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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549




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FORM 10-Q



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(MARK ONE)

|  |  |                                                                                         
|- |  | ----------------------------------------------------------------------------------------
|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003

OR

|  |  |                                                                                          
|- |  | -----------------------------------------------------------------------------------------
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.

FOR THE TRANSITION PERIOD FROM                      TO



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COMMISSION FILE NUMBER: 0-20772

QUESTCOR PHARMACEUTICALS, INC.

(Exact name of Registrant as specified in its charter)


|                                                                          |  |                                                
|------------------------------------------------------------------------- |  | -----------------------------------------------
|CALIFORNIA
(State or other jurisdiction
of incorporation or organization) |  | 33-0476164
(I.R.S. Employer
Identification No.)

3260 Whipple Road
Union City, CA 94587-1217
(Address of Principal Executive Offices)

REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 400-0700



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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter prior that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether Registrant is an accelerated filer (as
defined in Rule 12B-2 of the Act). Yes o  No x

At
August 12, 2003 there were 44,268,602 shares of the Registrants common
stock, no par value per share, outstanding.



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TABLE OF CONTENTS



|                                                                   |                                                                                               |                                                                    |  |  |  |  |  | 
|------------------------------------------------------------------ | --------------------------------------------------------------------------------------------- | ------------------------------------------------------------------ |  |  |  |  |  | 
|                                                                   | ITEM 1. FINANCIAL STATEMENTS                                                                 
|                                                                   |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS                             
|                                                                   |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                   
|                                                                   |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                   
|                                                                   |                                                                                               | NOTES TO CONDENSED CONSOLIDATED JUNE 30, 2003 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. DISCLOSURE CONTROLS AND PROCEDURES                        
|PART II. OTHER INFORMATION                                        
|                                                                   | ITEM 1. LEGAL PROCEEDINGS                                                                    
|                                                                   | ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                            
|                                                                   | ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                      
|                                                                   | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                                                                   | ITEM 5. OTHER INFORMATION                                                                    
|                                                                   | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                                                        
|Exhibit 10.28                                                     
|Exhibit 10.29                                                     
|Exhibit 15.1                                                      
|Exhibit 31                                                        
|Exhibit 32                                                        



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##### Table of Contents



QUESTCOR PHARMACEUTICALS, INC.

FORM 10-Q

TABLE OF CONTENTS

|           |  |                                                                                                           |  |     
|---------- |  | --------------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                           |  | Page
|           |  |                                                                                                           |  |     
|           |  | PART I. FINANCIAL INFORMATION                                                                             |  |     
|Item 1     |  | Financial Statements and Notes (Unaudited)                                                                |  | 3   
|           |  | Condensed Consolidated Balance SheetsJune 30, 2003 and December 31, 2002                                 |  | 3   
|           |  | Condensed Consolidated Statements of Operationsfor the three and six months ended
June 30, 2003 and 2002 |  | 4   
|           |  | Condensed Consolidated Statements of Cash Flowsfor the six months ended June 30,
2003 and 2002           |  | 5   
|           |  | Notes to Condensed Consolidated Financial Statements                                                      |  | 6   
|           |  | Independent Accountants Review Report                                                                    |  | 13  
|Item 2     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                     |  | 14  
|Item 3     |  | Quantitative and Qualitative Disclosures about Market Risk                                                |  | 31  
|Item 4     |  | Disclosure Controls and Procedures                                                                        |  | 31  
|           |  | PART II. OTHER INFORMATION                                                                                |  |     
|Item 1     |  | Legal Proceedings                                                                                         |  | 32  
|Item 2     |  | Changes in Securities and Use of Proceeds                                                                 |  | 32  
|Item 3     |  | Defaults upon Senior Securities                                                                           |  | 32  
|Item 4     |  | Submission of Matters to a Vote of Security Holders                                                       |  | 32  
|Item 5     |  | Other Information                                                                                         |  | 34  
|Item 6     |  | Exhibits and Reports                                                                                      |  | 34  
|Signatures |  |                                                                                                           |  | 36  

2



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##### Table of Contents






ITEM 1. FINANCIAL STATEMENTS




QUESTCOR PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARES)

|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         |             |        |              |         |   |        | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------ | ------- | ----------- | ------ | ------------ | ------- | - | ------ | 
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         | June 30,    |        | December 31,
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         | 2003        |        | 2002        
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         |             |        |             
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         | (Unaudited) |        | (Note 1)    
|ASSETS                                                                                                                                                                                                                                   |                                                                                                                                                                                     |  |                                            |         |             |        |              |        
|Current assets:                                                                                                                                                                                                                          |                                                                                                                                                                                     |  |                                            |         |             |        |              |        
|                                                                                                                                                                                                                                         | Cash and cash equivalents                                                                                                                                                           |  | $                                          | 5,624   |             |        | $            | 6,156   |  
|                                                                                                                                                                                                                                         | Short-term investments                                                                                                                                                              |  |                                            | 3,317   |             |        |              | 1,350   |  
|                                                                                                                                                                                                                                         | Accounts receivable, net of allowances of
$42 at June 30, 2003 and $49 at December 31, 2002                                                                                         |  |                                            | 1,359   |             |        |              | 1,590   |  
|                                                                                                                                                                                                                                         | Inventories, net                                                                                                                                                                    |  |                                            | 951     |             |        |              | 391     |  
|                                                                                                                                                                                                                                         | Prepaid expenses and other current assets                                                                                                                                           |  |                                            | 644     |             |        |              | 979     |  
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         |             |        |              |        
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  | Total current assets                       |         |             | 11,895 |              |         |   | 10,466 | 
|Property and equipment, net                                                                                                                                                                                                              |                                                                                                                                                                                     |  | 737                                        |         |             |        | 585          |        
|Purchased technology, net                                                                                                                                                                                                                |                                                                                                                                                                                     |  | 14,360                                     |         |             |        | 382          |        
|Goodwill and other indefinite lived intangible assets                                                                                                                                                                                    |                                                                                                                                                                                     |  | 479                                        |         |             |        | 479          |        
|Deposits and other assets                                                                                                                                                                                                                |                                                                                                                                                                                     |  | 839                                        |         |             |        | 854          |        
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         |             |        |              |        
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  | Total assets                               |         | $           | 28,310 |              |         | $ | 12,766 | 
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         |             |        |              |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                     |                                                                                                                                                                                     |  |                                            |         |             |        |              |        
|Current liabilities:                                                                                                                                                                                                                     |                                                                                                                                                                                     |  |                                            |         |             |        |              |        
|                                                                                                                                                                                                                                         | Accounts payable                                                                                                                                                                    |  | $                                          | 1,301   |             |        | $            | 1,230   |  
|                                                                                                                                                                                                                                         | Accrued compensation                                                                                                                                                                |  |                                            | 579     |             |        |              | 794     |  
|                                                                                                                                                                                                                                         | Other accrued liabilities                                                                                                                                                           |  |                                            | 950     |             |        |              | 1,205   |  
|                                                                                                                                                                                                                                         | Payable relating to product acquisition                                                                                                                                             |  |                                            | 5,183   |             |        |              |        |  
|                                                                                                                                                                                                                                         | Short-term debt and current portion of long-term debt                                                                                                                               |  |                                            | 87      |             |        |              | 218     |  
|                                                                                                                                                                                                                                         | Current portion of capital lease obligations                                                                                                                                        |  |                                            |        |             |        |              | 1       |  
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         |             |        |              |         |  
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  | Total current liabilities                  |         |             | 8,100  |              |         |   | 3,448  | 
|Convertible debentures, (face amount of $4,000), net of deemed
discount
of $845 at June 30, 2003 and $1,092 at December 31, 2002                                                                                                         |                                                                                                                                                                                     |  | 3,155                                      |         |             |        | 2,908        |        
|Other non-current liabilities                                                                                                                                                                                                            |                                                                                                                                                                                     |  | 851                                        |         |             |        | 833          |        
|Commitments                                                                                                                                                                                                                              |                                                                                                                                                                                     |  |                                            |         |             |        |              |        
|Preferred stock, no par value, 7,500,000 shares authorized; 2,155,715
Series A shares issued and outstanding at June 30, 2003 and
December 31, 2002 (aggregate liquidation preference of $10,000 at
June 30, 2003 and December 31, 2002) |                                                                                                                                                                                     |  | 5,081                                      |         |             |        | 5,081        |        
|Stockholders equity:                                                                                                                                                                                                                    |                                                                                                                                                                                     |  |                                            |         |             |        |              |        
|                                                                                                                                                                                                                                         | Preferred stock, no par value, 10,000 Series B shares issued and
outstanding at June 30, 2003, net of issuance costs (aggregate
liquidation preference of $10,000 at June 30, 2003) |  |                                            | 9,178   |             |        |              |        |  
|                                                                                                                                                                                                                                         | Common stock, no par value, 105,000,000 shares authorized;
44,268,602 and 38,676,592 shares issued and outstanding at June 30, 2003 and December 31, 2002, respectively             |  |                                            | 84,237  |             |        |              | 77,528  |  
|                                                                                                                                                                                                                                         | Deferred compensation                                                                                                                                                               |  |                                            | (24     | )           |        |              | (22     | )
|                                                                                                                                                                                                                                         | Accumulated deficit                                                                                                                                                                 |  |                                            | (82,268 | )           |        |              | (76,968 | )
|                                                                                                                                                                                                                                         | Accumulated other comprehensive loss                                                                                                                                                |  |                                            |        |             |        |              | (42     | )
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         |             |        |              |         |  
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  | Total stockholders equity                 |         |             | 11,123 |              |         |   | 496    | 
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         |             |        |              |        
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  | Total liabilities and stockholders equity |         | $           | 28,310 |              |         | $ | 12,766 | 
|                                                                                                                                                                                                                                         |                                                                                                                                                                                     |  |                                            |         |             |        |              |         |  

See accompanying notes.

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QUESTCOR PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

|                                                                                              |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |       |       | 
|--------------------------------------------------------------------------------------------- | ------------------------------------- | ---------------------------------- | ------ | ------------------ | ----- | ---------------- | ------ | -------- | ----- | -------- | ------ | ----- | ----- | - | ------ | ----- | ----- | 
|                                                                                              |                                       |                                    |        | Three Months Ended |       | Six Months Ended
|                                                                                              |                                       |                                    |        |                    |       |                 
|                                                                                              |                                       |                                    |        | June 30,           |       | June 30,         |        | June 30, |       | June 30,
|                                                                                              |                                       |                                    |        | 2003               |       | 2002             |        | 2003     |       | 2002    
|                                                                                              |                                       |                                    |        |                    |       |                  |        |          |       |         
|Revenues:                                                                                     |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |      
|                                                                                              | Net product sales                     |                                    | $      | 2,880              |       |                  | $      | 3,307    |       |          | $      | 5,242 |       |   | $      | 7,113 |      
|                                                                                              | Grant and royalty revenue             |                                    |        | 25                 |       |                  |        | 84       |       |          |        | 34    |       |   |        | 132   |      
|                                                                                              | Technology revenue                    |                                    |        |                   |       |                  |        | 250      |       |          |        | 250   |       |   |        | 250   |      
|                                                                                              | Services revenue from a related party |                                    |        |                   |       |                  |        | 100      |       |          |        |      |       |   |        | 100   |      
|                                                                                              |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |      
|                                                                                              |                                       | Total revenues                     |        |                    | 2,905 |                  |        |          | 3,741 |          |        |       | 5,526 |   |        |       | 7,595 | 
|                                                                                              |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |      
|Operating costs and expenses:                                                                 |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |      
|                                                                                              | Cost of product sales                 |                                    |        | 1,149              |       |                  |        | 728      |       |          |        | 1,824 |       |   |        | 1,362 |      
|                                                                                              | Sales and marketing                   |                                    |        | 1,501              |       |                  |        | 1,652    |       |          |        | 2,986 |       |   |        | 3,027 |      
|                                                                                              | General and administrative            |                                    |        | 1,016              |       |                  |        | 1,216    |       |          |        | 2,334 |       |   |        | 2,747 |      
|                                                                                              | Research and development              |                                    |        | 711                |       |                  |        | 682      |       |          |        | 1,322 |       |   |        | 1,110 |      
|                                                                                              | Depreciation and amortization         |                                    |        | 212                |       |                  |        | 315      |       |          |        | 381   |       |   |        | 659   |      
|                                                                                              |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |      
|                                                                                              |                                       | Total operating costs and expenses |        |                    | 4,589 |                  |        |          | 4,593 |          |        |       | 8,847 |   |        |       | 8,905 | 
|                                                                                              |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |      
|Loss from operations                                                                          |                                       |                                    | (1,684 | )                  |       |                  | (852   | )        |       |          | (3,321 | )     |       |   | (1,310 | )    
|Non-cash amortization of deemed discount on convertible debentures                            |                                       |                                    | (130   | )                  |       |                  | (131   | )        |       |          | (261   | )     |       |   | (175   | )    
|Interest income (expense), net                                                                |                                       |                                    | (18    | )                  |       |                  | (13    | )        |       |          | (14    | )     |       |   | 14     |      
|Other expense, net                                                                            |                                       |                                    | (3     | )                  |       |                  | (181   | )        |       |          | (80    | )     |       |   | (110   | )    
|Rental income, net                                                                            |                                       |                                    | 66     |                    |       |                  | 74     |          |       |          | 137    |       |       |   | 146    |      
|                                                                                              |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |      
|Net loss                                                                                      |                                       |                                    | (1,769 | )                  |       |                  | (1,103 | )        |       |          | (3,539 | )     |       |   | (1,435 | )    
|Non-cash deemed dividend related to beneficial conversion feature of
Series B Preferred Stock |                                       |                                    | 93     |                    |       |                  |       |          |       |          | 1,394  |       |       |   |       |      
|Dividends on Series B Preferred Stock                                                         |                                       |                                    | 200    |                    |       |                  |       |          |       |          | 367    |       |       |   |       |      
|                                                                                              |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |      
|Net loss applicable to common stockholders                                                    |                                       | $                                  | (2,062 | )                  |       | $                | (1,103 | )        |       | $        | (5,300 | )     |       | $ | (1,435 | )    
|                                                                                              |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |      
|Basic and diluted net loss per common share applicable to common stockholders                 |                                       | $                                  | (0.05  | )                  |       | $                | (0.03  | )        |       | $        | (0.13  | )     |       | $ | (0.04  | )    
|                                                                                              |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |      
|Weighted average shares of common stock outstanding                                           |                                       |                                    | 39,949 |                    |       |                  | 38,468 |          |       |          | 39,316 |       |       |   | 38,157 |      
|                                                                                              |                                       |                                    |        |                    |       |                  |        |          |       |          |        |       |       |   |        |      

See accompanying notes.

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QUESTCOR PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

(IN THOUSANDS)

|                                                                            |                                                           |   |                  |       |               |   |        |        |  
|--------------------------------------------------------------------------- | --------------------------------------------------------- | - | ---------------- | ----- | ------------- | - | ------ | ------ | -
|                                                                            |                                                           |   | Six Months Ended
|                                                                            |                                                           |   |                 
|                                                                            |                                                           |   | June 30, 2003    |       | June 30, 2002
|                                                                            |                                                           |   |                  |       |              
|OPERATING ACTIVITIES                                                        |                                                           |   |                  |       |               |   |        |       
|Net loss                                                                    |                                                           | $ | (3,539           | )     |               | $ | (1,435 | )     
|Adjustments to reconcile net loss to net cash used in operating activities: |                                                           |   |                  |       |               |   |        |       
|                                                                            | Stock-based compensation expense                          |   |                  | 25    |               |   |        | 311    |  
|                                                                            | Amortization of deemed discount on convertible debentures |   |                  | 261   |               |   |        | 175    |  
|                                                                            | Amortization of deferred compensation                     |   |                  | 13    |               |   |        |       |  
|                                                                            | Depreciation and amortization                             |   |                  | 381   |               |   |        | 659    |  
|                                                                            | Other-than-temporary loss on investment                   |   |                  | 51    |               |   |        | 181    |  
|                                                                            | Deferred rent expense                                     |   |                  | 18    |               |   |        | (24    | )
|                                                                            | Loss on the sale of investments                           |   |                  | 14    |               |   |        |       |  
|                                                                            | (Gain)/Loss on the sale of equipment, net                 |   |                  | 13    |               |   |        | (2     | )
|Changes in operating assets and liabilities:                                |                                                           |   |                  |       |               |   |        |       
|                                                                            | Accounts receivable                                       |   |                  | 231   |               |   |        | (1,035 | )
|                                                                            | Receivable from a related party                           |   |                  |      |               |   |        | (244   | )
|                                                                            | Inventories                                               |   |                  | (495  | )             |   |        | (321   | )
|                                                                            | Prepaid expenses and other current assets                 |   |                  | 319   |               |   |        | (102   | )
|                                                                            | Accounts payable                                          |   |                  | 71    |               |   |        | 270    |  
|                                                                            | Accrued compensation                                      |   |                  | (215  | )             |   |        | 3      |  
|                                                                            | Other accrued liabilities                                 |   |                  | (255  | )             |   |        | 237    |  
|                                                                            |                                                           |   |                  |       |               |   |        |       
|Net cash flows used in operating activities                                 |                                                           |   | (3,107           | )     |               |   | (1,327 | )     
|                                                                            |                                                           |   |                  |       |               |   |        |       
|INVESTING ACTIVITIES                                                        |                                                           |   |                  |       |               |   |        |       
|Purchase of property and equipment                                          |                                                           |   | (298             | )     |               |   | (309   | )     
|Purchase of short-term investments                                          |                                                           |   | (3,058           | )     |               |   |       |       
|Acquisition of purchased technology                                         |                                                           |   | (9,124           | )     |               |   |       |       
|Proceeds from maturities and sales of short-term investments                |                                                           |   | 1,068            |       |               |   |       |       
|Proceeds from sale of property and equipment                                |                                                           |   | 15               |       |               |   | 19     |       
|Decrease in other assets                                                    |                                                           |   | 1                |       |               |   | 48     |       
|                                                                            |                                                           |   |                  |       |               |   |        |       
|Net cash flows used in investing activities                                 |                                                           |   | (11,396          | )     |               |   | (242   | )     
|                                                                            |                                                           |   |                  |       |               |   |        |       
|FINANCING ACTIVITIES                                                        |                                                           |   |                  |       |               |   |        |       
|Issuance of common stock, net                                               |                                                           |   | 5,065            |       |               |   | 532    |       
|Issuance of Series B preferred stock and warrants, net                      |                                                           |   | 9,404            |       |               |   |       |       
|Issuance of convertible debentures                                          |                                                           |   |                 |       |               |   | 4,000  |       
|Short-term borrowings                                                       |                                                           |   | 288              |       |               |   | 119    |       
|Repayment of note payable to bank                                           |                                                           |   |                 |       |               |   | (5,000 | )     
|Repayment of short-term and long-term debt                                  |                                                           |   | (418             | )     |               |   | (254   | )     
|Payment of Series B preferred stock dividends                               |                                                           |   | (367             | )     |               |   |       |       
|Repayments of capital lease obligations                                     |                                                           |   | (1               | )     |               |   | (28    | )     
|                                                                            |                                                           |   |                  |       |               |   |        |       
|Net cash flows provided by/(used in) financing activities                   |                                                           |   | 13,971           |       |               |   | (631   | )     
|                                                                            |                                                           |   |                  |       |               |   |        |       
|Decrease in cash and cash equivalents                                       |                                                           |   | (532             | )     |               |   | (2,200 | )     
|Cash and cash equivalents at beginning of period                            |                                                           |   | 6,156            |       |               |   | 10,183 |       
|                                                                            |                                                           |   |                  |       |               |   |        |       
|Cash and cash equivalents at end of period                                  |                                                           | $ | 5,624            |       |               | $ | 7,983  |       
|                                                                            |                                                           |   |                  |       |               |   |        |       
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                           |                                                           |   |                  |       |               |   |        |       
|                                                                            | Cash paid for interest                                    |   | $                | 170   |               |   | $      | 60     |  
|                                                                            |                                                           |   |                  |       |               |   |        |       
|                                                                            | Amount payable relating to product acquisition            |   | $                | 5,183 |               |   | $      |       |  
|                                                                            |                                                           |   |                  |       |               |   |        |       

See accompanying notes.

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QUESTCOR PHARMACEUTICALS, INC.

NOTES TO CONDENSED CONSOLIDATED JUNE 30, 2003 FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

Questcor Pharmaceuticals, Inc. (the Company) is a specialty
pharmaceutical company that markets and sells brand name prescription drugs and
ethically promoted healthcare products. The Company focuses on the treatment of
acute and critical care conditions, including central nervous system (CNS)
diseases and gastroenterological disorders. The Companys strategy is to
acquire pharmaceutical products that it believes have sales growth potential,
are promotion sensitive and complement the Companys existing products. In
addition, through corporate collaborations, the Company intends to develop new
patented intranasal formulations of previously FDA approved drugs. The Company
currently markets six products in the U.S.: HP Acthar® Gel (Acthar), an
injectable drug that is approved for the treatment of certain CNS disorders
with an inflammatory component including the treatment of flares associated
with Multiple Sclerosis (MS) and is commonly used in treating patients with
infantile spasm; Nascobal®, a nasal gel used for the treatment of various
Vitamin B-12 deficiencies; Ethamolin®, an injectable drug used to treat
enlarged weakened blood vessels at the entrance to the stomach that have
recently bled, known as esophageal varices; Glofil®-125 and Inulin in Sodium
Chloride, which are both injectable agents that assess how well the kidney is
working by measuring glomerular filtration rate, or kidney function; and
VSL#3, a patented probiotic marketed as a dietary supplement to promote normal
gastrointestinal function. Probiotics are living organisms in food and dietary
supplements, which, upon ingestion in certain numbers, improve the health of
the host beyond their inherent basic nutrition. On June 17, 2003, the Company
acquired Nascobal®, a nasal gel formulation of Cyanocobalamin USP (Vitamin
B-12), from Nastech Pharmaceutical Company, Inc. (Nastech). The Company
began selling Nascobal in July 2003. The Company intends to market Nascobal to
patients with severe deficiencies of Vitamin B-12 caused by MS and Crohns
Disease as these patients frequently have severe deficiencies of Vitamin B-12
due to a compromised ability to absorb Vitamin B-12 through the
gastrointestinal system. In June 2002, the Company signed a license agreement
with Fabre Kramer Pharmaceuticals, Inc., whereby Fabre Kramer will manage and
provide funding for the clinical development programs for Hypnostat (an
intranasal triazolam for the treatment of insomnia) and Panistat (an
intranasal alprazolam for the treatment of panic disorders).

The accompanying unaudited consolidated financial statements of the
Company have been prepared in accordance with accounting principles generally
accepted in the United States and applicable Securities and Exchange Commission
regulations for interim financial information. These financial statements do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. The unaudited financial statements should be read in conjunction
with the audited financial statements and related footnotes included in the
Companys Annual Report on Form 10-K for the year ended December 31, 2002, as
filed on March 26, 2003 with the Securities and Exchange Commission. The
accompanying balance sheet at December 31, 2002 has been derived from the
audited financial statements at that date. In the opinion of the Companys
management, all adjustments (consisting of normal recurring adjustments)
considered necessary for fair presentation of interim financial information
have been included. Operating results for the interim periods presented are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2003. Certain amounts in the prior quarters financial statements
have been reclassified to conform with the current quarters presentation. The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.

2. STOCK-BASED COMPENSATION

The Company generally grants stock options to its employees for a fixed
number of shares with an exercise price equal to the fair value of the shares
on the date of grant. As allowed under the Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), the
Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25) and related
interpretations in accounting for stock awards to employees. Accordingly, no
compensation expense is recognized in the Companys financial statements in
connection with stock options granted to employees with exercise prices not
less than fair value. Deferred compensation for options granted to employees is
determined as the difference between the deemed fair market value of the
Companys common stock on the date options were granted and the exercise price.
For purposes of disclosures pursuant to SFAS 123, as amended by SFAS 148, the
estimated fair value of options is amortized to expense over the options
vesting periods.

Compensation expense for options granted to non-employees has been
determined in accordance with SFAS 123 as the fair value of the consideration
received or the fair value of the equity instruments issued, whichever is more
reliably measured. Compensation expense for options granted to non-employees is
periodically re-measured as the underlying options vest.

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The following table illustrates the effect on net loss per share if the
Company had applied the fair value recognition provisions of SFAS 123 to
stock-based employee compensation (in thousands, except per share amounts):

|                                                                        |                                                                                                           |   |                             |       |                           |   |        |       |      |   |        |       |   |   |        |       |  
|----------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------- | - | --------------------------- | ----- | ------------------------- | - | ------ | ----- | ---- | - | ------ | ----- | - | - | ------ | ----- | -
|                                                                        |                                                                                                           |   | Three months ended June 30, |       | Six months ended June 30,
|                                                                        |                                                                                                           |   |                             |       |                          
|                                                                        |                                                                                                           |   | 2003                        |       | 2002                      |   | 2003   |       | 2002
|                                                                        |                                                                                                           |   |                             |       |                           |   |        |       |     
|Net loss applicable to common stockholders, as reported                 |                                                                                                           | $ | (2,062                      | )     |                           | $ | (1,103 | )     |      | $ | (5,300 | )     |   | $ | (1,435 | )    
|                                                                        | Add: Stock-based employee compensation expense
included
in reported net loss                              |   |                             | 7     |                           |   |        | 3     |      |   |        | 14    |   |   |        | 7     |  
|                                                                        | Deduct: Total stock-based employee compensation
expense
determined under fair value method for all awards |   |                             | (310  | )                         |   |        | (418  | )    |   |        | (666  | ) |   |        | (773  | )
|                                                                        |                                                                                                           |   |                             |       |                           |   |        |       |      |   |        |       |   |   |        |      
|Net loss applicable to common stockholders, pro forma                   |                                                                                                           | $ | (2,365                      | )     |                           | $ | (1,518 | )     |      | $ | (5,952 | )     |   | $ | (2,201 | )    
|                                                                        |                                                                                                           |   |                             |       |                           |   |        |       |      |   |        |       |   |   |        |      
|Basic and diluted net loss per share applicable to
common stockholders: |                                                                                                           |   |                             |       |                           |   |        |       |      |   |        |       |   |   |        |      
|                                                                        | As reported                                                                                               |   | $                           | (0.05 | )                         |   | $      | (0.03 | )    |   | $      | (0.13 | ) |   | $      | (0.04 | )
|                                                                        |                                                                                                           |   |                             |       |                           |   |        |       |      |   |        |       |   |   |        |      
|                                                                        | Pro forma                                                                                                 |   | $                           | (0.06 | )                         |   | $      | (0.04 | )    |   | $      | (0.15 | ) |   | $      | (0.06 | )
|                                                                        |                                                                                                           |   |                             |       |                           |   |        |       |      |   |        |       |   |   |        |      

3. REVENUE RECOGNITION

Revenues from product sales of Acthar, Ethamolin, Glofil-125, Inulin and
VSL#3 are recognized based upon shipping terms, net of estimated reserves for
sales returns, government chargebacks, Medicaid rebates, and discounts. Revenue
is recognized upon shipment of product, provided the title to the products has
been transferred at the point of shipment. If title of product transfers at
point of receipt by the customer, revenue is recognized upon customer receipt
of the shipment. The Company records estimated sales allowances against product
revenues for expected returns, chargebacks, Medicaid rebates and discounts
based on historical sales returns, chargebacks, and Medicaid rebates, analysis
of return merchandise authorizations and other known factors such as shelf life
of products, as required. The Company continually assesses the historical
returns and other experience including customers compliance with return goods
policy and adjusts its allowances as appropriate. The Companys return policy
allows customers to return expired product for exchange within six months
beyond the expiration date. Effective August 12, 2002 the Company changed its
return goods policy such that it no longer issues credit memorandums for
returns. Rather, returns are exchanged for replacement product, and estimated
costs for such exchanges, which include actual product material costs and
related shipping charges, are included in Cost of product sales. Returns are
subject to quality assurance reviews prior to acceptance. The Company sells
product to wholesalers, who in turn sell its products to pharmacies and
hospitals. In the case of VSL#3, the Company sells directly to consumers. The
Company does not require collateral from its customers.

Revenue earned under collaborative research agreements is recognized as
the research services are performed. Amounts received in advance of services to
be performed are recorded as deferred revenue until the services are performed.

The Company has received government grants that support the Companys
research effort in specific research projects. These grants provide for
reimbursement of approved costs incurred as defined in the various awards.

The Company has received payments in exchange for proprietary licenses
related to technology and patents. The Company classifies these payments as
Technology Revenue. These payments are recognized as revenues upon receipt of
cash and the transfer of intellectual property, data and other rights licensed,
assuming no continuing material obligations exist.

Shipping and handling costs are included in Cost of product sales.

4. NASCOBAL ACQUISITION

On June 17, 2003, the Company acquired Nascobal, a nasal gel formulation
of Cyanocobalamin USP (Vitamin B-12), from Nastech. Under the terms of the
Nascobal Asset Purchase Agreement, the Company made an initial cash payment of
$9 million upon the closing of the acquisition and is required to pay an
additional $5.2 million payable on or before December 31, 2003. The $5.2
million payable is included in Payable relating to product acquisition on the
accompanying Condensed Consolidated Balance Sheet. As part of the acquisition,
the Company is also acquiring rights to Nascobal nasal spray, an improved
dosage form, for which a New Drug Application (NDA) is expected to be filed by Nastech with the FDA
before the end of 2003. Nastech retains a security interest in the patents,
trademarks, and other intellectual property relating to Nascobal. Subject to
the approval of the NDA for the new Nascobal nasal
spray dosage form by the FDA, the Company is required to make a $2 million
payment for the transfer of the NDA from Nastech to the Company. Further,
subject to the approval of the NDA for the new Nascobal nasal spray dosage form
and upon

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issuance of a pending U.S. patent for the new Nascobal nasal spray
dosage form, the Company is required to make a second $2 million
payment. The Company and Nastech have also entered into a long term
supply agreement under which Nastech will continue to manufacture Nascobal for
the Company at its FDA approved, cGMP manufacturing facility in Hauppauge, New
York.

The Company accounted for the product acquisition as an asset purchase and
allocated the purchase price based on the fair value of the assets acquired. Of
the purchase cost of $14.3 million, which includes acquisition costs of $0.1
million, $14.2 million was attributed to Purchased technology, and $0.1 million
to inventory. Purchased technology will be amortized over the estimated life
of 15 years. Amortization expense will be approximately $511,000 for 2003,
approximately $949,000 per year from 2004 through 2017, and approximately
$435,000 for 2018.

5. CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

The Company considers highly liquid investments with maturities from the
date of purchase of three months or less to be cash equivalents. At June 30,
2003, the Company had cash, cash equivalents and short-term investments of
$8,941,000.

Following is a summary of investments, at fair value, based on quoted
market prices for these investments (in thousands):

|                        |                              |                |       |                 |       |            |           |     |   |   |       |       | 
|----------------------- | ---------------------------- | -------------- | ----- | --------------- | ----- | ---------- | --------- | --- | - | - | ----- | ----- | 
|                        |                              |                | Gross |                 | Gross |            | Estimated
|June 30, 2003           |                              | Amortized Cost |       | Unrealized Gain |       | Fair Value
|                        |                              |                |       |                 |       |           
|Cash equivalents:       |                              |                |       |                 |       |            |           |     |   |   |       |      
|                        | Money Market Funds           |                | $     | 5,708           |       |            | $         |    |   |   | $     | 5,708 | 
|                        |                              |                |       |                 |       |            |           |     |   |   |       |      
|                        |                              | $              | 5,708 |                 |       |            |          |     |   | $ | 5,708 |      
|                        |                              |                |       |                 |       |            |           |     |   |   |       |       | 
|Short-term investments: |                              |                |       |                 |       |            |           |     |   |   |       |      
|                        | Commercial Paper             |                | $     | 249             |       |            | $         |    |   |   | $     | 249   | 
|                        | Corporate Bonds              |                |       | 3,067           |       |            |           | 1   |   |   |       | 3,068 | 
|                        |                              |                |       |                 |       |            |           |     |   |   |       |      
|                        |                              | $              | 3,316 |                 |       | $          | 1         |     |   | $ | 3,317 |      
|                        |                              |                |       |                 |       |            |           |     |   |   |       |       | 
|                       
|                        |                              |                | Gross |                 | Gross |            | Estimated
|December 31, 2002       |                              | Amortized Cost |       | Unrealized Loss |       | Fair Value
|                        |                              |                |       |                 |       |           
|Cash equivalents:       |                              |                |       |                 |       |            |           |     |   |   |       |      
|                        | Money Market Funds           |                | $     | 5,400           |       |            | $         |    |   |   | $     | 5,400 | 
|                        | Commercial Paper             |                |       | 499             |       |            |           |    |   |   |       | 499   | 
|                        |                              |                |       |                 |       |            |           |     |   |   |       |       | 
|                        |                              | $              | 5,899 |                 |       | $          |          |     |   | $ | 5,899 |      
|                        |                              |                |       |                 |       |            |           |     |   |   |       |       | 
|Short-term investments: |                              |                |       |                 |       |            |           |     |   |   |       |      
|                        | Commercial Paper             |                | $     | 498             |       |            | $         |    |   |   | $     | 498   | 
|                        | Corporate Bonds              |                |       | 761             |       |            |           |    |   |   |       | 761   | 
|                        | Corporate Equity Investments |                |       | 133             |       |            |           | (42 | ) |   |       | 91    | 
|                        |                              |                |       |                 |       |            |           |     |   |   |       |      
|                        |                              | $              | 1,392 |                 |       | $          | (42       | )   |   | $ | 1,350 |      
|                        |                              |                |       |                 |       |            |           |     |   |   |       |       | 

In 2003, the Company recognized an other-than-temporary loss of $51,000
and a realized loss of $14,000 related to its Rigel equity investment. These
amounts are included in other income (expense) on the accompanying Consolidated
Statement of Operations.

6. INVENTORIES

Inventories are stated at the lower of cost (first-in, first-out method)
or market and consist of the following (in thousands):

|                                                   |  |          |      |              |  |   |     |  
|-------------------------------------------------- |  | -------- | ---- | ------------ |  | - | --- | -
|                                                   |  | June 30, |      | December 31,
|                                                   |  | 2003     |      | 2002        
|                                                   |  |          |      |             
|Raw materials                                      |  | $        | 521  |              |  | $ | 70  |  
|Work in process                                    |  |          | 77   |              |  |   |    |  
|Finished goods                                     |  |          | 645  |              |  |   | 397 |  
|Less allowance for excess and obsolete inventories |  |          | (292 | )            |  |   | (76 | )
|                                                   |  |          |      |              |  |   |     |  
|                                                   |  | $        | 951  |              |  | $ | 391 |  
|                                                   |  |          |      |              |  |   |     |  

7. INTANGIBLE ASSETS

Goodwill and assembled workforce no longer subject to amortization
amounted to $479,000 at June 30, 2003 and December 31, 2002. In accordance
with SFAS 141 and 142, the Company discontinued the amortization of goodwill on
January 1, 2002. The

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Company performed an impairment test of goodwill as of
January 1, 2003, which did not result in an impairment charge. The Company will
continue to monitor the carrying value of goodwill through the annual
impairment tests.

Purchased technology at June 30, 2003 includes $14.2 million related to
the Nascobal acquisition, see Note 4  Nascobal Acquisition. The Nascobal
purchased technology is being amortized over its estimated life of 15 years.
The remaining net balance of $155,000 at June 30, 2003 and $382,000 at December
31, 2002 is being amortized over the estimated sales life of the associated
product (seven years), which will be amortized in full during the fourth
quarter of 2003.

8. LINE OF CREDIT

In January 2002, the Company entered into a revolving accounts receivable
line of credit with Pacific Business Funding, a division of Greater Bay
Bancorp. Under the agreement, the Company can borrow up to the lesser of 80% of
its eligible accounts receivable balance or $3,000,000. Interest accrues on
outstanding advances at an annual rate equal to prime rate plus four and
one-half percent. The term of the agreement is one year and the agreement
automatically renews annually, unless terminated by the Company. There were no
borrowings under this line of credit as of June 30, 2003. The line of credit is
secured by a blanket lien on all assets including intellectual property. As of
June 30, 2003, $958,000 was available for borrowing under the line of credit.

9. NET LOSS PER SHARE APPLICABLE TO COMMON STOCKHOLDERS

Basic and diluted net loss per share applicable to common stockholders is
based on net loss applicable to common stockholders for the relevant period,
divided by the weighted average number of common shares outstanding during the
period. Diluted earnings per share applicable to common stockholders gives
effect to all potentially dilutive common shares outstanding during the period
such as options, warrants, convertible preferred stock, and contingently
issuable shares. Diluted net loss per share applicable to common stockholders
has not been presented separately as, due to the Companys net loss position,
it is anti-dilutive. Had the Company been in a net income position at June 30,
2003, shares used in calculating diluted earnings per share applicable to
common stockholders would have included the dilutive effect of an additional
9,327,494 stock options, 12,780,446 convertible preferred shares, 2,531,646
shares issuable upon conversion of debentures (if dilutive), placement unit
options for 127,676 shares and 10,340,711 warrants.

10. EQUITY TRANSACTIONS

In March 2003, a warrant was exercised through a cashless exercise in
accordance with the terms of the warrant, and 315,827 shares of common stock
were issued.

In May 2003, the number of authorized shares of the Companys no par value
common stock was increased from 75,000,000 to 105,000,000.

In May 2003, the Companys 2003 Employee Stock Purchase Plan was approved
by shareholders. The Company has reserved 900,000 shares of common stock for
issuance under the plan.

In May 2003, the aggregate number of shares of Common Stock authorized for
issuance under the Companys 1992 Employee Stock Option Plan was increased by
1,000,000 shares, from 12,500,000 shares to 13,500,000 shares.

In June 2003, a warrant was exercised through a cashless exercise in
accordance with the terms of the warrant, and 72,168 shares of common stock
were issued.

On June 11, 2003, the Company consummated a private placement of its
Common Stock and warrants to purchase Common Stock. The Company issued
4,979,360 shares of Common Stock in the private placement at $1.01 per share,
which was the volume weighted average price of the Common Stock for the five
days prior to and including the close of the private placement. Gross proceeds
to the Company from the private placement were approximately $5 million. Net
of issuance costs, the proceeds to the Company were $4.9 million.

The purchasers of the Common Stock also received for no additional
consideration warrants exercisable for an aggregate of 2,987,616 shares of
Common Stock at an exercise price of $1.26 per share, which represented a 25%
premium to the volume weighted average price of the Common Stock for the five
days prior to and including the close of the private placement. The warrants
expire in June 2008.

11. SERIES B CONVERTIBLE PREFERRED STOCK

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In January 2003, the Company completed a private placement of Series B
Convertible Preferred Stock and warrants to purchase common stock to various
investors. Gross proceeds to the Company from the private placement were $10
million. Net of issuance costs, the proceeds to the Company were $9.4 million.

The Series B Preferred Stock has an aggregate stated value of $10 million
and each holder is entitled to a quarterly dividend at an initial rate of 8%
per year, which rate will increase to 10% per year on and after January 1,
2006, and to 12% on and after January 1, 2008. The dividends are paid in cash
on a quarterly basis. In addition, on the occurrence of designated events,
including the failure to maintain Net Cash, Cash Equivalent and Eligible
Investment Balances, as defined in the Companys Certificate of Determination
of Series B Preferred Stock (the Certificate of Determination), of at least
50% of the aggregate stated value of the outstanding shares of Series B
Preferred Stock, the dividend rate will increase by an additional 6% per year.
The Series B Preferred Stock is entitled to a liquidation preference over the
Companys common stock and Series A Preferred Stock upon a liquidation,
dissolution or winding up of the Company. The Series B Preferred Stock is
convertible at the option of the holder into the Companys common stock at a
conversion price of $0.9412 per share, subject to certain anti-dilution
adjustments. The Company has the right commencing on January 1, 2006 (assuming
specified conditions are met) to redeem the Series B Preferred Stock at a price
of 110% of stated value, together with all accrued and unpaid dividends and
accrued interest. In addition, upon the occurrence of designated Optional
Redemption Events (as defined below), the holders have the right to require the
Company to redeem the Series B Preferred Stock at 100% of stated value,
together with all accrued and unpaid dividends and interest. The Optional
Redemption Events include any of the following:



| |  |  | If the Company consolidates or merges with or into another entity
where the shareholders of the Company do not own at least 51% of the
surviving entity and such consolidation or merger is approved by the
Companys Board of Directors;                                                                                                                                                                                        
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | If the Company adopts any amendment to its Amended and Restated
Articles of Incorporation which materially and adversely affects the
rights of the holders of Series B Preferred Stock in respect of their
interests in shares of Common Stock that can be acquired upon conversion
of shares of Series B Preferred Stock in a manner different and more
adverse than it affects the rights of holders of Common Stock generally;
|
| |  |  | If the Company fails to declare or pay dividends in full on the
applicable dividend date, other than in circumstances where such
declaration or payment would not be permitted by Section 500 or 501 of
the California Corporations Code, or fails to pay certain redemption
prices on any share of Series B Preferred Stock when due;                                                                                           
|
| |  |  | If the Company fails to issue shares of Common Stock to any Series B
holder upon conversion or upon exercise of warrants when due;                                                                                                                                                                                                                                                                                               
|
| |  |  | If the Company commits certain breaches under, or otherwise violates
certain terms of, the transaction documents entered into in connection
with the issuance of the Series B Preferred Stock;                                                                                                                                                                                                                                   
|
| |  |  | If the Companys representations and warranties made in the
transaction documents entered into in connection with the issuance of
the Series B Preferred Stock are false or misleading in any material way
when made or deemed made; and                                                                                                                                                                                         
|
| |  |  | If the Company institutes a voluntary bankruptcy or similar
proceeding;                                                                                                                                                                                                                                                                                                                                                          

The redemption events described above are all within the control of the
Company. Therefore, in accordance with EITF Topic D-98, the Company has
classified the Series B Preferred Stock in permanent equity. In addition, the
Company initially recorded the Series B Preferred Stock at its fair value on
the date of issuance. The Company has elected not to adjust the carrying value
of the Series B Preferred Stock to the redemption value of such shares, since
it is uncertain whether or when the redemption events described above will
occur. Subsequent adjustments to increase the carrying value to the redemption
value will be made when it becomes probable that such redemption will occur. As
of June 30, 2003, the redemption value of the Series B Preferred Stock was $10
million.

The terms of the Series B Preferred Stock contain a variety of affirmative
and restrictive covenants, including limitations on indebtedness and liens.
Each share of Series B Preferred Stock is generally entitled to a number of
votes equal to 0.875 times the number of shares of Common Stock issuable upon
conversion of such share of Series B Preferred Stock. In addition, the Company
agreed that two of the investors are each entitled to appoint a representative
to attend Company Board of Directors meetings in a nonvoting observer capacity.

The purchasers of the Series B Preferred Stock also received for no
additional consideration warrants exercisable for an aggregate of 3,399,911
shares of Common Stock at an exercise price of $1.0824 per share, subject to
certain anti-dilution adjustments. The warrants expire in January 2007. The
warrants issued to the Series B holders were assigned a value of $1,527,000
which decreased the carrying value of the preferred stock. The warrants were valued using the
Black-Scholes method with the following assumptions: a

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risk free interest rate
of 3%; an expiration date of January 15, 2007; volatility of 82% and a dividend
yield of 0%. In connection with the issuance of the Series B Preferred Stock
and warrants, the Company recorded $1,301,000 related to the beneficial
conversion feature on the Series B Preferred Stock as a deemed dividend, which
increased the carrying value of the preferred stock. A beneficial conversion
feature is present because the effective conversion price of the Series B
Preferred Stock was less than the fair value of the Common Stock on the
commitment date. The deemed dividend increased the loss applicable to common
stockholders in the calculation of basic and diluted net loss per common share.

On June 13, 2003, the Company entered into agreements with the holders of
record of its Series B Preferred Stock, whereby the holders of Series B
Preferred Stock waived certain covenants and rights to receive additional
dividends as provided in the Certificate of Determination, which may have been
triggered as a result of the Nascobal acquisition and the use of the Companys
cash resources to pay the purchase price (the Acquisition). Specifically,
the holders of Series B Preferred Stock waived their right to receive an
additional aggregate six percent dividend in the event that the Acquisition
resulted in the Company being unable to satisfy the test set forth in Sections
500 and 501 of the California Corporations Code to allow for the Company to
redeem all of the issued and outstanding shares of Series B Preferred Stock.
Such waiver was granted through the earlier of (i) December 31, 2003 and (ii)
the date on which (A) the Companys assets (exclusive of goodwill, capitalized
research, and development expenses and deferred charges) equal less than 125%
of its liabilities (not including deferred taxes, deferred income and other
deferred credits) or (B) the Companys current assets equal less than 80% of
its current liabilities. Additionally, the holders of Series B Preferred
Stock waived their right to receive an additional aggregate six percent
dividend in the event that the Acquisition resulted in the Company being unable
to maintain Net Cash, Cash Equivalents and Eligible Investment Balances (as
defined in the Certificate of Determination) in an amount equal to $5 million.
Such waiver was granted through the earlier of (i) December 31, 2003 and (ii)
the date on which the Company fails to maintain Net Cash, Cash Equivalents and
Eligible Investment Balances in an amount equal to at least $2.5 million. The
holders of Series B Preferred Stock also agreed that: (i) the Acquisition would
not constitute a breach of the covenant in the Certificate of Determination
requiring the Company to use its best efforts to maintain compliance with
Sections 500 and 501 of the California Corporations Code to be able to pay
dividends on and to redeem all of the issued and outstanding shares of Series B
Preferred Stock; and (ii) the incurrence by the Company of contingent
obligations to pay additional amounts to Nastech of $5,183,333 and the granting
of a security interest in the acquired Nascobal product would not constitute a
breach of the covenants in the Certificate of Determination restricting the
Companys ability to incur indebtedness and create liens. In consideration of
such agreements, the Company agreed to adjust the exercise price of warrants to
purchase 3,399,911 shares of Common Stock previously issued by the Company to
the holders of Series B Preferred Stock from $1.0824 per share to $0.9412 per
share.

As a result of the decrease to the exercise price of the warrants, the
Company revalued the warrants issued to the Series B Preferred Stockholders,
resulting in an incremental value of $93,000 which decreased the carrying value
of the preferred stock. The warrants were valued using the Black-Scholes
method with the following assumptions: a risk free interest rate of 1.4%; an
expiration date of January 15, 2007; volatility of 70% and a dividend yield of
0%. In connection with the revaluation, the Company recorded $93,000 related to
the beneficial conversion feature on the Series B Preferred Stock as an
additional deemed dividend, which increased the carrying value of the Series B
Preferred Stock. The deemed dividend increased the net loss applicable to
common stockholders in the calculation of basic and diluted net loss per common
share.

12. RELATED PARTY TRANSACTIONS

In December 2001, the Company entered into a promotion agreement with VSL
Pharmaceuticals Inc. (VSL), a private company owned in part by the major
shareholders of Sigma Tau. Sigma Tau beneficially owned approximately 34% of
the Companys outstanding stock as of June 30, 2003. In June 2002, the Company
signed an amendment to the promotion agreement. Under these agreements, the
Company has agreed to purchase VSL#3 from VSL at a stated price, and has also
agreed to promote, sell, warehouse and distribute the VSL#3 product direct to
customers at its cost and expense, subject to certain expense reimbursements.
Revenues from sales of VSL#3 are recognized when product is shipped to the
customer. The Company does not accept returns of VSL#3. VSL#3 revenue for the
quarter ending June 30, 2003 was $222,000 and is included in Net product sales.
Included in Accounts Payable is $76,000 for amounts owed to VSL at June 30,
2003. An access fee to VSL is calculated quarterly, which varies based upon
sales and costs incurred by the Company subject to reimbursement under certain
circumstances. For the quarter ended June 30, 2003, the amount of reimbursable
costs incurred by the Company was greater than the amount owing to VSL. This
net reimbursement to the Company for the quarter ended June 30, 2003, of
$14,000 is included as a deduction in Sales and marketing expense in the
accompanying Consolidated Statement of Operations. During the quarter ended
June 30, 2003 the Company paid $103,000 to VSL for the purchase of VSL#3
product.

In January 2002, the Company entered into a royalty agreement with
Glenridge Pharmaceuticals LLC (Glenridge). Kenneth R. Greathouse, the
Companys Vice President of Commercial Operations, is a part owner of
Glenridge. This agreement calls for the payment of royalties on a quarterly
basis on the net sales of Acthar®. The Company paid Glenridge $56,000 and
$143,000 in the quarters ended June 30, 2003 and 2002, and $151,000 and $248,000 for the
six months ended June 30, 2003 and 2002, respectively,

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related to royalties on
Acthar® sales. The Company has accrued $79,000 for royalties earned in the
quarter ended June 30, 2003, which is included in Other accrued liabilities on
the accompanying Consolidated Balance Sheet.

13. COMPREHENSIVE LOSS

Comprehensive loss is comprised of net loss and the change in unrealized
holding gains and losses on available-for-sale securities.

|                           |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  
|-------------------------- |  | ------------------ | ------ | ---------------- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                           |  | Three Months Ended |        | Six Months Ended
|                           |  | June 30,           |        | June 30,        
|                           |  |                    |        |                 
|                           |  | 2003               |        | 2002             |  | 2003 |        | 2002
|                           |  |                    |        |                  |  |      |        |     
|Net loss                   |  | $                  | (1,769 | )                |  | $    | (1,103 | )    |  | $ | (3,539 | ) |  | $ | (1,435 | )
|Other comprehensive income |  |                    | 1      |                  |  |      | 191    |      |  |   | 42     |   |  |   | 100    |  
|                           |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  
|Comprehensive loss         |  | $                  | (1,768 | )                |  | $    | (912   | )    |  | $ | (3,497 | ) |  | $ | (1,335 | )
|                           |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  

14. SHAREHOLDER RIGHTS PLAN

On February 11, 2003 the Board of Directors of the Company adopted a
Shareholder Rights Plan. In connection with the Rights Plan, the Board of
Directors declared a dividend of one preferred share purchase right (the
Rights) for each outstanding share of common stock, no par value per share
(the Common Shares), of the Company outstanding at the close of business on
February 21, 2003 (the Record Date). Each Right will entitle the registered
holder thereof, after the Rights become exercisable and until February 10, 2013
(or the earlier redemption, exchange or termination of the Rights), to purchase
from the Company one one-hundredth (1/100th) of a share of Series C Junior
Participating Preferred Stock, no par value per share (the Preferred Shares),
at a price of $10 per one one-hundredth (1/100th) of a Preferred Share, subject
to certain anti-dilution adjustments (the Purchase Price). Until the earlier
to occur of (i) ten (10) days following a public announcement that a person or
group of affiliated or associated persons has acquired, or obtained the right
to acquire, beneficial ownership of 15% or more of the Common Shares (an
Acquiring Person) or (ii) ten (10) business days (or such later date as may
be determined by action of the Board of Directors prior to such time as any
person or group of affiliated persons becomes an Acquiring Person) following
the commencement or announcement of an intention to make a tender offer or
exchange offer the consummation of which would result in the beneficial
ownership by a person or group of 15% or more of the Common Shares (the earlier
of (i) and (ii) being called the Distribution Date), the Rights will be
evidenced, with respect to any of the Common Share certificates outstanding as
of the Record Date, by such Common Share certificate. An Acquiring Person does
not include any Existing Holder (defined as Sigma-Tau Finanziaria S.p.A.,
together with all of its Affiliates and Associates, including, without
limitation Defiante Farmaceutica L.D.A., Sigma-Tau International S.A., Paolo
Cavazza and Claudio Cavazza,), unless and until such time as such Existing
Holder shall become the beneficial owner of one or more additional Common
Shares of the Company (other than (i) pursuant to a dividend or distribution
paid or made by the Company on the outstanding Common Shares in Common Shares
or pursuant to a split or subdivision of the outstanding Common Shares or (ii)
additional Common Shares purchased prior to June 15, 2003 in accordance with
the terms of that certain Letter Agreement dated December 1, 2001 by and
between the Company and Sigma-Tau Finanziaria S.p.A., Paolo Cavazza and Claudio
Cavazza), unless, upon becoming the beneficial owner of such additional Common
Shares, such Existing Holder is not then the beneficial owner of 15% or more of
the Common Shares then outstanding.

In the event that a Person becomes an Acquiring Person or if the Company
were the surviving corporation in a merger with an Acquiring Person or any
affiliate or associate of an Acquiring Person and the Common Shares were not
changed or exchanged, each holder of a Right, other than Rights that are or
were acquired or beneficially owned by the Acquiring persons (which Rights will
thereafter be void), will thereafter have the right to receive upon exercise
that number of Common Shares having a market value of two times the then
current Purchase Price of one Right. In the event that, after a person has
become an Acquiring Person, the Company were acquired in a merger or other
business combination transaction or more than 50% of its assets or earning
power were sold, proper provision shall be made so that each holder of a Right
shall thereafter have the right to receive, upon the exercise thereof at the
then current Purchase Price of the Right, that number of shares of common stock
of the acquiring company which at the time of such transaction would have a
market value of two times the then current purchase price of one Right.

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Independent Accountants Review Report

The Board of Directors
Questcor Pharmaceuticals, Inc.

We have reviewed the accompanying condensed consolidated balance sheet of
Questcor Pharmaceuticals, Inc. as of June 30, 2003, and the related condensed
consolidated statements of operations for the three and six month periods ended
June 30, 2003 and 2002, and the condensed consolidated statements of cash flows
for the six month periods ended June 30, 2003 and 2002. These financial
statements are the responsibility of the Companys management.

We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.

Based on our reviews, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated financial statements
referred to above for them to be in conformity with accounting principles
generally accepted in the United States.

We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Questcor
Pharmaceuticals, Inc. as of December 31, 2002, and the related consolidated
statements of operations, preferred stock and stockholders equity (deficit),
and cash flows for the year then ended and in our report dated February 11,
2003, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of December 31, 2002 is fairly stated,
in all material respects, in relation to the consolidated balance sheet from
which it has been derived.

| |  |                      
| |  | ---------------------
| |  | /s/ ERNST & YOUNG LLP

Palo Alto, California
July 24, 2003

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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties, including statements regarding the period of time during which
our existing capital resources and income from various sources will be adequate
to satisfy our capital requirements. Our actual results could differ materially
from those discussed herein. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in this section,
as well as those discussed in our annual report on form 10-K for the fiscal
year ended December 31, 2002, including Item 1 Business of Questcor, and
including without limitation Risk Factors, as well as factors discussed in
any documents incorporated by reference herein or therein. Whenever used in
this Quarterly Report, the terms Questcor, Company, we, our, ours,
and us refer to Questcor Pharmaceuticals, Inc. and its consolidated
subsidiaries.

Overview

We are a specialty pharmaceutical company that markets and sells brand
name prescription drugs and ethically promoted healthcare products. We focus on
the treatment of acute and critical care conditions, including central nervous
system (CNS) diseases and gastroenterological disorders. Our strategy is to
acquire pharmaceutical products that we believe have sales growth potential,
are promotion sensitive and complement our existing products. In addition,
through corporate collaborations, we intend to develop new patented intranasal
formulations of previously FDA approved drugs. We currently market six products
in the U.S.: HP Acthar® Gel (Acthar), an injectable drug that is approved for
the treatment of certain CNS disorders with an inflammatory component including
the treatment of flares associated with multiple sclerosis (MS) and is also
commonly used in treating patients with infantile spasm; Nascobal®, a nasal gel
used for the treatment of various Vitamin B-12 deficiencies; Ethamolin®, an
injectable drug used to treat enlarged weakened blood vessels at the entrance
to the stomach that have recently bled, known as esophageal varices;
Glofil®-125 and Inulin in Sodium Chloride, which are both injectable agents
that assess how well the kidney is working by measuring glomerular filtration
rate, or kidney function; and VSL#3, a patented probiotic marketed as a
dietary supplement to promote normal gastrointestinal (GI) function. Probiotics
are living organisms in food and dietary supplements, which, upon ingestion in
certain numbers, improve the health of the host beyond their inherent basic
nutrition. On June 17, 2003, we acquired Nascobal®, a nasal gel formulation of
Cyanocobalamin USP (Vitamin B-12), from Nastech Pharmaceutical Company, Inc.
(Nastech). We began selling Nascobal in July 2003. We intend to market
Nascobal to patients with severe deficiencies of Vitamin B-12 caused by MS and
Crohns Disease as these patients frequently have severe deficiencies of
Vitamin B-12 due to a compromised ability to absorb Vitamin B-12 through the
gastrointestinal system.

Consistent with our efforts to focus on sales and marketing, our spending
on research and development activities is minimal. Expenses incurred for the
manufacturing site transfer and medical and regulatory affairs are classified
as Research and development expenses in the accompanying statement of
operations. We have entered into several agreements with pharmaceutical and
biotechnology companies to further the development of certain technology
acquired from RiboGene. In June 2002, we signed a definitive License Agreement
with Fabre Kramer Pharmaceuticals, Inc. (Fabre Kramer) for the exclusive
worldwide development and commercialization of Hypnostat (intranasal triazolam
for insomnia) and Panistat (intranasal alprazolam for panic disorders). Under
the License Agreement, Fabre Kramer assumed the primary responsibility for the
development of Hypnostat and Panistat. Our antiviral drug discovery program has
been partnered with Rigel Pharmaceuticals, Inc. of South San Francisco, CA. and
our antibacterial program has been partnered with Dainippon Pharmaceuticals
Co., Ltd. of Osaka, Japan.

We have sustained an accumulated deficit of $82.3 million from inception
through June 30, 2003. At June 30, 2003, we had $8.9 million in cash, cash
equivalents and short-term investments. Results of operations may vary
significantly from quarter to quarter depending on, among other factors, the
results of our sales efforts, timing of expiration of our products and the
resulting shipment of replacement product under our exchange policy, customers
adherence to our sales and exchange policies, completion of the Acthar site
transfer, the amount of inventory existing at the wholesale level, the
availability of finished goods from our sole-source manufacturers, the timing
of certain expenses, the acquisition of marketed products, the establishment of
strategic alliances and corporate partnering arrangements and the receipt of
milestone payments.

Critical Accounting Policies

Our management discussion and analysis of our financial condition and
results of operations is based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosures. On an
on-going basis, we evaluate our estimates, including those related to product
returns, sales allowances, bad debts, inventories, investments and intangible
assets. We base our estimates on historical experience and on various other
assumptions that we believe are reasonable under the circumstances, the results
of which form the

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basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements.

Sales Allowances and Product Returns and Rebates

We have estimated allowances for product returns, government chargebacks,
Medicaid rebates and cash discounts for prompt payment. We estimate our
allowances by utilizing historical information for existing products and data
obtained from external sources. For new products, we estimate our allowances
for product returns and rebates on specific terms for product returns and
rebates and our experience with similar products. Effective August 12, 2002, we
changed our return goods policy such that we no longer issue credit memorandums
for returns, rather all returns are exchanged for replacement product. The
estimated costs for such exchanges, which include actual product costs and
related shipping charges, are included in cost of product sales. In estimating
returns, we analyze (i) historical returns and sales patterns, (ii) current
inventory on hand at wholesalers and in the distribution channel and the
remaining shelf life of that inventory (ranging from 45 days to 3 years), and
(iii) changes in demand. We continually assess our historical experience
including customers compliance with return goods policy, and we adjust our
allowances as appropriate. In estimating Medicaid rebates, we match the actual
rebates to the actual sale on a product-by-product basis to arrive at an actual
rebate percentage. This actual percentage is used to estimate a rebate
percentage which is applied to current period sales to arrive at the rebate
expense for the period. In particular, we consider allowable prices by
Medicaid. If actual product returns, government chargebacks, Medicaid rebates
and cash discounts are greater than our estimates, additional allowances may be
required.

Inventories

We maintain inventory reserves primarily for obsolescence (due to the
expiration of shelf life). In estimating inventory obsolescence reserves, we
analyze on a product-by-product basis (i) the shelf life and the expiration
date, and (ii) our sales forecasts. Judgment is required in determining whether
the forecasted sales information is sufficiently reliable to enable us to
estimate inventory obsolescence.

Intangible Assets

We have intangible assets related to goodwill and other acquired
intangibles. The determination of related estimated useful lives and whether or
not these assets are impaired involves significant judgment. Changes in
strategy and/or market conditions could significantly impact these judgments
and require adjustments to recorded asset balances. We review intangible
assets, as well as other long-lived assets, for impairment whenever events or
circumstances indicate that the carrying amount may not be fully recoverable.

Results of Operations

Three months ended June 30, 2003 compared to the three months ended June
30, 2002:

For the quarter ended June 30, 2003, we incurred a net loss of $1,769,000
as compared to a net loss of $1,103,000 for the quarter ended June 30, 2002, an
increase of $666,000. Net loss applicable to common stockholders was $2,062,000
for the quarter ended June 30, 2003, and included the impact of the non-cash
deemed dividend of $93,000 related to the beneficial conversion feature on the
Series B Preferred Stock and Preferred Stock dividends of $200,000. Net loss
applicable to common stockholders was the same as net loss for the quarter
ended June 30, 2002.

Total revenues for the quarter ended June 30, 2003 decreased $836,000, or
22%, to $2,905,000 from total revenues of $3,741,000 for the quarter ended June
30, 2002.

For the quarter ended June 30, 2003, net product sales decreased $427,000,
or 13%, to $2,880,000 from $3,307,000 for the quarter ended June 30, 2002. The
net product sales for the second quarter of 2002 included the impact of advance
buying upon notification of the price increase for Ethamolin and Acthar that
went into effect June 24, 2002. From the date of the notification of the price
increase through the effective date of the price increase, we received
$3,231,000 of Acthar and Ethamolin orders of which $777,000 had shipped prior
to June 30, 2002. The remaining orders of $2,454,000 were filled in July 2002.
We believe that a portion of the decrease in net product sales for the quarter
ended June 30, 2003 as compared to the quarter ended June 30, 2002 is
attributable to these purchases made last year as a result of the notification
of the price increase. The list price of both Acthar and Ethamolin was
increased in April 2003; however, there was no advance notification of this
price increase. During the quarter ended June 30, 2003, we replaced vials at no cost for
certain of the returned product of Acthar batches that expired in November 2002
and May 2003. Subsequent to June 30, 2003, we will continue to replace
returned product from the November 2002 and May 2003 expired batches. We will
do so again for the Acthar batch that expires in January 2004.

We believe the shipment of replacement product may have displaced sales in
the quarter ended June 30, 2003, and the replacement of product expiring in May 2003,
January 2004 and future expiring product may displace future quarter sales. The
extent of this displacement is not ascertainable at this time.

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For the quarter ended June 30, 2003, net product sales of Ethamolin
declined substantially. We reviewed the external demand data and noted that
the demand for Ethamolin is declining. We believe this decline is partially a
result of procedures and devices being used to treat bleeding esophageal
varices rather than sclerosing agents. Also in the current period, we noted
one of our major customers purchased large quantities of Ethamolin. We
believe, through review of external data, that the amount purchased by this
major customer was in excess of historical demand and represents several months
of inventory. To the extent that inventory at the wholesale level exceeds the
ultimate demand, we believe that this will adversely impact our future net
product sales.

Grant and royalty revenue decreased by $59,000, or 70%, to $25,000 for the
quarter ended June 30, 2003 from $84,000 for the quarter ended June 30, 2002.
This decrease was primarily a result of lower reimbursement under our Small
Business Innovation Research (SBIR) grant due to less activity taking place
with the GERI compound research projects in the quarter ended June 30, 2003, as
compared to the quarter ended June 30, 2002.

For the quarter ended June 30, 2003, we did not recognize any technology
revenue. We recognized $250,000 in technology revenue, related to the License
Agreement with Fabre-Kramer for the quarter ended June 30, 2002. Additionally,
we had services revenue from a related party of $100,000 for the quarter ended
June 30, 2002. This amount reflects revenues recorded through June 30, 2002,
resulting from a $200,000 payment made to us by VSL for certain promotional
activities we undertook to support the launch of VSL#3 in the quarter ended
June 30, 2002. The remaining balance of $100,000 was recognized as revenue
ratably through December 2002, at which time it was fully recognized.

Cost of product sales increased $421,000, or 58%, to $1,149,000 for the
quarter ended June 30, 2003 from $728,000 for the quarter ended June 30, 2002.
This increase is due to increases in our excess inventory allowance, increases
in per unit material costs and increases in costs related to the replacement of
expired product. We expect per unit material costs to increase in the future
due to higher contract manufacturing costs. Cost of product sales as a
percentage of net product sales increased to 40% for the quarter ended June 30,
2003 as compared to 22% for the quarter ended June 30, 2002, primarily due to a
change of product mix and a charge of $233,000 in the period to increase the
excess inventory allowance. In April 2003, we decided to outsource certain
functions previously performed in our Carlsbad, California distribution center,
including, but not limited to, warehousing, shipping and quality control
studies. We have entered into agreements with various vendors to distribute
Acthar, Nascobal, Ethamolin, Glofil and Inulin, and we distribute VSL#3 from
our Union City facility.

Sales and marketing expenses for the quarter ended June 30, 2003 decreased
$151,000 or 9% to $1,501,000 from $1,652,000 for the quarter ended June 30,
2002. The decrease is primarily due to less marketing costs incurred in the
quarter ended June 30, 2003 as compared to June 30, 2002. The VSL#3 formal
product launch took place in May 2002, which contributed heavily to the sales
and marketing expense in the quarter ended June 30, 2002.

General and administrative expenses for the quarter ended June 30, 2003
decreased $200,000, or 16%, to $1,016,000 from $1,216,000 for the quarter ended
June 30, 2002. The decrease was primarily due to a decrease in legal expenses
relating to potential product acquisitions and financing opportunities and an
overall reduction of spending in the general and administrative functions for
the quarter ended June 30, 2003 as compared to the quarter ended June 30, 2002.

Research and development expenses for the quarter ended June 30, 2003
increased $29,000, or 4%, to $711,000, from $682,000 for the quarter ended June
30, 2002. The costs included in research and development relate primarily to
manufacturing site transfers and medical and regulatory affairs compliance
activities. This increase is primarily due to consulting and outside testing
costs incurred related to the Acthar site transfer in the current quarter. For
the quarter ended June 30, 2003, a third party contract laboratory performed
several tests as part of the Acthar manufacturing site transfer. To date, this
laboratory has been unsuccessful in qualifying the assay in order to complete
the transfer. If this laboratory is unable to validate this specific assay, we
may be forced to find a new contractor to complete this work, which in turn
could increase our costs substantially. The costs related to the Acthar site
transfer may fluctuate, depending on the timing of work performed and the costs
related to such activities.

Depreciation and amortization expense decreased by $103,000, or 33%, to
$212,000 for the quarter ended June 30, 2003, from $315,000 for the quarter
ended June 30, 2002. This decrease was due to minimal new capital purchases
made in the period, assets becoming fully depreciated, and a portion of
purchased technology becoming fully amortized, offset by a partial months
amortization of the purchased technology related to the Nascobal product
acquisition (for $14.2 million), which will be amortized over 15 years. The
prior purchased technologys net remaining balance of $155,000 will be fully
amortized in 2003.

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Non-cash amortization of deemed discount on convertible debentures for the
quarter ended June 30, 2003 was $130,000, consistent with the quarter ended
June 30, 2002. The convertible debentures were issued March 15, 2002.

Interest expense, net remained flat for the quarter ended June 30, 2003 as
compared to the quarter ended June 30, 2002.

Other expense, net decreased $178,000, or 98%, to $3,000 for the quarter
ended June 30, 2003, from $181,000 of other expense, net for the quarter ended
June 30, 2002. For the quarter ended June 30, 2002, we recorded an
other-than-temporary loss of $181,000 on our Rigel equity securities
investment. The Rigel investment was sold in its entirety in the second quarter of 2003.

Rental income, net remained flat for the quarter ended June 30, 2003 as
compared to the quarter ended June 30, 2002.

Non-cash deemed dividend of $93,000 for the period ended June 30, 2003 is
related to an increase to the beneficial conversion feature in connection with
the Series B Preferred Stock and warrants issued in January 2003. On June 13,
2003, we obtained a letter from our Series B Preferred Stock holders whereby
certain covenants were waived. In exchange for such waiver, the exercise price
of the warrant was reduced. The beneficial conversion feature was revalued
using the new exercise price and the increase in value was recorded as a deemed
dividend.

Preferred Stock dividends of $200,000 represent the 8% cash dividends
payable to the Series B Preferred Stock holders. These dividends are required
to be paid in cash quarterly.

Six months ended June 30, 2003 compared to the six months ended June 30,
2002:

For the six months ended June 30, 2003, we incurred a net loss of
$3,539,000 as compared to a net loss of $1,435,000 for the six months ended
June 30, 2002, an increase of $2,104,000. Net loss applicable to common
stockholders was $5,300,000 for the six months ended June 30, 2003, which
included the impact of the non-cash deemed dividend related to the beneficial
conversion feature on the Series B Preferred Stock of $1,394,000 and Preferred
Stock dividends of $367,000. Net loss applicable to common stockholders was the
same as net loss for the six months ended June 30, 2002.

For the six months ended June 30, 2003, net product sales decreased
$1,871,000, or 26%, to $5,242,000 from $7,113,000 for the six months ended June
30, 2002. This decline in net product sales was partially offset by an
increase in the list price of Acthar and Ethamolin in April 2003. The net
product sales for the six months of 2002 included the impact of advance buying
upon notification of the price increase for Ethamolin and Acthar that went into
effect June 24, 2002. From the date of the notification of the price increase
through the effective date of the price increase, we received $3,231,000 of
Acthar and Ethamolin orders of which $777,000 had shipped prior to June 30,
2002. The remaining orders of $2,454,000 were filled in July 2002. In
addition, during the six months ended June 30, 2002, we shipped backorders
outstanding at December 31, 2001 amounting to $334,000 for Acthar and $408,000
for Ethamolin. We believe that a portion of the decrease in net product sales
for the six months ended June 30, 2003 is attributable to these purchases made
as a result of the notification of the price increase and from the shipment of
the backorders. The remaining decrease in net product sales can be partially
attributed to our decision to not ship short-dated materials during the first
quarter of 2003 and may also be attributed to the replacement of previously
expired product at no cost to the customer in accordance with our exchange
policy. In the first quarter of 2003, due to the relatively short dating of
Acthar in our inventories and at the wholesale level, we briefly limited Acthar
shipments to critical care and emergency situations. After we obtained approval
in November 2002 to extend the expiration date on Acthar to 18 months from 12
months, we resumed shipments of Acthar with a January 2004 expiration date when
the extended dated material was released late in the first quarter of 2003.
During the six months ended June 30, 2003, we replaced vials at no cost for
certain of the returned product of Acthar batches that expired in November 2002
and May 2003. Subsequent to June 30, 2003, we will continue to replace
returned product from the November 2002 and May 2003 expired batches. We will
do so again for the Acthar batch that expires in January 2004.

We believe the shipment of replacement product may have displaced sales in
the six months ended June 30, 2003, and the replacement of product expiring in May 2003,
January 2004 and future expiring product may displace future quarter sales. The
extent of this displacement is not ascertainable at this time.

For the six months ended June 30, 2003, net product sales of Ethamolin
declined substantially. We reviewed the external demand data and noted that
the demand for Ethamolin is declining. We believe this decline is partially a
result of devices being used to treat bleeding esophageal varices rather than
sclerosing agents. Also in the current period, we noted one of our major
customers purchased large quantities of Ethamolin. We believe, through review
of external data, that the amount purchased by this major customer was in

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excess of historical demand and represents several months of inventory. To the
extent that inventory at the wholesale level exceeds demand, we believe that
this will adversely impact our future net product sales.

Grant and royalty revenue for the six months ended June 30, 2003 decreased
$98,000, or 74%, to $34,000 from $132,000 for the six months ended June 30,
2002. This decrease was a result of lower reimbursement under the SBIR grant
due to less activity taking place with the GERI compound research project in
the six months ended June 30, 2003 as compared to the six months ended June 30,
2002. The royalty revenue represents sales of Pramidin® in Italy, under a
license agreement we had with sirton Pharmaceuticals, S.p.A. that expired in
accordance with its terms in June 2002.

In both the six months ended June 30, 2003 and 2002, we recognized
$250,000 in technology revenue related to the License Agreement with
Fabre-Kramer. Additionally, we had services revenue from a related party of
$100,000 for the six months ended June 30, 2002. This amount reflects revenues
resulting from the $200,000 payment made by VSL for certain promotional
activities we undertook to support the launch of VSL#3. The remaining balance
of $100,000 was recognized as revenue ratably through December 2002 at which
time it was fully recognized.

Cost of product sales for the six months ended June 30, 2003 increased
$462,000, or 34%, to $1,824,000 from $1,362,000 for the six months ended June
30, 2002. The increase is due to increases in our excess inventory allowance,
increases in per unit material costs and increases in costs related to the
replacement of expired product. We expect per unit material costs to increase
in the future due to higher contract manufacturing costs. Cost of product sales
as a percentage of net product sales increased to 35% for the six months ended
June 30, 2003 from 19% for the six months ended June 30, 2002. This was
primarily due to a change in our product mix and a charge of $270,000 in the
period to increase the excess inventory allowance. In April 2003, we decided to
outsource certain functions previously performed in our Carlsbad, California
distribution center, including, but not limited to, warehousing, shipping and
quality control studies. We have entered into agreements with various vendors
to distribute Acthar, Nascobal, Ethamolin, Glofil and Inulin, and we distribute
VSL#3 from our Union City facility.

Sales and marketing expenses for the six months ended June 30, 2003
decreased by $41,000 to $2,986,000, from $3,027,000 for the six months ended
June 30, 2002. While the sales and marketing expenses were flat, a decreased
marketing spend for the six months ended June 30, 2003 was offset by increased
salary and other costs as a result of the full six months impact of the
expansion to our sales and marketing departments that took place in May 2002.

General and administrative expenses for the six months ended June 30, 2003
decreased by $413,000, or 15%, to $2,334,000 from $2,747,000 for the six months
ended June 30, 2002. The decrease was primarily due to $243,000 of non-cash
charges for stock-based compensation taken in the six months ended June 30,
2002. Also contributing to the decrease was an overall reduction of spending
in the general and administrative functions.

Research and development expenses for the six months ended June 30, 2003
increased by $212,000, or 19%, to $1,322,000 from $1,110,000 for the six months
ended June 30, 2002. The costs included in research and development relate
primarily to manufacturing site transfers and medical and regulatory affairs
compliance activities. This increase is primarily due to consulting and outside
testing costs incurred related to the Acthar site transfer in the first six
months of 2003 as compared to the first six months of 2002. In the six months
ended June 30, 2003, a third party contract laboratory completed several tests
as part of the Acthar manufacturing site transfer. To date, this laboratory
has been unsuccessful in qualifying the assay in order to complete the
transfer. If this laboratory is unable to validate this specific assay, we may
be forced to find a new contractor to complete this work, which in turn could
increase our costs substantially. The costs related to the Acthar site
transfer may fluctuate, depending on the timing of work performed and the costs
related to such activities.

Non-cash amortization of deemed discount on convertible debentures for the
six months ended June 30, 2003 increased by $86,000, or 49%, to $261,000 from
$175,000 for the six months ended June 30, 2002. The increase was due to the
current period representing a full six months amortization of deemed discount
related to the convertible debentures. The convertible debentures were issued
March 15, 2002.

Interest expense, net, increased by $28,000 to $14,000 for the six months
ended June 30, 2003 from net interest income of $14,000 for the six months
ended June 30, 2002. This was primarily due to the current period representing
a full six months interest expense on the convertible debentures issued March
15, 2002.

Other expense, net, decreased by $30,000, or 27%, to $80,000 for the six
months ended June 30, 2003 from $110,000 for the six months ended June 30,
2002. The decrease in expense is primarily due to a smaller loss related to
the Rigel equity securities investment recorded in the six months ended June
30, 2003 as compared to the same period for 2002. For the six months ended
June 30, 2003 we recorded an other-than-temporary loss of $51,000 and realized
losses of $14,000 on the Rigel equity investment as compared to a $181,000
other-than-temporary loss recorded on the Rigel equity securities investment
for the six month period

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ended June 30, 2002. The other expense for the six months ended June 30, 2002, was partially offset by other income recognized in
the period as a result of receipt of profits arising from short swing stock
trades executed by one of our 10% shareholders.

Rental income, net remained flat for the quarter ended June 30, 2003 as
compared to the quarter ended June 30, 2002.

Non-cash deemed dividend of $1,394,000 at June 30, 2003 is related to the
beneficial conversion feature in connection with the Series B Preferred Stock
and warrants issued in January 2003. A beneficial conversion feature is present
because the effective conversion price of the Preferred Stock was less than the
fair value of the Common Stock on the commitment date. In addition, on
June 13, 2003, we obtained a letter from our Series B Preferred Stock
holders whereby certain covenants were waived. In exchange for such waiver,
the exercise price of the warrant was reduced. The beneficial conversion
feature was revalued using the new exercise price and the increase in value was
recorded as a deemed dividend.

Preferred Stock dividends of $367,000 represent the 8% cash dividends
payable to the Series B Preferred Stock holders. These dividends are required
to be paid in cash quarterly.

Liquidity and Capital Resources

We have funded our activities to date principally through various
issuances of equity securities. Through June 30, 2003, we have raised total net
proceeds of $60.6 million. We have also funded our activities to date to a
lesser extent through product sales.

At June 30, 2003, we had cash, cash equivalents and short-term investments
of $8,941,000 compared to $7,506,000 at December 31, 2002. At June 30, 2003,
our working capital was $3,795,000 compared to $7,018,000 at December 31, 2002.
The decrease in our working capital was principally due to the $9,000,000 cash
payment we made to Nastech to acquire Nascobal, offset by net proceeds received
in the private placement of $10,000,000 of Series B Convertible Preferred Stock
in January 2003 and the private placement of $5 million of Common Stock and
warrants in June 2003.

As a result of the Nascobal product acquisition we are required to pay an
additional $5.2 million payable to Nastech on or before December 31, 2003. The
$5.2 million payable is included in the Payable relating to product
acquisition on the accompanying Condensed Consolidated Balance Sheet. As
part of the acquisition, we are also acquiring rights to Nascobal nasal spray,
an improved dosage form, for which an NDA is expected to be filed by Nastech
with the FDA before the end of 2003. Subject to the approval of the NDA for
the new Nascobal nasal spray dosage form by the FDA, we will be required to
make a $2 million payment for the transfer of the NDA from Nastech to us.
Further, subject to the approval of the NDA for the new Nascobal nasal spray
dosage form and upon issuance of a pending U.S. patent for the new Nascobal
nasal spray dosage form, we will be required to make a second $2 million
payment.

We may have substantial cash outlays for the Acthar site transfer. The
site transfer process is not complete and may require substantial cash outlays
for the work performed, capital expenditures and inventory, prior to the
transfer being complete.

In January 2002, we entered into a revolving accounts receivable line of
credit with Pacific Business Funding, a division of Greater Bay Bancorp. Under
the agreement, we can borrow up to the lesser of 80% of our eligible accounts
receivable balance or $3,000,000. Interest accrues on outstanding advances at
an annual rate equal to prime rate plus four and one-half percent. The term of
the agreement is one year and the note automatically renews annually, unless we
terminate the agreement. There were no borrowings under this line of credit as
of June 30, 2003. The line of credit is secured by a blanket lien on all of our
assets including intellectual property. As of June 30, 2003, $958,000 was
applicable for borrowing under the line of credit.

In January 2003, we completed a private placement of Series B Convertible
Preferred Stock and warrants to purchase common stock to various healthcare
investors. Our gross proceeds from the private placement were $10 million. The
Series B Preferred Stock has an aggregate stated value of $10 million and is
entitled to a quarterly dividend at an initial rate of 8% per year, which rate
will increase to 10% per year on and after January 1, 2006, and to 12% on and
after January 1, 2008. In addition, on the occurrence of designated events the
dividend rate will increase by an additional 6% per year. The Series B
Preferred Stock is entitled to a liquidation preference over our common stock
and Series A Preferred Stock upon a liquidation, dissolution or winding up of
Questcor. The Series B Preferred Stock is convertible at the option of the
holder into our common stock at a conversion price of $0.9412 per share,
subject to certain anti-dilution adjustments. We have the right commencing on
January 1, 2006 (assuming specified conditions are met) to redeem the Series B
Preferred Stock at a price of 110% of stated value, together with all accrued
and unpaid dividends and arrearage interest. In addition, upon the occurrence
of designated Optional Redemption Events, the holders have the right to require
us to redeem the Series B Preferred Stock at 100% of stated value, together
with all accrued and unpaid dividends and accrued interest. The terms of the
Series B Preferred Stock contain a variety of affirmative and restrictive
covenants, including limitations on indebtedness and liens. Each share of
Series B Preferred Stock is generally entitled to a number of votes equal to
0.875 times the number of shares

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of common stock issuable upon conversion of
such share of Series B Preferred Stock. The purchasers of the Series B
Preferred Stock also received for no additional consideration warrants
exercisable for an aggregate of 3,399,911 shares of our common stock at an
exercise price of $1.0824 per share, subject to certain anti-dilution
adjustments. The warrants expire in January 2007. In June 2003, the exercise
price of the warrants was adjusted to $0.9412 per share.

On June 11, 2003, we consummated a private placement of our Common Stock
and warrants to purchase Common Stock. We issued 4,979,360 shares of Common
Stock in the private placement at $1.01 per share, which was the volume
weighted average price
of the common stock for the five days prior to and including the close of
the private placement. Gross proceeds to us from the private placement were
approximately $5 million. The purchasers of our Common Stock also received for
no additional consideration warrants exercisable for an aggregate of 2,987,616
shares of Common Stock at an exercise price of $1.26 per share, which
represented a 25% premium to the volume weighted average price of the Common
Stock for the five days prior to and including the close of the private
placement. The warrants expire in June 2008.

Our future funding requirements will depend on many factors, including;
the timing and extent of product sales, returns of expired product, any
expansion or acceleration of our development programs; the acquisition and
licensing of products, technologies or compounds, if any; our ability to manage
growth; competing technological and market developments; costs involved in
filing, prosecuting, defending and enforcing patent and intellectual property
claims; the receipt of licensing or milestone fees from current or future
collaborative and license agreements, if established; the timing of regulatory
approvals; the timing and successful completion of the Acthar site transfer;
payment of dividends and compliance to prevent additional dividend events or
optional redemption events, and other factors.

We are funding a portion of our operating expenses through our cash flow
from operations, but may need to seek additional funds through public or
private equity financing or from other sources. While we raised gross proceeds
of $10 million through Series B Preferred Stock in January 2003 and $5 million
in a private placement in June 2003, and anticipate that our capital resources
based on our internal forecasts and projections will be adequate to fund
operations and capital expenditures, if we experience unanticipated cash
requirements, or if revenues fail to grow, we could be required to raise
additional cash. Regardless, we may seek additional funds, before the end of
2003, through public or private equity financing or from other sources to
potentially avoid the payment of additional dividends of 6% under the Series B
Convertible Preferred Stock for which we have a waiver through the end of 2003,
to acquire additional products and expand our operations and to meet future
obligations. Additionally, we may seek to raise additional capital whenever
conditions in the financial markets are favorable, even if we do not have an
immediate need for additional cash at that time. There can be no assurance that
additional funds can be obtained on desirable terms or at all.

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RISK FACTORS

You should carefully consider the following risk factors, in addition to
the other information included in this prospectus, before purchasing shares of
our common stock. Each of these risks could adversely affect our business,
financial condition and results of operations, as well as adversely affect the
value of an investment in our common stock.

We have a history of operating losses and may never generate sufficient revenue
to achieve profitability.

We have a history of recurring operating losses. Our operating losses from
inception through June 30, 2003 were $82.3 million, of
which $5.3 million
represented the loss applicable to common stockholders for the six
months ended
June 30, 2003, $2.8 million represented the loss for the year ended December
31, 2002, and $8.7 million represented the loss for the year ended December 31,
2001. Further substantial operating losses are expected to continue at least
through the end of 2003. To date, our revenues have been generated principally
from sales of Acthar, Ethamolin, Glofil-125, Inulin and VSL#3. In July 2003,
we began selling Nascobal, a product that we acquired in June 2003. We are
currently unable to estimate our future sales from Nascobal due to our limited
history with marketing and selling the product. We do not expect Hypnostat or
Panistat to be commercially available for a number of years, if at all.
Further, revenues from the sale of Emitasol, if any, will also be dependent on
FDA approval and the development of Emitasol in conjunction with a new
strategic partner, which has not yet been obtained.

Our ability to achieve a consistent, profitable level of operations will
be dependent in large part upon our ability to:



| |  |  | finance and acquire additional marketed products,                                                                                                                                                  
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | increase sales of current products,                                                                                                                                                                
|
| |  |  | finance the future growth of our sales/marketing and customer service organization,                                                                                                                
|
| |  |  | finance operations with external capital until positive cash flows are achieved,                                                                                                                   
|
| |  |  | enter into agreements with corporate partners for the development of Emitasol,                                                                                                                     
|
| |  |  | properly and timely complete the transfer of the manufacturing of
Acthar to new contract manufacturers including receiving the appropriate
approvals from the FDA and other regulatory authorities,
|
| |  |  | continue to receive products from our sole-source contract
manufacturers on a timely basis and at acceptable costs, and                                                                            
|
| |  |  | ensure customers compliance with
our sales and exchange policies.                                                                                                                                  

If we are unable to generate sufficient revenues from the sale of our
products, or if we are unable to contain costs and expenses, we may not achieve
profitability and may ultimately be unable to fund our operations.

If our revenues from sales of
Acthar decline or fail to grow, we may not have sufficient
revenues to fund our operations.

We rely
heavily on sales of Acthar. Acthar revenues comprised 68%, 65% and
41% of our total product revenues for the six months ended
June 30, 2003 and
years ended December 31, 2002 and December 31, 2001 (sales of Acthar began in
September 2001), respectively. We review external data sources to estimate
customer demand for our products. In the event that demand for our products is
less than our sales to wholesalers, excess inventory may result at the
wholesaler level, which may impact future product sales. If the supply of
Acthar available at the wholesale level exceeds the future demand, our future
revenues from the sales of Acthar may be affected adversely.

In December 2002, we noted that certain of our customers were not
complying with our expired product exchange policy. These customers were
deducting from amounts owed to us the full price of expired Acthar they
returned to us. While we reached an agreement with these customers to pay the
short-remittances upon their receipt of replacement product, certain customers
have continued to deduct from amounts owed to us the full price of expired
Acthar they return to us. Additionally, certain customers received an
administration fee from us for the Acthar that expired in November 2002 and May 2003. We will
provide replacement vials to them at no cost for Acthar that expired in
November 2002 and in May 2003. In the first quarter of 2003, due to the
relatively short dating of Acthar in our inventories and at the wholesale
level, we limited Acthar shipments to critical care and emergency situations. A
lot of Acthar, with an expiration date of January 2004 was released in the first quarter
of 2003. With the release of this lot normal shipments of Acthar resumed. We
believe that the replacement of expired Acthar at no cost and the decision to
briefly limit shipment of Acthar had a negative impact on our first quarter
2003 product sales of Acthar.

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In 2002 and 2001, the Acthar vials we sold had a one
year shelf life and, in the first quarter of 2003, we began shipping product
which expires in January 2004. Due to the short shelf-life of
Acthar, significant quantities
could expire at the wholesale or pharmacy level, which could then be returned
for replacement product under our exchange policy. Such shipment of replacement
product may displace future sales.

We are reviewing the amount of Acthar at the wholesale level to help
assess the demand for Acthar in 2003. We expect that Acthar will continue to
constitute a significant portion of our revenues for 2003. Although our goal is
to actively promote Acthar, and we have no reason to believe that our
promotion of Acthar will not be
successful, we cannot predict whether the strong demand for Acthar will
continue in the future or that we will continue to generate significant
revenues from sales of Acthar. In addition, we cannot currently predict
whether our efforts to promote Acthar for the treatment of MS will be
successful. If the demand for Acthar declines, or if we are forced to reduce
the price, or if exchange of product is higher than anticipated, or if we are
forced to re-negotiate contracts or terms, or if our customers do not comply
with our existing policies, or we are not successful in promoting Acthar for
the treatment of MS, our revenues from the sale of Acthar would decline. If the
cost to produce Acthar increases, and we are unable to raise the price
correspondingly, our gross margins on the sale of Acthar would decline. Any
delays or problems associated with the site transfer of the manufacturers of
Acthar could also reduce the amount of the product that will be available for
sale. If our revenues from the sale of Acthar decline or fail to
grow, our total revenues,
gross margins and operating results would be harmed and we may not have
sufficient revenues to fund our operations.

If we are unsuccessful in completing the Acthar site transfer, we may be unable
to meet the demand for Acthar and lose potential revenues.

Under our agreement with Aventis Pharmaceuticals, Inc. (Aventis),
Aventis manufactured and supplied Acthar through July 2002. Aventis filled one
final lot of Acthar that is included in inventories at June 30, 2003. It is
anticipated that the inventory of Acthar on hand at June 30, 2003, will be
sufficient to meet expected demand through late 2003. We have signed a
definitive agreement with Chesapeake Biological Laboratories (CBL) a contract
manufacturer for Acthar finished product and will continue to transfer the
final fill and labeling process from Aventis to CBL. Under our agreement with
Aventis, we purchased the active pharmaceutical ingredient (API) and other
inventory residing at Aventis. We believe this API will be sufficient to meet
our forecasted demand through 2005. This API originally manufactured by Aventis
has been transferred to CBL, the new final fill manufacturer. It is anticipated
that CBL will complete the transfer and begin supplying to us finished product
using the API manufactured by Aventis during 2003. CBL has completed
an initial fill of one lot of Acthar in June 2003. Based on
information we have received to date, we believe that this lot of
Acthar will be available for commercialization before the end of 2003. If
this lot is not available for commercialization before the end of 2003,
we may not be able to meet the demand for Acthar, which in turn will
lead to a decrease in revenues.

We have identified a potential new manufacturer, BioVectra dcl
(BioVectra) for the Acthar API. We have entered into an equipment and
materials transfer agreement with BioVectra which was extended indefinitely
through a verbal agreement, and we are currently negotiating a definitive API
supply agreement with BioVectra. However, we have experienced delays and cost
overruns in the validation of the release assay from Aventis to our new
third party contract laboratory. If we are unable to efficiently and timely validate the
release assay before we exhaust the API purchased from Aventis, we will
not be able to release finished goods and therefore we may not be able to meet the expected demand for Acthar.

As described above, the process of manufacturing Acthar is complex and we
may encounter problems associated with the site transfer. Once the site
transfer to CBL and the new API manufacturer has been completed and
the release assay has been validated and they begin
supplying Acthar to us, the cost of the product is expected to
increase which may cause our gross margins to decline. In
addition, if the site transfers and the corresponding approval by the FDA and
other regulatory authorities do not occur on a timely basis at the appropriate
costs to us, we will lose sales. Moreover, contract manufacturers that we may
use must continually adhere to current good manufacturing practices regulations
enforced by the FDA. If the facilities of these manufacturers cannot pass an
inspection, we may lose the FDA approval of our products. Failure to obtain
products for sale for any reason may result in an inability to meet product
demand and a loss of potential revenues.

We have little or no control over our wholesalers buying patterns, which may
impact future revenues, exchanges and excess inventory.

We sell our products primarily through major drug wholesalers located in
the United States. Consistent with the pharmaceutical industry, most of our
revenues are derived from the three largest drug wholesalers. While we attempt
to estimate inventory levels of

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our products at our major wholesale customers using inventory data
obtained from customers, historical prescription information and historical
purchase patterns, this process is inherently imprecise. We rely solely upon
our wholesale customers to effect the distribution allocation of our products.
There can be no assurance that these customers will adequately manage their
local and regional inventories to avoid outages or inventory build-ups. We
noted in the second quarter of 2003 that one of our major customers has
purchased Ethamolin units in excess of what we estimate their historical demand
to be which may adversely impact future sales.

Our
therapeutic pharmaceutical products have expiration dates that range
from 18 to 36 months from date of manufacture. We will generally accept for exchange
pharmaceutical products that have reached the expiration date. We establish
reserves for these exchanges at the time of sale. There can be no assurance
that we will be able to accurately forecast the reserve requirement that will
be needed in the future. Although our estimates are reviewed quarterly for
reasonableness, our product return activity could differ
significantly from our estimates because our analysis of product shipments,
prescription trends and the amount of product in the distribution channel may
not be accurate. Judgment is required in estimating these reserves. The actual
amounts could be different from the estimates and differences are accounted for
in the period in which they become known.

We do not control or significantly influence the purchasing patterns of
wholesale customers. These are highly sophisticated customers that purchase our
products in a manner consistent with their industry practices and perceived
business interests. Our sales are subject to the purchase requirements of our
major customers, which, presumably, are based upon their projected demand
levels. Purchases by any customer, during any period, may be above or below
actual prescription volumes of one or more of our products during the same
period, resulting in increases or decreases in product inventory existing in
the distribution channel, which are managed presumably in accordance with such
customers business practices.

We provide reserves for potentially excess, dated or otherwise impaired
inventory. Reserves for excess inventory are based on an analysis of expected
future sales that will occur before the inventory on hand will expire.
Judgment is required in estimating reserves for excess inventories. The actual
amounts could be different from the estimates and differences are accounted for
in the period in which they become known.

We have no experience marketing Nascobal and may be unsuccessful in doing so.

In June 2003, we acquired the product Nascobal, a nasal gel used for the
treatment of various Vitamin B-12 deficiencies for $14.2 million. We currently have no sales and
marketing experience with respect to Nascobal. We also cannot predict what the
demand for Nascobal will be. If the demand for Nascobal is less than we
anticipate, or we are unsuccessful in marketing Nascobal, our revenues from the
sale of Nascobal will be less than we are currently anticipating. We made an initial $9 million payment to Nastech to acquire Nascobal, and we
are required to pay an additional $5.2 million in non-contingent payments to
Nastech by December 31, 2003. We need to generate revenues from sales of
Nascobal in order to raise the necessary funds to make these
payments. If we are not successful in marketing Nascobal, we may need to seek
other sources of cash to make such payments or to fund operations. Moreover, if the amount of
Nascobal inventory at the wholesale level at the time that we purchased
Nascobal was higher than we anticipated, this may also affect the demand for
Nascobal in the near term.

Our inability to secure additional funding could lead to a loss of your
investment.

While we
raised gross proceeds of $10 million through Series B Preferred Stock
in January 2003 and $5 million in a private placement in June
2003, and anticipate that our capital resources based on our internal
forecasts and projections will be adequate to fund operations and
capital expenditures, if we experience unanticipated cash requirements,
or if revenues fail to grow, we could be required to raise additional
funds. Regardless, we may seek additional funds, before the end of
2003, through public or private equity financing or from other sources
to potentially avoid the payment of additional dividends of 6% under
the Series B Convertible Preferred Stock of which we have a waiver
through the end of 2003, to acquire additional products and expand
our operations and to meet future obligations. Additionally, we may
seek to raise capital whenever conditions in the financial markets
are favorable, even if we do not have an immediate need for
additional cash at that time. There can be no assurance that additional funds
can be obtained on desirable terms or at all.

In order to conduct our operating activities, we may require substantial
additional capital resources in order to acquire new products, increase sales
of existing products, and maintain our operations. In addition, if
revenues from product sales do not significantly increase or if further
capital investments do not materialize, or if such investments cannot be
completed at attractive terms to us, or if we are unable to receive any
additional capital investments at all, this may further limit our ability to
fund operations. Our future capital requirements will depend on many factors,
including the following:



| |  |  | existing product sales performance,                                                                                              
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | cost maintenance and potential future expansion of our sales force,                                                              
|
| |  |  | the cost and timing of the Acthar site transfer,                                                                                 
|
| |  |  | achieving better operating efficiencies,                                                                                         
|
| |  |  | obtaining product from our sole-source contract manufacturers and
completing the site transfer to new contract manufacturers, and
|
| |  |  | acquiring additional products.                                                                                                   

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We anticipate obtaining additional financing through public or private
debt or equity financings. However, additional financing may not be available
to us on acceptable terms, if at all. Further, additional equity financings
will be dilutive to our shareholders. If sufficient capital is not available,
then we may be required to reduce our operations or to delay, reduce the scope of, eliminate or divest one
or more of our products, product acquisition or manufacturing efforts.

If we are unable to contract with third party manufacturers, we may be unable
to meet the demand for our products and lose potential revenues.

We will rely on third party contract manufacturers to produce our marketed
products, Acthar, Nascobal, Ethamolin, Glofil, Inulin and VSL#3, and other
products that we may develop, commercialize or acquire in the future. Third
party manufacturers may not be able to meet our needs with respect to timing,
cost, quantity or quality. All of our manufacturers are sole-source
manufacturers and no currently qualified alternative suppliers exist.

Ethamolin is currently being manufactured by Ben Venue Laboratories (Ben
Venue). We do not have a formal Ethamolin manufacturing contract in place with
Ben Venue, rather we have an agreement on terms and conditions, and we purchase
product on a purchase order basis under these agreed upon terms and conditions.
Glofil is manufactured by ISO-Tex Diagnostics, Inc. pursuant to a supply
contract we have with them. The API for Inulin is manufactured by Pfanstiehl
Laboratories, Inc. on a purchase order basis, and the final fill product for
Inulin is manufactured by Ben Venue pursuant to an agreement on terms and
conditions, and we purchase product on a purchase order basis under these
agreed upon terms and conditions. We have been notified by Pfanstiehl
Laboratories, Inc. that they will no longer produce the Inulin API for us. We
are currently looking for alternative sources of Inulin API, however, we may
not be successful in our search. If we are unable to find an alternative
supplier for Inulin API, we may no longer be able to sell Inulin. VSL#3 is
supplied by VSL Pharmaceuticals, Inc. under a promotion agreement we have with
them. VSL has the sole responsibility for manufacturing and/or acquiring the
VSL#3 product.

If we are unable to contract for a sufficient supply of our required
products and substances on acceptable terms, or if we should encounter delays
or difficulties in our relationships with our manufacturers, or if the site
transfers and the corresponding approval by the FDA and other regulatory
authorities does not occur on a timely basis at the appropriate costs to us, we
will lose sales. Moreover, contract manufacturers that we may use must
continually adhere to current good manufacturing practices enforced by the FDA.
If the facilities of these manufacturers cannot pass an inspection, we may lose
the FDA approval of our products. During December of 2001, we experienced a
short supply situation with Ethamolin and Acthar due to manufacturing
constraints at two of our third party contract manufacturers, which were
resolved in 2002. We cannot guarantee that we will not have supply
interruptions in the future for Ethamolin and Acthar or any of our current or
future products. Failure to obtain products for sale for any reason may result
in an inability to meet product demand and a loss of potential revenues.

If our third party distributors are unable to distribute our products, we will
lose potential revenues.

We currently outsource certain functions previously performed in our
Carlsbad, California distribution center, including, but not limited to,
warehousing, shipping and quality control studies. The outsourcing of these
functions is complex, and we may experience difficulties at the third party
contractor level that could result in the non-shipment of our products. We
have transferred the distribution of Acthar, Nascobal, Ethamolin, Glofil and
Inulin to third party distributors, and we distribute VSL#3 from our Union City
facility. If we encounter problems with the distribution of these products at
the third party distribution level the products could become
unavailable and we could lose revenues, or the costs to distribute these products could become higher than we anticipated.

If we lose the services of certain key personnel or are unable to hire skilled
personnel in the future, our business will be harmed.

We are highly dependent on the services of Charles J. Casamento, Chairman,
President, and Chief Executive Officer, Timothy E. Morris, Senior Vice President of
Finance and Administration and Chief Financial Officer, and Kenneth R.
Greathouse, Senior Vice President of Commercial Operations. If we were to lose either
Mr. Casamento, Mr. Morris or Mr. Greathouse as employees, our business could be
harmed. Moreover, we do not carry key person life insurance for our senior
management or other personnel. Additionally, the future potential growth and
expansion of our business is expected to place increased demands on our
management skills and resources. Although only minor increases in staffing
levels are expected during 2003, recruiting and retaining management and
operational personnel to perform sales and marketing, business development,
regulatory affairs, medical affairs and contract manufacturing in the

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future will also be critical to our success. We do not know if we will be
able to attract and retain skilled and experienced management and operational
personnel in the future on acceptable terms given the intense competition among
numerous pharmaceutical and biotechnology companies for such personnel. If we
are unable to hire necessary skilled personnel in the future, our business
could be harmed.

Our products in the development stage may not be accepted by the market, which
may result in lower future revenues as well as a decline in our competitive
positioning.

Emitasol, an intranasal medication used to treat nausea and vomiting, is
in the development stage. Emitasol could be developed for two indications: a
decreased movement of the stomach region in diabetics causing fullness,
bloating and nausea, known as diabetic gastroparesis, and delayed onset emesis,
the vomiting associated with cancer chemotherapy patients occurring the day
after and beyond the chemotherapy treatment. The diabetic gastroparesis drug
candidate was being developed in collaboration with a subsidiary of Shire
Pharmaceutical Group plc in the U.S. and had completed a Phase II clinical
trial in patients with diabetic gastroparesis. With the expiration in July 2001
of the exclusive option to develop Emitasol held by Shire, development of
Emitasol under this collaboration stopped. Further development of Emitasol is
on hold pending our entering into an agreement with a future partner to fund
the development of Emitasol. We also have intranasal drug candidates, Panistat
for the management of panic disorders, and Hypnostat for the treatment of
insomnia, which have now been licensed to Fabre Kramer. There is no guarantee
that any of these drugs will successfully complete the additional clinical
testing needed to obtain FDA approval. Clinical trial results are frequently
susceptible to varying interpretations by scientists, medical personnel,
regulatory personnel, statisticians and others, which may delay, limit or
prevent further clinical development or regulatory approvals of a product
candidate. Also, the length of time that it takes for our partners to complete
clinical trials and obtain regulatory approval for product marketing can vary
by product and by the indicated use of a product. If one or more of these drugs
fail to successfully pass Phase III testing, we would be unable to market or
sell the product, which could result in lower future revenues as well as a
decline in our competitive positioning.

Additionally, our commercial products and any products that we
successfully develop, if approved for marketing, may never achieve market
acceptance. These products, if successfully developed, will compete with drugs
and therapies manufactured and marketed by major pharmaceutical and other
biotechnology companies. Physicians, patients or the medical community in
general may not accept and utilize the products that we may develop or that our
corporate partners may develop.

The degree of market acceptance of any products that we develop will
depend on a number of factors, including:



| |  |  | the establishment and demonstration of the clinical efficacy and safety of the product candidates,
| | - |  | --------------------------------------------------------------------------------------------------
|
| |  |  | their potential advantage over alternative treatment methods and competing products,              
|
| |  |  | reimbursement policies of government and third-party payors, and                                  
|
| |  |  | our ability to market and promote the products effectively.                                       

The failure of our products to achieve market acceptance may result in lower
future revenues as well as a decline in our competitive positioning.

A large percentage of our common stock is beneficially owned by one shareholder
and its affiliates, who in the future could attempt to take over control of our
management and operations or exercise voting power to advance their own best
interests and not necessarily those of other shareholders.

Sigma-Tau Finanziaria S.p.A. and its affiliates (Sigma-Tau) beneficially
own, directly or indirectly, approximately 27% of the voting power of our
outstanding voting capital stock, and they beneficially own, including shares
of our common stock issuable upon conversion of a convertible debenture and
exercise of warrants, approximately 34% of our outstanding common stock, as of
June 30, 2003. Accordingly, these shareholders may control the outcome of
certain shareholder votes, including votes concerning the election of
directors, the adoption or amendment of provisions in our Articles of
Incorporation, and the approval of mergers and other significant corporate
transactions. This level of concentrated ownership may, at a minimum, have the
effect of delaying or preventing a change in the management or voting control
of us by a third party. It may also place us in the position of having our
large shareholder take control of us and having new management inserted and new
objectives adopted.

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On January 17, 2003, Sigma-Tau requested that we increase the size of our
Board of Directors by two, with such directors to be nominated by Sigma-Tau and
elected by our Board of Directors as soon as possible. Sigma-Tau subsequently
rescinded this request. On March 11, 2003, Sigma-Tau indicated that they have
determined to sell all or a portion of the shares of our common stock that they
currently own. They further indicated that such sales, if they occur, will be
through open market transactions or privately negotiated, and will depend on
prevailing market conditions at time of sale. Such sales, if they occur, could
have a depressing effect on the market price of our common stock.
Since this announcement in March, according to information filed with the Securities and
Exchange Commission, Sigma-Tau has sold 30,000 shares of our common stock.

If competitors develop and market products that are more effective than ours,
our commercial opportunity will be reduced or eliminated.

The pharmaceutical and biotechnology industries are intensely competitive
and subject to rapid and significant technological change. A number of
companies are pursuing the development of pharmaceuticals and products that
target the same diseases and conditions that we target. For example, there are
products on the market that compete with Acthar, Nascobal, Ethamolin,
Glofil-125, Inulin, and VSL#3. Moreover, technology controlled by third parties
that may be advantageous to our business may be acquired or licensed by
competitors of ours, preventing us from obtaining this technology on favorable
terms, or at all.

Our ability to compete will depend on our ability to create and maintain
scientifically advanced technology, and to develop, acquire and commercialize
pharmaceutical products based on this technology, as well as our ability to
attract and retain qualified personnel, obtain patent protection, or otherwise
develop proprietary technology or processes, and secure sufficient capital
resources for the expected substantial time period between technological
conception and commercial sales of products based upon our technology.

Acthar is currently used in patients suffering from arthritis, multiple
sclerosis, and infantile spasm. Acthar may be challenged by newer agents, such
as synthetic corticosteriods, immune system suppressants known as
immunosuppressants, and anti-seizure medications (in the case of infantile
spasms) and other types of anti-inflammatory products for various autoimmune
conditions that have inflammation as a clinical aspect of the disease. An
injectable form of B-12 is widely available in generic form and provides the
same benefit as Nascobal at a lower overall cost. One company offers a
sclerotherapy agent (chemicals injected into varicose veins that damage and
scar the inside lining of the vein, causing it to close) that competes with
Ethamolin. Other competitive agents include Rubber Band Ligation methods
(procedures in which bleeding esophageal varices are tied off at their base
with rubber bands, cutting off the blood flow) such as the Multi-band Superview
manufactured by Boston-Scientific, the Multi-band Six Shooter manufactured by
Wilson-Cook, and the Multi-band Ligator manufactured by Bard. Other products
may reduce the number of bleeding esophageal varices by lowering portal
hypertension, such as Sandostatin® manufactured by Novartis. The competition to
market FDA-approved active bleeding esophageal varices therapies is intense.

There are numerous products that may be viewed as competitors to
Glofil-125. These include intrinsic tests, such as serum creatinine tests and
creatinine clearance tests, both used to measure how quickly the kidneys are
able to clear creatinine, an endogenously produced natural chemical, from the
blood. Extrinsic tests use such products as Tc-DTPA, manufactured by
Mallinckrodt, Inc., Omnipaque® (an injectable contrast media agent),
manufactured by Sanofi, a division of Sanofi-Synthelabo, and
Conray®-iothalamate meglumine (another injectable contrast medium),
manufactured by Mallinckrodt, Inc. There is intense competition among both FDA
and non-FDA approved products to measure kidney function.

Virtually any number of manufacturers of probiotics may be considered
competitors to VSL#3. Among the most notable are Culturelle by ConAgra and
Probiotica by Johnson and Johnson.

Several large companies products will compete with Emitasol in the
delayed onset emesis market, including Zofran® (a medication used to prevent
and treat chemotherapy induced nausea and vomiting) by Glaxo-Wellcome, Kytril®
(a medication used to prevent and treat chemotherapy induced nausea and
vomiting) by SmithKline Beecham and Reglan® (a medication used to prevent and
treat chemotherapy induced nausea and vomiting) by A.H. Robins. These
competitive products, however, are currently available in oral and intravenous
delivery forms only. Additionally, on March 26, 2003, the FDA approved Mercks
Emend (aprepitant) for various indications including delayed onset emesis. The
competition to develop FDA-approved drugs for delayed onset emesis and diabetic
gastroparesis is intense.

Many of the companies developing competing technologies and products have
significantly greater financial resources and expertise in development,
manufacturing, obtaining regulatory approvals, and marketing than we do. Other
smaller companies may also prove to be significant competitors, particularly
through collaborative arrangements with large and established companies.

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Academic institutions, government agencies and other public and private
research organizations may also seek patent protection and establish
collaborative arrangements for clinical development, manufacturing, and
marketing of products similar to ours. These companies and institutions will
compete with us in recruiting and retaining qualified sales and marketing and
management personnel, as well as in acquiring technologies complementary to our
programs. We will face competition with respect to:



| |  |  | product efficacy and safety,                                               
| | - |  | ---------------------------------------------------------------------------
|
| |  |  | the timing and scope of regulatory approvals,                              
|
| |  |  | availability of resources,                                                 
|
| |  |  | price, and                                                                 
|
| |  |  | patent position, including potentially dominant patent positions of others.

If our competitors succeed in developing technologies and drugs that are
more effective or less costly than any that we are developing, our technology
and future drugs may be rendered obsolete and noncompetitive. In addition, our
competitors may succeed in obtaining the approval of the FDA or other
regulatory approvals for drug candidates more rapidly than we will. Companies
that complete clinical trials, obtain required regulatory agency approvals and
commence commercial sale of their drugs before their competitors may achieve a
significant competitive advantage, including patent and FDA marketing
exclusivity rights that would delay our ability to market specific products. We
do not know if drugs resulting from the joint efforts of our existing or future
collaborative partner will be able to compete successfully with our
competitors existing products or products under development or whether we will
obtain regulatory approval in the U.S. or elsewhere.

We face possible delisting from the American Stock Exchange that would result
in a limited public market for our common stock.

Certain
of our financial measures have fallen below certain of the American Stock Exchanges (AMEX)
continued listing standards and we have therefore become subject to possible
delisting. Specifically, on August 9, 2002, we received notification from AMEX
that we had fallen below the standards set forth in the AMEX Guide Section
1003(a)(i) by having (1) shareholders equity of less than $2,000,000 and
losses from continuing operations in the last two fiscal years and (2)
shareholders equity of less than $4,000,000 and losses from continuing
operations in the last three fiscal years. The notification provided that we
could submit a plan to AMEX by September 10, 2002 advising it of the measures
we intended to take in order to bring us into compliance with AMEXs continuing
listing standards. We submitted such a plan of compliance to the AMEX on
September 10, 2002. On October 15, 2002, the AMEX notified us that it had
completed its review of our plan of compliance and determined that, in
accordance with Section 1009 of the AMEX Company Guide, the plan made a
reasonable demonstration of our ability to regain compliance with the continued
listing standards within eighteen months. We will be subject to periodic review
by the AMEX staff during the eighteen month extension period during which
period we are required to make progress consistent with our plan and to
ultimately comply with the continued listing standards. If we are delisted from
AMEX, the public market for our common stock would be limited. In January 2003
we completed a $10 million private placement of Series B convertible preferred
stock, and in June 2003 we completed a $5 million private placement of common
stock and warrants. These placements increased our net equity and we
believe this may bring us back into compliance with the AMEX listing
requirements.

If we fail to maintain or enter into new contracts related to collaborations
and in-licensed or acquired technology and products, our product development
and commercialization could be delayed.

Our business model has been dependent on our ability to enter into
licensing and acquisition arrangements with commercial or academic entities to
obtain technology for commercialization or marketed products. If we are unable
to enter into any new agreements in the future, our development and
commercialization efforts will be delayed. Disputes may arise regarding the
inventorship and corresponding rights in inventions and know-how resulting from
the joint creation or use of intellectual property by us and our licensors or
scientific collaborators. We may not be able to negotiate additional license
and acquisition agreements in the future on acceptable terms, if at all. In
addition, current license and acquisition agreements may be terminated, and we
may not be able to maintain the exclusivity of our exclusive licenses.

If collaborators do not commit sufficient development resources,
technology, regulatory expertise, manufacturing, marketing and other resources
towards developing, promoting and commercializing products incorporating our
discoveries, the development of our

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licensed products progress will be stalled. Further, competitive conflicts
may arise among these third parties that could prevent them from working
cooperatively with us. The amount and timing of resources devoted to these
activities by the parties could depend on the achievement of milestones by us
and otherwise generally may be controlled by other parties. In addition, we
expect that our agreements with future collaborators will likely permit the
collaborators to terminate their agreements upon written notice to us. This
type of termination would substantially reduce the likelihood that the
applicable research program or any lead candidate or candidates would be
developed into a drug candidate, would obtain regulatory approvals and would be
manufactured and successfully commercialized.

If none of our collaborations are successful in developing and
commercializing products, or if we do not receive milestone payments or
generate revenues from royalties sufficient to offset our significant
investment in product development and other costs, then our business could be
harmed. Disagreements with our collaborators could lead to delays or
interruptions in, or termination of, development and commercialization of
certain potential products or could require or result in litigation or
arbitration, which could be time-consuming and expensive and may result in lost
revenues and substantial legal costs which could negatively impact our results
from operations. In addition, if we are unable to acquire new marketed products
on a timely basis at appropriate purchase price and terms, we may not reach
profitability and may not generate sufficient cash to fund operations.

If we are unable to protect our proprietary rights, we may lose our competitive
position and future revenues.

Our success will depend in part on our ability to:



| |  |  | obtain patents for our products and technologies,                    
| | - |  | ---------------------------------------------------------------------
|
| |  |  | protect trade secrets,                                               
|
| |  |  | operate without infringing upon the proprietary rights of others, and
|
| |  |  | prevent others from infringing on our proprietary rights.            

We will only be able to protect our proprietary rights from unauthorized
use by third parties to the extent that these rights are covered by valid and
enforceable patents or are effectively maintained as trade secrets and are
otherwise protectable under applicable law. We will attempt to protect our
proprietary position by filing U.S. and foreign patent applications related to
our proprietary products, technology, inventions and improvements that are
important to the development of our business.

The patent positions of biotechnology and biopharmaceutical companies
involve complex legal and factual questions and, therefore, enforceability
cannot be predicted with certainty. Patents, if issued, may be challenged,
invalidated or circumvented. Thus, any patents that we own or license from
third parties may not provide any protection against competitors. Pending
patent applications we may file in the future, or those we may license from
third parties, may not result in patents being issued. Also, patent rights may
not provide us with proprietary protection or competitive advantages against
competitors with similar technology. Furthermore, others may independently
develop similar technologies or duplicate any technology that we have developed
or we will develop. The laws of some foreign countries may not protect our
intellectual property rights to the same extent as do the laws of the U.S.

In addition to patents, we rely on trade secrets and proprietary know-how.
We currently seek protection, in part, through confidentiality and proprietary
information agreements. These agreements may not provide meaningful protection
or adequate remedies for proprietary technology in the event of unauthorized
use or disclosure of confidential and proprietary information. The parties may
not comply or may breach these agreements. Furthermore, our trade secrets may
otherwise become known to, or be independently developed by competitors.

Our success will further depend, in part, on our ability to operate
without infringing the proprietary rights of others. If our activities infringe
on patents owned by others, we could incur substantial costs in defending
ourselves in suits brought against a licensor or us. Should our products or
technologies be found to infringe on patents issued to third parties, the
manufacture, use and sale of our products could be enjoined, and we could be
required to pay substantial damages. In addition, we, in connection with the
development and use of our products and technologies, may be required to obtain
licenses to patents or other proprietary rights of third parties, which may not
be made available on terms acceptable to us, if at all.

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Since we must obtain regulatory approval to market our products in the United
States and in foreign jurisdictions, we cannot predict whether or when we will
be permitted to commercialize our products.

Any products that we develop are subject to regulation by federal, state
and local governmental authorities in the U.S., including the FDA, and by
similar agencies in other countries. Any product that we develop must receive
all relevant regulatory approvals or clearances before it may be marketed in a
particular country. The regulatory process, which includes extensive
pre-clinical studies and clinical trials of each product to establish its
safety and efficacy, is uncertain, can take many years and requires the
expenditure of substantial resources. Data obtained from pre-clinical and
clinical activities are susceptible to varying interpretations that could
delay, limit or prevent regulatory approval or clearance. In addition, delays
or rejections may be encountered based upon changes in regulatory policy during
the period of product development and the period of review of any application
for regulatory approval or clearance for a product. Delays in obtaining
regulatory approvals or clearances could:



| |  |  | stall the marketing, selling and distribution of any products that our corporate partners or we develop,
| | - |  | --------------------------------------------------------------------------------------------------------
|
| |  |  | impose significant additional costs on our corporate partners and us,                                   
|
| |  |  | diminish any competitive advantages that we or our corporate partners may attain, and                   
|
| |  |  | decrease our ability to receive royalties and generate revenues and profits.                            

Regulatory approval, if granted, may entail limitations on the indicated
uses for which a new product may be marketed that could limit the potential
market for the product. Product approvals, once granted, may be withdrawn if
problems occur after initial marketing. Furthermore, manufacturers of approved
products are subject to pervasive review, including compliance with detailed
regulations governing FDA good manufacturing practices. The FDA periodically
revises the good manufacturing practices regulations. Failure to comply with
applicable regulatory requirements can result in warning letters, fines,
injunctions, civil penalties, recall or seizure of products, total or partial
suspension of production, refusal of the government to grant marketing
applications and criminal prosecution.

In addition, we cannot predict the extent of government regulations or the
impact of new governmental regulations that may result in a delay in the
development, production and marketing of our products. As such, we may be
required to incur significant costs to comply with current or future laws or
regulations. For example, successful late stage Phase III clinical trials for
such potentially important treatments such as diabetic gastroparesis and
delayed onset emesis may require the enrollment of many patients. Together, the
costs of these trials, if funded solely by us, could exceed our current
financial resources.

Our ability to generate revenues is affected by the availability of
reimbursement on our products, and our ability to generate revenues will be
diminished if we fail to obtain an adequate level of reimbursement for our
products from third party payors.

In both domestic and foreign markets, sales of our products will depend in
part on the availability of reimbursement from third-party payors such as state
and federal governments (for example, under Medicare and Medicaid programs in
the U.S.) and private insurance plans. Because of VSL#3s non-prescription
status, it is not widely covered by third party payors. In certain foreign
markets, the pricing and profitability of our products generally are subject to
government controls. In the U.S., there have been, and we expect there will
continue to be, a number of state and federal proposals that limit the amount
that state or federal governments will pay to reimburse the cost of drugs. In
addition, we believe the increasing emphasis on managed care in the U.S. has
and will continue to put pressure on the price and usage of our products, which
may impact product sales. Further, when a new therapeutic is approved, the
reimbursement status and rate of such a product is uncertain. In addition,
current reimbursement policies for existing products may change at any time.
Changes in reimbursement or our failure to obtain reimbursement for our
products may reduce the demand for, or the price of, our products, which could
result in lower product sales or revenues, thereby weakening our competitive
position and negatively impacting our results of operations.

In the U.S., proposals have called for substantial changes in the Medicare
and Medicaid programs. If such changes are enacted, they may require
significant reductions from currently projected government expenditures for
these programs. Driven by budget concerns, Medicaid managed care systems have
been implemented in several states and local metropolitan areas. If the
Medicare and Medicaid programs implement changes that restrict the access of a
significant population of patients to its innovative medicines, the market
acceptance of these products may be reduced.

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To facilitate the availability of our products for Medicaid patients, we
have contracted with the Center for Medicare and Medicaid Services. As a
result, we pay quarterly rebates consistent with the utilization of our
products by individual states. We also must give discounts under contract on
purchases or reimbursements of pharmaceutical products by certain other federal
and state agencies and programs. If these discounts and rebates become
burdensome to us and we are not able to sell our products through these
channels, our net sales could decline.

Our stock price has a history of volatility, and an investment in our stock
could decline in value.

The price of our stock, like that of other specialty pharmaceutical
companies, is subject to significant volatility. Our stock price has ranged in
value from $2.18 to $0.75 over the last two years. Any number of events, both
internal and external to us, may continue to affect our stock price. These
include, without limitation, the quarterly and yearly revenues and
earnings/losses, our ability to acquire and market appropriate pharmaceuticals,
announcement by us or our competitors regarding product development efforts,
including the status of regulatory approval applications; the outcome of legal
proceedings, including claims filed by us against third parties to enforce our
patents and claims filed by third parties against us relating to patents held
by the third parties; the launch of competing products; our ability to obtain
product from our contract manufacturers; the resolution of (or failure to
resolve) disputes with collaboration partners and corporate restructuring by
us.

If product liability lawsuits are successfully brought against us or we become
subject to other forms of litigation, we may incur substantial liabilities and
costs and may be required to limit commercialization of our products.

Our business will expose us to potential liability risks that are inherent in
the testing, manufacturing and marketing of pharmaceutical products. The use of
any drug candidates ultimately developed by us or our collaborators in clinical
trials may expose us to product liability claims and possible adverse
publicity. These risks will expand for any of our drug candidates that receive
regulatory approval for commercial sale and for those products we currently
market. Product liability insurance for the pharmaceutical industry is
generally expensive, if available at all. We currently have product liability
insurance for claims up to $10,000,000. However, if we are unable to maintain
insurance coverage at acceptable costs, in a sufficient amount, or at all, or
if we become subject to a product liability claim, our reputation, stock price
and ability to devote the necessary resources to the commercialization of our
products could be negatively impacted.



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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk at June 30, 2003 has not changed materially
from December 31, 2002, and reference is made to the more detailed disclosures
of market risk included in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2002 as filed with the Securities and Exchange Commission on
March 26, 2003.




ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the Companys Exchange
Act reports is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commissions rules and forms
and that such information is accumulated and communicated to the Companys
management, including its Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow for timely decisions regarding required disclosure. In
designing and evaluating the disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired
control objectives, and management is required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a(b), the Company carried out an evaluation,
under the supervision and with the participation of the Companys management,
including the Companys Chief Executive

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Officer and the Companys Chief
Financial Officer, of the effectiveness of the design and operation of the
Companys disclosure controls and procedures as of the end of the quarter
covered by this report. Based on the foregoing, the Companys Chief Executive
Officer and Chief Financial Officer concluded that the Companys disclosure
controls and procedures were effective at the reasonable assurance level.

There has been no change in the Companys internal controls over financial
reporting during the Companys most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Companys internal
controls over financial reporting.




PART II. OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

Not applicable




ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Not applicable




ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable




ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Company held its 2003 annual meeting of shareholders on May 12, 2003. The
following matters received the votes at the meeting as set forth below:



|1. |  | Election of Directors to hold office until the 2004 Annual Meeting of Shareholders.
|-- |  | -----------------------------------------------------------------------------------

|                     |  |           |            |                |  |  |           | 
|-------------------- |  | --------- | ---------- | -------------- |  |  | --------- | 
|                     |  | Votes For |            | Votes Withheld
|                     |  |           |            |               
|Charles J. Casamento |  |           | 32,007,104 |                |  |  | 1,618,570 | 
|Robert F. Allnutt    |  |           | 32,395,717 |                |  |  | 1,229,957 | 
|Frank J. Sasinowski  |  |           | 32,383,458 |                |  |  | 1,242,216 | 
|Jon S. Saxe          |  |           | 32,555,909 |                |  |  | 1,069,765 | 
|John T. Spitznagel   |  |           | 32,399,022 |                |  |  | 1,226,652 | 
|Roger G. Stoll       |  |           | 32,571,408 |                |  |  | 1,054,266 | 
|Virgil Thompson      |  |           | 32,566,108 |                |  |  | 1,059,566 | 



|2. |  | An amendment to the Companys Amended and Restated Articles of Incorporation increasing the total number of
shares of the Companys Common Stock, authorized for issuance by 30,000,000 shares, so that the total number of
shares of Common Stock authorized for issuance is 105,000,000 shares.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|        |  |  |            | 
|------- |  |  | ---------- | 
|For     |  |  | 31,102,927 | 
|Against |  |  | 2,490,425  | 

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|        |  |  |        | 
|------- |  |  | ------ | 
|Abstain |  |  | 32,222 | 



|3. |  | An amendment to the Companys 1992 Employee Stock Option Plan (the 1992 Plan) increasing the aggregate number
of shares of Common Stock authorized for issuance under the 1992 Plan by 1,000,000 shares, from 12,500,000 shares
to 13,500,000 shares.
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|        |  |  |            | 
|------- |  |  | ---------- | 
|For     |  |  | 31,418,748 | 
|Against |  |  | 2,174,505  | 
|Abstain |  |  | 32,421     | 

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|4. |  | Approval of the Companys 2003 Employee Stock Purchase Plan which provides for 900,000 shares of Common Stock to be
authorized for employee purchases.
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------

|        |  |  |            | 
|------- |  |  | ---------- | 
|For     |  |  | 32,305,729 | 
|Against |  |  | 1,274,555  | 
|Abstain |  |  | 45,390     | 



|5. |  | Ratification of Ernst & Young LLP as the Companys independent auditors for the fiscal year ending December 31, 2003.
|-- |  | ---------------------------------------------------------------------------------------------------------------------

|        |  |  |            | 
|------- |  |  | ---------- | 
|For     |  |  | 33,442,834 | 
|Against |  |  | 147,888    | 
|Abstain |  |  | 34,952     | 




ITEM 5. OTHER INFORMATION

Not applicable




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits

| |  |  |       |  |  |                                                                                                         
| |  |  | ----- |  |  | --------------------------------------------------------------------------------------------------------
| |  |  | 10.28 |  |  | Asset Purchase Agreement between Nastech Pharmaceutical Company, Inc. and Questcor Pharmaceuticals, Inc.
| |  |  |       |  |  |                                                                                                         
| |  |  | 10.29 |  |  | Supply Agreement by and between Nastech Pharmaceutical Company, Inc and Questcor Pharmaceuticals, Inc. 
| |  |  |       |  |  |                                                                                                         
| |  |  | 15.1  |  |  | Letter regarding Unaudited Financial Information.                                                       
| |  |  |       |  |  |                                                                                                         
| |  |  | 31    |  |  | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                
| |  |  |       |  |  |                                                                                                         
| |  |  | 32    |  |  | Certification pursuant to Section 906 of the Public Company Accounting Reform and Investor Act of 2002. 



---

| |  |  The Company has requested confidential treatment with respect to portions of this exhibit.
| |  | --------------------------------------------------------------------------------------------

(b)  Reports on Form 8-K

On January 16, 2003, we reported on Form 8-K, reporting under Item 5, that
we had consummated a $10 million private placement of Series B Convertible
Preferred Stock and Warrants to purchase Common Stock.

On February 14, 2003, we reported on Form 8-K, reporting under Item 5,
that on February 11, 2003 our Board of Directors adopted a Shareholder Rights
Plan.

On May 15, 2003, we furnished on Form 8-K, under Item 9, our press release
of our results for the quarter ended March 31, 2003.

34



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##### Table of Contents



On June 17, 2003, we reported on Form 8-K, reporting under Item 5, that on
June 17, 2003 we completed the Nascobal Product Acquisition, a private
placement of Common Stock and Warrants and entered into an agreement with our
Series B Preferred Stockholders.

35



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##### Table of Contents






SIGNATURES

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

|                      |  |                       |  |                                                                                                                                    
|--------------------- |  | --------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------
|                      |  | PHARMACEUTICALS, INC.
|                      |  |                       |  |                                                                                                                                    
|Date: August 14, 2003 |  | By:                   |  | /s/ CHARLES J. CASAMENTO                                                                                                           
|                      |  |                       |  |                                                                                                                                    
|                      |  | By:                   |  | Charles J. Casamento
Chairman, President & CEO                                                                                     
|                      |  |                       |  |                                                                                                                                    
|Date: August 14, 2003 |  |                       |  | /s/ TIMOTHY E. MORRIS                                                                                                              
|                      |  |                       |  |                                                                                                                                    
|                      |  |                       |  | Timothy E. Morris
Vice President, Finance & Administration
And Chief Financial Officer (Principal
Financial and Accounting Officer)

36



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##### Table of Contents



Exhibit Index

|      |  |                                                                                                         
|----- |  | --------------------------------------------------------------------------------------------------------
|10.28 |  | Asset Purchase Agreement between Nastech Pharmaceutical Company, Inc.
and Questcor Pharmaceuticals, Inc 
|      |  |                                                                                                         
|10.29 |  | Supply Agreement by and between Nastech Pharmaceutical Company, Inc
and Questcor Pharmaceuticals, Inc. 
|      |  |                                                                                                         
|15.1  |  | Letter regarding Unaudited Financial Information                                                        
|      |  |                                                                                                         
|31    |  | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                
|      |  |                                                                                                         
|32    |  | Certification pursuant to Section 906 of the Public Company Accounting Reform and Investor Act of 2002. 



---

| |  |  The Company has requested confidential treatment with respect to
portions of this exhibit.
| |  | --------------------------------------------------------------------------------------------

37