10-Q 1 alliance_10q-123108.txt -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------- FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2008 [ ] TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 000-12950 -------------------------------- ALLIANCE PHARMACEUTICAL CORP. (Exact Name of Registrant as Specified in Its Charter) NEW YORK 14-1644018 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 7590 FAY AVENUE, SUITE 402 92037 LA JOLLA, CALIFORNIA (Address of Principal Executive Offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING ARE CODE: (858) 410-5200 Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of "large accelerated filer," "accelerated file" and "smaller reporting company" in rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company |X| (Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Common Stock, $0.01 par value per share, 150,000,000 shares authorized, 63,216,247 shares issued and outstanding at February 11, 2009. ALLIANCE PHARMACEUTICAL CORP. ----------------------------- INDEX ----- Page No. -------- PART I - FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets at December 31, 2008 (unaudited) and June 30, 2008 3 Condensed Consolidated Statements of Operations (unaudited) 4 Condensed Consolidated Statements of Cash Flows (unaudited) 5 Notes to Unaudited Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 4T. Controls and Procedures 20 PART II - OTHER INFORMATION Item 1. Legal Proceedings 20 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 20 Item 3. Defaults Upon Senior Securities 21 Item 4. Submission of Matters to a Vote of Security Holders 21 Item 5 Other Information 21 Item 6. Exhibits 21

-2- PART I FINANCIAL INFORMATION: Item 1. Financial Statements ALLIANCE PHARMACEUTICAL CORP. ----------------------------- CONDENSED CONSOLIDATED BALANCE SHEETS ------------------------------------------------------------------------------------------- DECEMBER 31, 2008 JUNE 30, 2008 ------------- ------------- ASSETS (UNAUDITED) (AUDITED) ------ CURRENT ASSETS: Cash $ 1,000 $ 6,000 Restricted cash -- 16,000 Other current assets 18,000 39,000 ------------- ------------- Total current assets 19,000 61,000 PROPERTY AND EQUIPMENT - NET 51,000 87,000 ------------- ------------- $ 70,000 $ 148,000 ============= ============= LIABILITIES AND STOCKHOLDERS' DEFICIT ------------------------------------- CURRENT LIABILITIES: Accounts payable $ 333,000 $ 252,000 Accrued expenses 377,000 212,000 Deferred revenue 100,000 100,000 Advance from related party 90,000 -- Senior notes payable and accrued interest 10,952,000 11,065,000 ------------- ------------- Total current liabilities 11,852,000 11,629,000 OTHER LIABILITIES 750,000 750,000 ------------- ------------- Total liabilities 12,602,000 12,379,000 ------------- ------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' DEFICIT: Common stock - $0.01 par value; 150,000,000 shares authorized; 63,216,247 and 60,216,247 shares issued and outstanding, respectively 632,000 602,000 Additional paid-in capital 487,253,000 486,760,000 Accumulated deficit (500,417,000) (499,593,000) ------------- ------------- Total stockholders' deficit (12,532,000) (12,231,000) ------------- ------------- $ 70,000 $ 148,000 ============= ============= SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS. -3- ALLIANCE PHARMACEUTICAL CORP. ----------------------------- CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS --------------------------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, 2008 2007 2008 2007 ------------------ ------------------ ------------------ ------------------ (UNAUDITED) (UNAUDITED) REVENUES: Royalty, license and research $ -- $ -- $ -- $ 57,000 ------------------ ------------------ ------------------ ------------------ OPERATING EXPENSES: Research and development 102,000 91,000 92,000 260,000 General and administrative 178,000 194,000 369,000 491,000 ------------------ ------------------ ------------------ ------------------ 280,000 285,000 461,000 751,000 ------------------ ------------------ ------------------ ------------------ LOSS FROM OPERATIONS (280,000) (285,000) (461,000) (694,000) INVESTMENT INCOME 1,000 4,000 1,000 14,000 OTHER INCOME -- -- 25,000 163,000 INTEREST EXPENSE (192,000) (222,000) (397,000) (465,000) LOSS ON MODIFICATION OF DEBT -- -- -- (14,000) LOSS ON DISPOSITION OF EQUIPMENT -- -- (17,000) -- GAIN ON DISPOSITION OF ASSETS -- -- 25,000 -- ------------------ ------------------ ------------------ ------------------ NET LOSS $ (471,000) $ (503,000) $ (824,000) $ (996,000) ================== ================== ================== ================== NET LOSS PER COMMON SHARE, BASIC AND DILUTED $ (0.01) $ (0.01) $ (0.01) $ (0.02) ================== ================== ================== ================== WEIGHTED AVERAGE SHARES OUTSTANDING, BASIC AND DILUTED 62,531,000 55,156,000 61,380,000 52,236,000 ================== ================== ================== ================== SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -4- ALLIANCE PHARMACEUTICAL CORP. ----------------------------- CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS --------------------------------------------------------------------------------------- Six Months Ended December 31, 2008 2007 ----------- ----------- (UNAUDITED) OPERATING ACTIVITIES: Net loss $ (824,000) $ (996,000) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 18,000 19,000 Loss on modification of debt -- 14,000 Accrued interest on senior notes 397,000 465,000 Stock-based compensation 14,000 24,000 Loss on disposal of equipment 17,000 -- Changes in operating assets and liabilities: Other assets 38,000 (35,000) Accounts payable, accrued expenses and other 245,000 (228,000) ----------- ----------- Net cash used in operating activities (95,000) (737,000) ----------- ----------- FINANCING ACTIVITIES: Advance from related party 90,000 -- ----------- ----------- Net cash provided by financing activities 90,000 -- DECREASE IN CASH (5,000) (737,000) CASH AT BEGINNING OF PERIOD 6,000 873,000 ----------- ----------- CASH AT END OF PERIOD $ 1,000 $ 136,000 =========== =========== SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES: Issuance of common stock upon conversion of senior notes and interest $ 510,000 $ 2,173,000 =========== =========== SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.

-5- ALLIANCE PHARMACEUTICAL CORP. ----------------------------- NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- THREE AND SIX MONTHS ENDED DECEMBER 31, 2008 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION ------------ Alliance Pharmaceutical Corp. and its subsidiaries (collectively, the "Company," "Alliance," "we" or "us") are engaged in identifying, designing and developing novel medical products. Currently, the Company is focused on developing its lead product, OXYGENT(TM), an intravascular oxygen carrier designed to augment oxygen delivery in surgical patients. LIQUIDITY AND BASIS OF PRESENTATION ----------------------------------- The accompanying condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the ordinary course of business. The Company has incurred operating losses through December 31, 2008 and has negative working capital at that date of approximately $11.8 million. These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. As discussed in Note 3, in June 2004, the Company completed a private placement financing with net proceeds to the Company of approximately $10 million from the sale of common stock (the "June 2004 Private Placement"). In September 2004, the terms of the June 2004 Private Placement were renegotiated by mutual agreement of the Company and investors holding approximately $10.7 million of the original $11 million invested by the various investors in the June 2004 Private Placement. Concurrently, the investors who elected to rescind the June 2004 Private Placement were issued senior convertible promissory notes in like investment amounts (the "Senior Notes"), which, unless previously converted, were to mature and the unpaid principal, together with accrued interest, was to become due and payable on April 1, 2007. The Company requested that each holder of a Senior Note execute an amendment to extend the maturity date of the Senior Note from April 1, 2007 to June 30, 2008 under certain conditions, which we did not meet in a timely manner. This amendment was approved by substantially all of the Senior Note holders. The Company is now in default under the Senior Notes. The Company is continuing to seek additional financing of approximately $3 million to fund its continuing operations through June 2011 (see Note 5). We have not yet identified a source of the funds and it is uncertain if we will be able to do so. Failure to obtain such financing would likely result in the liquidation of our Company. It is unlikely that our shareholders would receive any of the proceeds from such liquidation. Because adequate funds have not been available to the Company in the past, the Company has already delayed its OXYGENT development efforts and has delayed, scaled back, and/or eliminated one or more of its other product development programs. The accompanying unaudited condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from the outcome of this uncertainty. PRINCIPLES OF CONSOLIDATION --------------------------- The accompanying unaudited condensed consolidated financial statements include the accounts of Alliance Pharmaceutical Corp., the accounts of its wholly owned subsidiary, Molecular Biosystems, Inc. ("MBI"), and its majority-owned subsidiaries, Talco Pharmaceutical, Inc. and PFC Therapeutics, LLC ("PFC Therapeutics"). All significant intercompany accounts and transactions have been eliminated. INTERIM UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------- The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information. These principles are consistent in all material respects with those applied in the Company's consolidated financial statements contained in the Company's annual report on Form 10-KSB for the fiscal year ended June 30, 2008, and pursuant to the instructions to Form 10-Q and Article 8 of Regulation S-X promulgated by the Securities and Exchange Commission (the "SEC"). Interim financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of -6- America for complete financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (all of which are of a normal recurring nature, including the elimination of intercompany accounts) necessary to present fairly the financial position, results of operations and cash flows of the Company for the periods indicated. Interim results of operations are not necessarily indicative of the results to be expected for the full year or any other interim periods. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto contained in the Company's annual report on Form 10-KSB for the year ended June 30, 2008. USE OF ESTIMATES ---------------- The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes to the condensed consolidated financial statements. Significant estimates made by management include, among others, recoverability of property and equipment and the valuation of deferred tax assets and stock options. Actual results could differ from these estimates. PROPERTY AND EQUIPMENT ---------------------- Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets, ranging from three to five years. Major betterments and renewals are capitalized, while routine repairs and maintenance are charged to expense when incurred. The Company assesses the recoverability of property and equipment by determining whether such assets can be recovered through projected undiscounted cash flows. The amount of impairment, if any, is measured based on fair value and is charged to operations in the period in which impairment is determined by management. At December 31, 2008, management has determined that there is no impairment of property and equipment. There can be no assurance, however, that market conditions will not change, which could result in future property and equipment impairment. REVENUE RECOGNITION ------------------- The Company recognizes revenue in accordance with Staff Accounting Bulletin ("SAB") No. 101, "REVENUE RECOGNITION IN FINANCIAL STATEMENTS," as revised by SAB No. 104. As such, the Company recognizes revenue when persuasive evidence of an arrangement exists, title transfer has occurred, or services have been performed, the price is fixed or readily determinable and collectibility is probable. Revenue is deferred until all contractual obligations have been satisfied. RESEARCH AND DEVELOPMENT REVENUES UNDER COLLABORATIVE AGREEMENTS ---------------------------------------------------------------- Research and development revenues under collaborative agreements are recognized as the related expenses are incurred, up to contractual limits. Payments received under these agreements that are related to future performance are deferred and recorded as revenue as they are earned over the specified future performance period. Revenue related to nonrefundable, upfront fees are recognized over the period of the contractual arrangements as performance obligations related to the services to be provided have been satisfied. Revenue related to milestones is recognized upon completion of each milestone's performance requirement. LICENSING AND ROYALTY REVENUES ------------------------------ Licensing and royalty revenues for which no services are required to be performed in the future are recognized immediately, if collectibility is reasonably assured. -7- RAW MATERIAL REVENUES --------------------- The Company recognizes revenues from the sales of raw material upon shipment, at which time title transfers and the Company has no further obligation. Such sales in the amount of $25,000 and $163,000 were recorded during the six months ended December 31, 2008 and December 31, 2007, respectively, in connection with raw material that the Company does not market. Inventory associated with the sales of these raw materials is carried at zero value. The amounts earned for these sales were recorded as other income in the accompanying condensed consolidated statements of operations. RESEARCH AND DEVELOPMENT EXPENSES --------------------------------- Research and development expenditures are charged to expense as incurred. Research and development expenditures include the cost of salaries and benefits for clinical, scientific, manufacturing, engineering and operations personnel, payments to outside researchers for preclinical and clinical trials and other product development work, payments related to facility lease and utility expenses, depreciation and amortization, patent costs, as well as other expenditures. During the six-month periods ended December 31, 2008 and 2007, the Company incurred research and development expenses of approximately $92,000 and $260,000, respectively. The research and development costs for the current period are primarily costs associated with filing a new patent in certain countries. FAIR VALUE OF FINANCIAL INSTRUMENTS ----------------------------------- The carrying amount of certain of the Company's financial instruments as of December 31, 2008 approximates their respective fair values because of the short-term nature of these instruments. Such instruments consist of cash, accounts payable, accrued expenses and other liabilities. The carrying value of debt approximates fair value as the related interest rate approximates a rate currently available to the Company. COMPUTATION OF NET INCOME (LOSS) PER COMMON SHARE ------------------------------------------------- Basic loss per share was computed by dividing the net loss by the weighted average number of common shares outstanding during the period. All potential dilutive common shares have been excluded from the calculation of diluted loss per share for the six months ended December 31, 2008 and 2007, as their inclusion would be anti-dilutive. The outstanding potentially dilutive common shares totaled approximately 64,424,000 and 63,317,000 at December 31, 2008 and 2007, respectively. ACCOUNTING FOR STOCK-BASED COMPENSATION --------------------------------------- At December 31, 2008, the Company has two stock-based employee compensation plans. Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)") requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company's consolidated statement of operations. Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. Stock-based compensation expense recognized in the Company's condensed consolidated statement of operations for the six months ended December 31, 2008 included compensation expense for share-based payment awards granted prior to, but not yet vested as of June 30, 2006, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS No. 123 and compensation expense for the share-based payment awards granted subsequent to June 30, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). As stock-based compensation expense recognized in the condensed consolidated statement of operations for the six months ended December 31, 2008 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The estimated average forfeiture rate was based on historical forfeiture experience and estimated future employee forfeitures. SFAS No. 123(R) requires cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options to be classified as financing cash flows. Due to the Company's loss position, there were no such tax benefits during the six months ended December 31, 2008. -8- DESCRIPTION OF PLANS -------------------- The Company's stock option plans provide for grants of options to employees and directors of the Company to purchase the Company's shares, as determined by management and the board of directors, at the fair value of such shares on the grant date. The options generally vest over a four- to five-year period beginning on the date of grant or up to one year after the date of grant and have a ten-year term. As of December 31, 2008, the Company is authorized to issue up to 8,100,000 shares under these plans and has 4,102,110 shares available for future issuance. SUMMARY OF ASSUMPTIONS AND ACTIVITY ----------------------------------- The fair value of stock-based awards to employees and directors is calculated using the Black-Scholes option pricing model, even though the model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restriction, which differ significantly from the Company's stock options. The Black-Scholes model also requires subjective assumptions regarding future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the pricing term of the grant effective as of the date of the grant. The expected volatility is based on the historical volatility of our common stock. These factors could change in the future, affecting the determination of stock-based compensation expense in future periods. A summary of option activity as of December 31, 2008 and changes during the six months then ended is presented below: 12/31/2008 --------------------------------------------- WEIGHTED-AVERAGE ---------------- REMAINING CONTRACTUAL AGGREGATE EXERCISE TERM INTRINSIC SHARES PRICE (YEARS) VALUE --------------------------------------------- Options outstanding at July 1, 2008 2,703,800 $ 3.49 5.84 Options granted -- Options forfeited/expired (58,100) Options exercised -- --------------------- Options outstanding at December 31, 2008 2,645,700 $ 3.03 5.46 $ -- --------------------------------------------- Unvested options expected to vest at December 31, 2008 465,500 $ 0.23 6.32 $ -- --------------------------------------------- Options exercisable at December 31, 2008 2,170,700 $ 3.64 5.27 $ -- =============================================

There were 58,100 options that expired from an expired plan during the six months ended December 31, 2008. There IC OMITTED][GRAPHIC OMITTED] were no options granted or exercised during the six months ended December 31, 2008. Upon the exercise of options, the Company issues new shares from its authorized shares. As of December 31, 2008, there was approximately $26,000 of total unrecognized compensation costs related to employee and director stock option compensation arrangements. That cost is expected to be recognized on a straight-line basis over the next four years on average. The total fair value of shares vested during the six months ended December 31, 2008 related to employee and director options and options issued to consultants was approximately $13,000 and $1,000 respectively, net of estimated forfeitures. The Company allocated $13,000 of the stock-based compensation expense related to employee and director stock options to general and administrative expenses and $1,000 of the stock-based compensation expense related to consultant stock options to research and development expenses. -9- RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS ----------------------------------------- In September 2006, the FASB issued SFAS No. 157, "FAIR VALUE MEASUREMENTS." SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accounting principals generally accepted in the U.S. and expands disclosures about fair value measurements. The statement does not require new fair value measurements, but is applied to the extent that other accounting pronouncements require or permit fair value measurements. SFAS No. 157 emphasizes that fair value is a market-based measurement that should be determined based on the assumptions that market participants would use in pricing an asset or liability. Companies that have assets and liabilities measured at fair value will be required to disclose information that enables the users of its financial statements to access the inputs used to develop those measurements. The reporting entity is encouraged, but not required, to combine the fair value information disclosed under this statement with the fair value information disclosed under other accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FSP 157-2, "EFFECTIVE DATE OF FASB STATEMENT NO. 157", which delays the effective date of SFAS No. 157 for non-financial assets and liabilities to fiscal years beginning after November 15, 2008. On July 1, 2008, the Company adopted SFAS No. 157 for financial assets and liabilities. The adoption did not have a material effect on the Company's results of operations and financial position. The Company is in the process of evaluating the impact of adoption of SFAS No. 157 for non-financial assets and liabilities, but does not anticipate that the adoption will have a material impact on its condensed consolidated financial statements. In February 2007, the FASB issued SFAS No. 159, "THE FAIR VALUE OPTION FOR FINANCIAL ASSETS AND FINANCIAL LIABILITIES." SFAS No. 159 permits entities to choose to measure at fair value many financial instruments and certain other items that are not currently required to be measured at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. SFAS No. 159 does not establish requirements for recognizing and measuring dividend income, interest income, or interest expense. This statement does not eliminate disclosure requirements included in other accounting standards. SFAS No. 159 is effective in fiscal years beginning after November 15, 2007. The Company adopted SFAS No. 159 on July 1, 2008. The adoption did not have a material effect on the Company's results of operations and financial position. In December 2007, the FASB issued SFAS No. 141(R), "BUSINESS COMBINATIONS" ("SFAS No. 141(R)"). SFAS No. 141(R) requires acquiring entities in a business combination to recognize the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors the information they need to evaluate and understand the nature and financial effect of the business combination. SFAS No. 141(R) is effective in fiscal years beginning after December 15, 2008. The Company expects to adopt SFAS No. 141(R) on July 1, 2009. The Company is currently assessing the impact the adoption of SFAS No. 141(R) will have on its consolidated financial statements. In December 2007, the FASB issued SFAS No. 160, "NONCONTROLLING INTERESTS IN CONSOLIDATED FINANCIAL STATEMENTS" ("SFAS No. 160"). SFAS No. 160 requires entities to report noncontrolling (minority) interests in subsidiaries as equity in the consolidated financial statements. SFAS No. 160 is effective in fiscal years beginning after December 15, 2008. The Company expects to adopt SFAS No. 160 on July 1, 2009. The Company is currently assessing the impact the adoption of SFAS No. 160 will have on its consolidated financial statements. In June 2008, the FASB ratified EITF No. 07-5, "DETERMINING WHETHER AN INSTRUMENT (OR EMBEDDED FEATURE) IS INDEXED TO AN ENTITY'S OWN STOCK," ("EITF 07-5"). EITF 07-5 provides guidance for determining whether an equity-linked financial instrument, or embedded feature, is indexed to an entity's own stock. EITF 07-5 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, and will be adopted by the Company in the first quarter of fiscal year 2010. The Company is currently assessing the potential impact, if any, of the adoption of EITF 07-5 on its consolidated results of operations and financial condition. -10- 2. PFC THERAPEUTICS, LLC On December 22, 2004, PFC Therapeutics and LEO Pharma A/S ("LEO"), one of the leading Danish research-based pharmaceutical companies that markets significant products within the fields of dermatology, metabolic and cardiovascular diseases and ophthalmology and antibiotics, signed an exclusivity agreement to enter into a license agreement, subject to continued due diligence by LEO, to develop and commercialize OXYGENT in Europe (EU member countries, EU membership applicants, Norway and Switzerland) and Canada (the "LEO Exclusivity Agreement"). The terms of the license agreement, if entered into, will include certain initial and future payments to PFC Therapeutics upon the completion of various regulatory and commercial milestones for OXYGENT development in Europe and royalties on commercial sales of OXYGENT in Europe and Canada. On January 5, 2005, the Company received the non-refundable portion of an exclusivity fee of $100,000 per the terms of the LEO Exclusivity Agreement. Because the amendment discussed below extends LEO's due diligence time-period, this amount has been deferred and is included in current liabilities in the accompanying consolidated balance sheet at June 30, 2008. On February 25, 2005, PFC Therapeutics and LEO agreed to amend the LEO Exclusivity Agreement. The amendment extends the period of time in which LEO may undertake its due diligence investigation from March 1, 2005 to a date that is sixty (60) days after submission by us to LEO of the results of a Phase 2b postoperative ileus study. The postoperative ileus endpoints will be incorporated in the Phase 2 clinical study described below. The remaining terms of the LEO Exclusivity Agreement remain in full force and effect. On May 13, 2005, PFC Therapeutics and Beijing Double-Crane Pharmaceutical Co., Ltd. ("Double-Crane"), the market leader for IV solutions and one of the largest pharmaceutical companies in the People's Republic of China (the "PRC"), entered into a development, license and supply agreement ("Double-Crane Agreement") for the development of OXYGENT in the PRC. Pursuant to the Double-Crane Agreement, Double-Crane made an upfront license fee payment and will make certain milestone and royalty payments to the Company. The upfront license fee of $500,000 was deferred until the Company's obligations to perform were satisfied. These obligations included the transfer and translation of all intellectual property, preclinical, clinical and regulatory data necessary for Double-Crane's clinical development and Investigational New Drug ("IND") application to the State Food and Drug Administration PRC (the "sFDA"). This transfer and all other corresponding obligations were completed and such amount was recognized as license revenue at June 30, 2007. Double-Crane intends to pursue an intraoperative and postoperative transfusion avoidance endpoint. Double-Crane's clinical development plan incorporates a new protocol design that is intended to build on the previously conducted Alliance Phase 2 and Phase 3 clinical trials. In these studies, the efficacy of OXYGENT in terms of drug activity (i.e., its ability to deliver oxygen) enabled patients to remain physiologically stable at lower intraoperative hemoglobin ("Hb") levels. OXYGENT was shown to be statistically better than blood in reversing, as well as maintaining reversal of, physiological transfusion triggers. Importantly, the Double-Crane study will not employ any blood harvesting techniques (i.e., acute normovolemic hemodilution or intraoperative autologous donation), which were implicated in safety issues in a previous Alliance Phase 3 clinical trial. Double-Crane is obligated pursuant to its agreement with Alliance to conduct clinical trials in the PRC in accordance with the International Conference on Harmonization of Technical Requirements for Registration of Pharmaceuticals for Human Use (the "ICH") Guidelines, which would allow Alliance to use any data derived from the clinical trials in other countries. Double-Crane will have the option to manufacture OXYGENT in the PRC after obtaining approval from the regulatory authorities in the PRC and they will also have a right of first refusal to add specific additional countries to the Double-Crane Agreement upon further negotiation with the Company. 3. DEBT OBLIGATIONS SENIOR NOTES PAYABLE -------------------- On July 2, 2004, Nycomed Denmark ApS ("Nycomed") notified the Company that it was unilaterally terminating its Development, Assignment and Supply Agreement (the "Nycomed Agreement") effective August 16, 2004. Subsequently, a dispute arose between the Company and some of its investors who participated in the June 2004 Private Placement. After considering all of the facts and circumstances relevant to the dispute, the Company's Board of Directors determined that it was in the Company's and the Company's shareholders' best interests to offer, as a settlement of the dispute, to rescind the June 2004 Private Placement. -11- On September 24, 2004, investors holding 30,546,423 shares of common stock and warrants to purchase 22,909,821 shares of common stock representing approximately $10.7 million of the $11 million invested in the June 2004 Private Placement elected to rescind the June 2004 Private Placement. In doing so, each of these investors returned to the Company its stock certificate representing the number of shares and the warrant that it received in the June 2004 Private Placement for cancellation. Immediately thereafter, these same investors entered into the Senior Note Purchase Agreement whereby the Company issued to such investors Senior Notes convertible into common stock at $0.25 per share, which was subsequently amended (see below), in principal amounts equal to the amounts such investors invested in the June 2004 Private Placement. After giving effect to both transactions, the Company issued 880,714 shares of common stock and warrants to purchase 660,536 shares of common stock in the June 2004 Private Placement, and the Company issued Senior Notes in an aggregate principal amount of approximately $10.7 million. The Senior Notes were due March 24, 2006, and bore interest at 6% per annum. In April 2006, the Company entered into the 2006 Amendment with each of the existing holders of Alliance's Senior Notes. Pursuant to the 2006 Amendment, the maturity date of each outstanding Senior Note was extended from March 24, 2006 to April 1, 2007. The conversion price of each Senior Note was reduced from $0.25 to $0.17, and the interest that accrued on each Senior Note from March 25, 2006 through April 1, 2007 was increased from 6% to 10% per annum. In addition to the amounts due under the Senior Notes, the holders of the Senior Notes were entitled to receive up to an aggregate of $11.4 million in payments based on future royalties from OXYGENT product sales (or under certain conditions from milestone payments) payable at a rate equal to 50% of such payments Alliance actually receives. On May 15, 2007, Alliance entered into an amendment (the "2007 Amendment") of its Senior Convertible Promissory Note Purchase Agreement and Registration Rights Agreement (as amended by the 2006 Amendment) with essentially all of the existing holders of the Senior Notes. Pursuant to the 2007 Amendment, the maturity date of each outstanding Senior Note was extended as follows: (a) The maturity date was extended from April 1, 2007 to the date ninety (90) days after the date of the 2007 Amendment. If the Company received more than $1.5 million but less than $3 million in connection with a Qualified Financing (as defined in the 2007 Amendment) prior to the expiration of the ninety (90) days (which the Company did not receive), the maturity date would have been automatically extended to the date that is one hundred eighty (180) days after the date of the 2007 Amendment; and (b) If the Company received at least $3 million in connection with a Qualified Financing prior to the extended maturity date, the maturity date would automatically become June 30, 2008. The holders of the Senior Notes also agreed to subordinate their rights to any debt that is issued in a Qualified Financing. Further, any financing that qualified as a Qualified Financing would not require additional approval from the Senior Note holders. Alliance also agreed to issue to each current holder of a Senior Note an additional note with principal amount equal to 20% of the outstanding principal amount of such Senior Note on the date of the 2007 Amendment, which resulted in Alliance issuing new promissory notes in the aggregate principal amount of approximately $1.8 million. These new notes bear interest at the rate of 10% per annum, matured on June 30, 2008 and are convertible into common stock of Alliance on the same terms as the Senior Notes at such time as Alliance has a sufficient number of authorized and unreserved shares of common stock to accommodate such conversion. The Company further agreed to an increase of 20% to the current royalty/milestone payment participation amounts set forth in the 2006 Amendment. Under the 2006 Amendment, Senior Note holders receive 50% of the total amounts of royalties and milestones received by the Company from third parties until 100% of the payment participation amounts have been received. The Senior Note holders who held their Senior Notes through June 30, 2008 will now receive payment sharing until 120% of the payment participation amounts have been received. The Company was unable to complete a Qualified Financing by the requisite dates. As a result, the Company is in default under the Senior Notes in the aggregate principal and interest amount of approximately $11 million. Alliance is continuing to seek additional financing that would qualify as a Qualified Financing for the purpose of funding its support of Double-Crane's development of OXYGENT in the PRC. -12- The Senior Notes can be converted anytime prior to the maturity date. During the six months ended December 31, 2008, holders of certain Senior Notes converted an aggregate of approximately $266,000 in principal and approximately $244,000 in accrued interest into an aggregate of 3,000,000 shares of our common stock at a conversion price of $0.17 per share. During the six months ended December 31, 2007, holders of certain Senior Notes converted an aggregate of approximately $2.1 million in principal and approximately $108,000 in accrued interest into an aggregate of 12,780,018 shares of our common stock at a conversion price of $0.17 per share. Also during the six months ended December 31, 2007, we recorded a loss on modification of debt of $14,000 resulting from the issuance of an additional note in connection with the 2007 Amendment. At December 31, 2008, the principal and accrued interest balances approximate $8 million and $3 million, respectively. The discussion included in this report assumes that we will continue as a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the ordinary course of business. As discussed in Note 1 to the consolidated financial statements, we may lack sufficient working capital to service our debts and to fund our continuing operations through the fiscal year ending June 30, 2009, which raises substantial doubt about our ability to continue as a going concern. As of December 31, 2008, we are in default under the terms of the 2007 Amendment and we owe the holders of our Senior Notes approximately $11 million in principal and accrued interest. We currently do not have the resources to repay the Senior Notes. If the holders of our Senior Notes demand repayment, and we are unable to do so, the holders of our Senior Notes may be able to force our liquidation. In the event of our liquidation, it is highly unlikely the holders of our equity securities will receive any of the proceeds of such liquidation. INDEMNIFICATION OBLIGATIONS --------------------------- The Company has undertaken certain indemnification obligations pursuant to which it may be required to make payments to an indemnified party in relation to certain transactions. The Company has agreed to indemnify its directors, officers, employees and agents to the maximum extent permitted under the laws of the State of New York. In connection with its facility leases, the Company has agreed to indemnify its lessors for certain claims arising from the use of the facilities. In connection with certain of its debt, stock purchase and other agreements, the Company has agreed to indemnify lenders, sellers and various other parties for certain claims arising from the Company's breach of representations, warranties and other provisions contained in the agreements. The duration of certain of these indemnification obligations does not provide for any limitation of the maximum potential future payments the Company could be obligated to make. Historically, the Company has not been obligated to make any payments for these obligations and no liabilities have been recorded for these indemnities in the accompanying unaudited condensed consolidated balance sheets. 4. RELATED PARTY TRANSACTION During the period ended December 31, 2008, the Company's Chief Executive Officer advanced $90,000 to the Company (the "Advance"). The Company is still negotiating the specific terms of the Advance, including the interest rate and maturity date. The Company anticipates the Advance will be convertible into shares of common stock under the same terms of the Senior Notes payable if the Company completes a Qualified Financing, as discussed in Note 3. 5. EQUITY REVERSE STOCK SPLIT ------------------- On April 3, 2008, the Board adopted, and our shareholders approved at the 2007 Annual Meeting on May 30, 2008, an amendment to our Certificate of Incorporation, as amended (the "Certificate Amendment"), to effect a reverse stock split (the "Reverse Stock Split"). The Certificate Amendment does not reduce the authorized number of shares of common stock so that we will continue to have an adequate number of shares available for future issuance, as discussed below. The Certificate of Amendment will, subject to the discretion of the Board, be filed with the Secretary of State of the State of New York as promptly as practicable, provided that the Board does not anticipate directing the Company to file the Certificate Amendment until such time as a Qualified Financing takes place. The amendment and the proposed Reverse Stock Split will become effective as of the date of such filing (the "Effective Date"). GENERAL The Company is presently authorized to issue 150,000,000 shares of common stock, of which 63,216,247 shares are outstanding, no shares are held in treasury and 73,403,945 shares are reserved for issuance at December 31 2008. Upon the effectiveness of the Reverse Stock Split, the Company will have 150,000,000 shares of common stock authorized, of which, as of the Effective Date, approximately 6,321,625 shares will be outstanding, and 7,340,395 shares will be reserved for issuance. -13- REASONS FOR AND CONSEQUENCES OF THE REVERSE STOCK SPLIT The Company requires additional funding to continue its operations and desires to issue new securities in a future private placement; however, it has become clear to management that investors are unwilling to invest any new money into the Company so long as its existing Senior Notes are outstanding. The Company has reached an agreement with substantially all of the holders of the Senior Notes to convert the outstanding principal amount and accrued but unpaid interest under the Senior Notes into common stock of the Company in accordance with the terms of the Senior Notes if certain conditions are met. To induce the holders of the Senior Notes to convert their Senior Notes into common stock of the Company, the Company agreed to modify the existing royalty and milestone sharing arrangements with the holders of the Senior Notes as follows: o The holders of the Senior Notes will be given the pro rata right to receive 100% of all royalties received by the Company from the sale of OXYGENT products up to the maximum total payment sharing amount of $11.4 million (currently, under our agreement with the holders of the Senior Notes, the holders of the Senior Notes have the right to only receive 50% of such royalties up to the maximum payment amount); and o The holders of the Senior Notes will also be given the pro rata right to receive: (i) 100% of the milestone payment to be paid to the Company by Double-Crane upon sFDA approval of OXYGENT in the PRC (currently, under the Note Purchase Agreement, the holders of the Senior Notes have the contractual right to only receive 50% of such milestone payment), and (ii) 50% of any other milestone payment received from a third party based on the development of an OXYGENT product, in each case subject to the total maximum amount of payments of $11.4 million. At December 31, 2008, prior to the Reverse Stock Split taking effect, the Senior Notes and accrued interest were convertible into 64,424,242 shares of common stock at $0.17 per share. In order to allow for the conversion of all of the Senior Notes, and the subsequent issuance of shares of common stock in connection with a potential private placement (as discussed below), the Company must effect the Reverse Stock Split for the purpose of increasing the authorized but unissued and unreserved shares of common stock. The conversion of the Senior Notes is conditioned on the following: (i) 100% of the Senior Notes being received in escrow by the Company for conversion and cancellation (unless this condition is waived by the Company); (ii) approval of the Reverse Stock Split by the Company's shareholders (which was accomplished at the 2007 Annual Meeting on May 30, 2008); (iii) filing of the Certificate Amendment and acceptance of the same with the Secretary of State of the State of New York; and (iv) receipt by the Company of at least $3 million in new financing from investors (a "Qualified Financing"). We have not yet identified a possible source of funds for a Qualified Financing. The Company has no additional plan, commitment, arrangement, understanding or agreement, either written or oral, to issue additional shares of common stock upon the effectiveness of the Reverse Stock Split, other than for the conversion of the existing Senior Notes and for the potential financing described above. The Reverse Stock Split may also result in an increase in the trading price of our common stock and could therefore create greater investor interest in our common stock and possibly enhance the marketability of our common stock to the financial market. However, although the Reverse Stock Split may increase the market price of our common stock, the actual effect of the Reverse Stock Split on our market price cannot be predicted. The market price of our common stock may not rise in proportion to the reduction in the number of shares outstanding as a result of the Reverse Stock Split. Further, the Company does not know if the Reverse Stock Split will lead to a sustained increase in the market price of our common stock. The market price of our common stock could also change as a result of other unrelated factors, including our operating performance and other factors related to our business as well as general market conditions. PRINCIPAL EFFECTS OF THE REVERSE STOCK SPLIT The following describes the effects of the Reverse Stock Split assuming the Board directs management to complete the Reverse Stock Split. -14- Based upon the 63,216,247 shares of common stock outstanding on December 31, 2008, the proposed Reverse Stock Split would decrease the outstanding shares of Common Stock by 90%, and thereafter 6,321,625 shares of common stock would be outstanding. The proposed Reverse Stock Split will not affect any common shareholder's proportionate equity interest in the Company, subject to the provisions relating to the elimination of fractional shares as described below. At December 31, 2008, there were outstanding options to purchase an aggregate of 2,645,700 shares of common stock under the Company's stock option plans (the "Plans") and an aggregate of 4,102,110 shares were available for grant under two of the Plans. The Company has reserved 6,747,810 shares for issuance upon the exercise of the granted options and upon exercise of options that may be granted in the future. The Plans provide for automatic adjustment in the event of a reverse stock split so that the amount of shares issuable upon exercise of outstanding options, the number of shares available for grant and the number of shares reserved for issuance will be reduced to one-tenth of the amount issuable prior to the Effective Date, and the exercise prices of the granted options would become ten times the present exercise prices. At December 31, 2008, there were outstanding warrants to purchase an aggregate of 2,231,893 shares of common stock and 2,231,893 shares of common stock reserved for issuance at such date for the warrants. The provisions of the relevant instrument pursuant to which the warrants were issued provide for automatic adjustment in the event of a reverse stock split so that the amount of shares issuable upon exercise of the warrants will be reduced to one-tenth of the amount issuable prior to the Effective Date, and the exercise price would become ten times the present exercise price. Accordingly, 223,189 shares of common stock will be reserved for issuance on the Effective Date for the warrants. At December 31, 2008, the Company, in addition to options and warrants, had outstanding $8 million principal amount of the Senior Notes and accrued interest of $3 million on said notes. The Senior Notes and accrued interest are convertible at any time, at the respective holders' option, into shares of common stock at $0.17 per share, subject to adjustment in the case of a reverse stock split. In accordance with the provisions of the relevant instruments pursuant to which the Senior Notes were issued, the number of shares of common stock into which they may be converted is 64,424,242, which amount will be reduced to 6,442,425 shares of common stock as a result of the Reverse Stock Split. The foregoing may be summarized as follows: IF REVERSE STOCK SPLIT NUMBER OF SHARES OF COMMON STOCK AS OF DECEMBER 31, 2008 IS EFFECTED * -------------------------------- ----------------------- ------------- Authorized 150,000,000 150,000,000 Issued and Outstanding** 63,216,247 6,321,625 Reserved for Issuance*** 73,403,945 7,340,395 Available for Future Issuance 13,379,808 136,337,980 Par Value Per Share $0.01 $0.01

---------------- * Without giving effect to fractional shares. ** Includes 635,000 shares of common stock deemed outstanding due to the automatic conversion of the Company's Series F Preferred Stock that occurred in March 2004. The stock certificate representing these shares of common stock has not yet been issued. *** Number of shares reserved for estimated issuance upon exercise of options, warrants and debt. 6. SUBSEQUENT EVENT During January 2009, the Chief Executive Officer increased the Advance to the Company by $10,000 for a total of $100,000 (see Note 4). ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (References to years are to our fiscal years ended June 30.) -15- PLAN OF OPERATION Since our inception in 1983, we have financed our operations primarily through the sale of equity and debt securities, and we have applied substantially all of our resources to research and development programs and to clinical trials. We have incurred operating losses since inception and, as of December 31, 2008, have an accumulated deficit of $500.4 million. We expect to incur significant operating losses over at least the next few years as we continue our research and product development efforts and attempt to commercialize our products. The Company is continuing to seek additional financing of approximately $3 million to fund its continuing operations through June 2011. Because adequate funds have not been available to the Company in the past, the Company has already delayed its OXYGENT development efforts and has delayed, scaled back, and/or eliminated one or more of its other product development programs (see Note 1 to the accompanying unaudited condensed consolidated financial statements and the "Liquidity and Capital Resources" section below). Our revenues from operations have come primarily from collaborations with corporate partners, including research and development, milestone and royalty payments. Our expenses have consisted primarily of research and development costs and administrative costs. To date, our revenues from the sale of products have not been significant. We believe our future operating results may be subject to quarterly fluctuations due to a variety of factors, including the timing of future collaborations and the achievement of milestones under collaborative agreements, whether and when new products are successfully developed and introduced by us or our competitors, and market acceptance of products under development. The discussion included in this report assumes that we will continue as a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the ordinary course of business. As discussed in Note 1 to the condensed consolidated financial statements, we may lack sufficient working capital to service our debts and to fund our continuing operations through the fiscal year ending June 30, 2009, which raises substantial doubt about our ability to continue as a going concern. As of December 31, 2008, we are in default under the terms of the 2007 Amendment and we owe the holders of our Senior Notes approximately $11 million in principal and accrued interest. We currently do not have the resources to repay the Senior Notes. If the holders of our Senior Notes demand repayment, and we are unable to do so, the holders of our Senior Notes may be able to force our liquidation. In the event of our liquidation, it is highly unlikely the holders of our equity securities will receive any of the proceeds of such liquidation. FORWARD-LOOKING INFORMATION Except for historical information, the statements made herein and elsewhere are forward-looking. The Company wishes to caution readers that these statements are only predictions and that the Company's business is subject to significant risks. The factors discussed herein and other important factors, in some cases have affected, and in the future could affect, the Company's actual results and could cause the Company's actual consolidated results for 2009, and beyond, to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. These risks include, but are not limited to, the inability to obtain adequate financing for the Company's development efforts; the likelihood that our creditors will force our liquidation; the inability to enter into collaborative relationships to further develop, manufacture and commercialize the Company's products; changes in any such relationships, or the inability of any collaborative partner to adequately commercialize any of the Company's products; the uncertainties associated with the lengthy regulatory approval process, including uncertainties associated with FDA decisions and timing on product development or approval; and the uncertainties associated with obtaining and enforcing patents important to the Company's business; and possible competition from other products. Furthermore, even if the Company's products appear promising at an early stage of development, they may not reach the market for a number of important reasons. Such reasons include, but are not limited to, the possibilities that the potential products will be found ineffective during clinical trials; failure to receive necessary regulatory approvals; difficulties in manufacturing on a large scale; failure to obtain market acceptance; and the inability to commercialize because of proprietary rights of third parties. The research, development and market introduction of new products will require the application of considerable technical and financial resources, while revenues generated from such products, assuming they are developed successfully, may not be realized for several years. Other material and unpredictable factors which could affect operating results include, without limitation, the uncertainty of the timing of product approvals and introductions and of sales growth; the ability to obtain necessary raw materials at cost-effective prices or at all; the effect of possible technology and/or other business acquisitions or transactions; and the increasing emphasis on controlling healthcare costs and potential legislation or regulation of healthcare pricing. Further cautionary information is contained in documents the Company files with the SEC from time to time, and you are encouraged to read the section entitled "Risk Factors" included in the Company's most recently filed Annual Report on Form 10-KSB filed with the SEC on October 2, 2008. -16- RESEARCH AND DEVELOPMENT For the six months ended December 31, 2008 and 2007, we incurred research and development expenses of $92,000 and $260,000, respectively, for OXYGENT, an intravascular oxygen carrier that we are developing to augment oxygen delivery in surgical patients at risk of acute oxygen deficit. Research and development costs to date for our oxygen-therapeutic product candidates, including Oxygent, total approximately $161 million. While difficult to predict, we estimate that the completion of clinical trials for OXYGENT will cost at least an additional $70 million. We do not anticipate that OXYGENT will reach the market for at least a few years, if at all, and, because of the numerous risks and uncertainties associated with product development efforts, we are unable to predict the extent of any future expenditures or when material net cash inflows from OXYGENT may commence, if at all. In January 2007, the French Ethics Committee (IRB) and the French Competent Authority (regulatory agency) granted approval to start the Phase 2b clinical trial for OXYGENT to prevent postoperative ileus resulting from hypoxia during major surgery trial. Subsequently in November 2007, Alliance suspended the clinical trial due to lack of adequate funding. On February 6, 2007, we announced the manufacture and release for shipment of OXYGENT for the clinical trials planned in France and the PRC. Alliance successfully completed the contract manufacture of OXYGENT clinical trial material. However, on March 15, 2007, we announced that, in accordance with the current regulations of the sFDA, the supplies for an IND application and clinical development must be manufactured in a facility in the PRC. As a result, Alliance agreed to accelerate the manufacturing technology transfer to Double-Crane, which originally was planned to occur when Phase 3 trials were initiated in the PRC. This technology transfer is underway with Double-Crane completing the manufacturing facility and purchasing the required equipment for emulsion manufacture. Once clinical supplies are manufactured by Double-Crane, Double-Crane has indicated that it will submit its IND application for initiation of the agreed upon clinical development plan. Double-Crane will start a Phase 1 safety trial in Chinese nationals immediately after the sFDA approves the IND application. Double-Crane has considerable experience in manufacturing large-volume parenteral and IV solutions and has expressed a desire to supply Alliance with clinical and commercial supplies of OXYGENT from its facilities in the PRC. Supply of OXYGENT to the U.S. would be contingent on Double-Crane's compliance to cGMP and registration with the U.S. FDA. RESULTS OF OPERATIONS THREE MONTHS ENDED DECEMBER 31, 2008 AS COMPARED WITH THREE MONTHS ENDED DECEMBER 31, 2007 There was no revenue for the three months ended December 31, 2008, or for the three months ended December 31, 2007. Research and development expenses increased by $11,000, or 13%, to $102,000 for the three months ended December 31, 2008, compared to $91,000 for the three months ended December 31, 2007. The increase in research and development expenses was primarily due to an increase in patent expenses of $40,000 in connection with filing a new patent in certain countries, partially offset by decreases in all other research and development expenses. General and administrative expenses decreased by $16,000, or 8%, to $178,000 for the three months ended December 31, 2008, compared to $194,000 for the three months ended December 31, 2007. The decrease in general and administrative expenses was primarily the result of a decrease in legal and accounting fees. Investment income for the three months ended December 31, 2008 was $1,000, compared to $4,000 for the three months ended December 31, 2007. The decrease was primarily a result of a lower cash balance. Interest expense was $192,000 for the three months ended December 31, 2008, a decrease of 14% compared to $222,000 for the three months ended December 31, 2007. The decreased interest expense for the current quarter was primarily the result of lower Senior Note principal balances because of conversions during fiscal year 2008. -17- SIX MONTHS ENDED DECEMBER 31, 2008 AS COMPARED WITH SIX MONTHS ENDED DECEMBER 31, 2007 There was no revenue for the six months ended December 31, 2008, compared to $57,000 for the six months ended December 31, 2007. The revenue for the prior period was composed of royalties received from sales other than IMAGENT. Research and development expenses decreased by $168,000, or 64%, to $92,000 for the six months ended December 31, 2008, compared to $260,000 for the six months ended December 31, 2007. The decrease in research and development expenses was primarily due to a decrease of $98,000 because of the discontinued clinical trial in France, a refund of $18,000 in clinical trial insurance during the current period, a decrease in contract manufacturing of OXYGENT clinical trial material of $36,000, a decrease of $29,000 in research and development personnel costs, a decrease in preclinical costs of $8,000 and a decrease of $7,000 in archiving and storage costs, partially offset by an increase in patent expenses of $28,000 related to a new patent. General and administrative expenses decreased by $122,000, or 25%, to $369,000 for the six months ended December 31, 2008, compared to $491,000 for the six months ended December 31, 2007. The decrease in general and administrative expenses was primarily a decrease of $68,000 in legal and accounting fees, a decrease of $29,000 in rent and other office-related expenses, a decrease of $12,000 in personnel costs and a decrease of $13,000 in travel expenses. For the six months ended December 31, 2008, we recorded a gain on the sale of an asset of $25,000, which was primarily due to the agreement to terminate all on-going obligations under previous agreements between the Company and Imcor whereby both companies agreed that the continuing rights and obligations of each company under the terms of the previous agreements were terminated and were of no further force or effect. Imcor paid $25,000 to Alliance in satisfaction of all of Imcor's obligations and liabilities under the terms of the previous agreements. In return, Alliance released Imcor from all liabilities, including future royalty payments, if any. For the six months ended December 31, 2008, we recorded a loss on disposal of equipment of $17,000, which was primarily the gift of $31,000 of equipment, less $14,000 of depreciation, to Double-Crane. For the six months ended December 31, 2007, we recorded a loss on modification of debt of $14,000 resulting from the issuance of an additional note in connection with the 2007 Amendment (see Note 3). Investment income decreased by $13,000 to $1,000 for the six months ended December 31, 2008, compared to $14,000 for the six months ended December 31, 2007. The decrease was primarily a result of lower cash balances during the current period. Other income was $25,000 for the six months ended December 31, 2008, compared to $163,000 for the six months ended December 31, 2007, which were both the result of proceeds recorded from the sale of raw material inventory (which was previously written off). Interest expense was $397,000 for the six months ended December 31, 2007, compared to $465,000 for the six months ended December 31, 2006. The decreased interest expense for the current period was the result of lower Senior Note principal balances due to the conversion of certain principal amounts into common stock. LIQUIDITY AND CAPITAL RESOURCES Since inception, we have funded our operations primarily through the sale of equity securities, payments under our collaboration agreements and debt financing. From inception to December 31, 2008, we had received $243 million in net proceeds from sales of our equity securities, $260.8 million in payments from collaboration agreements and $74.3 million in debt financing of which $41 million of such debt has been converted into equity and $25.9 million of such debt has been retired through the restructuring of various agreements and the issuance of warrants to purchase our common stock. -18- At December 31, 2008, we had approximately $1,000 in cash compared to $6,000 at June 30, 2008. The decrease resulted primarily from the net cash used in operations of $95,000. At December 31, 2008, we had a working capital deficit of $11.8 million, compared to a working capital deficit of $11.6 million at June 30, 2008. The deficit increase was principally due to a net decrease in prepaid expenses and other current assets of $21,000, a net increase in accounts payable and accrued expenses of $84,000, loans from an officer of $90,000, an increase in deferred compensation of $165,000, an increase in the Senior Note accrued interest of $397,000, partially offset by conversion of a Senior Note and accrued interest of $510,000. Our operations to date have consumed substantial amounts of cash and are expected to continue to do so for the foreseeable future. Net cash used in operating activities totaled $95,000 for the six months ended December 31, 2008, compared to net cash used of $737,000 for the six months ended December 31, 2007. The decrease during the six months ended December 31, 2008 was primarily due to a decrease in payments for research and development activities, an increase in deferred compensation and loans received from an officer. At December 31, 2008, the following approximate debt obligations were outstanding: (a) $333,000 owed to various vendors; (b) $377,000 in accrued expenses, including $305,000 in deferred compensation; (c) $100,000 in deferred revenue; (d) $90,000 of advances from an officer; (e) $11 million in Senior Notes, including $3 million in accrued interest; (f) $750,000 in deferred royalty payments to be paid through future IMAGENT earn-out payments, if any. In the event there are no future IMAGENT earn-out payments, the deferred royalties will not be paid. Until we can generate significant continuing revenues, we expect to satisfy our future cash needs through strategic collaborations, private or public sales of our securities, debt financings or by licensing all or a portion of our product candidates or technology. We cannot be certain that additional funding will be available to us on acceptable terms, or at all. We no longer have working capital to fund our operations; therefore, in addition to seeking to complete a Qualified Financing, we are seeking additional collaborative research and development relationships with suitable corporate partners for our products. Because adequate funds have not been available to us in the past, we have already delayed our OXYGENT development efforts and have delayed, scaled back, and/or eliminated one or more of our other product development programs. The accompanying unaudited condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern, which contemplates, among other things, the realization of assets and satisfaction of liabilities in the ordinary course of business. We have incurred operating losses through December 31, 2008. These factors, among others, raise substantial doubt about the Company's ability to continue as a going concern. As of December 31, 2008, we are in default under the terms of the 2007 Amendment and we owe the holders of our Senior Notes approximately $11 million in principal and accrued interest. We currently do not have the resources to repay the Senior Notes. If the holders of our Senior Notes demand repayment, and we are unable to do so, the holders of our Senior Notes may be able to force our liquidation. In the event of our liquidation, it is highly unlikely the holders of our equity securities will receive any of the proceeds of such liquidation. The accompanying unaudited condensed consolidated financial statements do not include any adjustment to reflect the possible future effects on the recoverability and classification of assets or the amount and classification of liabilities that may result from the outcome of this uncertainty. WHERE YOU CAN FIND MORE INFORMATION We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended, and must file reports, proxy statements and other information with the SEC. The reports, information statements and other information we file with the Commission can be inspected and copied at the Commission Public Reference Room, 100 F Street, N.E. Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at (800) SEC-0330. The Commission also maintains a Web site (http://www.sec.gov) that contains reports, proxy, information statements and other information regarding registrants, like us, which file electronically with the Commission. -19- We were incorporated in New York in 1983. Our principal executive offices are located at 7590 Fay Avenue, Suite 402, La Jolla, California 92037, and our telephone number is (858) 410-5200. Our common stock is traded on the OTCBB under the symbol "ALLP.OB." CRITICAL ACCOUNTING POLICIES There were no significant changes in critical accounting policies or estimates from those at June 30, 2008. OFF-BALANCE SHEET FINANCING ARRANGEMENTS As of December 31, 2008, we did not have any off-balance sheet financing arrangements or any equity ownership interests in any variable interest entity or other minority-owned ventures. ITEM 4T. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures. The Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of the Company's disclosure controls and procedures. Based upon that evaluation, our CEO and CFO concluded that as of December 31, 2008 our disclosure controls and procedures were effective at the reasonable assurance level in timely alerting them to the material information relating to the Company (or the Company's consolidated subsidiaries) required to be included in the Company's periodic filings with the SEC, subject to the various limitations on effectiveness set forth below under the heading, "Limitations on the Effectiveness of Internal Controls," such that the information relating to the Company, required to be disclosed in SEC reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company's management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. (b) Changes in internal control over financial reporting. There has been no change in the Company's internal control over financial reporting that occurred during the three-month period ended December 31, 2008 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. LIMITATIONS ON THE EFFECTIVENESS OF INTERNAL CONTROLS The Company's management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material error. An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the internal control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, and/or the degree of compliance with the policies or procedures may deteriorate. PART II OTHER INFORMATION: ITEM 1. LEGAL PROCEEDINGS None. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS During the quarter ended December 31, 2008, holders of certain Senior Notes converted an aggregate of approximately $266,000 in principal and approximately $244,000 in accrued interest into an aggregate of 3,000,000 shares of our common stock at a conversion price of $0.17 per share. -20- The offers and sales of these securities were deemed to be exempt from registration under the Securities Act of 1933, as amended, (the "Securities Act") in reliance on Section 4(2) of the Securities Act and/or Regulation D promulgated thereunder as transactions by us not involving a public offering. The recipients of the securities in each such transaction represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to share certificates issued in such transactions. All recipients had adequate access to information about us. ITEM 3. DEFAULTS UPON SENIOR SECURITIES The Company is currently in default with respect to the repayment of all outstanding principal under the Senior Notes, totaling $8 million, and accrued interest under the Senior Notes, totaling $3 million, at December 31, 2008. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS (a) Index to Exhibits EXHIBIT DESCRIPTION 31.1 Certification of our Chief Executive Officer, pursuant to Securities Exchange Act Rule 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002. * 31.2 Certification of our Chief Financial Officer, pursuant to Securities Exchange Act Rule 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002. * 32.1 Certification of our Chief Executive Officer under Section 906 of the Sarbanes Oxley Act of 2002. (18 U.S.C. Section 1350). * 32.2 Certification of our Chief Financial Officer under Section 906 of the Sarbanes Oxley Act of 2002. (18 U.S.C. Section 1350). * ---------------- * Filed Herewith. -21- 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. ALLIANCE PHARMACEUTICAL CORP. (Registrant) Date: February 16, 2009 By: /s/ Duane J. Roth ----------------------------------------- Duane J. Roth Chairman and Chief Executive Officer By: /s/ Jack DeFranco ----------------------------------------- Jack DeFranco Chief Operating Officer and Chief Financial Officer -22-

ALLIANCE PHARMACEUTICAL CORP. 10-Q