# SECURITIES AND
EXCHANGE COMMISSION

# WASHINGTON, D.C. 20549

# FORM 10-Q

(Mark One)

|[X] |  | Quarterly
Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the
         quarterly period ended September 30, 2003
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------

|[   ] |  | Transition
report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the
         transition period from _______ to _______
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

Commission File Number
                 
                 
                 
0-24760

Orphan Medical, Inc.(Exact name of registrant as specified in its charter)

|Delaware                                               | 41-1784594                             
|------------------------------------------------------ | ---------------------------------------
|(State or other jurisdiction of                        | (I.R.S. Employer Identification Number)
|incorporation or organization)                        
|                                                      
|13911 Ridgedale Drive, Suite 250, Minnetonka, MN 55305 | (952) 513-6900                         
|(Address of principal executive office                 | (Registrants telephone number,        
|and zip code)                                          | including area code)                   

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, 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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes _X_        No __

Indicate the number of shares
outstanding of each of the issuers classes of common stock, as of the latest practical
date.

|Common Stock, $.01 par value | 10,744,703                       
|---------------------------- | ---------------------------------
|(Class)                      | (Outstanding at November 1, 2003)

---

INDEX

# ORPHAN MEDICAL, INC.®

|Page No.                                                                                        
|------------------------------------------------------------------------------------------------
|                                                                                                
|PART I. FINANCIAL INFORMATION                                                                   
|                                                                                                
|Item 1.  Financial Statements (Unaudited)                                                       
|                                                                                                
|Balance Sheets  September 30, 2003 and December 31, 2002                                       
|                                                                                                
|Statements of Operations  Three and nine months ended September 30, 2003 and September 30, 2002
|                                                                                                
|Statements of Cash Flows  Nine months ended September 30, 2003 and September 30, 2002          
|                                                                                                
|Notes to Financial Statements                                                                   
|                                                                                                
|Item 2.  Managements Discussion and Analysis of Financial Condition and Results of Operations  
|                                                                                                
|Item 3.  Quantitative and Qualitative Disclosures about Market Risk                             
|                                                                                                
|Item 4.  Controls and Procedures                                                                
|                                                                                                
|PART II. OTHER INFORMATION                                                                      
|                                                                                                
|Items 1 through 5 have been omitted
since all items are inapplicable or answers negative.       
|                                                                                                
|Item 6.  Exhibits and Reports on Form 8-K                                                       

Antizol®,
Antizol-Vet®,
Cystadane®, Xyrem®,
MedExpand, The Orphan Drug Company, Orphan
Medical®, Inc. and Dedicated to Patients with Uncommon
Diseases® are trademarks of the Company.

2

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# PART I  FINANCIAL INFORMATION

ITEM 1.   Financial Statements

# ORPHAN MEDICAL, INC.
BALANCE SHEETS
(In thousands except share data)

|                                                              | September 30,2003 |  | December 31,2002 |        
|------------------------------------------------------------- | ----------------- |  | ---------------- | -------
|
|Assets                                                        |                   |  |                  |        
|Current assets:                                               |                   | 
|Cash and cash equivalents                                     |                   |  | $                | 26,680 
|Restricted cash                                               |                   |  |                  | 127    
|Accounts receivable, less allowance for doubtful accounts of 
|$56 and $25, respectively                                     |                   |  |                  | 1,480  
|Inventories                                                   |                   |  |                  | 1,232  
|Prepaid expenses and other                                    |                   |  |                  | 715    
|                                                              |                   |  |                  |        
|Total current assets                                          |                   |  |                  | 30,234 
|Property and equipment, net                                   |                   |  |                  | 855    
|Total assets                                                  |                   |  | $                | 31,089 
|                                                              |                   |  |                  |        
|Liabilities and shareholders equity                          |                   | 
|Current liabilities:                                          |                   | 
|Accounts payable                                              |                   |  | $                | 763    
|Accrued royalties                                             |                   |  |                  | 133    
|Accrued compensation                                          |                   |  |                  | 1,080  
|Accrued expenses                                              |                   |  |                  | 2,348  
|                                                              |                   |  |                  |        
|Total current liabilities                                     |                   |  |                  | 4,324  
|Capital lease obligation-less current maturities              |                   |  |                  | 66     
|Commitments                                                   |                   | 
|Shareholders equity:                                         |                   | 
|Senior Convertible Preferred Stock, $.01 par value;          
|14,400 shares authorized; 8,706 shares issued and outstanding |                   |  |                  |       
|Series B Convertible Preferred Stock, $.01 par value;         |                   | 
|5,000 shares authorized; 3,957 and 3,677 shares issued        |                   | 
|and outstanding                                               |                   |  |                  |       
|Series C Convertible Preferred Stock, $.01 par value;        
|4,000 shares authorized; 0 shares issued and outstanding      |                   |  |                  |       
|Series D Convertible Preferred Stock, $.01 par value;         |                   | 
|1,500,000 shares authorized; 0 shares issued and              |                   |  |                  |       
|outstanding                                                   |                   | 
|Common stock, $.01 par value; 25,000,000 shares authorized;   |                   | 
|10,744,703 and 10,460,283 issued and outstanding              |                   |  |                  | 108    
|Additional paid-in capital                                    |                   |  |                  | 76,665 
|Accumulated deficit                                           |                   |  |                  | (50,074
|                                                              |                   |  |                  |        
|Total shareholders equity                                    |                   |  |                  | 26,699 
|                                                              |                   |  |                  |        
|Total liabilities and shareholders equity                    |                   |  | $                | 31,089 
|                                                              |                   |  |                  |        

Note:   The Balance Sheet at December
31, 2002 has been derived from the audited financial statements at that date but does not
include all of the information and footnotes required by generally accepted accounting
principles for complete financial statements.

See Accompanying Notes.

3

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# Orphan Medical, Inc.
Statements of Operations
(In thousands except per share data)

(Unaudited)

|                                                     | For the Three Months EndedSeptember 30, |  | For the Nine Months EndedSeptember 30, |       
|---------------------------------------------------- | --------------------------------------- |  | -------------------------------------- | ------
|
|Revenues, net                                        |                                         |  | $                                      | 2,982 
|Cost of sales                                        |                                         |  |                                        | 501   
|                                                     |                                         |  |                                        |       
|                                                     |                                         |  |                                        |       
|Gross Profit                                         |                                         |  |                                        | 2,481 
|                                                     |                                         |  |                                        |       
|Operating expenses:                                  |                                         | 
|Research and development                             |                                         |  |                                        | 2,540 
|Sales and marketing                                  |                                         |  |                                        | 3,316 
|General and administrative                           |                                         |  |                                        | 1,542 
|                                                     |                                         |  |                                        |       
|Total operating expenses                             |                                         |  |                                        | 7,398 
|                                                     |                                         |  |                                        |       
|Loss from operations                                 |                                         |  |                                        | (4,917
|                                                     |                                         |  |                                        |       
|Interest income, net                                 |                                         |  |                                        | 40    
|Other income                                         |                                         |  |                                        |      
|                                                     |                                         |  |                                        |       
|                                                     |                                         |  |                                        |       
|Net (loss) income before taxes                       |                                         |  |                                        | (4,877
|Income tax expense                                   |                                         |  |                                        | (251  
|                                                     |                                         |  |                                        |       
|Net (loss) income                                    |                                         |  |                                        | (5,128
|Less: Preferred stock dividends                      |                                         |  |                                        | 238   
|                                                     |                                         |  |                                        |       
|                                                     |                                         |  |                                        |       
|Net (loss) income attributable tocommon shareholders |                                         |  | $                                      | (5,366
|                                                     |                                         |  |                                        |       
|                                                     |                                         |  |                                        |       
|(Loss) earnings per common share                     |                                         | 
|Basic                                                |                                         |  | $                                      | (0.50 
|Diluted                                              |                                         |  | $                                      | (0.50 
|                                                     |                                         |  |                                        |       
|Weighted average number of shares outstanding        |                                         | 
|Basic                                                |                                         |  |                                        | 10,682
|Diluted                                              |                                         |  |                                        | 10,682

See Accompanying Notes.

4

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# Orphan Medical, Inc.
Statements of Cash Flows
(In thousands)

(Unaudited)

|                                                                | For the Nine Months Ended
|--------------------------------------------------------------- | -------------------------
|
|Operating activities                                            |                          
|Net income (loss)                                               |                          
|Adjustments to reconcile net loss to net cash used in operating |                          
|activities:                                                     |                          
|Depreciation and amortization                                   |                          
|Gain on disposition of products                                 |                          
|Changes in operating assets and liabilities:                    |                          
|Accounts receivable and current assets                          |                          
|Inventories                                                     |                          
|Accounts payable and accrued expenses                           |                          
|                                                                |                          
|Net cash used in operating activities                           |                          
|Investing activities                                            |                          
|Purchase of office equipment                                    |                          
|Decrease in restricted cash                                     |                          
|Net proceeds on disposition of products                         |                          
|                                                                |                          
|Net cash provided (used in) by investing activities             |                          
|Financing activities                                            |                          
|Employee stock purchase plan                                    |                          
|Stock option exercise proceeds                                  |                          
|Payments on capital lease                                       |                          
|Private common stock placement                                  |                          
|Cash dividends                                                  |                          
|                                                                |                          
|Net cash provided by financing activities                       |                          
|Increase (decrease) in cash and cash equivalents                |                          
|Cash and cash equivalents at beginning of period                |                          
|                                                                |                          
|Cash and cash equivalents at end of period                      |                          
|                                                                |                          

See Accompanying Notes.

5

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# ORPHAN MEDICAL, INC.

# NOTES TO FINANCIAL STATEMENTS
(Unaudited)

|1. |  | Basis
of Presentation
|-- |  | ---------------------

Business
Orphan Medical acquires, develops, and markets products of high medical
value intended to treat sleep disorders, pain and other central nervous
disorders that are addressed by physician specialists. A drug has high medical
value if it offers a major improvement in the safety or efficacy of patient
treatment and has no substantially equivalent substitute. The Company has had
six pharmaceutical products approved for marketing by the United States Food and
Drug Administration (FDA). While three have been divested, the Company is
focusing its resources on Xyrem®(sodium oxybate) oral solution, a medication
approved for cataplexy, a significant and debilitating symptom of narcolepsy.
The Company is conducting clinical trials to assess Xyrem in treating excessive
daytime sleepiness and fragmented nighttime sleep, the other prominent symptoms
of narcolepsy. A new compound, Butamben (butyl-p-aminobenzoate) suspension for
injection, is being evaluated for development as a treatment of pain. The
Company is seeking other approved or development-stage products in the specialty
areas it serves.

Basis of Presentation
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, these financial statements do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal, recurring accruals) considered necessary for fair
presentation have been included. Operating results for the three-month and
nine-month period ended September 30, 2003 are not necessarily indicative of the
results that may be expected for the year ended December 31, 2003. For further
information, refer to the audited financial statements and accompanying notes
contained in the Companys Annual Report filed on Form 10-K for the year ended
December 31, 2002.

|2. |  | Disposition
of Products
|-- |  | -----------------------

On June 10, 2003, the Company
announced the disposition of Busulfex®(busulfan) Injection to ESP Pharma, Inc. for
$29.3 million plus the book value of inventory, approximately $0.2 million.  The Company
announced the sale of the product Sucraid®(sacrosidase) oral solution to a specialty
pharmaceutical company on May 6, 2003 for $1.5 million.  The Company also divested a
third product, Elliotts B Solution®to the same specialty company for proceeds that were
not material.  Proceeds from these dispositions will be used for further development and
marketing of Xyrem and for the creation of a stronger presence in the sleep and central
nervous system (CNS) markets.

|3. |  | Use
of Estimates
|-- |  | ----------------

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

6

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|4. |  | Stock-Based
Compensation
|-- |  | ------------------------

At September 30, 2003 the Company has
a stock-based employee compensation plan.  The Company accounts for its plan under the
recognition and measurement principles of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. No stock-based
compensation cost is reflected in the net loss for the three or nine month periods ended
September 30, 2003 or 2002, as all options granted under this plan had an exercise price
equal to market value of the underlying common stock on the date of grant.

The following table illustrates the
effect on net income (loss) and net income (loss) per share if the Company had applied the fair value
recognition provisions of Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation.

|                                                        | Three Months EndedSeptember 30, |      | Nine Months EndedSeptember 30,
|------------------------------------------------------- | ------------------------------- | ---- | ------------------------------
|(in thousands except per share data)                    | 2003                            | 2002 | 2003                          
|Net income (loss) as reported                           |                                 |      | $                             
|Deduct total stock-based employee compensation expense  |                                 |     
|determined under fair value-based method for all awards |                                 |      |                               
|                                                        |                                 |      |                               
|Pro forma net income (loss)                             |                                 |      | $                             
|                                                        |                                 |      |                               
|Earnings (loss) per share                               |                                 |     
|Basic  as reported                                     |                                 |      | $                             
|Basic  as pro forma                                    |                                 |      | $                             
|Diluted  as reported                                   |                                 |      | $                             
|Diluted  as pro forma                                  |                                 |      | $                             

|5. |  | Revenue
Recognition
|-- |  | -------------------

Sales for all products, except Xyrem,
are recognized at the time a product is shipped to the Companys customers and are
recorded net of reserves for discounts for prompt payment. Sales of Xyrem are recognized
at the time product is shipped from the specialty pharmacy to the patient and are recorded
net of discounts for prompt payment. Except for Xyrem, the Company is obligated to accept,
for exchange, from all domestic customers products that have reached their expiration
date, which range from two to four years depending on the product. The Company is not
obligated to accept exchange of outdated product from its international distribution
partners. The Company establishes a reserve for the estimated cost of the exchanges. The
Company monitors the exchange of product and modifies its reserve as necessary. Management
bases these reserves on historical experience and these estimates are subject to change.

7

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|6. |  | Inventories
|-- |  | -----------

Inventories are valued at
the lower of cost or market determined using the first-in, first-out (FIFO)
method. The Companys policy is to establish an excess and obsolete reserve
for its products in excess of the expected demand for such products.

|                            | September 30, 2003 |  | December 31, 2002 |      
|--------------------------- | ------------------ |  | ----------------- | -----
|Raw materials and packaging |                    |  | $                 | 311  
|Finished goods              |                    |  |                   | 921  
|                            |                    |  |                   |      
|                            |                    |  | $                 | 1,232
|                            |                    |  |                   |      

8

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|7. |  | Earnings
Per Share
|-- |  | ------------------

Earnings per share is computed in
accordance with SFAS No. 128, Earnings Per Share. Basic earnings (loss) per
share is computed based on the weighted average number of common shares outstanding during
the period. Diluted earnings (loss) per share is computed based on the weighted average
shares outstanding and the dilutive impact of common stock equivalents outstanding during
the period. The dilutive effect of employee stock options and warrants is measured using
the treasury stock method. The dilutive effect of both series of convertible preferred
stock is computed using the if-converted method. Common stock equivalents are
not included in periods where there is a loss, as they are antidilutive. The following is
a reconciliation of net income (loss) and weighted average common shares outstanding for
purposes of calculating basic and diluted earnings (loss) per share:

|                                                | Three Months EndedSeptember 30, |      | Nine Months EndedSeptember 30,
|----------------------------------------------- | ------------------------------- | ---- | ------------------------------
|(in thousands except per share data)            | 2003                            | 2002 | 2003                          
|Numerator                                       |                                 |      |                               
|Numerator for basic earnings per share         |                                 |     
|income available to common shareholders         |                                 |      | $                             
|Add back to effect assumed conversions:         |                                 |     
|Preferred stock dividends                       |                                 |      |                               
|                                                |                                 |      |                               
|Numerator for diluted earnings per share        |                                 |      | $                             
|                                                |                                 |      |                               
|Denominator                                     |                                 |     
|Denominator for basic earnings per share       |                                 |     
|weighted average shares                         |                                 |      |                               
|Effect of dilutive securities:                  |                                 |     
|Preferred shares                                |                                 |      |                               
|Stock options                                   |                                 |      |                               
|Warrants                                        |                                 |      |                               
|                                                |                                 |      |                               
|Denominator for diluted earnings per share     |                                 |     
|weighted average shares and assumed conversions |                                 |      |                               
|                                                |                                 |      |                               
|Basic earnings per share                        |                                 |      | $                             
|                                                |                                 |      |                               
|Diluted earnings per share                      |                                 |      | $                             
|                                                |                                 |      |                               

|8. |  | Commitments
|-- |  | -----------

The Company has various commitments
under agreements with outside consultants and contractors to provide services relating to
drug development, drug acquisition, manufacturing and marketing. At September 30, 2003,
the Company estimates that it could incur approximately $13.5 million of additional
expenditures in subsequent periods under existing commitments. Commitments for research
and development expenditures will likely fluctuate from quarter to quarter and from year
to year depending on, among other factors, the timing of product development and the
progress of clinical development programs.

9

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|9. |  | Borrowings
|-- |  | ----------

The Company entered into a new line
of credit facility with a commercial bank on March 27, 2003. The new line of credit
facility has a term of one-year and includes a borrowing base equal to 75 percent of
eligible accounts receivable up to a maximum amount of $2.5 million. Certain other assets
have also been pledged as collateral for this facility. The interest rate is equal to two
points over the banks prime rate. The Company is also subject to certain other
requirements during the term of the facility, including (a) minimum quarterly net tangible
equity of $6.0 million plus 50 percent of the proceeds of any equity securities or
subordinated debt offering and (b) maximum monthly operating loss of $2.7 million. The
Company had not borrowed under this facility at September 30, 2003.

|10. |  | Income
taxes
|--- |  | ------------

In 2003 the Company disposed of three
products resulting in a net gain of $30.3 million. As a result of the gain from product
dispositions, the Company estimates that it will have alternative minimum tax expense of
$0.5 million in fiscal 2003.

|11. |  | Subsequent
Event
|--- |  | ----------------

On October 30, 2003 Orphan Medical,
Inc. announced that it had licensed European sales and marketing rights for Xyrem to
Celltech Pharmaceuticals, a division of Celltech Group Plc. Celltech has indicated that it
expects to file a Xyrem marketing authorization application for the cataplexy indication
in Europe in early 2004 and, upon approval, will use its specialist sales forces to market
the product to the target audience of neurologists and sleep specialists.

Under the terms of the agreement,
Celltech will be responsible for the registration, sales and marketing of Xyrem in Europe.
Celltech made an upfront payment of $2.5 million to Orphan Medical and will make further
payments of up to $6 million tied to product development milestones and up to $7 million
tied to sales-related milestones. Celltech will also pay Orphan Medical a royalty on sales
of the product which will begin no earlier than 2005. The licensing agreement includes the
use of Xyrem in narcolepsy and provides Celltech with rights to negotiate in regard to
other potential future indications including fibromyalgia syndrome.

10

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

Cautionary StatementThis Quarterly Report on Form 10-Q contains statements that are not
descriptions of historical facts. 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. Such statements may be forward-looking
statements that are subject to risks and uncertainties. Actual results could
differ materially from those currently anticipated due to a number of factors,
including those identified in the section of this Quarterly Report filed on Form
10-Q for the quarterly period ended September 30, 2003 titled Risk Factors.

General
Since its inception, the activities of the Company have consisted primarily
of obtaining the rights for developing and marketing proposed pharmaceutical
products, managing the development of these products and preparing for and
initiating the commercial introduction of six products. The Company operates in
a single business segment: pharmaceutical products. The Company has experienced
recurring losses from operations and has generated an accumulated deficit
through September 30, 2003 of $50.1 million. In addition, the Company expects to
incur additional losses from operations in fiscal years at least for the next
six fiscal quarters.

Recent Developments
On October 30, 2003 Orphan Medical, Inc. announced that it had licensed
European sales and marketing rights for Xyrem to Celltech Pharmaceuticals, a
division of Celltech Group plc. Celltech has indicated that it expects to file a
Xyrem marketing authorization application for the cataplexy indication in Europe
in early 2004 and, upon approval, will use its specialist sales forces to market
the product to the target audience of neurologists and sleep specialists.

Under the terms of the
agreement, Celltech will be responsible for the registration, sales and
marketing of Xyrem in Europe. Celltech made an upfront payment of $2.5 million
to Orphan Medical and will make further payments of up to $6 million tied to
product development milestones and up to $7 million tied to sales-related
milestones. Celltech will also pay Orphan Medical a royalty on sales of the
product which will begin no earlier than 2005. The licensing agreement includes
the use of Xyrem in narcolepsy and provides Celltech with rights to negotiate in
regard to other potential future indications including fibromyalgia syndrome.

On June 10, 2003, the
Company announced the disposition of the rights to Busulfex to ESP Pharma, Inc.
for $29.3 million plus the book value of inventory, approximately $0.2 million.
The Company announced the disposition of the product Sucraid to a specialty
pharmaceutical company on May 6, 2003 for $1.5 million. The Company also
divested a third product, Elliotts B Solution to the same specialty company for
proceeds that were not material. Proceeds from these dispositions

11

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will be used for further development and marketing of Xyrem and for the creation of a
stronger presence in the sleep and central nervous system (CNS) markets.

# Three Months Ended September 30, 2003
vs. Three Months Ended September 30, 2002

Net loss applicable to common
shareholders was $5.4 million for the three months ended September 30, 2003 compared to a
net loss applicable to common shareholders of $4.3 million for the three months ended
September 30, 2002. This change is attributable to a decrease in total revenues for the
current quarter as compared to the prior year resulting from the product dispositions that
occurred during the quarter ended June 30, 2003. The revenue decrease from product
dispositions was partially offset by a full quarter of revenue from Xyrem which was
approved in July 2002. Operating expenses decreased from the prior year primarily due to
the additional expense of commercial launch preparation incurred during the third quarter
of 2002.

Net sales decreased 28 percent to
$3.0 million for the three months ended September 30, 2003 compared to $4.2 million for
the same period in the prior year largely due to the aforementioned product dispositions.
Net sales for the quarter ended September 30, 2002 included $2.1 million from the
divested products, which did not recur in the current period.
Sales of Xyrem were approximately $1.1 million for the quarter ended September 30, 2003.
As of September 30, 2003, more than 900 physicians had written 2,934 prescriptions for
Xyrem of which 2,017 had been filled, with over 400 prescriptions in process.
Approximately 16 percent of patients do not fill their initial prescription. After
initiating therapy, there has been an 12 percent discontinuation rate following use of
Xyrem of which only 4 percent is due to side effects and 2 percent due to lack of
efficacy. The Company experienced prescription growth of 32 percent during the quarter as
compared to the quarter ended June 30, 2003.

Sales of Antizol®
(fomepizole) Injection were comparable to the prior year.

Gross profit margins decreased to 83
percent for the quarter ended September 30, 2003 compared to 85 percent for the same
period the prior year due to product mix. Cost of sales as a percentage of net sales will
fluctuate from quarter to quarter and from year to year depending on, among other factors,
demand for the Companys products, new product introductions and the mix of approved
products shipped.

Research and development expense
increased 13 percent to $2.5 million in the three months ended September 30, 2003 compared
to $2.3 million for the three months ended September 30, 2002. The increase results from
increased spending for the ongoing Phase III(b) trials for Xyrem. Both of these trials for
Xyrem are now underway and will increase research and development spending in subsequent
quarters. Clinical spending for trials is dependent on a number of factors, including
among others, the number of human subjects screened and enrolled in the trial, and the
number of active clinical sites. Development expenses will increase in the fourth quarter
of 2003 to approximately $3.0 million.

Sales and marketing expense decreased
6 percent to $3.3 million for the three months ended September 30, 2003 from $3.5 million
for the three months ended September 30, 2002. This decrease is attributable to timing of
spending for the support of the commercial activities of Xyrem, approved by the FDA in
July 2002 and launched in October 2002. Expenses in the prior year included spending for
the preparation of the commercial launch of Xyrem. Sales and marketing expenses will be in
the $4.0 million range the fourth quarter of 2003.

12

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General and administrative expense
decreased 20 percent to $1.5 million for the period ended September 30, 2003 compared to
$1.9 million for the three months ended September 30, 2002. General and administrative
expenses will be in the $1.5 million range in the fourth quarter of 2003.

Interest (expense) income is the sum
of interest income from investment activities less interest expense from financing
activities. The Company pays a minimum interest expense related to the Companys
credit facility.

During the quarter ended September
30, 2003, the Company recorded $0.3 million of income tax expense as an increase in the estimated tax expense related to the gain on
product dispositions. Since the Company expects to be unprofitable for at least the next
six quarters, the Company continues to provide a valuation allowance for the entire amount
of deferred tax assets.

Preferred stock dividends relate to
the Senior Convertible Preferred Stock that was issued on July 23, 1998 and Series B
Convertible Preferred Stock issued on August 2, 1999. Both have dividend rates of 7.5
percent. Preferred stock dividends were $0.2 million for both the three-months ended
September 30, 2003 and 2002. Preferred stock dividends, which commenced on February 1,
1999, are payable in arrears on August 1 and February 1 of each year. The Company has
chosen to satisfy its dividend payment obligation by issuing additional common or
preferred stock, as permitted by the terms of the Senior Convertible Preferred Stock and
the Series B Convertible Preferred Stock respectively. For the February 1, 2003 and August
1, 2003 Senior Preferred Stock dividend, the Company elected to issue 33,167 and 32,646,
respectively, shares of common stock to satisfy its obligation. The Company also intends
to continue to satisfy this obligation in the future by issuing common stock. The Company
is obligated to pay the dividend for the Series B Convertible Preferred Stock in cash or
through the issuance of additional preferred shares. The Company also intends to satisfy
the Series B Convertible Preferred Stock obligation by issuing additional preferred
shares, which will cause preferred stock dividends to increase in subsequent quarters.

# Nine Months Ended September 30, 2003
vs. Nine Months Ended September 30, 2002

Net income applicable to common
shareholders was $16.5 million for the nine months ended September 30, 2003 compared to a
net loss applicable to common shareholders of $7.2 million for the nine months ended
September 30, 2002. The aforementioned product dispositions resulted in gross proceeds of
$30.8 million and approximately $0.5 million of expenses associated with the transactions.
Operating expenses increased over the prior year primarily due to the commercialization of
Xyrem and the ongoing development activities for Xyrem. These increases in expenses were
offset by the disposition of products during the nine months ended September 30, 2003 and
an increase in net sales for the nine months ended September 30, 2003 compared to the same
period in the prior year.

Net sales increased 5 percent to
$11.9 million for the nine months ended September 30, 2003 compared to $11.3 million for
the same period in the prior year. Sales for the nine months ended September 30, 2002
included $6.2 million from the divested products. Net sales for the current
year included $3.5 million up to the dates of divestment. Sales for Xyrem were approximately $2.5 million for the
nine months ended September 30, 2003.

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Sales of Antizol increased 15 percent
over the same period the prior year as more hospitals with emergency rooms are stocking
the product.

Net sales for the nine months ended
September 30, 2003 included approximately $3.6 million from divested products prior to the
divestiture of these products.

Gross profit margins decreased to 83
percent for the nine months ended September 30, 2003 compared to 85 percent for the same
period the prior year due to product mix. Cost of sales as a percentage of net sales will
fluctuate from quarter to quarter and from year to year depending on, among other factors,
demand for the Companys products, new product introductions and the mix of approved
products shipped.

Research and development expense
increased 31 percent to $6.1 million in the nine months ended September 30, 2003 compared
to $4.7 million for nine months ended September 30, 2002. The increase results from
increased spending for the ongoing Phase III(b) trial for Xyrem and the initiation of the
EXCEEDS trial during the first quarter of 2003. Both of theses trials for Xyrem now
underway will increase research and development spending in subsequent quarters. Clinical
spending for trials is dependent on a number of factors, including among others, the
number of human subjects screened and enrolled in the trial, and the number of active
clinical sites.

Sales and marketing expense increased
53 percent to $11.1 million for the nine months ended September 30, 2003 from $7.3 million
for the nine months ended September 30, 2002. This increase is attributable to spending
supporting the commercial launch of Xyrem, approved in July 2002 and launched in October
2002. These expenses included the addition of staff, including a dedicated sales force and
other staff supporting the selling and marketing efforts for Xyrem, along with extensive
marketing and medical education efforts.

General and administrative expense
increased 17 percent to $5.2 million for the nine months ended September 30, 2003 compared
to $4.5 million for the nine months ended September 30, 2002. The increase results from
increased staffing and other infrastructure supporting the growth of the Company.

Interest (expense) income is the sum
of interest income from investment activities less interest expense from financing
activities. In addition, the Company pays minimum interest expense related to the
Companys credit facility.

During the nine months ended
September 30, 2003, the Company recorded $0.5 million of income tax expense related to the
gain on product dispositions. Since the Company expects to be unprofitable for at least
the next six quarters, the Company continues to provide a valuation allowance for the
entire amount of deferred tax assets.

Preferred stock dividends relate to
the Senior Convertible Preferred Stock that was issued on July 23, 1998 and Series B
Convertible Preferred Stock issued on August 2, 1999. Both have dividend rates of 7.5
percent. Preferred stock dividends were $0.7 million for both the ninemonths ended
September 30, 2003 and 2002. Preferred stock dividends, which commenced on February 1,
1999, are payable in arrears on August 1 and February 1 of each year. The Company has
chosen to satisfy

14

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its dividend payment obligation by
issuing additional common or preferred stock, as permitted by the terms of the Senior
Convertible Preferred Stock and the Series B Convertible Preferred Stock respectively.
For the February 1, 2003 and August 1, 2003 Senior Preferred Stock dividend, the Company
elected to issue 33,167 and 32,646, respectively, shares of common stock to satisfy its
obligation. The Company also intends to continue to satisfy this obligation in the future
by issuing common stock. The Company is obligated to pay the dividend for the Series B
Convertible Preferred Stock in cash or through the issuance of additional preferred
shares. The Company also intends to satisfy the Series B Convertible Preferred Stock
obligation by issuing additional preferred shares, which will cause preferred stock
dividends to increase in subsequent quarters.

Liquidity and Capital Resources
Since July 2, 1994, the effective date it was spun-off from Chronimed, Inc.,
the Company has financed its operations principally from net proceeds of $90.8
million from several public and private financings, interest income and product
sales, including $30.3 million of net proceeds from the divestiture of products
during the quarter ended June 30, 2003.

Net working capital
(current assets less current liabilities) increased from $6.7 million at
December 31, 2002 to $25.9 million at September 30, 2003. Cash and cash
equivalents increased from $6.9 million at December 31, 2002 to $26.7 million at
September 30, 2003. The increase in these amounts is directly attributable to
the product dispositions discussed previously.

The Company entered into a
new line of credit facility with a commercial bank on March 27, 2003, and
terminated its previous line of credit on that date. The Companys line of
credit facility, which has a term of one-year, includes a borrowing base equal
to 75 percent of eligible accounts receivable up to a maximum amount. In
conjunction with the product dispositions, the Company amended the maximum
amount of the line of credit from $3.5 million to $2.5 million. Certain other
assets have also been pledged as collateral for this facility. The interest rate
is equal to two points over the banks prime rate. The Company will be
subject to certain other requirements during the term of the facility, including
minimum quarterly net equity amounts. The Company had not borrowed under this
facility as of September 30, 2003.

The Companys
commitments for outside development spending were $13.5million at
September 30, 2003 and $5.6 million at December 31, 2002. This increase is the
result of the initiation of the EXCEEDS clinical trial and commitments for sales
and marketing programs. If additional products are licensed for development,
these expenditures and commitments could increase significantly.

Management believes the
Companys current cash availability, anticipated operating cash flows from
product revenues and license fees from the execution of the agreement with
Celltech for the registration and marketing of Xyrem in Europe will be
sufficient to fund its operations at least through December 31, 2004.

For continued listing on
the Nasdaq National Market, a company must satisfy a number of requirements,
which in the Companys case include either: (1) net equity in excess of
$10.0 million or (2) a market capitalization of at least $50.0 million. The
Company met both the thresholds at September 30, 2003. The Companys market
capitalization was approximately $96.8 million as of September 30, 2003 (Based
on Nasdaqs method of calculating market capitalization which

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ingnores preferred stock
using the last sale price of $9.14 and 10.6 million shares outstanding).
Although the Company does not expect to be profitable in 2003 or 2004, the
Company nevertheless expects to continue to meet the listing requirements for
listing on the Nasdaq National Market. However, there can be no assurance that
the Company will continue to meet these requirements in the future.

In connection with the 1998 and 1999
private placements of convertible preferred stock, the Company agreed to certain
restrictions and covenants, which could limit its ability to obtain additional financing.
Even without these restrictions, the Company can make no assurances that additional
financing opportunities will be available or, if available, on acceptable terms.

Geographic Sales Information
The Company tracks sales in two geographic regions, domestic and
international. The Company has no assets outside of the United States. The
following is a summary of net sales by geographic region for the three month and
nine month periods ended September 30, 2003 and 2002, respectively. Domestic sales for the three
months ended September 30, 2003 declined as a result of the product dispositions.
International sales declined year over year and quarter over quarter due to the
product divestments discussed earlier.

|              |  | (in thousands) |   |      
|------------- |  | -------------- | - | -----
|
|
|Domestic      |  |                | $ | 2,828
|International |  |                |   | 154  
|              |  |                |   |      
|Total         |  |                | $ | 2,982
|              |  |                |   |      

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Risk Factors
An investment in our common stock involves a number of risks, including
among others, risks associated with companies that operate in the pharmaceutical
industry. These risks are substantial and inherent in our operations and
industry. Any investor or potential investor should carefully consider the
following information about these risks before buying shares of common stock.

# We have a history of losses, which we expect to continue.

We have been unprofitable since our
inception in January 1993. We expect operating losses at least through 2004 because
anticipated gross profits from product revenues will not offset our operating expenses,
including additional spending to support drug development activities. The amount of these
losses may vary significantly from year-to-year and quarter-to-quarter. Our actual losses
will depend on, among other factors, the timing of product development, regulatory
approval, and market demand for our Food and Drug Administration (FDA)
approved products. We cannot assure you that we will ever generate sufficient product
revenues to achieve profitability.

Limitations to sources of
additional capital  restrictions, covenants and rights related to Senior Convertible
Preferred Stock and Series B Convertible Preferred Stock.

On July 23, 1998, we completed the
private sale to UBS Capital of $7.5 million of Senior Convertible Preferred Stock. On
August 2, 1999, we completed another private sale to UBS Capital of $2.95 million of
Series B Convertible Preferred Stock. In conjunction with the issuance of the preferred
shares, we agreed to several restrictions and covenants, and granted certain voting and
other rights to the holders of the preferred shares. One of the most important of these
restrictions is that we cannot incur additional indebtedness, except for indebtedness
secured solely by our trade receivables, until we have profitable operations, subject to
certain limitations. Another important restriction is that, without the approval of a
majority of the preferred stockholders, we cannot issue additional equity securities
unless the selling price per share exceeds the then conversion price of the outstanding
convertible preferred stock or the sale of equity is accomplished in a public offering.
The present conversion price is $8.14 per share for the Senior Convertible Preferred Stock
and $6.50 for the Series B Convertible Preferred Stock.

These restrictions could make it more
difficult and more costly for us to obtain additional capital. We cannot assure you that
additional sources of capital will be available to us or, if available, on terms
acceptable to us.

# Possible price
volatility and limited liquidity of stock.

There is generally significant
volatility in the market prices and limited liquidity of securities of early stage
companies, and particularly of early stage pharmaceutical companies. Contributing to this
volatility are various factors and events that can affect our stock price in a positive or
negative manner. These factors and events include, but are not limited to:

 announcements by us or our
competitors of new product developments or clinical testing results;  governmental
approvals, refusals to approve, regulations or actions;  developments or disputes
relating to patents or proprietary rights;

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   public concern over the safety of therapies;
   financial performance;
   fluctuations in financial performance from period to period; and
   small float or number of shares of our stock available for sale
and trade.

These and other factors and events
may have a significant impact on our business and on the market price of the common stock.

We cannot be sure that future
capital will be available to meet our expected capital requirements.

Although we believe that we have sufficient
capital to meet our current business objectives, if we expand our business plans, we may
need additional capital. Adequate funds for our operations, continued development, and
expansion of our business plans, whether from financial markets or from other sources, may
not be available when needed on acceptable terms, or at all. If we issue additional
securities your holding may be diluted.

Possible volatility of stock price
and reduced liquidity of the market for the Stock  possible loss of Nasdaq National
Market listing and failure to qualify For Nasdaq Small Cap Market listing.

There is a risk that the market value
and the liquidity of the public float for our common stock could be adversely affected in
the event we no longer meet the Nasdaqs requirements for continued listing on the
National Market. For continued listing on the Nasdaq National Market, a company must
satisfy a number of requirements, which in our case includes either: (1) minimum net
equity in excess of $10.0 million as reported on Form 10-Q or Form 10-K or (2) a market
capitalization of at least $50.0 million. Market capitalization is defined as total
outstanding shares multiplied by the last sales price quoted by Nasdaq. We met both
requirements as of September 30, 2003, however, we cannot assure you that we will be able
to continue to meet both requirements in future periods.

# There is a limited market for our products.

Most orphan drugs have a potential
United States market of less than $25 million annually and many address annual markets of
less than $1 million. We cannot assure you that sales of our products will be adequate to
make us profitable even if the products are accepted by medical specialists and used by
patients.

# We rely on the limited protection of the Orphan Drug Act.

United States

Under the Orphan Drug Act, the FDA
may grant orphan drug designation to drugs intended to treat a rare disease or
condition. The Orphan Drug Act generally defines rare disease or
condition as one that affects populations of fewer than 200,000 people in the United
States. The Orphan Drug Act provides us with certain limited protections for our products.

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The first step in obtaining the
limited protection under the Orphan Drug Act is acquiring the FDAs approval of
orphan drug designation, which must be requested before submitting a New Drug
Application (NDA). After the FDA grants orphan drug designation, it publishes
the generic identity of the therapeutic agent and the potential orphan indication
specified in the request. Orphan drug designation does not constitute FDA approval. In
addition, orphan drug designation does not convey any advantage in, or shorten the
duration of, the regulatory approval process.

The second step in obtaining the
limited protection under the Orphan Drug Act is acquiring the FDAs recognition of
orphan drug status. The Orphan Drug Act confers orphan drug status upon the
first company to receive FDA approval to market a drug with orphan drug
designation for a specific designated indication. Orphan drug status does not
protect against another formulation or drug of materially different composition from being
approved, with or without orphan drug status, for the same indication. FDA approval of an
orphan drugalso results in United States marketing exclusivity for a period of seven
years, subject to certain limitations. Although obtaining FDA approval to market a product
with orphan drug status can be advantageous, we cannot assure you that the scope of
protection or the level of marketing exclusivity will remain in effect in the future. In
addition, United States orphan drug status does not provide any marketing exclusivity in
foreign markets. Although certain foreign countries provide development and marketing
benefits to orphan drugs, we cannot assure you that such benefits can be obtained or, if
obtained, will be of material value to us. The FDA has granted us orphan drug status for
Xyrem, Antizol, and Cystadane® (betaine anhydrous for oral solution).

Even if the FDA approves an NDA for a
drug with an orphan drug designation, the FDA may still approve the same drug for a
different indication, or a molecular variation of the same drug for the same indication.
We are currently not aware of any orphan drug designation granted to another company for a
compound similar to any of the Companys currently marketed products.

The possible amendment of the Orphan
Drug Act by Congress has been the subject of congressional discussion from time to time
over the last ten years. Although Congress has made no significant changes to the Orphan
Drug Act for a number of years, members of Congress have from time to time proposed
legislation that would limit the application of the Orphan Drug Act. We cannot assure you
that the Orphan Drug Act will remain in effect or that it will remain in effect in its
current form. The precise scope of protection that orphan drug designation and marketing
approval may afford in the future is unknown. We cannot assure you that the current level
of exclusivity will remain in effect.

Europe

An orphan drug act was enacted in
Europe that provides up to ten years of market exclusivity for a drug that meets the
requirements of the act. For a pharmaceutical product to qualify for the benefits of the
act, the prevalence or incidence (whichever is greater) must not exceed five patients per
10,000 in the population. Our European partner has obtained orphan drug designation for
Cystadane in Europe. The Company has obtained orphan drug designation for Antizol, for use
in methanol poisonings, and Xyrem in Europe.We cannot provide assurance that any of our
pharmaceutical products will qualify for orphan drug protection in Europe or that another
company will not obtain an approval that would block us from marketing our product in
Europe.

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The FDA and foreign regulatory
authorities must approve our products for sale.

Government regulation in the United
States and abroad is a significant factor in the testing, production and marketing of our
current and future pharmaceutical products. Each product must undergo an extensive
regulatory review process conducted by the United States Food and Drug Administration and
by comparable agencies in other countries. We cannot market any medicine we may develop or
license as a prescription product in any jurisdiction, including most foreign countries,
in which the product does not receive regulatory approval. The approval process can take
many years and requires the expenditure of substantial resources.

We depend on external laboratories
and medical institutions to conduct our pre-clinical and clinical analytical testing in
compliance with good clinical and laboratory practices established by the FDA and other
regulatory agencies. The data obtained from pre-clinical and clinical testing is subject
to varying interpretations that could delay, limit or prevent regulatory approval. In
addition, changes in FDA policy for drug approval during the period of development and in
the requirements for regulatory review of each submitted NDA could result in additional
delays or outright rejection.

We cannot assure you that the FDA or
any foreign regulatory authority will approve in a timely manner, if at all, any product
we develop. Generally, the FDA and foreign regulatory authorities approve only a very
small percentage of newly discovered pharmaceutical compounds that enter pre-clinical
development. Moreover, even if the FDA approves a product, it may place commercially
unacceptable limitations on the uses, or indications, for which a product may
be marketed. In addition addition to potentially limiting the commercial market, this
could result in additional cost and delay for further studies to provide additional data
on safety or effectiveness.

# FDA approval does not guarantee financial success.

Three of our current products have
been approved for marketing by regulatory authorities in the United States and elsewhere.
We cannot assure you that any of our products will be commercially successful or achieve
the expected financial results. 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 our prospects. In addition, the efforts of government entities and third party payors
to contain or reduce the costs of health care may adversely affect our sales and limit the
commercial success of our products.

We cannot completely insulate our
drug development portfolio from the possibility of clinical or commercial failures. Some
products that we have selected for development may not produce the results expected during
clinical trials or receive FDA approval. Drugs approved by the FDA may not generate
product sales of an acceptable level. We have discontinued the development of eleven
products from our portfolio since inception and disposed of three approved products.

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Significant government
regulation continues once a product is approved for sale.

After a reviewing division
of the FDA approves a drug, the FDAs Division of Drug Marketing,
Advertising and Communication must accept such drugs marketing claims,
which are the basis for the drugs labeling, advertising and promotion. We
cannot be sure that the Division of Drug Marketing, Advertising and
Communication will accept our proposed marketing claims. The failure of the
Division of Drug Marketing, Advertising and Communication to accept our proposed
marketing claims could have a material adverse effect on our business and
prospects.

The FDA can require that a
company conduct post-marketing adverse event surveillance programs
to monitor any side effects that occur after the companys drug is approved
for marketing. If the surveillance program indicates unsafe side effects, the
FDA may recall the product, and suspend or terminate a companys
authorization to market the product. The FDA also regulates the manufacturing
process for an approved drug. The FDA may impose restrictions or sanctions upon
the subsequent discovery of previously unknown problems with a product or
manufacturer. One possible sanction is requiring the withdrawal of such product
from the market. The FDA must approve any change in manufacturer as well as most
changes in the manufacturing process prior to implementation. Obtaining the
FDAs approval for a change in manufacturing procedures or change in
manufacturers is a lengthy process and could cause production delays and loss of
sales, which would have a material adverse effect on our business and our
prospects.

Certain foreign countries
regulate the sales price of a product after marketing approval is granted. We
cannot be sure that we can sell our products at satisfactory prices in foreign
markets even if foreign regulatory authorities grant marketing approval.

# We rely on
others for product development opportunities.

We engage only in limited
research to identify new pharmaceutical compounds. To build our product
portfolio, we have adopted a license and acquisition strategy. This strategy for
growth requires us to identify and acquire pharmaceutical products targeted at
niche markets within selected strategic therapeutic market segments. These
products usually require further development and approval by regulatory bodies
before they can be marketed. We cannot assure you that any such products can be
successfully acquired, developed, approved or marketed. We must rely upon the
willingness of others to sell or license pharmaceutical product opportunities to
us. Other companies, including those with substantially greater resources,
compete with us to acquire such products. We cannot assure you that we will be
able to acquire rights to additional products on acceptable terms, if at all.
Our failure to acquire or license any new pharmaceutical products, or our
failure to promote and market any products successfully or products within an
existing therapeutic area, could have a material adverse effect on our business
and our prospects.

We have contractual
development rights to certain compounds through various license agreements.
Generally, the licensor can unilaterally terminate these agreements for several
reasons, including, but not limited to the following reasons:

 for cause if we
breach the contract;
 if we become insolvent or bankrupt;

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 if we do not apply specified minimum resources and efforts to develop the compound under license; or
 if we do not achieve certain minimum royalty payments, or in some cases, minimum sales levels.

We cannot assure you that
we can meet all specified requirements and avoid termination of any license
agreements. We cannot assure you that if any agreement is terminated, we will be
able to enter into similar agreements on terms as favorable as those contained
in our existing license agreements.

We depend on others to
manufacture and supply the products we market.

We do not have and do not
intend to establish any internal product testing, synthesis of bulk drug
substance, or manufacturing capability for drug product. Accordingly, we depend
on others to supply and manufacture the components incorporated into all of our
finished drug products. The inability to contract for these purposes on
acceptable terms could adversely affect our ability to develop and market our
products. Failure by parties with whom we contract 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
adversely affect our business and our prospects. The loss of a supply or
manufacturing contractor could materially adversely affect our business and our
prospects.

The loss of either a bulk
drug supplier or drug product manufacturer would require us to obtain regulatory
clearance in the form of a pre-approval submission and incur
validation and other costs associated with the transfer of the bulk drug or drug
product manufacturing process. We believe that it could take as long as two
years for the FDA to approve such a submission. Because our products are
targeted to relatively small markets and our manufacturing production runs are
small by industry standards, we have not incurred the added costs to certify and
maintain secondary sources of supply for bulk drug substance or backup drug
product manufacturers for some products. Should we lose either a bulk drug
supplier or a drug product manufacturer, we could run out of salable product to
meet market demands or investigational product for use in clinical trials, while
we wait for the FDA approval of a new bulk drug supplier or drug product
manufacturer. We cannot assure you that the change of a bulk drug supplier or
drug product manufacturer and the transfer of the processes to another third
party will be approved by the FDA, and if approved, in a timely manner. The loss
of or the change of a bulk drug supplier or a drug product manufacturer could
have a material adverse effect on our business and prospects.

Bulk Drug Supply

Bulk drug substance is the active
chemical compound used in the manufacture of our drug products. We depend substantially
on single suppliers for the supply of bulk drug substance used in each of our products.
If we were to lose any of these companies as a supplier, we would be required to identify
a new supplier for the bulk drug substance used in those products. We also cannot assure
you that our bulk drug supply arrangements with our current suppliers, or any other
future such supplier, might not change in the future. We cannot assure you that any
change would

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not adversely affect production of
the Companys currently marketed products or any other drug the Company might
attempt to develop or market.

Drug Product Manufacture

From bulk drug substance, drug
product manufacturers formulate a finished drug product and package the product for sale
or for use in clinical trials. We depend substantially on single suppliers for drug
product manufacturing of each of our products. If we were to lose any of these companies
as a supplier, we would be required to identify a new manufacturer. We cannot assure you
that our drug product manufacturing arrangements with these suppliers will not change or
that the manufacturing services will continue to be available on terms satisfactory to us.
Any change in our manufacturing agreements could adversely affect production of our
currently marketed products or any other drug that we might attempt to develop or market,
which could have a material adverse effect on our business and prospects.

We cannot control our
contractors compliance with applicable regulations.

The FDA defines and regulates good
manufacturing practices to which bulk drug suppliers and drug product manufacturers are
subject. The Drug Enforcement Agency (DEA) defines and regulates the handling and
reporting requirements for certain drugs which have abuse potential, known as
scheduled drugs. Foreign regulatory authorities prescribe similar rules and
regulations. Our supply and manufacturing contractors must comply with these regulatory
requirements. Failure by our contractors to comply with FDA or DEA requirements or
applicable foreign requirements could result in significant time delays or in our
inability to commercialize or continue to market a product. Either result could have a
material adverse effect on our business and prospects. Failure to comply with good
manufacturing practices or other applicable legal requirements can lead to federal seizure
of violative products, injunctive actions brought by the federal government, or potential
criminal and civil liability for Orphan Medical, our officers, or our employees. We cannot
assure you that we will be able to maintain relationships either domestically or abroad
with contractors whose facilities and procedures comply or will continue to comply with
FDA or DEA requirements or applicable foreign requirements. DEA establishes quotas for
Schedule I drug substances. We cannot assure you that the DEA will always grant sufficient
quotas to meet market demand for our Xyrem product line. In rare cases in the past when
demand exceeded quotas there was insufficient drug substance to meet commercial drug
market demand.

# We depend upon others for distribution.

We have an agreement with a specialty
pharmacy to distribute Xyrem. Xyrem is classified as a Schedule III controlled substance
and approved under Subpart H of the FDAs review process, and distribution will be
strictly controlled. The specialty pharmacy is the only source through which Xyrem can be
obtained. Distribution is governed by the FDAs Subpart H regulations and fully
complies with the risk-management controls jointly developed by Orphan Medical, the FDA,
the Drug Enforcement Agency and law enforcement agencies. Every shipment of Xyrem is
subject to stringent safeguards to ensure it reaches only individuals for whom it has been
legitimately prescribed.

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We have an agreement with a
distribution contractor to provide integrated distribution and operations services to
support transactions between us and our wholesalers, specialty distributors, and direct
customers. This contractor also provides reimbursement management, patient assistance and
information hotline services along with specialty distribution and marketing services to
physician practices with respect to our products.

We have a separate agreement with
another distributor that distributes Antizol and Antizol-Vet. The contractor may also
distribute future products should those products receive marketing clearance from the FDA.
We are substantially dependent on this contractors ability to successfully
distribute Antizol and Antizol-Vet.

A mail order pharmacy is the
principal distributor, on a non-exclusive basis, in the United States for Cystadane. The
pharmacy distributes this product directly to patients through the mail. We are
substantially dependent on this pharmacys ability to successfully distribute
Cystadane directly to patients in the United States.

We cannot assure you that our
distribution arrangements with these three entities or other companies would be available,
or continue to be available to us on commercially acceptable terms. The loss of a
distributor or failure to renew agreements with an existing distributor would have a
material adverse effect on our business and prospects.

We rely on foreign marketing
alliances and have no assurance of foreign licensees.

Our strategy to sell our products in
foreign markets is to license foreign marketing and distribution rights to a foreign
company after a new drug application (referred to in the industry as an NDA)
is submitted or approved in the United States. We consider Europe, Asia, and Canada our
most attractive foreign markets. Our current foreign arrangements are:

EUROPE.    We have licensed the marketing and
distribution rights for Xyrem, Antizol and Cystadane in Europe. If our licensees
are unsuccessful in their registration and distribution efforts, we may find it
difficult to contract with other distributors for these products within Europe.
A regulatory application for Xyrem has not yet been filed, but is expected to be
filed in the first part of next year. Prior to complete regulatory approval,
distribution of Xyrem is limited to named patient or emergency
use. Distribution of all products except Antizol is limited to named
patient or emergency use basis until full regulatory approval
is obtained. Antizol has been approved for use in the United Kingdom but is
limited to named patient basis in other parts of Europe. This
distribution of Xyrem and Antizol is expected to result in a limited
contribution to the Companys revenues. Full regulatory approval is
expected for Xyrem no earlier than 2005.

AUSTRALIA AND NEW ZEALAND.    We have
licensed marketing and distribution rights for Cystadane in Australia and New Zealand, but
sales of these products have not been material. We do not expect sales to increase in the
near future to the point that they become material.

ISRAEL.    We
have licensed marketing and distribution rights for Antizol and Cystadane in
Israel. Full regulatory approval for Cystadane was obtained in Israel in
February 2000. We do not expect such distribution to result in material
revenues.

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CANADA.    We
have licensed marketing and distribution rights for Antizol in Canada. For
Cystadane we have only licensed the distribution rights in Canada. We do not
expect such distribution to result in material revenues.

We depend on our foreign licensees
for the regulatory registration of our products in foreign countries. We cannot be sure
that our licensees can obtain such registration. In addition, we cannot be sure that we
will be able to negotiate commercially acceptable license agreements for our other
products or in additional foreign countries. Furthermore, we cannot assure you that these
companies will be successful in marketing and selling our products in their respective
territories.

# Our products might be recalled.

A product can be recalled at our
discretion or at the discretion of the FDA, the U.S. Federal Trade Commission, or other
government agencies having regulatory authority for marketed products. A recall may occur
due to disputed labeling claims, manufacturing issues, quality defects, safety issues, or
other reasons. We report such events, should they occur, to the FDA and/or other government and regulatory
 agencies in accordance with applicable laws and regulations. We
cannot assure you that a product recall will not 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 our business and prospects. To date, no recall of products marketed by
the Company has occurred.

We face limits on price
flexibility and third-party reimbursement.

The flexibility of prices that we can
charge for our products depends on government regulation, both in the United States and
abroad, and on other third parties. One important factor is the extent to which
reimbursement for our products will be available to patients 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. We are uncertain as to the pricing flexibility we will have
with respect to, and if we will be reimbursed for, newly approved health care products.

In the United States, we expect
continuing federal and state proposals to implement greater government control of the
pricing and profitability of prescription pharmaceuticals. Cost controls, if mandated by a
government agency, could decrease, or limit, the price we receive for our products or
products we may develop in the future. We may not be able to recover our development
costs, which could be substantial. We may not be able to realize an appropriate profit
margin. This could have a material adverse effect on our business. Furthermore, federal
and state regulations govern or influence reimbursement of health care providers for
medical treatment of certain patients. We cannot assure you that actions taken by federal
and/or state governments, if any, with regard to health care reform will not have a
material adverse effect on our business and prospects.

Certain private health insurers and
third-party payors may attempt to control costs further by selecting exclusive providers
of pharmaceuticals. If such arrangements are made with our competitors, these insurers and
third-party payors would not reimburse patients who purchase our competing products. This
would diminish the market for our products and could have a material adverse effect on our
business and prospects.

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Patents and other proprietary
rights are significant factors in the pharmaceutical industry.

The pharmaceutical industry and the
investment community places considerable importance and value on obtaining patent,
proprietary, and trade secret protection for new technologies, products and processes. The
patent position of pharmaceutical firms is often highly uncertain and generally involves
complex legal, technical and factual questions. Our success depends on several issues,
including, but not limited to our ability:

-to obtain, and enforce proprietary protection for our products under United States and foreign patent laws and other
intellectual property laws;
-to preserve the confidentiality of our trade secrets; and
-to operate without infringing the proprietary rights of third parties.

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 assure
you that any patents will be issued from any applications or that any issued patents will
afford us adequate protection or competitive advantage. Also, we cannot assure you that
any issued patents will not be challenged, invalidated, infringed or circumvented. Parties
not affiliated with us have obtained or may obtain United States or foreign patents or
possess or may possess proprietary rights relating to our products. We cannot assure you
that patents now in existence or later issued to others will not adversely affect the
development or commercialization of our products.

We believe that the active
ingredients or compounds in our FDA-approved products, Cystadane Antizol, Antizol-Vet, and
Xyrem, are in the public domain and presently are not subject to patent protection in the
United States. However, we have an issued patent with respect to our formulation of Xyrem
and for the indication of fibromyalgia and chronic fatigue. We could, however, incur
substantial costs asserting any infringement claims that we may have against others.

We seek to protect our proprietary
information and technology, in part, through confidentiality agreements and
inventors rights agreements with our employees. We cannot assure you that these
agreements will not be breached, that we will have adequate remedies for any breach, or
that our trade secrets will not otherwise be disclosed to or discovered by our
competitors. We also cannot assure you that our planned activities will not infringe
patents owned by others. We could incur substantial costs in defending infringement suits
brought against us. We also could 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 often must obtain licenses under patents or other
proprietary rights of third parties. We cannot assure you that we can obtain any such
licenses on acceptable terms, if at all. If we cannot obtain required licenses on
acceptable terms, we could encounter substantial difficulties in developing, manufacturing
or marketing one or more of our products. To date, Orphan Medical has not been involved in
any patent related litigation.

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# We face intense competition in our industry.

Competition in the pharmaceutical
industry is intense. Potential competitors in the United States are numerous and include
pharmaceutical, chemical and biotechnology companies. Many of these companies have
substantially greater capital resources, marketing experience, research and development
staffs and facilities than we do. We seek to limit potential sources of competition by
developing products that are eligible for orphan drug status upon NDA approval or other
forms of protection. We cannot assure you, however, that our competitors will not succeed
in developing similar technologies and products more rapidly than we can. Similarly, we
cannot assure you that these competing technologies and products will not be more
effective than any of those that we have developed or are currently developing.

We expect rapid
technological and other change to be constant in our industry.

The pharmaceutical industry
has experienced rapid and significant technological change as well as structural
changes, such as those brought about by changes in heath care delivery or in
product distribution. We expect that pharmaceutical technology will continue to
develop and change rapidly, and our future success will depend, in large part,
on our ability to develop and maintain a competitive position. Technological
development by others may result in our products becoming obsolete 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, new medical treatments, or changes in the manner in which
health care is delivered or products provided could alter existing treatment
regimes or health care practices, and thereby reduce the need for one or more of
our products, which would adversely affect our business and our prospects.

# We face substantial product liability and insurance risks.

Testing and selling health
care products entails the inherent risk of product liability claims. The cost of
product liability insurance coverage has increased and is likely to continue to
increase in the future. 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 $30 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 assure you that we will be able to
maintain product liability insurance on acceptable terms or that our insurance
will provide adequate coverage against potential claims. A successful uninsured
product liability or other claim against us could have a material adverse effect
on our business and prospects.

Item 3.   Quantitative and Qualitative Disclosures about Market Risk

Not Applicable

Item 4.   Controls and Procedures

Evaluation of Disclosure
Controls and Procedures.Under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief Financial
Officer, we evaluated the effectiveness of the design and operation of our
disclosure controls and

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procedures (as defined in Rule
13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act))
as of the end of the period covered by this report. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that, as of the end of the period
covered by this report, our disclosure controls and procedures are adequately designed to
ensure that information required to be disclosed by us in the reports that we file or
submit under the Securities and Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in applicable rules and forms.

Changes in Internal Controls.
During our third fiscal quarter, there were no significant changes made in our internal
control over financial reporting (as defined in Rule 13(a)-15(f) under the Exchange Act)
that have materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.

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# PART II  OTHER INFORMATION

Items 1-5 are not applicable and have been omitted.

Item 6.   Exhibits and Reports on Form 8-K

| |  | (a) |  | Exhibits:
| |  | --- |  | ---------

| | ExhibitNumber          Description
| | ----------------------------------

| |  |  |  | 31.1 |  | Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | 
| |  |  |  | ---- |  | -------------------------------------------------------------------------------------------------- | 

| |  |  |  | 31.2 |  | Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002 | 
| |  |  |  | ---- |  | -------------------------------------------------------------------------------------------------- | 

| |  |  |  | 32.1 |  | Certification
of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 | 
| |  |  |  | ---- |  | -------------------------------------------------------------------------------------------------- | 

| |  |  |  | 32.2 |  | Certification of
Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 | 
| |  |  |  | ---- |  | -------------------------------------------------------------------------------------------------- | 

| |  | (b) |  | Reports
on Form 8-K:
| |  | --- |  | --------------------

| | The
Company recently filed the following Current Reports on Form 8-K.
| | ---------------------------------------------------------------------

| | Current Report on Form 8-K filed July 24, 2003 under Item 5. Other
Events reporting certain financial matters.
| | ----------------------------------------------------------------------------------------------------------------

| | Current
Report on Form 8-K filed October 23, 2003 under Item 12, Disclosure of Results of
Operations and Financial Conditionreporting 2003 Third Quarter results and
financial condition.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Current
Report on Form 8-K filed October 31, 2003 under Item 5, Other Events reporting
a licensing agreement with Celltech plc.
| | ---------------------------------------------------------------------------------------------------------------------------------

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# SIGNATURE

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

|                         |    | Orphan Medical, Inc.Registrant                                                                  
|------------------------ | -- | ------------------------------------------------------------------------------------------------
|Date:  November 14, 2003 | By | /s/   Timothy G. McGrath                                                                        
|                         |    |                                                                                                 
|                         |    | Timothy G McGrathChief Financial Officer(duly authorized officer andprincipal financial officer)

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# INDEX TO EXHIBITS

|Exhibit |  |                                                                     | Page
|------- |  | ------------------------------------------------------------------- | ----
|
|31.1    |  | Certification of Chief Executive Officer pursuant to Section 302 of |     
|        |  | the Sarbanes-Oxley Act of 2002                                      |     
|31.2    |  | Certification of Chief Financial Officer pursuant to Section 302 of |     
|        |  | the Sarbanes-Oxley Act of 2002                                      |     
|32.1    |  | Certification of Chief Financial Officer pursuant to Section 906 of |     
|        |  | the Sarbanes-Oxley Act of 2002                                      |     
|32.2    |  | Certification of Chief Financial Officer pursuant to Section 906 of |     
|        |  | the Sarbanes-Oxley Act of 2002                                      |     

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