees to pay Employee, as of the Effective Date of this Agreement, an
annual Base Salary of $150,000, payable in accordance with the Company's regular
payroll schedule, less applicable withholdings and deductions. Employee `s
annual Base Salary is subject to being increased as part of the Company's annual
salary review process.. If Employee is an Officer of the Company, changes to
Base Salary must be approved by the Board of Directors of the Company (the
"Board").

b. PARTICIPATION IN BENEFIT PLANS. Employee
shall be entitled to participate in any vacation or other benefit plan, to the
extent eligible, that is generally available to the other employees of the
Company at the same level as Employee. The Company reserves the right to amend,
modify or terminate any employee benefits at any time for any reason.
<PAGE>

3. DEFINITIONS. The following definitions shall apply with
respect to this agreement.

a. BASE SALARY means the Employee's annual
salary; it shall not include overtime pay, commissions or any other benefits and
special allowances for which the Employee is eligible (e.g., bonuses). If
Employee's annual salary is adjusted following the Effective Date of this
Agreement, the adjusted annual salary would then represent Employee's Base
Salary. "Weekly Salary" shall mean the Base Salary divided by fifty-two.
"Monthly Salary" shall mean Base Salary divided by 12.

b. CHANGE OF CONTROL shall mean a change in
ownership or control of the Company effected through any of the following
transactions:

(2) any stockholder-approved transfer or
other disposition of all or substantially all of the Company's assets, or

(3) the acquisition, directly or
indirectly by any person or related group of persons (other than the Company or
a person that directly or indirectly controls, is controlled by, or is under
common control with, the Company), of beneficial ownership (within the meaning
of Rule 13d3 of the 1934 Act) of securities possessing more than fifty percent
(50%) of the total combined voting power of the Company's outstanding securities
pursuant to a tender or exchange offer made directly to the Company's
stockholders, or

(4) a change in the composition of the
Board over a period of thirty-six (36) consecutive months or less such that a
majority of the Board members ceases, by reason of one or more contested
elections for Board membership, to be comprised of individuals who either (A)
have been Board members continuously since the beginning of such period or (B)
have been elected or nominated for election as Board members during such period
by at least a majority of the Board members described in clause (A) who were
still in office at the time the Board approved such election or nomination.

resignation is provided to the Company within thirty (30) days of the event :
(i) a reduction in the Base Salary of the Employee of more than fifteen percent
(15%); (ii) a relocation (or demand for relocation) of Employee's place of
employment to a location more than fifty (50) miles from Employee's current
place of employment; (iii) a significant or material reduction in Employee's job
duties or level of responsibility.

d. 1934 ACT means the Securities Exchange Act
of 1934, as amended, and the rules and regulations promulgated thereunder.

e. TERMINATION FOR CAUSE means a termination of
Employee's employment by the Company due to the Employee's:

(1) Misconduct that has a material
adverse effect on the Company's operations, prospects, reputation or business;

(2) Conviction of a felony;

(3) Act of fraud against, or theft of
property belonging to, the Company; or

(4) Gross negligence or the repeated
failure of Employee to perform her duties and responsibilities to the reasonable
satisfaction of the Board or superior after written notice of such failure, or
any breach by Employee of her fiduciary duties to the Company or any breach by
Employee of his confidentiality or proprietary information agreement with the
Company.

f. TERMINATION WITHOUT CAUSE means a
termination of Employee's employment by the Company for any reason other than
those specified in subparagraph 3.e.(1) through (4) above.

g. DISABILITY means that as a result of any
physical or mental injury or disability, Employee is unable to perform the
essential functions of her job, with or without reasonable accommodation. A
notice will be issued when the Company has reasonably determined that Employee
has become unable to perform substantially her services and duties hereunder
with or without reasonable accommodation because of any physical or mental
injury or disability, and that it is reasonably likely that she will not be able
to resume substantially performing her services and duties on substantially the
terms and conditions as set forth in this Employment Agreement.

4. EMPLOYMENT. The Company shall be entitled to all of the
benefits and profits arising from or incident to the work, services and advice
rendered by the Employee relating to the work performed for the Company. The
Employee shall make all information available to the Company that relates to the
Company's business of which she has any knowledge and shall not use any such
information or the benefits of any such information for her personal profit or
that of any third party. The Employee agrees to use her best efforts to promote
the interests of the Company including, where appropriate, the publication of
articles in medical and scientific journals and the participation in medical and
scientific seminars and symposiums
<PAGE>

relating to the business and affairs of the Company and/or her research efforts
performed for and on behalf of the Company.

6. CONFIDENTIALITY. Employee recognizes that her employment
with the Company will involve contact with information of substantial value to
the Company, which is not generally known in the trade and which gives the
Company an advantage over its competitors who do not know or use it, including
but not limited to techniques, designs, drawings, processes, inventions,
developments, equipment, prototypes, sales and customer information, and
business and financial information, relating to the business, products,
practices or techniques of the Company (hereinafter referred to as "Confidential
Information"). Employee shall at all times regard and preserve as confidential
such Confidential Information obtained by Employee from whatever source and
shall not, either during Employee's employment or thereafter, publish or
disclose any part of such Confidential Information in any manner, or use the
same except on behalf of the Company, without the prior written consent of the
Company. Further, Employee shall, during her employment and thereafter, refrain
from any acts or omissions that would reduce the value of such Confidential
Information to the Company.

7. ASSIGNMENT OF RIGHTS. Employee hereby agrees that any
Inventions made, developed, perfected, devised, conceived or reduced to practice
by Employee during the period of her employment by the Company, and any other
Inventions made, developed, perfected, devised, conceived or reduced to practice
by Employee during said period of twelve (12) months after termination of her
employment if based upon the Confidential Information of the Company, relating
either directly or indirectly to the business, products, practices or techniques
of the Company or to the Company's actual or demonstrably anticipated research
or development, or resulting from any work performed by Employee for the Company
or with the equipment, supplies, facilities or Confidential Information of the
Company, are the sole property of the Company, and hereby assigns and agrees to
assign to the Company, its successors and assigns, all of my right, title and
interest in and to said Inventions, and any patent applications or Letters
Patent thereon.

NOTIFICATION

THIS AGREEMENT DOES NOT APPLY TO AN INVENTION FOR WHICH NO
EQUIPMENT, SUPPLIES, FACILITY, OR TRADE SECRET INFORMATION OF THE COMPANY WAS
USED AND WHICH WAS
<PAGE>

DEVELOPED ENTIRELY ON EMPLOYEE'S OWN TIME, AND (a) WHICH DOES NOT RELATE (1) TO
THE BUSINESS OF THE COMPANY OR (2) TO THE COMPANY'S ACTUAL OR DEMONSTRABLY
ANTICIPATED RESEARCH OR DEVELOPMENT, OR (b) WHICH DOES NOT RESULT FROM ANY WORK
PERFORMED BY EMPLOYEE FOR THE COMPANY, AS DEFINED AND PROVIDED BY SECTION 2870
OF THE CALIFORNIA LABOR CODE.

10. CLAIMS BY THIRD PARTY. As to any Inventions which were
made, developed, perfected, devised, conceived or reduced to practice by
Employee during the period of her employment by the Company, and up to and
including a period of twelve (12) months after termination of her employment,
but which are claimed for any reason to belong to an entity or person other than
the Company, Employee will promptly disclose the same in writing to the Company
and shall not disclose the same to others if the Company, within twenty (20)
days thereafter, shall claim ownership of such Inventions under the terms of
this Agreement.

12. RECORDS PROPERTY OF COMPANY. Employee agrees that all
accounts, notes, data sketches, drawings and other documents and records, and
all material and physical items of any kind, including all reproductions and
copies thereof, which relate in any way to the business, products, practices or
techniques of the Company or contain Confidential Information, made by Employee
or that come into Employee's possession by reason of her employment are the
property of the Company and shall be promptly surrendered to the Company at the
conclusion of Employee's employment.
<PAGE>

14. SEVERANCE. PAYMENTS AND OTHER BENEFITS IN THE EVENT OF
TERMINATION OF EMPLOYMENT FOLLOWING A CHANGE OF CONTROL.

(1) The Company shall make the
following payments to Employee:

(B) SEVERANCE PAYMENTS. The
Company shall pay to Employee 1.5 times the sum of (a) her Base Salary in effect
immediately prior to the Change of Control and (b) a payment equal to the higher
of (x) 100% of the Employee's annual target bonus as determined under the
Company's incentive compensation plan or (y) an average of the last three actual
bonuses accorded to Employee. If an annual incentive compensation plan has not
been implemented for the current year, then the determination in (y) will
govern.

(2) The Company shall provide the following
benefits to Employee:

with the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended
("COBRA"). The eligible Employee (and, if applicable, her eligible dependents)
will be provided with a COBRA election form and notice which describe her rights
to continuation coverage under COBRA. If an eligible Employee elects COBRA
continuation coverage, then the Company will pay for COBRA coverage (such
payments shall not include COBRA coverage with respect to the Company's Section
125 health care reimbursement plan) for eighteen (18) months. After such period
of Company-paid coverage, the eligible Employee (and, if applicable, his or her
eligible dependents) may continue COBRA coverage at his or her own expense in
accordance with COBRA. No provision of this agreement will affect the
continuation coverage rules under COBRA. Therefore, the period during which the
eligible employee must elect to continue the Company's group health plan
coverage under COBRA, the length of time during which COBRA coverage will be
made available to the eligible employee, and all the eligible employee's other
rights and obligations under COBRA will be applied in the same manner that such
rules would apply in the absence of this Plan. In the event, however, an
Employee becomes eligible for benefits under another plan prior to the
expiration of the period in which the Company is paying benefit premiums, the
Company shall no longer be obligated to pay such benefit premiums. The Employee
is required to notify the Company of eligibility for benefits under another plan
and is expected to enroll in the new group plan at the first eligible
opportunity unless Employee chooses, at Employee's sole expense, to continue
COBRA benefits through the Company. If Employee fails to notify the Company of
Employee's eligibility for alternative benefits, the Company shall have the
right to discontinue payment of COBRA premiums upon thirty (30) days notice to
Employee. In no event shall a cash payment be made to Employee in lieu of the
payment of COBRA premiums. The payment of COBRA premiums by the Company shall
not extend the maximum eligible COBRA coverage period.

(B) OUTPLACEMENT SERVICES.
The Company will make available to Employee, upon her request, outplacement
services provided by a reputable outplacement counselor selected by the Company
for a period of six months following termination. The Company will assume the
cost of all such outplacement services. In no event will a cash payment be made
in lieu of outplacement benefits.

16. SEVERANCE PAYMENTS AND OTHER BENEFITS IN THE EVENT OF
TERMINATION OTHER THAN FOLLOWING A CHANGE OF CONTROL.

a. In the event Employee's employment is
terminated Without Cause other than within two (2) years following a Change in
Control, the Company shall provide the payments and other benefits specified
below to Employee:
<PAGE>

(1) The Company shall make the following
payments to Employee:

(A) ACCRUED SALARY AND BENEFITS.
The Company shall pay Employee's Base Salary through the effective date of
termination of Employee's Employment. In addition, employee shall receive the
following: (i) payment for accrued but unused vacation time; and (ii) group
health coverage, including eligible medical, dental and vision insurance
through the last day of the calendar month during which the termination
occurs (group health coverage after such date being governed by COBRA.)

(B) SEVERANCE PAYMENTS. The
Company shall pay to Employee a severance payment equal to twelve (12) months
of Employee's Monthly Salary, in effect immediately prior to termination.
This twelve-month period will be referred to as the Severance Period.

(2) The Company shall provide the
following benefits to Employee

chooses, at Employee's sole expense, to continue COBRA benefits through the
Company. If the Employee fails to notify the Company of Employee's eligibility
for alternative benefits, the Company shall have the right to discontinue
payment of COBRA premiums upon thirty (30) days notice to Employee. In no event
shall a cash payment be made to eligible employees in lieu of the payment of
COBRA premiums. The payment of COBRA premiums by the Company shall not extend
the maximum eligible COBRA coverage period.

(B) OUTPLACEMENT. The Company will
make available to Employee, upon her request, outplacement services provided by
a reputable outplacement counselor selected by the Company for a period of six
months following termination. The Company will assume the cost of all such
outplacement services. In no event will a cash payment be made in lieu of
outplacement benefits.

17. SECTION 280G LIMITATION ON SEVERANCE PAYMENTS. The
Severance Payments as described in Paragraph 14a(1)(B) of this Agreement shall
be reduced as necessary so that the present value, as determined in accordance
Section 280G(d)(4) of the Internal Revenue Code, of the sum of (i) the Severance
Payments and (ii) all other payments, if any, that must be taken into account
for purposes of computation under Section 280G(b)(2)(A)(ii) of the Internal
Revenue Code in respect of Employee does not exceed 2.99 times Employee's base
amount, as "base amount" is defined in Section 280G(b)(3) of the Internal
Revenue Code .

18. OUTSTANDING LOAN. Employee has an outstanding loan balance
due to the Company in the amount of $15,315. This loan balance will be forgiven
in its entirety if and when the Company determines, in its sole discretion, that
Employee has completed satisfactorily the technology transfer/manufacturing
outsourcing project. If a Termination Without Cause occurs prior to the loan
forgiveness date, then the loan balance would be forgiven at that time.
Otherwise, the entire loan balance is due and payable within thirty (30) days of
the effective date of any termination of Employee's employment.

19. RETENTION BONUS PROGRAMS. Employee will continue to
participate in the Retention Package program as explained in the memorandum to
Employee dated December 3, 1998 except that if the Company terminates Employee
Without Cause as defined in paragraph 3e herein prior to February 1, 2000, her
stock grant and stock option outlined in paragraphs 2 and 3 of the memorandum
dated December 3, 1998 will become immediately vested in full.

20. RESIGNATION, DEATH OR DISABILITY. Employee will not be
entitled to any Severance Benefits or Severance Payments under Paragraphs 14 or
16, or under any other plan, or any other provision of this Agreement, if her
employment is terminated by the Company for Cause or if her employment
terminates due to disability, death or resignation (other than a resignation
which constitutes a CONSTRUCTIVE TERMINATION).
<PAGE>

21. EXCLUSIVITY. Employee shall not, while employed by the
Company engage in any other employment or business venture for her account or on
behalf of others that relates, directly or indirectly, to the business and
affairs of the Company without the prior written consent of the Company.

23. NOTICE. Any and all notices, designations, consents,
offers, acceptances or any other communication provided for herein shall be
given in writing by registered or certified mail, return receipt requested,
which shall be addressed, in the case of the Company, to its office in San
Diego, California, and in Employee's case to her last known place of residence
as reflected on the Company's records.

24. ENTIRE AGREEMENT. This Agreement, and any stock option or
stock purchase agreements between the Employee and the Company, constitute the
entire agreement between Employee and the Company and contains all of the
agreements between the parties with respect to the subject matter hereof; this
Agreement supersedes any and all other agreements, either oral or in writing,
between the parties with respect to the subject matter hereof.

26. NO OTHER AGREEMENTS. Employee affirms that Employee has no
agreement with any other party that would preclude her compliance with her
obligations under this Agreement as set forth above.

27. GOVERNING LAW. This Agreement shall be subject to and
governed by the laws of the State of California.

31. HEADINGS. The headings of this Agreement are inserted for
convenience only and are not to be considered in construction of the provisions
hereof.

34. GENERIC DRUG ENFORCEMENT ACT CERTIFICATION. The
undersigned, certifies that she (1) has never been charged with or convicted of
a federal felony for conduct relating to the development, approval, or
regulation of any drug product or device regulated by the United States Food and
Drug Administration, and (2) has never been debarred or subject to a debarment
proceeding under the Generic Drug Enforcement Act of 1992.

(THIS SECTION HAS BEEN INTENTIONALLY LEFT BLANK FOR FORMATTING REASONS.)
<PAGE>

WHEREAS, the parties have executed this Agreement as of the
date first above written.

MOLECULAR BIOSYSTEMS, INC.

By:
--------------------------------------

Officer of Molecular Biosystems, Inc.

By:
--------------------------------------
Joni Harvey

<PAGE>

EXHIBIT 10.4

EMPLOYMENT AGREEMENT

This is an EMPLOYMENT AGREEMENT "Agreement" effective as of January 21,
1999 ("Effective Date"), between ELIZABETH HOUGEN, an individual ("Employee"),
and MOLECULAR BIOSYSTEMS, INC., a Delaware corporation ("the Company").

1. EMPLOYMENT.

a. POSITION. The Company agrees to employ Employee as its CHIEF
FINANCIAL OFFICER AND EXECUTIVE DIRECTOR OF FINANCE.

b. DUTIES. Employee shall diligently, and to the best of her ability,
perform all such duties incident to her position and use her best efforts to
promote the interests of the Company.

c. TIME TO BE DEVOTED TO EMPLOYMENT. Employee shall devote her full
time and energy to the business of the Company and shall not be engaged in any
competitive business activity without the express written consent of the
Company. Employee hereby represents that she is not a party to any agreement
which would be an impediment to entering into this Employment Agreement and that
she is permitted to enter into this Employment Agreement and perform the
obligations hereunder.

d. AT-WILL EMPLOYMENT. Employee shall be employed on an at-will basis
and may terminate her employment and may be terminated from her employment at
any time with or without cause, subject to the severance payment provisions set
forth in paragraphs 14 and 16 below.

2. COMPENSATION AND BENEFITS.

a. ANNUAL SALARY. In consideration of and as compensation for the
services agreed to be performed by Employee hereunder, the Company agrees to pay
Employee, as of the Effective Date of this Agreement, an annual Base Salary of
$125,000, payable in accordance with the Company's regular payroll schedule,
less applicable withholdings and deductions. Employee `s annual Base Salary is
subject to being increased as part of the Company's annual salary review
process.. If Employee is an Officer of the Company, changes to Base Salary must
be approved by the Board of Directors of the Company (the "Board").

b. PARTICIPATION IN BENEFIT PLANS. Employee shall be entitled to
participate in any vacation or other benefit plan, to the extent eligible, that
is generally available to the other employees of the Company at the same level
as Employee. The Company reserves the right to amend, modify or terminate any
employee benefits at any time for any reason.
<PAGE>

3. DEFINITIONS. The following definitions shall apply with respect to this
agreement.

a. BASE SALARY means the Employee's annual salary; it shall not include
overtime pay, commissions or any other benefits and special allowances for which
the Employee is eligible (e.g., bonuses). If Employee's annual salary is
adjusted following the Effective Date of this Agreement, the adjusted annual
salary would then represent Employee's Base Salary. "Weekly Salary" shall mean
the Base Salary divided by fifty-two. "Monthly Salary" shall mean Base Salary
divided by 12.

b. CHANGE OF CONTROL shall mean a change in ownership or control of the
Company effected through any of the following transactions:

(1) a merger, consolidation or reorganization approved by the
Company's stockholders, unless securities representing more than fifty percent
(50%) of the total combined voting power of the voting securities of the
successor corporation are immediately thereafter beneficially owned, directly or
indirectly and in substantially the same proportion, by the persons who
beneficially owned the Company's outstanding voting securities immediately prior
to such transaction, or

(2) any stockholder-approved transfer or other disposition of all or
substantially all of the Company's assets, or

(3) the acquisition, directly or indirectly by any person or related
group of persons (other than the Company or a person that directly or indirectly
controls, is controlled by, or is under common control with, the Company), of
beneficial ownership (within the meaning of Rule 13d3 of the 1934 Act) of
securities possessing more than fifty percent (50%) of the total combined voting
power of the Company's outstanding securities pursuant to a tender or exchange
offer made directly to the Company's stockholders, or

(4) a change in the composition of the Board over a period of
thirty-six (36) consecutive months or less such that a majority of the Board
members ceases, by reason of one or more contested elections for Board
membership, to be comprised of individuals who either (A) have been Board
members continuously since the beginning of such period or (B) have been elected
or nominated for election as Board members during such period by at least a
majority of the Board members described in clause (A) who were still in office
at the time the Board approved such election or nomination.

2
<PAGE>

resignation is submitted within thirty (30) days of the event : (i) a reduction
in the Base Salary of the Employee of more than fifteen percent (15%); (ii) a
relocation (or demand for relocation) of Employee's place of employment to a
location more than fifty (50) miles from Employee's current place of employment;
(iii) a significant or material reduction in Employee's job duties or level of
responsibility.

d. 1934 ACT means the Securities Exchange Act of 1934, as amended, and
the rules and regulations promulgated thereunder.

e. TERMINATION FOR CAUSE means a termination of Employee's employment
by the Company due to the Employee's:

(1) Misconduct that has a material adverse effect on the Company's
operations, prospects, reputation or business;

(2) Conviction of a felony;

(3) Act of fraud against, or theft of property belonging to, the
Company; or

(4) Gross negligence or the repeated failure of Employee to perform
her duties and responsibilities to the reasonable satisfaction of the Board or
superior after written notice of such failure, or any breach by Employee of her
fiduciary duties to the Company or any breach by Employee of her confidentiality
or proprietary information agreement with the Company.

f. TERMINATION WITHOUT CAUSE means a termination of Employee's
employment by the Company for any reason other than those specified in
subparagraph 3.e.(1) through (4) above.

g. DISABILITY means that as a result of any physical or mental injury
or disability, Employee is unable to perform the essential functions of her job,
with or without reasonable accommodation. A notice will be issued when the
Company has reasonably determined that Employee has become unable to perform
substantially her services and duties hereunder with or without reasonable
accommodation because of any physical or mental injury or disability, and that
it is reasonably likely that she will not be able to resume substantially
performing her services and duties on substantially the terms and conditions as
set forth in this Employment Agreement.

4. EMPLOYMENT. The Company shall be entitled to all of the benefits and
profits arising from or incident to the work, services and advice rendered by
the Employee relating to the work performed for the Company. The Employee shall
make all information available to the Company that relates to the Company's
business of which she has any knowledge and shall not use any such information
or the benefits of any such information for her personal profit or that of any
third party. The Employee agrees to use her best efforts to promote the
interests of the Company including, where appropriate, the publication of
articles in medical and scientific journals and the participation in medical and
scientific seminars and symposiums

3
<PAGE>

relating to the business and affairs of the Company and/or her research efforts
performed for and on behalf of the Company.

5. DISCLOSURES. Employee shall promptly disclose in writing to the officials
designated by the Company to receive such disclosures, complete information
concerning each and every invention, discovery, improvement, device, design,
apparatus, practice, process, method or product (hereinafter referred to as
"Inventions"), whether Employee considers them patentable or not, made,
developed, perfected, devised, conceived or reduced to practice by Employee,
either solely or in collaboration with others, during the period of Employee's
employment by the Company, and up to and including a period of twelve (12)
months after termination of employment, whether or not during regular working
hours, relating either directly or indirectly to the business, products,
practices or techniques of the Company or to the Company's actual or
demonstrably anticipated research or development, or resulting from any work
performed by Employee for the Company or with the equipment, supplies,
facilities or confidential information of the Company.

6. CONFIDENTIALITY. Employee recognizes that her employment with the Company
will involve contact with information of substantial value to the Company, which
is not generally known in the trade and which gives the Company an advantage
over its competitors who do not know or use it, including but not limited to
techniques, designs, drawings, processes, inventions, developments, equipment,
prototypes, sales and customer information, and business and financial
information, relating to the business, products, practices or techniques of the
Company (hereinafter referred to as "Confidential Information"). Employee shall
at all times regard and preserve as confidential such Confidential Information
obtained by Employee from whatever source and shall not, either during
Employee's employment or thereafter, publish or disclose any part of such
Confidential Information in any manner, or use the same except on behalf of the
Company, without the prior written consent of the Company. Further, Employee
shall, during her employment and thereafter, refrain from any acts or omissions
that would reduce the value of such Confidential Information to the Company.

7. ASSIGNMENT OF RIGHTS. Employee hereby agrees that any Inventions made,
developed, perfected, devised, conceived or reduced to practice by Employee
during the period of her employment by the Company, and any other Inventions
made, developed, perfected, devised, conceived or reduced to practice by
Employee during said period of twelve (12) months after termination of her
employment if based upon the Confidential Information of the Company, relating
either directly or indirectly to the business, products, practices or techniques
of the Company or to the Company's actual or demonstrably anticipated research
or development, or resulting from any work performed by Employee for the Company
or with the equipment, supplies, facilities or Confidential Information of the
Company, are the sole property of the Company, and hereby assigns and agrees to
assign to the Company, its successors and assigns, all of my right, title and
interest in and to said Inventions, and any patent applications or Letters
Patent thereon.

NOTIFICATION

THIS AGREEMENT DOES NOT APPLY TO AN INVENTION FOR WHICH NO
EQUIPMENT, SUPPLIES, FACILITY, OR TRADE SECRET INFORMATION OF THE COMPANY WAS
USED AND WHICH WAS

4
<PAGE>

8. COVENANT OF COOPERATION. Employee shall, at any time during employment or
thereafter, upon request and without further compensation therefor, but with all
reasonable expenses incurred by Employee to be reimbursed, do all lawful acts,
including but not limited to the execution of papers and oaths, the giving of
testimony, and the obtaining of evidence that in the opinion of the Company, its
successors or assigns, may be necessary or desirable for obtaining, sustaining,
reissuing or enforcing Letters Patent in the United States and throughout the
world for said Inventions, and for perfecting, recording or maintaining the
title of the Company, its successors and assigns, to said Inventions and to any
patent applications made and any Letters Patent granted for said Inventions in
the United States and throughout the world.

9. PATENT ENFORCEMENT. The Company shall have the sole discretion whether to
obtain, maintain, modify or enforce any domestic or foreign patent for said
Inventions assigned to the Company pursuant to this Agreement. The Company is
free to enter into any licensing or assignment agreement with any third party or
to use whatever means it deems best to develop, promote or market said
Inventions assigned to the Company pursuant to this Agreement or any domestic or
foreign patent thereof.

10. CLAIMS BY THIRD PARTY. As to any Inventions which were made, developed,
perfected, devised, conceived or reduced to practice by Employee during the
period of her employment by the Company, and up to and including a period of
twelve (12) months after termination of her employment, but which are claimed
for any reason to belong to an entity or person other than the Company, Employee
will promptly disclose the same in writing to the Company and shall not disclose
the same to others if the Company, within twenty (20) days thereafter, shall
claim ownership of such Inventions under the terms of this Agreement.

11. RECORD KEEPING. Employee shall keep complete, accurate and authentic
accounts, notes, data and records of any and all of said Inventions in the
manner and form requested by the Company. Such accounts, notes, data and
records, including all copies thereof, shall be the property of the Company, and
upon its request, Employee will promptly surrender the same to it, or if not
previously surrendered, Employee will promptly surrender the same to the Company
at the conclusion of her employment.

12. RECORDS PROPERTY OF COMPANY. Employee agrees that all accounts, notes,
data sketches, drawings and other documents and records, and all material and
physical items of any kind, including all reproductions and copies thereof,
which relate in any way to the business, products, practices or techniques of
the Company or contain Confidential Information, made by Employee or that come
into Employee's possession by reason of her employment are the property of the
Company and shall be promptly surrendered to the Company at the conclusion of
Employee's employment.

5
<PAGE>

13. NON-SOLICITATION. During Employee's employment with the Company and for
one (1) year thereafter, Employee will not solicit any employee of the Company
to leave the Company for any reason or to accept employment with any other
company. As part of this restriction, Employee will not interview any employee
of the Company or provide any input to any third party regarding any such person
for the purpose of offering such person employment elsewhere during the period
in question. However, this obligation shall not affect any responsibility
Employee may have as an employee of the Company with respect to the bona fide
hiring and firing of Company personnel.

14. SEVERANCE PAYMENTS AND OTHER BENEFITS IN THE EVENT OF TERMINATION OF
EMPLOYMENT FOLLOWING A CHANGE OF CONTROL.

a. In the event that either of the following two events occur within
two years after a Change of Control, the Company will provide the following
payment and benefits to Employee: (i) Employee's employment is terminated by the
Company Without Cause, or (ii) Employee's employment terminates as a result of a
Constructive Termination:

(1) The Company shall make the following payments to Employee:

(A) ACCRUED SALARY AND BENEFITS. The Company shall pay
Employee's Base Salary through the effective date of termination of Employee's
Employment. In addition to the Severance Payments payable to an eligible
employee as described below, such employee shall receive the following: (i)
payment for accrued but unused vacation time; and (ii) group health coverage,
including eligible medical, dental and vision insurance through the last day of
the calendar month during which the termination occurs (group health coverage
after such date being governed by COBRA.)

(B) SEVERANCE PAYMENTS. The Company shall pay to Employee an
amount equal to 1.5 times the sum of the following: (a) her Base Salary in
effect immediately prior to the Change of Control and (b) a payment equal to the
higher of (i) 100% of Employee's target bonus as determined under the Company's
incentive compensation plan or (ii) an average of the last three actual bonuses
awarded to Employee. If the Company has not implemented an annual incentive
compensation plan for the current year, as referred to in the foregoing
sentence, then the amount determined under (ii) shall govern.

(C) MANNER OF PAYMENT. Severance Payments may be paid in
accordance with regular payroll periods, in a single lump sum payment, or any
combination thereof, as deemed appropriate by the Company. Taxes and other
appropriate deductions will be withheld; however, 401k contributions will not be
allowed.

(2) The Company shall provide the following benefits to Employee:

6
<PAGE>

to elect temporary continuation coverage under the Company's group health plan
in accordance with the Consolidated Omnibus Budget Reconciliation Act of 1985,
as amended ("COBRA"). The eligible Employee (and, if applicable, her eligible
dependents) will be provided with a COBRA election form and notice which
describe her rights to continuation coverage under COBRA. If an eligible
Employee elects COBRA continuation coverage, then the Company will pay for COBRA
coverage (such payments shall not include COBRA coverage with respect to the
Company's Section 125 health care reimbursement plan) for eighteen (18) months.
After such period of Company-paid coverage, the eligible employee (and, if
applicable, her eligible dependents) may continue COBRA coverage at her own
expense in accordance with COBRA. No provision of this agreement will affect the
continuation coverage rules under COBRA. Therefore, the period during which the
eligible employee must elect to continue the Company's group health plan
coverage under COBRA, the length of time during which COBRA coverage will be
made available to the eligible employee, and all the eligible employee's other
rights and obligations under COBRA will be applied in the same manner that such
rules would apply in the absence of this Plan. In the event, however, an
Employee becomes eligible for benefits under another plan prior to the
expiration of the period in which the Company is paying benefit premiums, the
Company shall no longer be obligated to pay such benefit premiums. The Employee
is required to notify the Company of eligibility for benefits under another plan
and is expected to enroll in the new group plan at the first eligible
opportunity unless Employee chooses, at Employee's sole expense, to continue
COBRA benefits through the Company. If Employee fails to notify the Company of
Employee's eligibility for alternative benefits, the Company shall have the
right to discontinue payment of COBRA premiums upon thirty (30) days notice to
Employee. In no event shall a cash payment be made to Employee in lieu of the
payment of COBRA premiums. The payment of COBRA premiums by the Company shall
not extend the maximum eligible COBRA coverage period.

(B) OUTPLACEMENT SERVICES. The Company will make available to
Employee, upon her request, outplacement services provided by a reputable
outplacement counselor selected by the Company for a period of six months
following termination. The Company will assume the cost of all such outplacement
services. In no event will a cash payment be made in lieu of outplacement
benefits.

15. ACCELERATION OF STOCK OPTIONS IN THE EVENT OF A CHANGE OF CONTROL. In
the event of a Change of Control (whether or not followed by termination of
Employee's employment), all stock options under any Company stock option plan
which Employee holds at the time of such Change of Control shall become fully
"vested" (i.e., immediately exercisable). The Company shall also extend the
period of exercisability of those stock options to the maximum of four years, or
the natural expiration of the stock options, whichever is earlier.

16. SEVERANCE PAYMENTS AND OTHER BENEFITS IN THE EVENT OF TERMINATION OTHER
THAN FOLLOWING A CHANGE OF CONTROL.

a. In the event Employee's employment is terminated Without Cause other
than within two (2) years following a Change in Control, the Company shall
provide the payments and other benefits specified below to Employee:

7
<PAGE>

(1) The Company shall make the following payments to Employee:

(A) ACCRUED SALARY AND BENEFITS. The Company shall pay Employee's Base
Salary through the effective date of termination of Employee's Employment. In
addition, employee shall receive the following: (i) payment for accrued but
unused vacation time; and (ii) group health coverage, including eligible
medical, dental and vision insurance through the last day of the calendar month
during which the termination occurs (group health coverage after such date being
governed by COBRA.)

(B) SEVERANCE PAYMENTS. The Company shall pay to Employee a severance
payment equal to twelve (12) months of Employee's Monthly Salary, in effect
immediately prior to termination. This twelve (12) month period will be referred
to as the "Severance Period."

(C) MANNER OF PAYMENT. These Severance Payments may be paid in
accordance with regular payroll periods over the duration of the Severance
Period, in a single lump sum, or any combination thereof, as deemed appropriate
by the Company. Taxes and other appropriate deductions will be withheld however,
401(k) contributions will not be allowed.

(2) The Company shall provide the following benefits to Employee

8
<PAGE>

(B) OUTPLACEMENT. The Company will make available to Employee,
upon her request, outplacement services provided by a reputable outplacement
counselor selected by the Company for a period of six months following
termination. The Company will assume the cost of all such outplacement services.
In no event will a cash payment be made in lieu of outplacement benefits.

17. SECTION 280G LIMITATION ON SEVERANCE PAYMENTS. The Severance Payments as
described in Paragraph 14(1)(B) of this Agreement shall be reduced as necessary
so that the present value, as determined in accordance Section 280G(d)(4) of
the Internal Revenue Code, of the sum of (i) the Severance Payments and (ii) all
other payments, if any, that must be taken into account for purposes of
computation under Section 280G(b)(2)(A)(ii) of the Internal Revenue Code in
respect of Employee does not exceed 2.99 times Employee's base amount, as "base
amount" is defined in Section 280G(b)(3) of the Internal Revenue Code .

18. RETENTION BONUS PROGRAM. Employee will continue to participate in the
Retention Package program as explained in the memorandum to Employee dated
December 3, 1998.

19. RESIGNATION, DEATH OR DISABILITY. Employee will not be entitled to any
Severance Benefits or Severance Payments under Paragraphs 14 or 16, or under any
other plan, or any other provision of this Agreement, if her employment is
terminated by the Company for Cause or if her employment terminates due to
disability, death or resignation (other than a resignation which constitutes a
CONSTRUCTIVE TERMINATION).

20. EXCLUSIVITY. Employee shall not, while employed by the Company engage in
any other employment or business venture for her account or on behalf of others
that relates, directly or indirectly, to the business and affairs of the Company
without the prior written consent of the Company.

21. PROHIBITION AGAINST ASSIGNMENT. Employee agrees that this Agreement and
the rights, interests and benefits hereunder shall not be assigned, transferred,
pledged or hypothecated in any way by Employee or any executor, administrator,
heir, legatee, distributee or any other person claiming under Employee by virtue
of this Agreement and shall not be subject to execution, attachment or similar
process. Any attempt to assign, transfer, pledge or hypothecate or otherwise
dispose of this Agreement or of such rights, interests and benefits

9
<PAGE>

contrary to the foregoing provisions, or the levy of any attachment or similar
process thereon shall be null and void and without effect and shall relieve the
Company of any and all liability hereunder.

22. NOTICE. Any and all notices, designations, consents, offers, acceptances
or any other communication provided for herein shall be given in writing by
registered or certified mail, return receipt requested, which shall be
addressed, in the case of the Company, to its office in San Diego, California,
and in Employee's case to her last known place of residence as reflected on the
Company's records.

23. ENTIRE AGREEMENT. This Agreement, and any stock option or stock purchase
agreements between the Employee and the Company, constitute the entire agreement
between Employee and the Company and contains all of the agreements between the
parties with respect to the subject matter hereof; this Agreement supersedes any
and all other agreements, either oral or in writing, between the parties with
respect to the subject matter hereof.

24. BINDING EFFECT. This Agreement shall be binding upon and inure to the
benefit of Employee and the Company and their respective heirs, legal
representatives, executors, administrators, and successors.

25. NO OTHER AGREEMENTS. Employee affirms that Employee has no agreement
with any other party that would preclude her compliance with her obligations
under this Agreement as set forth above.

26. GOVERNING LAW. This Agreement shall be subject to and governed by the
laws of the State of California.

27. AMENDMENT OF AGREEMENT. No change or modification of this Agreement
shall be valid unless the same is in writing and signed by Employee and the
Company. No waiver of any provision of this Agreement shall be valid unless in
writing and signed by the person or party to be charged.

28. SEVERABILITY. If any portion or portions of this Agreement shall be, for
any reason, deemed to be invalid or unenforceable, the remaining portion or
portions shall nevertheless be valid, enforceable and carried into effect,
unless to do so would clearly violate the present legal and valid intention of
the parties hereto.

29. BREACH. In the event either party breaches this Agreement and the other
party prevails in an action to enforce the terms of this Agreement, the losing
party agrees to pay to the prevailing party all reasonable attorneys' fees and
costs incurred by the prevailing party in prosecuting such action, and all
damages suffered by the prevailing party.

30. HEADINGS. The headings of this Agreement are inserted for convenience
only and are not to be considered in construction of the provisions hereof.

10
<PAGE>

31. WAIVER OR BREACH. The waiver by either of the parties hereto of any
breach of any provision hereof shall not be construed to be a waiver of any
succeeding breach of that provision or a waiver of any other provision of this
Agreement.

32. ARBITRATION OF DISPUTES. Any dispute arising under this Agreement shall
be resolved through final and binding arbitration conducted pursuant to the
rules of the American Arbitration Association. This shall be in lieu of any
right to a jury trial, which right is expressly waived.

33. GENERIC DRUG ENFORCEMENT ACT CERTIFICATION. The undersigned, certifies
that she (1) has never been charged with or convicted of a federal felony for
conduct relating to the development, approval, or regulation of any drug product
or device regulated by the United States Food and Drug Administration, and (2)
has never been debarred or subject to a debarment proceeding under the Generic
Drug Enforcement Act of 1992.

(THIS SECTION HAS BEEN INTENTIONALLY LEFT BLANK FOR FORMATTING REASONS.)

11
<PAGE>

WHEREAS, the parties have executed this Agreement as of the date
first above written.

MOLECULAR BIOSYSTEMS, INC.

By:
-----------------------------------------
Officer of Molecular Biosystems, Inc.

By:
-----------------------------------------
Elizabeth Hougen

<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF MOLECULAR BIOSYSTEMS, INC. DATED DECEMBER
31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000

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<PERIOD-START> APR-01-1999
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<SECURITIES> 10,895
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