ORPHAN MEDICAL, INC.

CAUTIONARY STATEMENTS FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995


         An investment in the Common Stock involves a number of risks, including
among others risks associated with development stage companies and companies
that operate in the pharmaceutical industry, which are substantial and inherent
in the operations of the Company. You should carefully consider the following
information about these risks, together with the information in the rest of this
Quarterly Report. You should also be aware that certain statements contained in
this Quarterly Report that are not related to historical results are
forward-looking statements. When used in this Quarterly Report on Form 10-Q and
in our future filings with the Securities and Exchange Commission, shareholder
reports, press releases and in oral statements made with the approval of an
authorized executive officer, the words or phrases "will likely result", "look
for", "may result", "will continue", "is anticipated", "expect", "project", or
similar expressions are intended to identify "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995 Actual
results may differ materially from those projected or implied in such
forward-looking statement. Factors that could cause or contribute to such
differences include, but are not limited to, the following risk factors.


LOW REVENUES AND LACK OF PROFITABLE OPERATIONS.
         The Company has been unprofitable since it began operations in January
1993. As of September 30, 1998, the Company had an accumulated deficit of
$32,615,067. Through September 30, 1998, we sold $3,986,978 and made a gross
profit of $3,072,934 on the following products: Elliotts B Solution, Cystadane,
Antizol-Vet, Sucraid and Antizol. These levels of sales and gross profits are
insufficient to sustain future product development and business growth.

UNCERTAINTY OF FUTURE FINANCIAL RESULTS.
         Operating losses of the Company are expected to continue through 1999
because gross profit from our five approved products and from new product
introductions in 1999 are not expected to offset expected additional spending.
We will need to continue to spend on the development plans for Busulfex and
Xyrem, plus additional sales and marketing efforts for the new product
introductions. The amount of future losses may vary significantly at various
times and will depend on several factors, including the timing of product
development and regulatory approval. We cannot give any assurance that the
Company will ever generate significant product revenues or become profitable.

DEVELOPMENT STAGE COMPANY.
         We are a development stage company. As such, our operations and our
product development are subject to all of the risks inherent in establishing a
new business enterprise. These risks include the following: reliance on key
personnel; a lack of fully-developed products; insufficient capital; competition
from numerous well-established and well-capitalized competitors; expected
operating losses through 1999; a market subject to extensive regulatory
oversight; and reliance on outside contractors for the manufacture and
distribution of our proposed products.

         You should weight the likelihood of our success against the problems,
expenses and delays typically encountered when developing new pharmaceutical or
medical products. You should also consider the highly competitive and heavily
regulated environment in which we operate.

FURTHER FUTURE CAPITAL REQUIREMENTS; NO ASSURANCE OF AVAILABILITY OF FUTURE 
CAPITAL.
         We expect that our cash, cash equivalents, and short-term investments
as of September 30, 1998 plus the anticipated cash flows from the sale of the
five products that are approved and expected introduction of Busulfex in 1999
will be sufficient to fund the Company's operations through 1999. However, if we
encounter any large reduction in product revenues or a delay in the FDA approval
and market launch of Busulfex, we may require additional funding to fully
implement our development plan for Xyrem. A lack of funding could prevent the
commercial introduction of Xyrem altogether. We may be unable to obtain adequate
funds for the Company's operations, whether from financial markets or from other
sources, on terms attractive to the Company. A lack of 




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funding could cause us to delay, scale back or eliminate some or all the
products currently under development, including acquisition and licensing
programs.

DEPENDENCE ON LICENSE AND ACQUISITION STRATEGY.
         We have adopted a license and acquisition strategy to build our product
portfolio. Our growth strategy depends upon our continued ability to identify
and acquire new pharmaceutical products targeted at niche strategic therapeutic
markets. We rely on the willingness of others to sell or license pharmaceutical
product opportunities to us because we do not conduct our own proprietary
research and development of new pharmaceutical products. Other companies,
including many with much greater resources, compete with us to acquire such
products. We may not be able to acquire rights to additional products on
acceptable terms, if at all. If we are unable to acquire or license new
pharmaceutical products within a selected niche market or to promote and market
commercially successful products within the selected niche market our business
and prospects could be materially and adversely affected.

         We have contractual production rights to certain compounds through
various license agreements. Most of these agreements give the licensors the
right to terminate the license with a short notice for a number of events that
are categorized as "for cause" under the license agreements. These agreements
are also terminable by the licensor if the Company is insolvent or bankrupt,
does not apply minimum resources and efforts to develop the compound under
license or does not achieve certain minimum royalty payments. The agreements may
be terminated and, if terminated, we may not be able to enter into similar
agreements on terms as favorable to us as those contained in its existing
license agreements.

DEPENDENCE ON FOREIGN MARKETING ALLIANCES; NO ASSURANCE OF FOREIGN LICENSEES.
         Our strategy for deriving revenues for the sale of our products in
foreign markets is to enter into marketing alliances with multinational and
foreign pharmaceutical companies. From inception through September 30, 1998, we
have entered into distribution agreements to sell Cystadane in Australia, New
Zealand and Europe and Antizol in Europe. Sales of Cystadane for Australia, New
Zealand and Europe have not been and are not expected to be material.
Distribution of Antizol in Europe will initially be done on a "named patient" or
"emergency use" basis until full regulatory approval is obtained. We do not
expect such "emergency use" distribution to result in material sales.
Distribution of Antizol in Europe through normal or the usual distribution
channels will not begin until the product has received marketing approval in
each European country where our distributor expects to sell the product. We
typically receive upfront fees for entering into such distribution arrangements.
We expect to realize future benefits because we will be the exclusive supplier
of the product sold to the distributor in these foreign markets. However, we
cannot provide any assurance that we will be able to negotiate additional
alliances for our other products on acceptable terms, if at all, or that such
alliances will be successful. In addition, the successful distribution of
Cystadane and Antizol outside of the United States is highly dependent on our
marketing partners. If our marketing partners are unsuccessful in their
distribution efforts, we would have difficulty in contracting other distributors
for these products within the licensed territories.

STRINGENT GOVERNMENT REGULATION; NEED FOR FDA AND OTHER REGULATORY APPROVALS.
         Government regulation in the United States and abroad is a significant
factor in the production, testing and marketing of our current and future
products. Prior to marketing, each of our products must undergo an extensive
regulatory approval process conducted by the FDA in the United States and by
comparable agencies in other countries. The approval process can take many years
and require the expenditure of substantial resources. We cannot provide any
assurance that the FDA or any foreign regulatory authority will approve in a
timely manner, or at all, any product that we may develop. Generally, only a
very small percentage of newly discovered pharmaceutical compounds that enter
pre-clinical development are approved for sale. We are not allowed to market
medicines that we may develop as a prescription product in jurisdictions in
which the products do not receive regulatory approval. Once approved, a
department of marketing surveillance within the Center for Drugs, an FDA
division, must approve marketing claims, which are the basis for a product's
labeling, advertising and promotion. We cannot provide any assurance that the
FDA's marketing surveillance department will approve the marketing claims that
we are seeking. The failure to obtain approval of acceptable marketing claims on
a product could have a material adverse effect on the Company and its prospects.

         The Company depends on external laboratories and medical institutions
to conduct its pre-clinical and clinical testing in compliance with
FDA-established clinical and laboratory practices. The data obtained from
pre-




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clinical and clinical testing are subject to different interpretations that
could delay, limit or prevent regulatory approval. In addition, a product may be
delayed or rejected based upon changes in FDA policy for drug approval during
the period of development. Products may also be delayed or rejected because of
changes in the requirements for regulatory review of each submitted New Drug
Application ("NDA"). Moreover, even if the FDA approves a product, such approval
may entail commercially unacceptable limitations on the uses, or "indications,"
for which a product may be marketed. Further studies may also be required to
provide additional data on safety or effectiveness. The FDA also requires
manufacturers to monitor an approved product's side effects through
post-marketing adverse event surveillance programs.

         An FDA approved product and its manufacturer are subject to continual
regulatory review. A discovery of previously unknown problems with a product or
manufacturer may result in restrictions or sanctions on such products or
manufacturer, including the withdrawal of such product from the market. FDA
approval is required before we can implement most changes in the manufacturing
procedures for any of our approved products, as well any change in manufacturers
of such products. Obtaining the FDA's approval for a change in manufacturing
procedures or change in manufacturers could cause production delays and loss of
sales, which would have a material adverse effect on the Company's business and
its prospects.

         The FDA has the authority to "Schedule" a drug under the Controlled
Substances Act. Scheduling refers to the specific levels of control a
manufacturer, distributor, pharmacy, and prescribing physician must maintain to
ensure that a drug is appropriately used, and not abused. Generally, states
follow the federal scheduling designation for a specific drug, but a state is
not precluded from adopting a more restrictive scheduling designation for the
same drug. We expect Xyrem will be federally scheduled and we have requested
that it be designated a Schedule IV drug (typically, most hypnotic medications
available by prescription). However, if Xyrem is designated a Schedule II drug
(such as pentobarbitol), the cost to manufacture and distribute Xyrem, should it
receive marketing clearance from the FDA, would be negatively affected. We can
give no assurance that Xyrem will be designated a Schedule IV drug, and if it
receives a more restrictive designation by the federal government or the states,
it may have a material effect on the Company's business and its prospects.

         In certain countries, the sales price of a product must also be
approved after marketing approval is granted. We cannot give any assurance that
satisfactory prices can be obtained in foreign markets even if the appropriate
marketing approval is obtained.

RELIANCE ON ORPHAN DRUG STATUS.
         Under the Orphan Drug Act, the FDA may grant orphan drug designation to
drugs intended to treat a "rare disease or condition." Generally, a "rare
disease or condition" is regarded as one that affects populations of less than
200,000 people in the United States. Orphan drug designation must be requested
before submitting an NDA. Once the FDA grants orphan drug designation, it will
publish the generic identity of the therapeutic agent and its potential orphan
use. Under current law, the first company to receive FDA approval to market the
designated drug for the designated indication is conferred orphan drug status.
The orphan drug status grants United States marketing exclusivity for a period
of seven years following approval by the FDA, subject to certain limitations.
However, orphan drug designation does not convey any advantage in the regulatory
approval process or shorten its duration. Moreover, although obtaining FDA
approval to market a product with orphan drug status is advantageous, we cannot
provide any assurance that the scope of protection or the level of marketing
exclusivity that the orphan drug status and marketing approval currently provide
will continue.

         Currently, two of our products (Busulfex and Xyrem) have orphan drug
designation, while four of our products (Antizol, Elliotts B Solution, Cystadane
and Sucraid) have orphan drug status. We cannot provide any assurance that any
future product candidates will receive an orphan drug designation or that any of
our products with such a designation will be the first to be approved by the FDA
for the designated indication, thereby obtaining orphan drug status (i.e.,
marketing exclusivity). Orphan drug designation does not prevent other
manufacturers from attempting to develop the same drug for the designated
indication or from obtaining the approval of an NDA for their drug prior to the
approval of our NDA. If another sponsor's NDA for the same drug and the same
indication is approved first, and that sponsor has received orphan drug
designation for its drug, that sponsor is entitled to exclusive marketing
rights. In that case, the FDA would delay the approval of our application to
market our competing product for seven years, subject to certain limitations. We
cannot provide any assurance that our products will receive orphan drug
designations and FDA marketing approval before our competitors' products.



<PAGE>

         NDA approval of a drug with an orphan drug designation does not prevent
the FDA from approving the same drug for a different indication, or a molecular
variation of the same drug for the same indication. Also, doctors are not
restricted by the FDA from prescribing an approved drug for uses not approved by
the FDA. Therefore, it possible that a competitor's drug could be prescribed for
indications for which the Company's product has received orphan drug designation
and NDA approval. The prescription of approved drugs for unapproved uses
(commonly referred to as "off label" use) could adversely affect the marketing
potential of products that have received orphan drug designation and NDA
approval. In addition, NDA approval of a drug with an orphan drug designation
does not provide any marketing exclusivity in foreign markets.

         The United States Congress' possible amendment of the Orphan Drug Act
has been frequently discussed. Although the Orphan Drug Act has not been subject
to significant changes for a number of years, members of Congress have at
various times proposed changes that would limit the application of the Orphan
Drug Act. We cannot provide any assurance as to the precise scope of protection
that orphan drug designation and marketing approval may afford in the future or
that the current level of exclusivity will remain in effect.

RELIANCE ON PATENTS AND OTHER PROPRIETARY RIGHTS.
         Obtaining patent and trade secret protection for new technologies,
products and processes is very important in the pharmaceutical industry. Our
success will depend, in part, on our ability to obtain, enjoy and enforce
protection for our products under U.S. and foreign patent laws and other
intellectual property laws, preserve the confidentiality of our trade secrets
and operate without infringing the proprietary rights of third parties. A
pharmaceutical firm's patent position is often very uncertain and generally
involves complex legal and factual questions. At September 30, 1998, Busulfex is
the only product that we have under development for which the use of or
treatment methods licensed by us are covered by U.S. patents. We evaluate the
desirability of seeking patent or other forms of protection for our products in
foreign markets based on the expected costs and relative benefits of attaining
such protection. We cannot provide any assurance that any patents will be issued
from any applications or that any issued patents will give us adequate
protection. Further, issued patents could be challenged, invalidated, infringed
or circumvented. We cannot provide any assurance that any rights granted under
issued patents will actually provide us competitive advantages. Parties not
affiliated with us have obtained or may obtain U.S. or foreign patents or
possess or may possess proprietary rights relating to our products. We cannot
provide any assurance that patents now in existence or issued in the future to
others will not adversely affect the development or commercialization of our
products or that our planned activities will not infringe third parties'
patents.

         We could incur substantial costs in defending against infringement
suits brought against us or any of our licensors or in asserting any
infringement claims that we may have against others. We could also incur
substantial costs in connection with any suits relating to matters for which we
have agreed to indemnify our licensors or distributors. An adverse outcome in
any such litigation could have a material adverse effect on our business and
prospects. In addition, we could be required to obtain licenses under patents or
other proprietary rights of third parties. We cannot give any assurance that any
such licenses would be made available on terms acceptable to us, or at all. If
we are required to, and do not obtain any such required licenses, we could be
prevented from, or encounter delays in, developing, manufacturing or marketing
one or more of our products.

         Two of the Company's products, Busulfex and Xyrem, are in the
development stage. Even if we successfully develop such products and obtain
marketing clearance from the FDA, there is a risk that applicable patent
coverage, if any, will have expired or will expire shortly after such approval.
The expiration of the patent protection could have a material adverse effect on
the sales and profitability of such product. Further, some of the compounds we
have developed or intend to develop (Cystadane, Elliotts B Solution, Antizol,
Antizol-Vet, Xyrem and Sucraid) are believed to be in the public domain or not
presently subject to patent protection in the United States.

         We also seek to protect our proprietary information and technology in
part by confidentiality agreements and inventors' rights agreements with our
employees. There is a risk that these agreements will be breached, that we will
not have adequate remedies for any such breach or that our trade secrets will
otherwise be disclosed to or discovered by our competitors.



<PAGE>

INDUSTRY SUBJECT TO INTENSE COMPETITION.
         Competition in the pharmaceutical industry is intense. Potential
competitors in the United States are numerous and include pharmaceutical,
chemical and biotechnology companies. Many competitors have substantially
greater capital resources, marketing experience, research and development staffs
and facilities than us. Although we seek to limit competition by developing
products that are eligible for orphan drug designation and NDA approval or other
forms of protection, there is a risk that our competitors will successfully
develop similar technologies and products more quickly than us. There is also a
risk that these competing technologies and products will be more effective than
any of those that we are or will be developing.

         We are aware that potential competitors are developing products that
have received orphan drug designations for the same respective indications as
Busulfex and Xyrem. If these drugs are approved for marketing before our
products, we would be required to obtain a license from these entities before
our own competing products could be marketed. We cannot provide any assurance
that any required license would be available on commercially acceptable terms,
or at all.

INDUSTRY SUBJECT TO RAPID TECHNOLOGICAL CHANGE.
         The pharmaceutical industry has experienced rapid and significant
technological change. We expect that pharmaceutical technology will continue to
develop rapidly. Our future success will therefore depend, in large part, on our
ability to develop and maintain a competitive position. Technological
development by others may result in our products' obsolescence before they are
marketed or before we recover a significant portion of the development and
commercialization expenses incurred with respect to such products. In addition,
alternative therapies or new medical treatments could alter existing treatment
regimes, and thereby reduce the need for one or more of our products, which
would adversely affect our business and its prospects.

RISKS OF NEW PRODUCT DEVELOPMENT; MARKET UNCERTAINTY.
         Five of our products have been approved for marketing by regulatory
authorities in the United States or elsewhere. Even if the rest of our products
are approved for sale, we cannot provide any assurance that they will be
commercially successful or that they will obtain the results expected. We may
encounter unanticipated problems relating to the development, manufacturing,
distribution and marketing of our products. Some of these problems may be beyond
our financial and technical capacity to solve. The failure to adequately address
any such problems could have a material adverse effect on our business and
prospects.

         No drug development portfolio can be completely insulated from
potential failures. It is possible that some products that we have selected for
development will not produce the results expected during clinical studies, not
receive FDA approval or fail to generate product sales of an acceptable level.
To date, we have terminated the development of eleven products from our
portfolio: one in 1994, one in 1996, and nine products in 1997. We terminated
nine products in 1997 to permit us to focus our development efforts on those
products that fit within three selected strategic therapeutic market segments:
Antidote, Oncology Support, and Sleep Disorders. The termination of the
development of any one of our remaining development products could have a
material adverse effect on the Company and its prospects.

         Most orphan drugs have a potential United States market of less than
$10 million annually and many target annual markets of less than $1 million. We
can provide no assurance that the sales of our products will be profitable even
if accepted and used by patients and medical specialists.

DEPENDENCE UPON OTHERS FOR CLINICAL TESTING AND MANUFACTURING.
         We do not have and do not intend to establish any internal product
testing, manufacturing or distribution capabilities. Accordingly, we will be
required to enter into arrangements with other companies for the clinical
testing, manufacture and distribution of our products. Our inability to retain
third-parties for these purposes on acceptable terms could adversely affect our
ability to develop and market our products. Third-parties' failures to
adequately perform their responsibilities may delay the submission of products
for regulatory approval, impair our ability to deliver our products on a timely
basis or otherwise impair our competitive position. In addition, our dependence
on third-parties for the development, manufacture and distribution of our
products may adversely affect our potential profit margins and our ability to
develop and deliver our products on a timely basis.


<PAGE>

         The manufacture of drugs can be an expensive, time consuming and
complex process and may require the use of materials with limited availability
or a dependence on sole suppliers. In addition, Busulfex and Xyrem have not yet
been manufactured in commercial quantities. We cannot provide any assurance that
such products can be so manufactured in a cost-effective manner. Manufacturers
of our products will be subject to applicable FDA-prescribed "good manufacturing
practices" or other rules and regulations prescribed by foreign regulatory
authorities. We cannot provide any assurance that we will be able to enter into
or maintain relationships either domestically or abroad with manufacturers whose
facilities and procedures comply or will continue to comply with FDA-prescribed
practices or applicable foreign requirements. If we enter into manufacturing
agreements, we will be dependent on such manufacturers for continued compliance
with FDA-prescribed practices and applicable foreign standards. The failure of a
manufacturer of a Company product to comply with FDA-prescribed practices or
applicable foreign requirements could result in significant time delays or
hinder our ability to commercialize or continue to market a product. Any of
these negative effects could have a material adverse effect on the Company and
its prospects. In the United States, failure to comply with FDA-prescribed
practices or other applicable legal requirements can lead to federal seizure of
violative products, injunctive actions brought by the federal government, and
potential criminal and civil liability on the part of a company and its officers
and employees.

DEPENDENCE UPON OTHERS FOR DISTRIBUTION.
         We have an exclusive agreement with Cardinal Health, Inc. ("Cardinal"),
whereby Cardinal, through its "Specialty Companies," will provide a variety of
services to support the effective distribution of our products. Cardinal will
provide the following services to the Company: integrated distribution and
operations services to process and support transactions between the Company and
wholesalers, specialty distributors, and direct customers; reimbursement
management; patient assistance and information hotline services; and specialty
distribution and marketing services to physician practices. Cardinal currently
distributes Elliotts B Solution, Antizol, Antizol-Vet and Sucraid. Cardinal will
also distribute our proposed products when and if those products receive
marketing clearance from the FDA. We will, therefore, be substantially dependent
upon Cardinal's ability to successfully distribute Elliotts B Solution, Antizol,
Antizol-Vet, Sucraid and the proposed products that may receive FDA marketing
clearance.

         Cystadane is currently distributed in the United States by Chronimed
Inc. ("Chronimed"). Chronimed distributes this product directly to patients
through its mail order pharmacy. We are substantially dependent upon Chronimed's
ability to successfully distribute Cystadane directly to patients in the United
States.

         Antizol-Vet was distributed on an exclusive basis through W.A. Butler
Company ("Butler") from January 1997 through October 1998. Butler may continue
distributing Antizol-Vet, but on a non-exclusive basis. The Company expects to
market Antizol-Vet directly and utilize Cardinal for distribution. We do not
expect this change to have a material effect on sales of Antizol-Vet.

         We cannot provide any assurance that other distribution companies would
be available or continue to be available on commercially acceptable terms, if at
all. The loss of a distributor or failure to renew agreements with an existing
distributor could have a material adverse effect on the Company and its
prospects.

UNCERTAIN EXTENT OF PRICE FLEXIBILITY AND THIRD-PARTY REIMBURSEMENT.
         Our ability to commercialize our products successfully will depend in
part on the price we may be able to charge for our products. Another factor is
the extent to which reimbursement for the cost of such products and related
treatment will be available from government health administration authorities,
private health insurers and other third-party payors. Government officials and
private health insurers are increasingly challenging the price of medical
products and services. There is much uncertainty as to the pricing flexibility
suppliers will have with respect to newly approved health care products. There
is also much uncertainty about the reimbursement status of such products.

         In the United States, we expect that there will continue to be a number
of federal and state proposals to implement government control of pricing and
profitability of prescription pharmaceuticals. Cost controls, if mandated by a
government agency, could decrease the price that we receive for our current or
future products. Cost controls could also prevent the recovery of potentially
substantial development costs and an appropriate profit margin. These effects
could have a material adverse effect on the Company. Furthermore, federal and
state regulations govern or influence the reimbursement to health care providers
in connection with medical treatment of 




<PAGE>

certain patients. The actions of federal and/or state governments could
adversely affect the prospects for sales of our products. We cannot provide any
assurance that the actions of federal and/or state governments, if any, with
regard to health care reform will not have a material adverse effect on the
Company and its prospects.

         Certain third-party payors may attempt to further control costs by
selecting exclusive providers of their pharmaceutical products. If such
arrangements were made with our competitors, such payors would not reimburse
patients for purchases of our competing products. This lack of reimbursement
would diminish the market for our products and could have a material adverse
effect on the Company and its prospects.

RISK OF PRODUCT RECALL.
         Product recalls may be issued at the discretion of the Company, the
FDA, the U.S. Federal Trade Commission, or other government agencies having
regulatory authority for product sales, and may occur due to disputed labeling
claims, manufacturing issues, quality defects, or other reasons. There is always
a risk that product recalls will occur. We do not carry any insurance to cover
the risk of a potential product recall. Any product recall could have a material
adverse effect on the Company and its prospects.

PRODUCT LIABILITY AND INSURANCE RISKS.
         The Company's testing and sale of human health care products entails an
inherent risk of product liability claims against the Company. As we expand the
scope of our clinical testing, we will be exposed to increasing potential
liabilities. Companies operating in the pharmaceutical industry find it
increasingly difficult to maintain product liability insurance coverage at
reasonable levels. Substantial increases in insurance premium costs in many
cases have rendered coverage economically impractical. We currently carry
product liability coverage in the aggregate amount of $10 million for all claims
made in any policy year. Although to date we have not been the subject of any
product liability or other claims, we cannot provide any assurance that we will
be able to maintain product liability insurance on acceptable terms or that our
insurance will provide adequate coverage against potential claims. The
successful assertion of any uninsured product liability or other claim against
us could have a material adverse effect on our business and prospects.

DEPENDENCE ON CERTAIN OFFICERS AND KEY MANAGEMENT PERSONNEL.
         Our success will be largely dependent upon the efforts of our executive
officers and key management personnel. The loss of the services of an executive
officer or one or more key employees, or our inability to attract and retain
skilled management and marketing personnel in the future, could have a material
adverse effect on the Company and its prospects.

RESTRICTIONS, COVENANTS AND RIGHTS RELATED TO SENIOR CONVERTIBLE PREFERRED
STOCK.
         On July 23, 1998, we completed the sale to UBS Capital II LLC ("UBS
Capital") of a private placement of $7.5 million of Senior Convertible Preferred
Stock (the "Preferred Shares"). The private placement agreement also gave UBS
Capital the option to invest up to an additional $4.5 million within 90 days of
July 23, 1998. UBS Capital did not exercise its option to purchase additional
Preferred Shares, but we are discussing with UBS Capital an extension of time
for the exercise of this option, including other financing alternatives. In
conjunction with the issuance of the Preferred Shares, we agreed to several
restrictions and covenants, and granted certain voting and other rights to
Preferred Shares holders, including but not limited to the following:

         1. We are restricted from issuing additional equity securities,
including convertible debt instruments, warrants, and stock options, except for
a "Permitted Issuance", which is limited to: (i) shares of Common Stock issued
after July 23, 1998 to Chronimed pursuant to the terms of the Termination
Agreement between the Company and Chronimed; (ii) shares of Common Stock issued
upon exercise of stock options that are outstanding on July 23, 1998; (iii)
stock options granted and shares of Common Stock issuable upon exercise of such
options pursuant to the terms of stock option plans approved by the Company's
Board of Directors; provided that the aggregate number of shares of Common Stock
issued, or issuable, under (i), (ii) and (iii) cannot exceed two million shares,
(iv) Common Stock issued upon the exercise of warrants that, as of June 30,
1998, entitled holders to purchase an aggregate of 213,255 shares of Common
Stock, (v) Common Stock issued upon the conversion of the Preferred Shares, and
(vi) securities issued pursuant to any public offering of the Company's
securities registered under the Securities Act.


<PAGE>

         In addition, the majority of Preferred Shares holders must approve the
sale of any private placement of equity securities. If approved by the Preferred
Shares holders, UBS Capital has the right of first refusal with respect to the
purchase or sale of any such private placement.

         2. Preferred Shares holders may convert their shares into shares of
Common Stock at a per share price equal to $8.50 per share. If we issue or sell,
or are deemed to have issued or sold, shares of our Common Stock for a per share
price of less than the conversion price in effect for the Preferred Shares
immediately prior to the time of such issue or sale, then, unless such issuance
or sale was a Permitted Issuance (as described in paragraph 1 above), the
conversion price for the Preferred Shares shall be reduced immediately upon such
issue or sale or deemed issue or sale. The conversion price shall be reduced to
a price determined by dividing (i) the sum of (1) the product derived by
multiplying the conversion price in effect immediately prior to such issue or
sale by the number of shares of Common Stock deemed outstanding immediately
prior to the new issue or sale, plus (2) the consideration, if any, received by
the Company upon the new issue or sale, by (ii) the number of shares of Common
Stock deemed outstanding immediately after such issue or sale.

                  3. The dividend rate on the Preferred Shares is 7.5 percent
per annum. At the Company's option, dividends are payable in either cash or by
issuing additional Preferred Shares (during the first four dividend payment
dates) or by Common Stock (after the fourth dividend payment date). However, the
dividend rate will increase to 20 percent per annum, payable solely in cash, if
either: (i) at any time during any 730-day period individuals who constituted
the Board of Directors at the beginning of such period, or July 23, 1998
(whichever is later), cease for any reason to constitute a majority of the Board
of Directors then in office; or (ii) the Board of Directors fails to declare and
pay in full, on any date when semi annual dividends are due. The Preferred
Shares holders may waive by majority vote their right to receive the increased
dividend rate.

                  4. The Company cannot incur any indebtedness unless certain
financial conditions are met. The Company may only incur debt if, after giving
effect to the additional indebtedness, the Company's aggregate indebtedness
outstanding as of the date of such incurrence, but excluding financing that is
secured by accounts receivable but not by the Company's intellectual property
rights, does not exceed two and one-half times the Company's EBITDA. For
purposes of this restriction, EBITDA means the sum of (i) net income, (ii)
interest expense (iii) depreciation and amortization, and other non-cash items
properly deducted in determining net income and (iv) federal, state and local
income taxes, computed and calculated in accordance with generally accepted
accounting principles for the twelve month period immediately prior to the date
of the new debt incurrence for which there are quarterly financial statements
available.

                  5. The Company cannot pay cash dividends, cash distributions
not classified as dividends with respect to its issued and outstanding Common
Stock or cash payments on the redemption of such Common Stock. This restriction
applies as long as at least 20 percent of the issued Preferred Shares remain
outstanding.

                  6. For as long as 20 percent of the number of shares of Common
Stock into which the shares of Convertible Preferred Shares first issued to UBS
Capital could be converted remain outstanding, the majority of the Preferred
Shares holders shall be entitled to elect one (1) director to serve on the
Company's Board of Directors until his successor is replaced by a majority of
the Preferred Shares holders. For purposes of this election, Preferred Shares
holders vote separately as a single class to the exclusion of all other classes
of Common Stock and each share of Preferred Shares is entitled to one vote.

                  7. Preferred Shares holders vote separately as a single class,
and approval of the majority of Preferred Shares holders is required, whenever a
shareholder vote is required pursuant to certain provisions of the Minnesota
Business Corporation Act, for the purpose of according voting rights with
respect to shares acquired or to be acquired in a control share acquisition, as
such term is defined in the Minnesota Business Corporation Act. In addition,
holders of Preferred Shares are entitled to vote on all other matters requiring
shareholder approval on an "as if" converted basis.

                  8. On July 23, 2008, the Company is required to elect to
either (1) require Preferred Shares holders to convert all remaining unconverted
Preferred Shares into Common Stock upon the payment by the Company of a
conversion fee to the holder, payable in cash or Common Stock, or (2) redeem for
cash the holder's unconverted Preferred Shares for $1,000 per share plus accrued
dividends. The conversion fee cannot exceed $3.0 million and 




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will be reduced prorata to the extent the number of unconverted Preferred Shares
at the end of the ten year term is less than the number of Preferred Shares
issued to the holders during the ten year term.

RELATIONSHIP WITH CHRONIMED.
Although the Company believes the agreements that it had with Chronimed since
its July 1, 1994 spin-off were commercially reasonable, such agreements were not
the product of arms-length negotiations. In June 1997, the Company terminated
these agreements (the "Termination Agreement"), except for the Cystadane
Agreement. The Termination Agreement provides that the Company pay Chronimed
compensation equal to $2,500,000, consisting of cash and shares of the Company's
Common Stock. The October 1996 Cystadane Agreement between the Company and
Chronimed applies solely to the domestic distribution of Cystadane. Several of
the Company's directors and executive officers are current or former employees,
shareholders and/or directors of Chronimed. The Termination Agreement and the
October 1996 Cystadane Agreement were approved by all of the independent outside
members of the Company's Board of Directors.

POSSIBLE VOLATILITY OF STOCK PRICE AND DILUTION OF STOCK - TERMINATION AGREEMENT
WITH CHRONIMED.
         After paying Chronimed $250,000 on signing the Termination Agreement in
June 1997, we had a remaining obligation to compensate Chronimed with cash and
Common Stock having a total value of $2,250,000. Cash payments against this
remaining obligation are to be based on a 3 percent temporary royalty on our
product sales, which we began paying quarterly on September 30, 1997.
Unregistered shares of Common Stock equal to 1 percent of our outstanding shares
at each quarter end, which we began issuing on March 31, 1998, are to be issued
quarterly to Chronimed. We are obligated to continue paying the royalties and
issuing Common Stock until the sum of all royalty payments and the market value
of all issued Common Stock equals $2,250,000. We are also obligated to file a
registration statement with the Securities and Exchange Commission to register
such shares. The market value of shares issued to Chronimed as payment against
the remaining obligation of $2,250,000 is determined as follows: (1) the market
value of any such shares sold within 90 days after the effective date of a
registration statement covering such shares will be equal to the net proceeds
realized by Chronimed from the sale of such shares; and (2) the market value of
any such shares not sold within 90 days after the effective date of a
registration statement covering such shares will be equal to the average last
bid price for shares of Common Stock as reported on Nasdaq for the last five
days within the 90 day period.

         We anticipate that Chronimed will sell in the open market the shares it
receives from us within the 90 day period. We have the option, regardless of the
market price of our Common Stock, to buy-out for cash the remaining obligation
to Chronimed. Through September 30, 1998, we have paid Chronimed approximately
$102,000 in royalties and issued 185,971 shares of Common Stock, of which
123,056 shares have been sold by Chronimed in market transactions for net cash
proceeds of $1,063,452. At September 30, 1998, our unpaid obligation to
Chronimed has an estimated value of approximately $669,000. This obligation is
classified as a "Current Liability."

         There is risk that our current shareholders' ownership could be
substantially diluted and/or the market value of their shares adversely affected
in the event any one or a combination of the following events occur: (1) sales
by Chronimed of the Common Stock cause the price of the Common Stock to
decrease; (2) in the event of a decline in the value of the Common Stock, we
would be required to issue more shares in subsequent periods to satisfy its
remaining obligation to Chronimed; or (3) our sales of future products are
significantly less than forecasted, which would decrease the temporary royalty
payments that would be applied against the remaining obligation and, thereby,
increase the number of shares required to be issued to Chronimed.

         The realization of one or more of these risks, or our decision to
exercise our option to effect a cash buy-out of the remaining obligation, could
have a material adverse effect on the Company's business, its prospects and its
shareholders.

POSSIBLE VOLATILITY OF STOCK PRICE AND REDUCED LIQUIDITY OF THE MARKET FOR THE
STOCK - LOSS OF NASDAQ NATIONAL MARKET LISTING.
         There is risk that the market value and the liquidity of the public
float for the Common Stock could be adversely affected in the event we no longer
meet Nasdaq's requirements for continued listing on the National Market tier.
For continued listing on the Nasdaq National Market, a company must satisfy a
number of requirements, which in our case includes either: (1) net tangible
assets in excess of $4.0 million as reported on Form 10-Q or Form 10-K or (2) a
market capitalization of at least $50.0 million. At September 30, 1998, our net
tangible 




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assets equaled $6,017,585 and our market capitalization was approximately $48.9
million (based on the last sale price of $7.688 and 6,354,373 shares
outstanding. Net tangible assets are defined as total assets less total
liabilities. Market capitalization is defined as total outstanding shares
multiplied by the last sales price quoted by Nasdaq. If we fail to satisfy at
least one of the two Nasdaq listing requirements at any time, the Common Stock
would no longer qualify for listing on the Nasdaq National Market. However, the
Common Stock would qualify for quotation on the Nasdaq Small Cap Market if the
Company has net tangible assets in excess of $2.0 million, or local over the
counter trading if the Company does not qualify for the Nasdaq Small Cap Market.
Without additional equity financing, the Company expects that its net tangible
assets will fall below the $4.0 million requirement by March 31, 1999 or sooner,
and below $2.0 million by June 30, 1999, or sooner. A failure to meet Nasdaq's
listing requirements on either the National Market or the Small Cap Market could
have a material adverse effect on our ability to raise additional capital and on
the market value of the Common Stock. The realization of any one or combination
of these risks could have a material adverse effect on the Company's business,
its prospects and its shareholders.

POSSIBLE VOLATILITY OF STOCK PRICE - GENERAL.
         Market prices of securities of early stage pharmaceutical companies are
generally subject to significant volatility. Contributing to this volatility are
various factors and events, such as the announcements by the Company or its
competitors of new product developments, clinical testing results, governmental
approvals, regulations or actions, developments or disputes relating to patents
or proprietary rights, public concern over the safety of therapies and
fluctuations in financial performance from period to period. These and other
factors and events may have a significant impact on the Company's business and
on the market price of the Common Stock.