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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




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Form 10-K

|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|  
|   |  | For the Fiscal Year ended December 31,
    2003                                             
|or
|  
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-20772

Questcor Pharmaceuticals, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                                         |  |                                          
|---------------------------------------------------------------------------------------- |  | -----------------------------------------
|California                                                                               |  | 33-0476164                               
|(State or other jurisdiction
    of incorporation or organization)                       |  | (I.R.S. Employer
     Identification No.)
|                                                                                        
|3260 Whipple Road
    Union City, California(Address of principal executive
    offices) |  | 94587(Zip Code)                          

Registrants telephone number, including
area code:

(510) 400-0700


Securities registered pursuant to
Section 12(b) of the Act:

None


Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, no par value


(Title of class)


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

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

The aggregate market value of the voting and
non-voting Common Stock held by non-affiliates of the Registrant
was approximately $31,217,565 as of June 30, 2003, based
upon the last sales price of the Registrants Common Stock
reported on the American Stock Exchange. The determination of
affiliate status for the purposes of this calculation is not
necessarily a conclusive determination for other purposes. The
calculation excludes approximately 13,051,037 shares held
by directors, officers and stockholders whose ownership exceeds
five percent of the Registrants outstanding Common Stock
as of June 30, 2003. Exclusion of these shares should not
be construed to indicate that such person controls, is
controlled by or is under common control with the Registrant.

As of March 22, 2004 the Registrant had
50,923,101 shares of Common Stock outstanding.

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
o

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrants Definitive Proxy
Statement filed with the Commission pursuant to
Regulation 14A in connection with the 2004 Annual Meeting
of Shareholders are incorporated by reference into Part III
of this Report.



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ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31,
2003


TABLE OF CONTENTS

|              |  |                                                                                               |  |      |    | 
|------------- |  | --------------------------------------------------------------------------------------------- |  | ---- | -- | 
|              |  |                                                                                               |  | Page
|              |  |                                                                                               |  |     
|PART I       
|Item 1.       |  | Business                                                                                      |  |      | 2  | 
|Item 2.       |  | Properties                                                                                    |  |      | 27 | 
|Item 3.       |  | Legal Proceedings                                                                             |  |      | 27 | 
|Item 4.       |  | Submission of Matters to a
    Vote of Security Holders                                       |  |      | 27 | 
|PART II      
|Item 5.       |  | Market for Registrants
    Common Equity and Related Shareholder Matters                     |  |      | 28 | 
|Item 6.       |  | Selected Consolidated
    Financial Data                                                      |  |      | 29 | 
|Item 7.       |  | Managements Discussion
    and Analysis of Financial Condition and
    Results of Operations |  |      | 31 | 
|Item 7(A)     |  | Quantitative and Qualitative
    Disclosures about Market Risk                                |  |      | 53 | 
|Item 8.       |  | Financial Statements and
    Supplementary Data                                               |  |      | 54 | 
|Item 9.       |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure      |  |      | 54 | 
|Item 9(A)     |  | Controls and Procedures                                                                       |  |      | 54 | 
|PART III     
|Item 10.      |  | Directors and Executive
    Officers of the Registrant                                        |  |      | 54 | 
|Item 11.      |  | Executive Compensation                                                                        |  |      | 55 | 
|Item 12.      |  | Security Ownership of
    Certain Beneficial Owners and Management                            |  |      | 55 | 
|Item 13.      |  | Certain Relationships and
    Related Transactions                                            |  |      | 55 | 
|Item 14.      |  | Principal Accountant Fees
    and Services                                                    |  |      | 55 | 
|PART IV      
|Item 15.      |  | Exhibits, Financial
    Statement Schedules and Reports on Form 8-K                           |  |      | 55 | 
|              |  | Signatures                                                                                    |  |      | 58 | 
|EXHIBIT 10.28
|EXHIBIT 10.29
|EXHIBIT 10.30
|EXHIBIT 23.1 
|EXHIBIT 31   
|EXHIBIT 32   



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PART I





|        |                     
|------- | --------------------
|Item 1. | Business of Questcor

Except for the historical information contained
herein, the following discussion contains forward-looking
statements that involve risks and uncertainties. Questcors
actual results could differ materially from those discussed
here. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in this
Item 1 Business of Questcor, including without
limitation Risk Factors, and Item 7
Managements Discussion and Analysis of Financial
Condition and Results of Operations, as well as those
discussed in any documents incorporated by reference herein or
therein. When used in this annual 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
acquires, markets and sells brand name prescription drugs
through our U.S. direct sales force and international
commercialization partners. We focus on the treatment of central
nervous system (CNS) diseases and
gastroenterological disorders, which are served by a
concentrated group of physicians such as neurologists and
gastroenterologists. Our strategy is to acquire pharmaceutical
products that we believe have sales growth potential, are
promotionally responsive to a focused and targeted sales and
marketing effort, and complement our existing products. In
addition, through corporate collaborations, we intend to develop
new patented intranasal formulations of medications previously
approved by the Food and Drug Administration (FDA).
For the year ended December 31, 2003, our total revenues
were $14.1 million.

Large multinational companies dominate the
U.S. prescription pharmaceutical market. These companies
tend to focus on drugs with annual sales in excess of
$1 billion and often divest products that, as a result of
consolidation or lack of strategic fit, do not meet the
threshold level of sales required for continued marketing and
promotion. Since our inception, we have acquired and licensed
products from Aventis Pharmaceuticals, Inc.
(Aventis), Schwartz Pharma AG, Nastech
Pharmaceutical Company, Inc. (Nastech) and
other pharmaceutical companies. Smaller drug development or
biotech companies that do not have the capabilities to
effectively market and sell FDA approved products will also be
sources of products. In 2003 we acquired an FDA approved product
from Nastech.

Since 1995, we have introduced 7 products and
currently market 5 products in the United States. We promote
certain of our products through our nationwide sales and
marketing force of approximately 30 professionals, targeting
high-prescribing acute care and specialty physicians such as
gastroenterologists and neurologists. We contract with third
parties for the manufacture of all our products as well as the
warehousing and distribution of our products.

Our current products are: 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®, the
only prescription 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, an injectable agent that assesses 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. Due to minimal demand and increasing production
costs, we discontinued marketing and selling Inulin in September
2003 and Neoflo in 2001.

In June 2003, we acquired Nascobal®, an FDA
approved nasal gel formulation of Cyanocobalamin USP (Vitamin
B-12), from Nastech, a leading formulation science company. We
began distributing Nascobal in July 2003. We are marketing
Nascobal for patients with MS and Crohns Disease, since
these patients are at

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high risk of developing 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. We have entered into several agreements with
pharmaceutical and biotechnology companies to further the
development of certain acquired technology. In June 2002, we
signed a definitive License Agreement with Fabre Kramer
Pharmaceuticals, Inc. (Fabre Kramer), whereby
we granted Fabre Kramer exclusive worldwide rights to develop
and commercialize HypnostatTM (intranasal triazolam
for the treatment of insomnia) and PanistatTM
(intranasal alprazolam for the treatment of panic disorders). We
have partnered with Rigel Pharmaceuticals, Inc.
(Rigel) of South San Francisco, California for
our antiviral drug discovery program, and partnered with
Dainippon Pharmaceuticals Co., Ltd. (Dainippon) of
Osaka, Japan for our antibacterial program.

We have rights to the following registered
trademarks: HP Acthar® Gel, Ethamolin®, Nascobal®
and Glofil®-125. We also have the following unregistered
trademarks: MigrastatTM, EmitasolTM,
HypnostatTM and PanistatTM. VSL#3® is
owned by VSL Pharmaceuticals, Inc. Pramidin® is owned
by sirton pharmaceuticals S.p.A (sirton). Emitasol
is approved in Italy as Pramidin and has been marketed in the
past by sirton. Each other trademark, trade name or service mark
appearing in this document belongs to its respective holder.

Questcor is the surviving corporation of a merger
between Cypros Pharmaceutical Corporation and
RiboGene, Inc. (RiboGene). The merger was
completed on November 17, 1999. Our principal office is
located at 3260 Whipple Road, Union City, California 94587 and
our telephone number is (510) 400-0700. Our corporate Internet
address is www.questcor.com. We do not intend for the
information contained on our website to be part of this Annual
Report.

Strategy

We believe that our ability to market and acquire
brand name products and our ability to increase our sales and
improve our marketing infrastructure uniquely positions us to
continue to grow.

The key elements of our strategy include:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Increase sales of products through targeted
    promotion. We seek to increase sales by promoting certain of our
    products to high-prescribing specialty physicians through our
    nationwide sales and marketing organization that includes
    approximately 30 professionals. Our current target audience for
    Nascobal are gastroenterologists, bariatric surgeons and
    neurologists, and neurologists for Acthar. Product usage and
    recommendations by these specialists generally influence usage
    by primary care physicians.                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | Identify and license or acquire brand name
    prescription products. We seek to acquire the rights to brand
    name pharmaceutical products that we believe will
    (i) benefit from increased marketing efforts directed at
    high-prescribing specialty physicians, (ii) leverage our
    existing sales infrastructure, and (iii) complement our
    existing products. Since our inception, we have acquired or
    licensed seven products. Products to be considered for
    acquisition would have to be complementary to our existing
    products, synergistic with promotional efforts currently being
    undertaken by our sales force, and contribute to our gross
    margin. There is no assurance we will be able to acquire such
    products or, if acquired, that they will produce attractive
    gross margins. We intend to purchase products with cash
    generated from operations, if any, or from capital raised
    through the sale of equity on terms acceptable to us.
|
| |  | Acquire companies that sell products that
    complement our current products and sales strategy. We regularly
    review opportunities to acquire companies that sell products
    that complement the current products that we sell and target the
    physicians to whom we promote our products. We intend to acquire
    companies using our common stock, if such stock is at acceptable
    levels, or cash generated from operations, if any, or from
    capital raised through the sale of equity on terms acceptable to
    us.                                                                                                                                                                                                                                                                                                                                                                                                                                                                

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Marketed Pharmaceutical and Related Healthcare
Products

Our marketed products as of December 31,
2003 include: Acthar, which we acquired in July 2001; Nascobal,
which we acquired in June 2003; Ethamolin, which we acquired in
November 1996; Glofil-125, which we acquired in August 1995; and
VSL#3, which we acquired the rights to market and sell pursuant
to a Promotion Agreement effective January 2002.

Acthar.HP Acthar
Gel (Acthar) is a natural source, highly purified
preparation of the adrenal corticotropin hormone
(ACTH). Unlike ACTH, Acthar is specially formulated
to provide prolonged release after intramuscular or subcutaneous
injection. It works by stimulating the adrenal cortex to secrete
the natural endogenous corticosteroids, including cortisol,
corticosterone, aldosterone, and a number of weakly androgenic
substances.

In July 2001, we signed an agreement with Aventis
to acquire the worldwide rights to Acthar. Due to limited
distribution of Acthar prior to our acquisition of the product
from Aventis, drug wholesalers did not have access to Acthar. We
began shipping Acthar to drug wholesalers at the end of the
third quarter of 2001. As part of our agreement with Aventis,
Aventis agreed to manufacture and supply Acthar for us through
July 2002 at a fixed price per vial. Aventis produced their
final batch of Acthar for us in July 2002 which had a January
2004 expiration date. Under our agreement with Aventis, we
purchased the active pharmaceutical ingredient (the
API) and other inventory residing at Aventis. We
produced our first batch of finished Acthar vials using the API
from Aventis at our contract manufacturer, Chesapeake Biological
Laboratories, Inc., and commenced shipment of finished
product during 2003. We have also made plans to produce our
first batch of the API at our new contract manufacturer during
2004 and we expect to use the API for the production of finished
vials for commercial use during 2005. Based on internal sales
forecasts, our existing inventory of the API, previously
manufactured for us by Aventis, should be adequate to supply the
annual demand for Acthar through 2006. However, there can be no
assurance that the existing inventory of the API will be
sufficient to meet our demand through 2006 or that our third
party manufacturers will be able to supply Acthar. Additionally,
under our prior arrangement, Aventis supplied Acthar at a fixed
price per vial through July 2002. The transfer of manufacturing
from Aventis to new third party manufacturers will likely result
in higher unit costs, which would result in a decrease of our
gross margins on sales of Acthar. Acthar gross margins were 78%
for the year ended December 31, 2003.

Acthar is used in a wide variety of conditions,
including the treatment of infantile spasm (IS),
periodic flare associated with MS, and various forms of
arthritis, collectively called joint pain. Although the FDA
approved package labeling does not include IS, Acthar has been
used to treat this condition. We believe IS is the disease with
the most compelling need for Acthar treatment. IS is an
epileptic syndrome characterized by the triad of infantile spasm
(generalized seizures), hypsarrhythmia and arrest of psychomotor
development at seizure onset. We estimate that as many as 2,000
children annually experience bouts of this devastating syndrome
in the U.S. In 90% of children with IS, the spasms occur
during the first year of life, typically between 3 to
6 months of age. The age of first onset rarely occurs after
the age of two. Patients left untreated or treated inadequately
have a poor prognosis for intellectual and functional
development. About two-thirds of patients are neurologically
impaired prior to the onset of IS, while one-third are otherwise
normal. Rapid and aggressive therapy to control the abnormal
seizure activity appears to improve the chances that these
children will develop to their fullest potential.

The market for IS therapies has not changed much
over the last several years. Acthar remains the treatment of
choice; however, Acthars availability in the several years
before our acquisition from Aventis was very restricted. As
such, many physicians used synthetic steroids and even sought to
obtain vigabatrin from Canada, an unapproved product in the
United States. Vigabatrin, an enzyme inhibitor, is marketed
under the trade name Sabril® in Canada. A symposium on IS,
sponsored by the Child Neurology Society, discussed the fact
that there has been no clinical evidence to show that any
therapy is better than Acthar for the treatment of IS. The
proceedings of that symposium have been made available to all
pediatric neurologists as a continuing medical education
monograph.

Acthar is indicated for use in acute
exacerbations of MS and is prescribed currently for patients
that have MS and experience painful, episodic flares. During
2003, we began to promote Acthar as an alternative to

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intravenous methylprednisolone, a corticosteroid,
for the treatment of exacerbations of MS. Intravenous
methylprednisolone is currently the treatment of choice for this
indication. The primary advantage of Acthar in this setting is
that it provides the patient with the freedom and convenience of
intramuscular or subcutaneous administration at home, rather
than the intravenous administration of methylprednisolone,
without sacrificing efficacy or tolerability. Sales promotion of
Acthar for joint pain is not anticipated at this point.


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. Solu-Medrol, the primary
competitive product to Acthar for the treatment of MS flare, is
now available to patients after an announced shortage in 2003.

Nascobal.Cyanocobalamin is one of the B-12 (cobalamin) class of
vitamins. Cyanocobalamin is the principal member of the class,
and the most widely employed in medicine in the United States.
It is currently commercially available over the counter in an
oral formulation and by prescription in injectable and nasal
formulations.

The diets of most adult Americans provide the
recommended intake of Vitamin B-12, but deficiency can
still occur. Vitamin B-12 deficiency has a number of
causes, including malabsorption of Vitamin B-12 resulting
from structural or functional damage to the gastrointestinal
system, caused by surgery or various disease states.
Vitamin B-12 deficiency of this type has traditionally been
treated with an intramuscular injection of Vitamin B-12.
Most individuals who develop a Vitamin B-12 deficiency
resulting from structural or functional damage to the
gastrointestinal system have an underlying stomach or intestinal
disorder that limits the absorption of Vitamin B-12.
Characteristic signs of Vitamin B-12 deficiency include
fatigue, weakness, nausea, constipation, flatulence (gas), loss
of appetite and weight loss. Deficiency also can lead to
neurological changes such as numbness and tingling in the hands
and feet. Additional symptoms of Vitamin B-12 deficiency are
difficulty in maintaining balance, depression, confusion, poor
memory and soreness of the mouth or tongue. Sometimes the only
symptom of these intestinal disorders is anemia resulting from
Vitamin B-12 deficiency. Dietary deficiency of
Vitamin B-12 has also been seen in strict vegetarians but
this type of deficiency can be treated with oral
Vitamin B-12 supplements.

Currently in the United States approximately
37 million injection dosages of Vitamin B-12 are
prescribed annually to address all causes of Vitamin B-12
deficiency. Although the potential market for the use of
Nascobal is large, we will initially focus our promotional
efforts on patients who through surgery or as a result of
disease cannot readily absorb Vitamin B-12. The initial
promotional efforts will focus on patients who are susceptible
to a Vitamin B-12 deficiency caused by Crohns
disease, gastric bypass surgery or multiple sclerosis.

People with Crohns disease may have
difficulty absorbing Vitamin B-12 because of intestinal
inflammation. Crohns patients who have had both a primary
and secondary surgical resection of their small bowel may
develop Vitamin B-12 deficiency. Vitamin B-12
deficiency can also predate surgery in Crohns patients. A
study in patients with Crohns disease found that up to 60%
of those who had not had surgery showed signs of
Vitamin B-12 deficiency, probably due to the malabsorption
caused by the disease itself. Surgical procedures of the
gastrointestinal tract, such as surgery to remove all or part of
the stomach, often result in a loss of cells that secrete
stomach acid and intrinsic factor, a substance normally present
in the stomach. Surgical removal of the distal ileum, a section
of the intestines, also can result in the inability to absorb
Vitamin B-12. Individuals who have had either of these
surgeries usually require lifelong supplemental
Vitamin B-12 to prevent a deficiency. In the
U.S. alone there are approximately 500,000 Crohns
patients, of which approximately 175,000 are candidates for
Vitamin B-12 therapy.

Gastric bypass surgery is a surgical procedure
performed on morbidly obese patients. Obesity is a major health
problem in the United States and it is estimated that over
12 million Americans are classified as morbidly obese. To
assist with weight loss, bariatric surgeons perform a variety of
surgical procedures on the stomach and intestines designed to
restrict or limit the intake of food. As a result of these
procedures, the absorption of Vitamin B-12 through diet is
extremely limited. In fact, approximately 50% of patients two
years

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after surgery had significant vitamin and mineral
deficiency. In 2003, it is estimated that 90,000 gastric bypass
surgeries were performed and the number of procedures is
expected to increase to 140,000 in 2004.


A study of multiple sclerosis (MS)
patients found that over 20% had abnormally low serum
Vitamin B-12 levels. Cerebral spinal fluid levels of
Vitamin B-12 were also reduced in patients with MS. It is
speculated that Vitamin B-12 associated transmethylation
may be an important component in the demyelination that is
characteristic of MS. Over 350,000 people in the U.S. have
MS.

Vitamin B-12 deficiency may also result from
a variety of disease states. It is estimated that 1% of the
U.S. population (approximately 2,750,000 people) will
develop pernicious anemia in their lifetime. Pernicious anemia
is a rare blood disorder characterized by the inability of the
body to properly utilize Vitamin B-12. Pernicious anemia
occurs when there is an absence of intrinsic factor, a substance
normally present in the stomach. Vitamin B-12 deficiency is
found in up to 10% of patients over 60 years old. Another
study suggests that approximately half of Americans over 65 can
not absorb the Vitamin B-12 contained in their food. Among
the estimated 800,000 HIV and AIDS patients in the U.S., 10 to
20% (or approximately 80,000-160,000 people) are
Vitamin B-12 deficient.

Current maintenance treatment for
Vitamin B-12 deficiency calls for injections of
Vitamin B-12 once per month for life. This chronic need for
Vitamin B-12 replacement therapy often requires frequent
trips to a health care professionals office or visits by a
home health care professional to receive injections.

Nascobal Gel is the only intranasal
Vitamin B-12 available, and is the only non-injectable
prescription Vitamin B-12 therapy. It is administered once
a week which can enhance compliance and provide more consistent
blood levels than monthly injections of Vitamin B-12.
Nascobal is covered by most major pharmaceutical benefit
programs.

In September 2003, the FDA approved our request
to have Nascobal labeled for first-line use for all
Vitamin B-12 deficiencies except pernicious anemia.
Previously, the approved Nascobal labeling required the initial
stabilization of Vitamin B-12 levels with injectable
Vitamin B-12 before switching to Nascobal.

As part of our acquisition of Nascobal, we also
acquired the rights to Nascobal nasal spray, a new dosage form,
for which a New Drug Application was filed by Nastech with the
FDA in December 2003.

Nascobal competes in the market for Vitamin B-12
replacement therapy. This market on a unit basis is dominated by
inexpensive generic Vitamin B-12 injections. The Vitamin B-12
injection requires the additional expense of a doctors
office visit once a month. Some patients may also receive over
the counter Vitamin B-12 tablets or sublingual formulations of
Vitamin B-12; however, the effectiveness of tablets and
sublingual formulation is questionable in the patients for whom
Nascobal is marketed.

Ethamolin.End-stage
liver disease, also known as hepatic cirrhosis, results in
approximately 26,000 deaths annually in the United States.
Hepatic cirrhosis promotes the formation of enlarged weakened
blood vessels at the entrance to the stomach that have recently
bled, known as esophageal varices, through development of portal
hypertension. When portal venous blood pressure rises, the
varicosities that develop may cause life threatening upper
gastrointestinal hemorrhage and are associated with a high
mortality rate. At least 33,000 patients in the United
States have either actively bleeding esophageal varices or
esophageal varices that are at imminent risk of bleeding.

Early and effective treatment of esophageal
varices to achieve hemostasis is essential to a favorable
outcome in a bleeding patient. The most common pharmaceutical
treatment protocol involves the injection of a sclerosing agent
into the varix, achieving clot formation and obliteration of the
varix. Sclerotherapy agents are chemicals that are injected into
varicose veins that damage and scar the inside of the vein,
causing it to close. This form of hemostasis is called
sclerotherapy and usually requires multiple treatment sessions.
Ethamolin is the only sclerotherapy agent approved by the FDA
for the treatment of esophageal varices that have recently bled.
However, there is strong competition from band ligation, a form
of surgery, that is becoming the treatment of choice for this
emergent clinical condition. At the present time, we are not
actively promoting Ethamolin.

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Several companies may offer less expensive
sclerotherapy agents that compete with Ethamolin. However,
Ethamolin is the only product which is FDA approved for treating
esophageal varices. Other competitive agents include
ScleromateTM (an injectable agent used to treat
varicose veins and spider veins), 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.

Glofil-125.Glofil-125 is approved by the FDA for measuring glomerular
filtration rate (GFR), a measurement of kidney
function. Nephrology, transplant, oncology and nuclear medicine
departments at major medical centers are the primary users of
Glofil-125. Glofil-125 is an injectable radioisotope diagnostic
agent, which provides rapid information on GFR with great
accuracy. Radioisotopes have very short half-lives and require
special handling. Present diagnostic procedures for measuring
kidney function include serum creatinine and creatinine
clearance tests. These two tests are the most commonly performed
methods of measuring kidney function because of their low cost.
However, both methods may significantly overestimate kidney
function in the estimated 700,000 patients with severe
renal disease. The utility of Glofil-125 has been established in
published clinical studies as being a more direct and accurate
measure of kidney function yielding much more reliable results
than serum creatinine or creatinine clearance tests. This
improved accuracy can be essential in monitoring disease
progression, implementing appropriate interventions and
assessing the degree of success of kidney grafts, post
transplant. However, most early stage patients are not deemed to
require this degree of accuracy in the determination of renal
function.

Due to its high degree of accuracy, Glofil-125
has also been used in clinical trials administered by the
National Institutes of Health. Use of Glofil-125 in clinical
trials can provide the trial administrators with an accurate
measure of kidney function and illustrate the effects of the
drug being studied on normal kidney function.

The biggest impediment to future growth in the
sales of Glofil-125 is the current lack of availability of the
test to practicing clinicians. The main reason for this is
because routine testing with Glofil-125 requires dedicated
laboratory facilities and trained technicians. Due to the lack
of strategic fit, as well as the acquisition and growth
potential of Nascobal, the promotional efforts on Glofil-125
will be limited to supporting existing users.

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
of which are used to measure how quickly the kidneys are able to
clear creatinine, an endogenously produced 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.

VSL#3.We acquired
U.S. promotion rights from VSL Pharmaceuticals, Inc.
for VSL#3 under an agreement effective January 2002. VSL#3 is a
patented over the counter probiotic preparation of eight live
freeze-dried lactic acid bacterial species. Probiotics are
living organisms in foods and dietary supplements, which, upon
ingestion in certain numbers, improve the health of the host
beyond their inherent basic nutrition. We formally launched
VSL#3 to the market as a dietary supplement to promote normal
gastrointestinal (GI) function at the annual
Digestive Disease Week meeting in May 2002.

We believe the emerging role for probiotics in
the management of patients with Inflammatory Bowel Disease
(IBD) offers an attractive market opportunity for
VSL#3 which at the same time effectively complements our current
promotion of Nascobal to this same group of gastroenterologists.
IBD is one of the most common chronic gastrointestinal illnesses
and consists mainly of two conditions  ulcerative
colitis and Crohns disease. It is estimated that almost
one million Americans have IBD, with roughly 50% due to
ulcerative colitis and 50% due to Crohns disease. About 25
to 40% of ulcerative colitis patients eventually

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must have their colon removed because of massive
bleeding, severe illness, rupture of the colon, or risk of
cancer. A number of surgeries may be performed for ulcerative
colitis. One such procedure, which is becoming increasingly
common for ulcerative colitis, is ileal pouch anal anastomosis
surgery. This operation allows the patient to have relatively
normal bowel movements because it preserves part of the rectum.
A major long-term complication that occurs as a result of this
surgery is pouchitis. Pouchitis is the non-specific inflammation
of the ileal reservoir that appears to be associated with
bacterial overgrowth and dysbiosis. Published clinical trials
have reported that VSL#3 is effective in maintaining remission
of pouchitis and in preventing pouchitis.


VSL#3 has received Orphan Drug designation from
the Office of Orphan Products Development at the FDA for two
indications: (1) the treatment of active chronic pouchitis;
and (2) the prevention of disease relapse in patients with
chronic pouchitis. Orphan Drug designation applies to diseases
and disease states with a prevalence of less than
200,000 patients in the United States. Orphan Drug
designation confers certain protection such as market
exclusivity for seven years once the product has been approved.
For VSL Pharmaceuticals, Inc. and us to take advantage of
this designation, VSL#3 would have to be approved as a new
biological prescription product by the FDA. We do not control
the clinical or product development strategy for VSL#3. There
can be no assurance that VSL#3 will ever be approved as a new
biological product by the FDA or that it will ever enjoy the
benefits of this Orphan Drug designation.

Effective January 1, 2004, VSL
Pharmaceuticals, Inc. assigned the promotion agreement for
VSL#3 to Sigma Tau Pharmaceuticals, Inc. and its affiliates
(Sigma Tau). Sigma Tau entered into a promotion
agreement with InKine Pharmaceutical Company, Inc.
(InKine). Under the terms of the agreement, Sigma
Tau will pay to InKine a fixed fee to promote VSL#3 to
gastroenterologists as a second detail. In the short term, we
could benefit from this increased promotion effort in that we
are responsible for taking orders and shipping VSL#3 directly to
customers. As such, we recognize the revenues for the sales of
VSL#3 in the United States regardless of which company promotes
the product. We are currently in discussion with Sigma Tau about
an extension or renewal of the promotion agreement. There is no
assurance that our promotion agreement will be renewed, or if it
is renewed, that the terms of the agreement will not be
substantially different than the current terms of the agreement.
If the agreement is not renewed, we will not recognize any
revenue from VSL#3 sales once the agreement expires in January
2005.

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

Inulin.Due to
minimal demand, increasing production costs and lack of
strategic fit, we discontinued marketing and selling Inulin in
September 2003. In December 2003 we sold the NDA for Inulin.

Drug Development

Our development stage products include the
intranasal drugs Emitasol, Hypnostat and Panistat.



| |                 
| | ----------------
| | Intranasal Drugs



| |         
| | --------
| | Emitasol

Through our merger with RiboGene, we acquired
Emitasol, an intranasal form of metoclopramide. Metoclopramide
is an approved antiemetic and is available in both oral and
intravenous forms to treat diabetic gastroparesis and to prevent
acute chemotherapy-induced emesis. We, through future strategic
partners, may also choose to investigate Emitasol for the
treatment of diabetic gastroparesis and delayed onset emesis
(nausea and vomiting) associated with cancer chemotherapy.

Emitasol was being developed and marketed in
certain countries throughout the world through corporate
partners. It is approved in Italy as Pramidin, and during 2002
was distributed by sirton under our existing license agreement
in Italy for the treatment of a variety of gastrointestinal
disorders and emesis. For the year ended December 31, 2002,
sirton distributed approximately 15,592 units of Pramidin
in Italy. This agreement expired in accordance with terms in
June 2002. We entered into a marketing agreement in December
2000 with Ahn-Gook Pharmaceuticals (Ahn-Gook), for
intranasal metoclopramide, to be marketed under the trade name
Emitasol, in Korea. Ahn-Gook also signed an agreement with
sirton to obtain the intranasal

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metoclopramide finished product. Emitasol has
been approved in Korea, and is distributed by Ahn-Gook in Korea
for the treatment of gastrointestinal disorders and emesis, on a
hospital by hospital basis. In the United States, Emitasol could
be proposed as a method to control diabetic gastroparesis and to
prevent delayed onset emesis associated with cancer
chemotherapy. Prior to 2003, there were no drugs specifically
approved to treat delayed onset emesis. However, on
March 26, 2003, the FDA approved Mercks Emend
(aprepitant) with 5-HT3 antagonist for various indications,
including delayed onset emesis. On July 25, 2003, the FDA
also approved MGI Pharmas Aloxi (palonsetron
hydrochloride) for the prevention of acute nausea and vomiting
associated with chemotherapy and the prevention of delayed
nausea and vomiting associated with chemotherapy. Given these
recent approvals, our potential to develop Emitasol for delayed
onset emesis has diminished. We will continue to partner or to
seek funding for the development of Emitasol on a limited basis.
If we are not successful in finding a development partner or in
obtaining funding for the development of Emitasol, we plan to
abandon our Emitasol project.




| |                       
| | ----------------------
| | Hypnostat and Panistat

Through our merger with RiboGene, we acquired
Hypnostat, an intranasal form of triazolam for the treatment of
insomnia, and Panistat, an intranasal alprazolam for the
treatment of panic disorders. In June 2002, we signed a
definitive License Agreement with Fabre Kramer, whereby we
granted Fabre Kramer exclusive worldwide rights to develop and
commercialize Hypnostat and Panistat. Immediately after the
License Agreement was signed, we received a cash payment of
$250,000 for the transfer of all technology related to the
products. We are entitled to future payments from Fabre Kramer
when specific developmental milestones are met. We received a
milestone payment from Fabre-Kramer of $250,000 in the first
quarter of fiscal year 2003, which we recognized as revenue as
there were no continuing obligations. We will also receive a
milestone payment upon the acceptance of a New Drug Application
and the approval of a New Drug Application for Hypnostat and
Panistat, provided Fabre Kramer has not entered into an
agreement prior to these events. If Fabre Kramer has entered
into an agreement, we will share the payments received by them
under the agreement. In addition, we are entitled to a share of
future worldwide product-related Fabre-Kramer revenues, based on
a percentage of total revenues.

Fabre Kramer is developing Hypnostat for the
short-term treatment of insomnia. We believe that Hypnostat,
when given intranasally, may be effective in treating insomnia.
Advantages of Hypnostat as compared to alternatives may include
ease of administration, an increased level of efficacy, cost
effectiveness, and possibly reduced side effects. The potential
advantages of Hypnostat are significant in light of the fact
that thirty to forty million Americans suffer from serious sleep
disorders which are often untreated or inadequately treated.
Continued sleep impairment may cause severe health effects. Oral
triazolam (Halcion®) has been one of the most successful
and most prescribed sleep-inducing agents in the world, with
over 11 billion prescriptions filled. Oral triazolam is
considered safer in terms of overdose, drug interactions, and
addictive potential as compared to barbiturates. In addition,
oral triazolam produces less morning grogginess, as compared to
other benzodiazepines. Oral triazolam and other benzodiazepines
are recommended for short-term use in conservative doses.
Zolpidem (Ambien®) and zaleplon (Sonata®) are newer
hypnosedative agents that are chemically unrelated to
benzodiazepines. However, both zolpidem and zaleplon have
similar pharmacokinetic and pharmacodynamic effects and do not
differ with respect to efficacy, tolerability, residual effects,
memory impairment, rebound insomnia, or abuse potential compared
to oral triazolam. Over the counter medications containing
diphenhydramine (such as Benadryl® and Sominex®) have
been shown to increase the risk of symptoms of delirium
including disorganized speech, poor attention level, and altered
consciousness in the elderly. Other over the counter medications
such as valerian and melatonin may be useful in alleviating mild
short-term insomnia, but further clinical trials are required to
fully evaluate efficacy and safety.

Prior clinical trials for Hypnostat support that
triazolam is absorbed and effective when given intranasally.
Phase I trials indicated that the overall amount of
triazolam which reaches the plasma is very similar whether the
drug is given intranasally or orally. Given the similarity in
uptake of the two dosage forms, similarity might also be
expected in their clinical performance. The expected similarity
in performance is supported for the intranasal dosage form. In a
prior Phase II pilot study, Hypnostat at 0.125 mg was
superior to oral triazolam at

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0.250 mg for time to sleep onset (p=0.008),
effective sleep time (p=0.008), and stage two sleep time
(p<0.05) and was equivalent to oral triazolam at
0.250 mg for quality of sleep. We therefore anticipate that
intranasal triazolam may be effective for treating insomnia.
Hypnostat is currently in the Phase II stage of development
and Fabre Kramer is conducting the clinical testing. We believe
it will be several years, if ever, before Hypnostat is
commercially available.


Fabre Kramer intends to develop Panistat for the
management of panic disorder or the short-term relief of anxiety
symptoms. We believe that Panistat, when given intranasally, may
be effective in treating panic disorders. Advantages of Panistat
as compared to alternatives may include ease of administration,
an increased level of efficacy, and cost effectiveness.

The potential advantages of Panistat are
significant in light of the fact that anxiety disorders are the
most common mental disorder in the United States, affecting
approximately 19 million people. According to the National
Institute of Mental Health, approximately 25% of those affected
by anxiety disorders seek treatment. Generalized anxiety
disorder is characterized by constant uncontrollable worry.
Panic disorder is characterized by acute, spontaneous, and
repeated anxiety attacks which involve an intense, terrifying,
and unfocused fear in the absence of any external threat. Panic
attacks typically last for approximately 20 to 30 minutes and
may cause racing heartbeat, chest pains, difficulty breathing,
choking sensations, dizziness, and numbness. Panic attacks can
occur as often as several times per week or several times per
day. Approximately 2.4 million people in the United States
suffer from panic disorder, which often progresses into chronic
anxiety and agoraphobia.

Early treatment can help keep a panic disorder
from progressing. Benzodiazepines, including oral alprazolam
(Xanax®), have proven to be safe and effective for treating
panic disorder for over 20 years. Benzodiazepines block
panic attacks during the first or second day of treatment.
Surprisingly low rates of abuse of this and other medicines are
reported in persons with panic disorder. Many antidepressants,
including doxepin (Sinequan®), sertraline (Zoloft®),
fluoxetine (Prozac®), imipramine (Tofranil®), and
paroxetine hydrochloride (Paxil®), are useful in treating
panic attacks without causing physical dependence. However,
successful treatment requires full strength dosage and usually
takes four to eight weeks for therapeutic effects to be
observed. In addition, antidepressants cause panic attacks to
initially increase in approximately half of panic disorder
sufferers. Phenelzine sulfate (Nardil®) is effective for
panic disorder, but is complicated to use. Although phenelzine
sulfate is safe when used by an experienced physician, it is
typically reserved for cases where simpler medications have
failed or cannot be used. Unsafe elevations of blood pressure
for several hours can occur if one does not adhere to diet and
medication restrictions. Cognitive-behavioral therapy
(CBT) teaches the patient to anticipate and prepare
for situations and bodily sensations that may trigger panic
attacks. CBT generally requires at least eight to twelve weeks
for the patient to learn the skills and put them into practice.
CBT requires a motivated patient and a specially trained
therapist. Clinical experience suggests that for many patients
with panic disorder, a combination of CBT and medication may be
the best treatment. Other treatment options include relaxation,
breathing techniques, hypnotherapy, and psychotherapy. To date,
no clinical work has been performed on Panistat. We believe it
will be several years, if ever, before Panistat is commercially
available.



| |                                                   
| | --------------------------------------------------
| | Glial Excitotoxin Release Inhibitors
    (GERIs)

The GERIs are neuroprotective compounds that may
prevent ischemic brain damage originating from astrocytes
(astroglial cells). Astrocytes serve important metabolic
functions and are thought to be responsible for the bulk of
brain swelling following stroke or injury. The GERI compounds
were being funded by a Small Business Innovation Research
(SBIR) grant from the NIH. The grant was terminated
on July 31, 2003. Although we have had some preliminary
discussions with potential corporate partners regarding the GERI
compounds, there can be no assurance that we will enter into a
collaboration to fund future research on these compounds. We do
not intend to expend any additional resources on these
compounds. There can be no assurance that we will be successful
in licensing the GERI program or that we will realize license
fees or revenues from such programs.

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Other Strategic Alliances and
Collaborations



| |                        
| | -----------------------
| | The Dainippon Agreement

We have an exclusive, worldwide license agreement
with Dainippon to use our antibacterial peptide deformylase and
ppGpp degradase technology for the research, development and
commercialization of pharmaceutical products. We have retained
the right to co-promote, in Europe and the United States,
certain products resulting from the arrangement. We will be
entitled to receive potential milestone payments upon the
achievement of clinical and regulatory milestones up to the
amount of $5.0 million in Japan and $5.0 million in
one other major market. The first milestone payment will occur
upon the initiation of a human clinical trial using a compound
included in the agreement. We will receive a potential royalty
on net sales that will range from 5% to 10%, depending on sales
volume and territory.

Dainippon has been conducting research on two
specific bacterial targets, peptide deformylase and ppGpp
degradase. To date, Dainippon has focused most of their efforts
on the deformylase project. Their efforts on the ppGpp degradase
project have ended. Several compounds have been synthesized and
tested in vivo against drug resistant bacteria. Although the
compounds have shown good in vivo activity, Dainippon has not
selected any compounds for clinical studies in animals. There
can be no assurance that Dainippon will ever select any
compounds for preclinical studies or if selected that these
compounds will eventually be approved as drugs. There can also
be no assurance that we will ever receive any milestone payments
or royalties under our agreement with Dainippon.



| |                                        
| | ---------------------------------------
| | The Rigel Pharmaceuticals
    Agreement

We have an exclusive agreement with Rigel
Pharmaceuticals, Inc. (Rigel) to use our
antiviral technology. Under the agreement, we have assigned to
Rigel certain antiviral technology, including our Hepatitis C
virus internal ribosome entry site and NS5A drug discovery
technology, for the research, development and commercialization
of pharmaceutical products. We will be entitled to potential
future milestone payments upon the achievement of certain
clinical and regulatory milestones, including the selection of a
compound developed under the agreement for submission as an
Investigational New Drug, and royalty payments on sales. The
status of this project is on-going at Rigel. There can also be
no assurance that we will ever receive any milestone payments or
royalties under our agreement with Rigel.

Licenses and Distribution Agreements

CSC Pharmaceuticals Handels GmbH
(CSC).In April 1997,
RiboGene entered into an agreement with CSC which was assigned
to us upon our merger with RiboGene. The agreement grants CSC an
exclusive license to market and sell Emitasol in Austria,
Poland, the Czech Republic, Bulgaria, Russia, Hungary, the
Slovak Republic, Romania, and the remaining Community of
Independent States and eight other eastern European countries.
CSC has agreed to pay us a royalty based on net sales within the
countries listed above. The agreement will expire on a
country-by-country basis 10 years after the first
commercial sale in that country. Although we can terminate the
license if CSC did not obtain approval in any country contained
in the agreement by April 16, 1999, we have not done so,
since CSC has filed for regulatory approval in Austria, Russia,
Hungary and the Slovak Republic. In 2001, CSC received approval
to market Emitasol in Poland and the Czech Republic. CSC has
also filed for approval in several other countries. As of the
end of 2003, CSC has not begun to market Emitasol in Poland and
the Czech Republic and has no immediate plans to do so. It is
difficult to predict when, if ever, CSC will begin to market
Emitasol in their approved territories.

Laboratorios Silesia
SA.In December 1999, we signed a
license agreement with Laboratorios Silesia SA for marketing
intranasal metoclopramide, to be marketed under the trade name
Emitasol, in Chile. Laboratories Silesia SA also signed an
agreement with sirton to obtain the intranasal metoclopramide,
finished product under the trade name Pramidin. This product is
marketed as Pramidin in Italy. We received a small up-front
payment and will receive royalties on net sales, if any, of
Emitasol in this territory. The product was submitted for
approval in Chile and was rejected. As of December 2003, the
status of this product remains uncertain.

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Ahn-Gook Pharmaceutical Co.,
Ltd.We entered into a license
agreement in December 2000 and amended in December 2002 with
Ahn-Gook for marketing intranasal metoclopramide, to be marketed
in Korea under the trade name Emitasol. Ahn-Gook received
government approval to market Emitasol in 2002. Ahn-Gook began
selling Emitasol in the Republic of Korea in the first half of
2003. Through 2003, the sales of the product are minimal.
Ahn-Gook intends to manufacture Emitasol in Korea. We received
an up-front cash payment of $50,000 in 2000 and a milestone
payment of $150,000 in 2002 upon transfer of technology and will
earn future royalties based on actual sales in Korea. In
December 2002, we expanded the license agreement to include
twelve additional countries in Asia and since we have no future
obligations, we recognized $200,000 in revenues related to the
up-front cash payment and milestone payment under the agreement.
We will receive an up-front payment and additional royalties
upon commercialization of Emitasol in each of these new
countries.

Manufacturing

We do not currently manufacture any of our
acquired products or our products in development. Our commercial
products, Acthar, Nascobal, Ethamolin, VSL#3 and Glofil-125, are
manufactured for us by approved contract manufacturers.

As part of our agreement with Aventis to acquire
Acthar, Aventis agreed to manufacture the finished goods from
existing inventory of the active pharmaceutical ingredient (the
API) through July 2002. Aventis produced its final
batch of finished Acthar in July 2002. The production of Acthar
requires the production of the API and the production of the
finished product. The API is an extraction from porcine
pituitary glands. Although the extraction process is well known
by individuals within Aventis, the extraction may be difficult
to reproduce at a new vendor. Under our agreement with Aventis,
we purchased the API and other inventory residing at Aventis.
Based on internal sales forecasts, our existing inventory of the
API, previously manufactured for us by Aventis, should be
adequate to supply the annual demand for Acthar through 2006. We
are transferring the manufacturing process of the API to a new
third party manufacturer, BioVectra, dcl
(BioVectra). We have signed an agreement with
BioVectra, which requires minimum production totaling
$1.7 million during the term of the agreement. The
agreement terminates on December 31, 2007 and includes two
one-year extension options. The production of the first batch of
API is scheduled to begin in 2004. We have contracted with a
third party manufacturer, Chesapeake Biological
Laboratories, Inc., for Acthar finished product. During
2003 our first batch of Acthar vials were produced by Chesapeake
Biological Laboratories, Inc. using API from Aventis and
shipment to customers commenced in September 2003. The
production of the API and the finished product are subject to
inspection and ultimate approval by the FDA. While we have
reviewed our plans and progress to date with the FDA, and
received a positive response, additional approvals will be
required through the transfer process. On November 4, 2002,
we met with the FDA to discuss our manufacturing transfer plan
for Acthar. In connection with that meeting, the FDA approved
our Supplemental New Drug Application filed on
September 27, 2002 to extend the labeled shelf life of
Acthar from twelve months to 18 months from the date of
manufacture. We released an Acthar lot with 18 month dating
in 2003. The transfer of manufacturing of Acthar from Aventis to
new third party manufacturers will result in higher unit costs.

We have experienced delays and cost overruns in
the validation of the potency release assay being transferred
from Aventis to our new third party contract laboratory.
Beginning in January 2004, we initiated a plan designed to
assist with the successful transfer of this assay. There are no
assurances that we will be successful in transferring this assay
to a third party contract laboratory. If we are unable to
efficiently and timely validate the potency release assay prior
to the date when Aventis can no longer conduct this assay, we
will not be able to release both API and finished goods and
therefore we may not be able to meet the expected demand for
Acthar. We anticipate that Aventis will continue to conduct this
assay through the end of 2004.

The Acthar site transfer process has numerous
risks that could have a materially adverse impact on our
financial results in future years. Such risks include the
ability of the new independent third party contractors to
produce qualified API and finished goods in sufficient
quantities, on a timely basis and at an acceptable cost, that
the production facilities and the processes will be approved by
the FDA and that the API and finished product will be similar in
potency and efficacy as the Aventis API and finished product
historically produced

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by Aventis. Although we believe we have adequate
time and resources to ensure that the site transfer of Acthar
will occur timely and correctly with minimal impact on future
revenues, there can be no assurance that the site transfer will
occur timely and correctly and that the transfer will not have a
materially adverse impact on the company in the future.


Nascobal is manufactured by Nastech under a
long-term supply agreement at a fixed price per unit, under
which Nastech will continue to manufacture Nascobal at its FDA
approved, current good manufacturing practice (cGMP)
manufacturing facility in Hauppauge, New York. Nastech
plans on transferring Nascobal manufacturing in 2005 to a new
facility in Bothell, Washington.

During 2002, we successfully transferred the
manufacturing of Ethamolin from Schering Plough to Ben Venue
Laboratories (Ben Venue). We obtained full FDA
approval for the transfer to Ben Venue in September 2002. Ben
Venue manufactures Ethamolin for us on a purchase order basis.
We believe we have sufficient product on hand to cover demand
through late 2005.

We obtain VSL#3 from Sigma Tau
Pharmaceuticals, Inc. (Sigma Tau) under our
promotion agreement with them. However, we have no experience
with manufacturing VSL#3, and we are relying completely on Sigma
Tau to supply us with the product. Due to our lack of experience
with VSL#3 and our reliance on Sigma Tau, we can provide no
assurances as to the timely manufacture of this product.

Our manufacturer of Glofil-125 was subject to an
inspection by the FDA in July 2003. As a result of this
inspection, our manufacturer received notification that several
items required attention in order to comply with FDA
regulations. We are working with our manufacturer on addressing
any outstanding issues resulting from the FDA inspection. Based
on the information available, we believe that the manufacture of
Glofil-125 will not be affected.

There can be no assurance that any of our bulk or
finished goods contract manufacturers will continue to meet our
requirements for quality, quantity and timeliness or the
FDAs cGMP requirements. Also, there can be no assurance
that we will be able to complete the production of Acthar API,
nor that our contract manufacturers will be able to meet all
cGMP requirements, nor that lots will not have to be recalled
with the attendant financial consequences to us.

Our dependence upon others for the manufacture of
bulk or finished forms of our products may adversely affect the
future profit margin on the sale of those products and our
ability to develop and deliver products on a timely and
competitive basis. We do not have substitute suppliers for any
of our products although we strive to plan appropriately and
maintain safety stocks of product to cover unforeseen events at
manufacturing sites. In the event we are unable to manufacture
our products, either directly or indirectly through others or on
commercially acceptable terms, if at all, we may not be able to
commercialize our products as planned.

Sales and Marketing

As of December 31, 2003, we have hired,
trained and deployed a total of 24 product specialists and
marketing personnel to support the commercialization of our
primary promoted products, Acthar, Nascobal and VSL#3. Our
current strategic focus is neurology and gastroenterology. Our
promotion and educational efforts of Acthar are focused on
pediatric neurologists and on a subset of high potential
neurologists dedicated to the treatment of multiple sclerosis in
adults. We market Nascobal to physicians who treat patients at
high risk of developing deficiencies of Vitamin B-12. Our
priority targets for Nascobal are gastroenterologists
(Crohns disease), bariatric surgeons (gastric bypass
surgery), and neurologists (MS, dementia). Each of these
physician specialists sees a high number of patients with a
compromised ability to absorb Vitamin B-12 through the
gastrointestinal system. We market VSL#3 to gastroenterologists.
We are not actively marketing Ethamolin and Glofil-125 at this
time.

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International Distribution
Agreements



| |                             
| | ----------------------------
| | Beacon Pharmaceuticals, Ltd.

In October 2002 we signed an agreement with
Beacon Pharmaceuticals, Ltd. of Tunbridge Wells, Kent, UK, for
the exclusive marketing and distribution of Acthar in the United
Kingdom on a named patient basis. Sales to Beacon
Pharmaceuticals, Ltd. in 2003 were $78,000.



| |             
| | ------------
| | IDIS Limited

In November 2003, we signed an agreement with
IDIS Limited of Sirbiton, Surrey, UK for the exclusive
distribution of Acthar, Ethamolin and Nascobal on a named
patient basis. The agreement covers all countries of the world
except the United States, Australia and New Zealand where Acthar
and Ethamolin are sold through a distributor, UK, where Acthar
is sold through Beacon Pharmaceuticals, Ltd., and Israel where
Nascobal is sold through a distributor.

Competition

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 will target. There are products
and treatments on the market that compete with Acthar, Nascobal,
Ethamolin, Glofil-125 and VSL#3. Moreover, technology controlled
by third parties that may be advantageous to our business may be
acquired or licensed by our competitors, which may prevent us
from obtaining this technology on favorable terms, or at all.

Our ability to compete will depend on our ability
to acquire and commercialize pharmaceutical products that
address critical medical needs, as well as our ability to
attract and retain qualified personnel, and secure sufficient
capital resources for the acquisition of products.

Most of our competitors are larger than us and
have substantially greater financial, marketing and technical
resources than we have. In addition, many of these competitors
have substantially greater experience than we do in acquiring,
developing, testing and obtaining FDA and other approvals of
pharmaceuticals. Furthermore, if we commence commercial sales of
products that are currently in the development stage, when they
are approved, we will also be competing with respect to
manufacturing efficiency and marketing capabilities, areas in
which we have limited experience. If any of the competitors
develop new products that are superior to our products, our
ability to expand into the pharmaceutical markets may be
materially and adversely affected.

Competition among products will be based, among
other things, on product efficacy, safety, reliability,
availability, price and patent position. An important factor
will be the timing of market introduction of our or our
competitors products. Accordingly, the relative speed with
which we can acquire products and supply commercial quantities
of the products to the market is expected to be an important
competitive factor. Our competitive position will also depend
upon our ability to attract and retain qualified personnel and
to secure sufficient capital resources for product acquisition
and commercialization of products.

Government Regulation



| |                                     
| | ------------------------------------
| | Marketed Pharmaceutical
    Products

The processes carried out in the production of
pharmaceutical products by pharmaceutical firms, including
manufacturers from whom we purchase products, are subject to
regulation by the FDA. Any restrictions or prohibitions
applicable to sales of products we market could materially and
adversely affect our business.

We market prescription drug products that have
been approved by the FDA. The FDA has the authority to revoke
existing approvals if new information reveals that they are not
safe or effective. The FDA also regulates the promotion,
including advertisement, of prescription drugs.

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Drug products must be manufactured, packaged, and
labeled in accordance with their approvals and in conformity
with cGMP standards and other requirements. Drug manufacturing
facilities must be registered with and approved by the FDA and
must list with the FDA the drug products they intend to
manufacture or distribute. The manufacturer is subject to
inspections by the FDA and periodic inspections by other
regulatory agencies. The FDA has extensive enforcement powers
over the activities of pharmaceutical manufacturers, including
authority to seize and prohibit the sale of unapproved or
non-complying products, and to halt manufacturing operations
that are not in compliance with current cGMPs. The FDA may
impose criminal penalties arising from non-compliance with
applicable regulations.



| |                     
| | --------------------
| | Drugs in Development

Our products in development through our partners
are subject to extensive regulation by the U.S., principally
under the Federal Food, Drug and Cosmetic Act (FDCA)
and the Public Health Service Act, and foreign governmental
authorities prior to commercialization. In particular, drugs and
biological products are subject to rigorous preclinical and
clinical testing and other approval requirements by the FDA,
state and local authorities and comparable foreign regulatory
authorities. The process for obtaining the required regulatory
approvals from the FDA and other regulatory authorities takes
many years and is very expensive. There can be no assurance that
any product developed by us or our development partners will
prove to meet all of the applicable standards to receive
marketing approval in the U.S. or abroad. There can be no
assurance that these approvals will be granted on a timely
basis, if at all. Delays and costs in obtaining these approvals
and the subsequent compliance with applicable federal, state and
local statutes and regulations could materially adversely affect
our ability to commercialize our products and our ability to
earn sales revenues.



| |      
| | -----
| | VSL#3

We are marketing VSL#3 as a dietary supplement.
If approval of VSL#3 as a biological product is pursued by Sigma
Tau at a later date, the regulatory hurdles discussed above will
apply.

The manufacturing, distribution, and sale of
dietary supplements and medical foods are subject to regulation
by one or more federal agencies, principally the FDA and the
Federal Trade Commission (the FTC). Our activities
are also regulated by various governmental agencies for the
states and localities in which VSL#3 is distributed and sold.
Among other matters, the FDA and FTC are concerned with product
safety and claims that refer to a products ability to
provide dietary support for health-related conditions.

The regulation of dietary supplements is
principally governed by the Dietary Supplement Health and
Education Act (DSHEA), which was enacted in 1994,
amending the FDCA. DSHEA establishes a statutory class of
dietary supplements, which includes vitamins,
minerals, herbs, amino acids and other dietary ingredients for
human use to supplement the diet. Dietary ingredients that were
not on the market as of October 15, 1994 require the
submission by the manufacturer or distributor to the FDA of
evidence of a history of use or other evidence of safety
establishing that the ingredient will reasonably be expected to
be safe. Among other things, DSHEA prevents the further
regulation of dietary ingredients as food additives
and allows the use of statements of nutritional support on
product labels. The FDA has issued proposed and final
regulations in this area and indicates that further guidance and
regulations are forthcoming.

In November 1998, the FTC Bureau of Consumer
Protection announced its new advertising guidelines for the
dietary supplement industry, which it labeled Dietary
Supplements: An Advertising Guide for Industry. These
guidelines reiterate many of the policies the FTC has announced
over the years, including requirements for substantiation of
claims made in advertising about dietary supplements.

The FDA has announced its intent to issue cGMP
regulations for the dietary supplement industry. The FDA has
published an advance notice of proposed rulemaking, and on
March 13, 2003 published proposed regulations. This rule is
not yet final. The comment period on the proposed cGMP
regulations (Federal Register Docket No. 96N-0417) was
extended from June 11, 2003 to August 11, 2003.
Comments have been received by the FDA and the regulation is in
revision. We are evaluating the proposed cGMP regulations and
will assess the impact of the final cGMP rules on our operations.

15



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Patents and Proprietary Rights

Our success may depend in part upon our ability
to maintain confidentiality, operate without infringing upon the
proprietary rights of third parties, and obtain patent
protection for our products. We have obtained patent coverage,
either directly or through licenses from third parties, for
Nascobal and some of our products in development or marketed
overseas. We currently own or have licensed a total of
thirty-four issued U.S. and foreign patents covering all
formulations of Nascobal, eighteen issued U.S. and foreign
patents covering Hypnostat, six issued U.S. and foreign patents
covering Emitasol, and nine issued U.S. and foreign patents
covering our other technology. We also hold the right to a
patent application for a new and improved spray formulation of
Nascobal. However, we may not be renewing our foreign patents
relating to Nascobal, since Nascobal is only approved in Sweden
and our current plans do not include seeking approval in
additional foreign countries.

We acquired intellectual property associated with
our intranasal program, including Emitasol for diabetic
gastroparesis and delayed onset emesis associated with
chemotherapy, Migrastat (intranasal propranolol) for migraine
treatment, and intranasal benzodiazepines such as Hypnostat and
Panistat for various conditions such as anxiety, seizures, panic
attacks and sleep disorders. We have licensed rights to
intranasal metoclopramide in Italy, Chile, South Korea, Austria,
the Russian Federation, Asia (excluding Japan) and certain
former Eastern European countries. The former Italian licensee,
sirton, received approval to market intranasal metoclopramide
(Pramidin) in Italy. The agreement with sirton expired according
to terms in June 2002. There can be no assurance that the
foreign licensees will obtain the necessary regulatory approvals
to market Emitasol, or that, in the event such approvals are
obtained, Emitasol will achieve market acceptance in such
countries, or that we will ever realize royalties on sales of
Emitasol in such countries. We have also filed several other
patent applications in the U.S. and abroad on our various
products and expect to file additional applications in the
future.

Employees

At December 31, 2003, we had
39 full-time employees (as compared to 52 full-time
employees at December 31, 2002).

Our success will depend in large part on our
ability to attract and retain key employees. At
December 31, 2003, we had 24 employees engaged directly in
the marketing and selling of our on-market products. We believe
that our relationship with our employees is good. None of our
employees are represented by a collective bargaining agreement,
nor have we experienced work stoppages.

Website Address

Our website address is www.questcor.com. We make
available free of charge through our website our annual report
on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and all amendments to these reports as
soon as reasonably practicable after such material is
electronically filed with, or furnished to, the SEC, by
providing a hyperlink to the SECs website directly to such
reports.

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RISK FACTORS



| |                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------
| | 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 accumulated deficit through December 31, 2003 is
$82.9 million, of which $5.9 million represented the
net loss applicable to common stockholders for the twelve months
ended December 31, 2003, $2.8 million represented the
net loss for the year ended December 31, 2002, and
$8.7 million represented the net loss for the year ended
December 31, 2001. Operating losses are expected to
continue at least through the end of 2004. To date, our revenues
have been generated principally from sales of Acthar, Nascobal,
Ethamolin, Glofil-125, Inulin and VSL#3. In July 2003, we
began selling Nascobal, a product that we acquired in June 2003.
We discontinued selling Inulin in September 2003. We do not
expect Emitasol, Hypnostat or Panistat to be commercially
available for a number of years, if at all.

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



| |   |                                                                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | increase sales of current products,                                                                                                                                                                                                                                                         
|
| |  | finance and acquire additional marketed products,                                                                                                                                                                                                                                           
|
| |  | finance the future growth of our sales/marketing
    and customer service organization,                                                                                                                                                                                                     
|
| |  | finance operations with external capital until
    consistent positive cash flows are achieved,                                                                                                                                                                                             
|
| |  | properly and timely complete the transfer of the
    manufacturing of Acthar API to the new contract manufacturer and
    the transfer of the release assay to a third party laboratory
    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,                                                                                                                                                                     
|
| |  | continue to control our operating
    expenses, 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 product sales decline or
fail to grow, we may not have sufficient revenues to fund our
operations.

We rely heavily on sales of Acthar and Nascobal.
Acthar revenues comprised 58%, 65% and 41% of our total net
product revenues for the years ended December 31, 2003,
2002 and 2001 (sales of Acthar began in September 2001),
respectively. Nascobal sales comprised 15% of net product
revenues for the year ended December 31, 2003 (sales of
Nascobal began in July 2003, while promotion began in October
2003). We anticipate that as a percentage of our total sales,
Nascobal will increase and Acthar will decrease. 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 or Nascobal available at the wholesale level
exceeds the future demand, our future revenues from the sales of
Acthar or Nascobal may be affected adversely.

We monitor the amount of Acthar and Nascobal at
the wholesale level as well as prescription data obtained from
third party sources to help assess product demand in 2004. We
expect that Acthar and Nascobal will continue to constitute a
significant portion of our revenues in 2004. Although our goal
is to actively promote Acthar and Nascobal, and we have no
reason to believe that our promotion of Acthar and Nascobal will
not be successful, we cannot predict whether the demand for
Acthar and Nascobal will continue in the future or that we will
continue to generate significant revenues from sales of Acthar
and Nascobal. We may choose, in the future, to reallocate our
sales and promotion efforts for Acthar and Nascobal which may

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result in a decrease in revenues from one or both
of the products. If the demand for Acthar or Nascobal declines,
or if we are forced to reduce the prices, or if exchanges of
expired products are 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, our revenues from the
sale of Acthar or Nascobal 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. If our revenues from the sale of Acthar or Nascobal
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.


Effective January 1, 2004, VSL
Pharmaceuticals, Inc. assigned the VSL#3 promotion
agreement to Sigma Tau. Sigma Tau entered into a promotion
agreement with InKine Pharmaceutical Company, Inc.
(InKine). Under the terms of the agreement, Sigma
Tau will pay to InKine a fixed fee to promote VSL#3 to
gastroenterologists as a second detail. In the short term, we
could benefit from this increased promotion effort in that we
are responsible for taking orders and shipping VSL#3 directly to
customers. As such, we recognize the revenues for the sale of
VSL#3 in the United States regardless of which company promotes
the product. There is no assurance that our promotion agreement
will be renewed or if it is renewed that the terms of the
agreement will not be substantially different than the current
terms of the agreement. If the agreement is not renewed, we will
not recognize any revenue from VSL#3 sales once the agreement
expires in January 2005.

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

Any delays or problems associated with the site
transfer of the manufacturers or third party contract
laboratories for testing of Acthar could reduce the amount of
the product that will be available for sale and adversely affect
our operating results. Under our agreement with Aventis
Pharmaceuticals, Inc. (Aventis), Aventis
manufactured and supplied Acthar through July 2002. During 2003,
we signed a definitive agreement with Chesapeake Biological
Laboratories (CBL), a contract manufacturer for
Acthar finished product, and transferred the final fill and
packaging 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 that this API should be sufficient to meet our
forecasted demand through 2006. CBL, the new final fill
manufacturer, began supplying to us finished product during 2003
using the API manufactured by Aventis.

We have selected a new contract laboratory to
perform various bioassays associated with the release of API and
finished product. These assays have been performed and are
continuing to be performed by Aventis. However, we have
experienced delays and cost overruns in the validation of the
potency bioassay from Aventis to our new third party contract
laboratory. Beginning in 2004, we will resume the testing
necessary to transfer the assay to a new contact laboratory. 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. If we are
unable to efficiently and timely validate the potency assay
before the date when Aventis can no longer conduct this assay,
we will not be able to release API and 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 our new API
manufacturer, BioVectra, has been completed and the bioassays
have been validated and they begin supplying released API to us,
the cost of the product is expected to increase which may cause
our gross margins to decline. In addition, if the site transfer
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.

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If our customers do not comply with our
exchange policy and/or demand that we implement a return policy,
our revenues would be significantly impacted.

We have an exchange policy in which we will ship
replacement product for expired product returned to us within
six months after expiration. This policy is not commonplace in
the industry as the standard policy is to issue credit memoranda
in exchange for expired product that is returned. Our customers
have expressed dissatisfaction with our exchange policy and,
although they have complied to date, have suggested that they
may choose not to adhere to it in the future. Since we sell a
majority of our products to the three largest distributors and
no viable alternatives exist, we may be forced to change our
current policy to a return policy in which credit memoranda are
issued. In the event this occurred, the negative financial
impact on our revenues, operations and cash position would be
substantial in the near term.

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 planned to return to us.
While we reached an agreement with these customers to pay these
short-remittances (returns receivable) upon their
receipt of replacement product for the Acthar that expired in
November 2002 and May 2003, 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 expired product that was
exchanged. Certain of our customers continued to short-remit for
expired product returns in 2003. As of December 31, 2003,
the returns receivable amount is $420,000. A majority of returns
of expired product, which in turn has created this returns
receivable, have been replaced in accordance with our exchange
policy, and we are in the process of seeking reimbursement. The
next batches of Acthar expire in January 2004 and December 2004,
the next batches of Ethamolin expire in January and February
2004 and the next Nascobal batch expires in February 2005. We
expect that our customers will continue to short remit us in the
future as these batches expire and our customers seek to return
expired product. Should our customers not reimburse us for the
returns receivable upon shipment of replacement product, the
negative impact on our cash and operations would be substantial.

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 expired in January 2004. In November
2002, the shelf life of Acthar was increased to 18 months.
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. We are actively monitoring inventory levels at the
wholesalers and have implemented a plan designed to minimize the
amount of returns of expired product, however there can be no
assurance that our actions will be effective in reducing the
return of expired product or minimizing the negative impact on
receivables and future sales. Such shipment of replacement
product may displace future sales.

See the Critical Accounting Policies section in
the Management Discussion and Analysis of Financial Conditions
and Results of Operations for further discussion of our exchange
policy.

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. Our three largest customers
represented over 75% of our net product sales for fiscal year
2003. While we attempt to estimate inventory levels of our
products at our major wholesale customers using inventory data
obtained from these 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 had purchased Ethamolin units in
excess of what we estimated their historical demand to be. This
build-up of inventory adversely impacted Ethamolin sales in 2003
and may adversely impact future sales of Ethamolin.

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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.

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 of required reserves could be different from the
estimates and differences are accounted for in the period in
which they become known.

We have limited experience marketing Nascobal
and may be unsuccessful in doing so.

In June 2003, we acquired Nascobal, a nasal gel
used for the treatment of various Vitamin B-12 deficiencies. We
currently have limited 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 if we are unsuccessful in marketing Nascobal, our
revenues from the sale of Nascobal will be less than we are
currently anticipating. As part of the acquisition, Questcor
also acquired the rights to Nascobal nasal spray, a new dosage
form, for which an NDA was filed with the FDA by Nastech in
December 2003. Subject to the approval of the NDA for the new
Nascobal nasal spray dosage form by the FDA, we will make a
$2 million payment to Nastech for the transfer of the NDA
from Nastech to Questcor. Further, subject to the approval of
the NDA by the FDA 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 make a second
$2 million payment to Nastech. 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 a private placement of Series B
Preferred Stock in January 2003, $5 million through a
private placement of common stock in June 2003, and
$2.4 million and the surrender of outstanding warrants
through a private placement of common stock in January 2004, we
anticipate that our capital resources based on our internal
forecasts and projections will be adequate to fund operations
and capital expenditures through at least December 31,
2004, unless a substantial portion of our cash is used for
product acquisition or our fiscal year 2004 revenues are less
than we expect. If Nastech is successful in obtaining approval
for the NDA covering the nasal spray formulation, and if the
patent covering this formulation issues after the approval of
the NDA, we would be required to pay $4 million to Nastech.
If we experience unanticipated cash requirements, or if revenues
fail to grow, or we are required to make the milestone payments
to Nastech, we could be required to raise additional funds.
Regardless, we may seek additional funds, before the end of
2004, through public or private equity financing or from other
sources to potentially avoid the payment of additional dividends
of 6% under our Series B Convertible Preferred Stock, to

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acquire additional products, to expand our
operations or 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,                                                                                                 
|
| |  | maintaining customer compliance with our policies,                                                                                       
|
| |  | obtaining product from our sole-source contract
    manufacturers and completing the site transfer to new contract
    manufacturers, and
|
| |  | acquiring additional products.                                                                                                           

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 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. from whom we purchase on a lot by lot
basis. Nascobal is manufactured by Nastech under a long-term
supply agreement. VSL#3 is supplied by Sigma Tau Pharmaceuticals
under a promotion agreement we have with them. Sigma Tau
Pharmaceuticals has the sole responsibility for manufacturing
and/or acquiring the VSL#3 product.

See If we are unsuccessful in completing
the Acthar site transfer, we may be unable to meet the demand
for Acthar and lose potential revenues for discussion of
third party manufacturers of Acthar.

If we are unable to contract for a sufficient
supply of our required products and services on acceptable
terms, or if we should encounter delays or difficulties in our
relationships with our manufacturers, or if the site transfer
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. Failure to

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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 and Glofil 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 our
Chairman, President, and Chief Executive Officer,
Mr. Charles J. Casamento, our Senior Vice President of
Finance and Administration and Chief Financial Officer,
Mr. Timothy E. Morris, and our Vice President of Sales and
Marketing, Mr. R. Jerald Beers. If we were to lose
Mr. Casamento, Mr. Morris or Mr. Beers 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 2004,
recruiting and retaining management and operational personnel to
perform sales and marketing, business development, regulatory
affairs, quality assurance, medical affairs and contract
manufacturing in the 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 commercial products and 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.

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 our commercial
products and any products that we successfully 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 payers, 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.

22



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##### Table of Contents



A large percentage of our voting stock is
beneficially owned by a small number of shareholders, 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,
or Sigma-Tau, beneficially own, directly or indirectly,
approximately 26% 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, approximately 28% of our outstanding common stock, as
of March 22, 2004. Additionally, as reported on Amendment
No. 1 to Schedule 13D, filed with the SEC on
February 13, 2004, Corporate Opportunities Fund, L.P. and
its affiliates and Montreux Equity Partners II SBIC, L.P. and
its affiliates beneficially own approximately 11% of our voting
capital stock. Accordingly, these shareholders, acting
individually or together, could 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
these large shareholders take control of us and having new
management inserted and new objectives adopted.

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, 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.

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.

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

23



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##### Table of Contents



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 partners
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.


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 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 an
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

24



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##### Table of Contents



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 United
States.

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.

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 United States., 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

25



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##### Table of Contents



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 United States) 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 United States, 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. We believe
the increasing emphasis on managed care in the United States has
and will continue to put pressure on the price and usage of our
products, which may also 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 United States, proposals have called for
substantial changes in the Medicare and Medicaid programs. Any
such changes enacted may require significant reductions from
currently projected government expenditures for these programs.
The Medicare Prescription Drug Improvement Act, enacted in
December 2003, provides for, among other things, an immediate
reduction in the Medicare reimbursement rates for many drugs
administered in a physicians office. The Medicare Act, as
well as other changes in government legislation or regulation or
in private third party payors policies toward
reimbursement for our products, may reduce or eliminate
reimbursement of our products costs. 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. We are unable to predict what impact the Medicare Act
or other future legislation, if any, relating to third party
reimbursement, will have on our product sales.

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 common stock, like that of other
specialty pharmaceutical companies, is subject to significant
volatility. Our stock price has ranged in value from $0.60 to
$2.18 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,

26



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##### Table of Contents



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.






|        |           
|------- | ----------
|Item 2. | Properties

At December 31, 2003, we lease four
buildings. We lease our 23,000 square foot headquarters in
Union City, California under a lease agreement that expires in
2011. Our headquarters is currently occupied by the Executive,
Finance and Administration, Sales and Marketing, Medical and
Regulatory Affairs, distribution of VSL#3, Contract
Manufacturing, Quality Control and Quality Assurance departments.

We are subleasing 100% of a building in Hayward,
California under a sublease agreement that expires in 2006. The
Hayward premises has 30,000 square feet of laboratory and
office space under a master lease that expires in November 2012.
While we anticipate that our sublessee will fulfill the term of
the sublease agreement, if they were to default, it would have a
negative impact on us as we would still be obligated to make
rent payments on the Hayward facility under the master lease
agreement.

We lease a 8,203 square foot facility in
Carlsbad, California under a lease that expires January 2006.
During 2003, we subleased 100% of the space under two separate
subleases expiring in January 2006 and January 2005. The
sublease expiring in January 2005 includes a renewal option to
extend the term for three month periods.

In May 2001, we closed our Neoflo manufacturing
facility located in Lees Summit, Missouri. The lease
period ends in December 2004 and, during 2003, we subleased the
space through December 2004.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

None.






|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

No matters were submitted to a vote of security
holders for the quarter ended December 31, 2003.

27



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##### Table of Contents






PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Shareholder Matters

We are listed on the American Stock
Exchange, Inc. From January 1998 to November 1999 we were
traded under the symbol CYP. On November 17,
1999, we changed our name to Questcor Pharmaceuticals, Inc.
and began trading under the symbol QSC.

The following table sets forth, for the periods
presented, the high and low closing price per share of our
common stock.

|                   |  |               |      |     |  |   |      | 
|------------------ |  | ------------- | ---- | --- |  | - | ---- | 
|                   |  |              
|                   |  | Common Stock 
|                   |  | Closing Price
|                   |  |              
|Quarter Ended      |  | High          |      | Low
|                   |  |               |      |    
|December 31, 2003  |  | $             | 0.92 |     |  | $ | 0.60 | 
|September 30, 2003 |  |               | 1.00 |     |  |   | 0.75 | 
|June 30, 2003      |  |               | 1.20 |     |  |   | 0.75 | 
|March 31, 2003     |  |               | 1.34 |     |  |   | 0.78 | 
|December 31, 2002  |  |               | 1.16 |     |  |   | 0.90 | 
|September 30, 2002 |  |               | 1.35 |     |  |   | 0.89 | 
|June 30, 2002      |  |               | 2.01 |     |  |   | 1.28 | 
|March 31, 2002     |  |               | 2.18 |     |  |   | 1.29 | 

The last sale price of our common stock on
March 22, 2004 was $0.93. As of March 22, 2004 there
were approximately 296 holders of record of our common stock.

We have never paid a cash dividend on our common
stock. Our dividend policy is to retain our earnings, if we
achieve positive earnings, and to support the expansion of our
operations. Our Board of Directors does not intend to pay cash
dividends on our common stock in the foreseeable future. Any
future cash dividends will depend on future earnings, capital
requirements, our financial condition and other factors deemed
relevant by our Board of Directors.

28



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##### Table of Contents








|        |                                         
|------- | ----------------------------------------
|Item 6. | Selected Consolidated Financial
    Data

The following table sets forth certain financial
data with respect to our business. The selected consolidated
financial data should be read in conjunction with our
Consolidated Financial Statements and related Notes and
Managements Discussion and Analysis of Financial
Condition and Results of Operations and other information
contained elsewhere in this Form 10-K.

|                                           |                                                                                                                  |                                       |   |              |   |            |   |        |   |         |   |        |   |  |   |         |   |  |   |         |   |  |   |        |  
|------------------------------------------ | ---------------------------------------------------------------------------------------------------------------- | ------------------------------------- | - | ------------ | - | ---------- | - | ------ | - | ------- | - | ------ | - |  | - | ------- | - |  | - | ------- | - |  | - | ------ | -
|                                           |                                                                                                                  |                                       |   | Five Months  |   |           
|                                           |                                                                                                                  | Years Ended December 31,              |   | Ended        |   | Year Ended
|                                           |                                                                                                                  |                                       |   | December 31, |   | July 31,  
|                                           |                                                                                                                  | 2003                                  |   | 2002(2)      |   | 2001       |   | 2000   |   | 1999(1) |   | 1999  
|                                           |                                                                                                                  |                                       |   |              |   |            |   |        |   |         |   |       
|                                           |                                                                                                                  |                                      
|                                           |                                                                                                                  | (In thousands, except per share data)
|Consolidated Statement of Operations Data: |                                                                                                                  |                                       |   |              |   |            |   |        |   |         |   |        |   |  |   |         |   |  |   |         |   |  |   |       
|                                           | Net product sales                                                                                                |                                       | $ | 13,655       |   |            | $ | 13,819 |   |         | $ | 5,196  |   |  | $ | 2,134   |   |  | $ | 624     |   |  | $ | 2,518  |  
|                                           | Total revenues                                                                                                   |                                       |   | 14,063       |   |            |   | 14,677 |   |         |   | 5,667  |   |  |   | 3,594   |   |  |   | 956     |   |  |   | 2,569  |  
|                                           | Total operating costs and expenses                                                                               |                                       |   | 17,397       |   |            |   | 17,080 |   |         |   | 15,050 |   |  |   | 17,752  |   |  |   | 23,257  |   |  |   | 10,026 |  
|                                           | Loss from operations                                                                                             |                                       |   | (3,334       | ) |            |   | (2,403 | ) |         |   | (9,383 | ) |  |   | (14,158 | ) |  |   | (22,301 | ) |  |   | (7,457 | )
|                                           | Net loss                                                                                                         |                                       |   | (3,791       | ) |            |   | (2,785 | ) |         |   | (8,697 | ) |  |   | (13,762 | ) |  |   | (22,210 | ) |  |   | (6,784 | )
|                                           | Net loss applicable to common stockholders                                                                       |                                       |   | (5,947       | ) |            |   | (2,785 | ) |         |   | (8,697 | ) |  |   | (13,762 | ) |  |   | (22,210 | ) |  |   | (6,784 | )
|                                           | Net loss per common share applicable to common
    stockholders  basic and diluted                              |                                       |   | (0.14        | ) |            |   | (0.07  | ) |         |   | (0.28  | ) |  |   | (0.56   | ) |  |   | (1.22   | ) |  |   | (0.43  | )
|                                           | Shares used in computing net loss per common
    share applicable to common stockholders  basic and
    diluted |                                       |   | 41,884       |   |            |   | 38,407 |   |         |   | 31,425 |   |  |   | 24,722  |   |  |   | 18,240  |   |  |   | 15,712 |  

|                                 |                                                                                                                                          |                |   |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |         |  
|-------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------- | -------------- | - | ------- | - | ---- | - | ------- | - | ---- | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                 |                                                                                                                                          |               
|                                 |                                                                                                                                          | December 31,  
|                                 |                                                                                                                                          |               
|                                 |                                                                                                                                          | 2003           |   | 2002    |   | 2001 |   | 2000    |   | 1999
|                                 |                                                                                                                                          |                |   |         |   |      |   |         |   |     
|                                 |                                                                                                                                          |               
|                                 |                                                                                                                                          | (In thousands)
|Consolidated Balance Sheet Data: |                                                                                                                                          |                |   |         |   |      |   |         |   |      |   |         |   |  |   |         |   |  |   |        
|                                 | Cash, cash equivalents and short-term investments
    (includes $5 million compensating balance at
    December 31, 2001, 2000 and 1999) |                | $ | 3,220   |   |      | $ | 7,506   |   |      | $ | 10,571  |   |  | $ | 8,151   |   |  | $ | 21,699  |  
|                                 | Working capital                                                                                                                          |                |   | 4,352   |   |      |   | 7,018   |   |      |   | 2,659   |   |  |   | 1,261   |   |  |   | 16,943  |  
|                                 | Total assets                                                                                                                             |                |   | 22,929  |   |      |   | 12,766  |   |      |   | 14,946  |   |  |   | 14,848  |   |  |   | 32,221  |  
|                                 | Long-term obligations                                                                                                                    |                |   | 3,402   |   |      |   | 2,908   |   |      |   | 122     |   |  |   | 548     |   |  |   | 6,078   |  
|                                 | Preferred stock, Series A                                                                                                                |                |   | 5,081   |   |      |   | 5,081   |   |      |   | 5,081   |   |  |   | 5,081   |   |  |   | 5,081   |  
|                                 | Preferred stock, Series B                                                                                                                |                |   | 8,278   |   |      |   |        |   |      |   |        |   |  |   |        |   |  |   |        |  
|                                 | Common stock                                                                                                                             |                |   | 85,232  |   |      |   | 77,528  |   |      |   | 74,018  |   |  |   | 66,152  |   |  |   | 65,423  |  
|                                 | Accumulated deficit                                                                                                                      |                |   | (82,915 | ) |      |   | (76,968 | ) |      |   | (74,183 | ) |  |   | (65,486 | ) |  |   | (51,724 | )
|                                 | Total stockholders equity (deficit)                                                                                                     |                |   | 10,578  |   |      |   | 496     |   |      |   | (300    | ) |  |   | 927     |   |  |   | 13,626  |  



---



|    |                                                                                                                                                                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Includes the results of operations of
    RiboGene, Inc. from November 17, 1999 through
    December 31, 1999, including a one-time charge for
    restructuring costs of $1.5 million and a charge of
    $15.2 million for acquired in process research and
    development costs.

29



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|    |                                                                                                                                                                                                                                                           
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Effective January 1, 2002, we adopted
    Statement of Financial Accounting Standards, or SFAS,
    No. 141 Business Combinations and SFAS,
    No. 142 Goodwill and Other Intangible Assets.
    See Note 1 to the Consolidated Financial Statements.

QUARTERLY FINANCIAL INFORMATION
(UNAUDITED)

|                                                                  |  |                                       |       |          |  |          |       |          |  |   |        |   |  |   |        |  
|----------------------------------------------------------------- |  | ------------------------------------- | ----- | -------- |  | -------- | ----- | -------- |  | - | ------ | - |  | - | ------ | -
|                                                                  |  |                                      
|                                                                  |  | Quarter Ended                        
|                                                                  |  |                                      
|                                                                  |  | 12/31/03                              |       | 09/30/03 |  | 06/30/03 |       | 03/31/03
|                                                                  |  |                                       |       |          |  |          |       |         
|                                                                  |  |                                      
|                                                                  |  | (In thousands, except per share data)
|Net product sales                                                 |  | $                                     | 4,470 |          |  | $        | 3,943 |          |  | $ | 2,880  |   |  | $ | 2,362  |  
|Total revenues                                                    |  |                                       | 4,570 |          |  |          | 3,967 |          |  |   | 2,905  |   |  |   | 2,621  |  
|Cost of product sales                                             |  |                                       | 953   |          |  |          | 796   |          |  |   | 1,149  |   |  |   | 675    |  
|Net income (loss)                                                 |  |                                       | 324   |          |  |          | (576  | )        |  |   | (1,769 | ) |  |   | (1,770 | )
|Net income (loss) applicable to common
    stockholders           |  |                                       | 129   |          |  |          | (776  | )        |  |   | (2,062 | ) |  |   | (3,238 | )
|Net income (loss) per share applicable to common
    stockholders |  |                                       | 0.00  |          |  |          | (0.02 | )        |  |   | (0.05  | ) |  |   | (0.08  | )

|                                                         |  |                                       |       |          |  |          |       |          |  |   |        |   |  |   |       |  
|-------------------------------------------------------- |  | ------------------------------------- | ----- | -------- |  | -------- | ----- | -------- |  | - | ------ | - |  | - | ----- | -
|                                                         |  |                                      
|                                                         |  | Quarter Ended                        
|                                                         |  |                                      
|                                                         |  | 12/31/02                              |       | 09/30/02 |  | 06/30/02 |       | 03/31/02
|                                                         |  |                                       |       |          |  |          |       |         
|                                                         |  |                                      
|                                                         |  | (In thousands, except per share data)
|Net product sales                                        |  | $                                     | 2,934 |          |  | $        | 3,772 |          |  | $ | 3,307  |   |  | $ | 3,806 |  
|Total revenues                                           |  |                                       | 3,234 |          |  |          | 3,848 |          |  |   | 3,741  |   |  |   | 3,854 |  
|Cost of product sales                                    |  |                                       | 651   |          |  |          | 829   |          |  |   | 708    |   |  |   | 634   |  
|Net income (loss)                                        |  |                                       | (355  | )        |  |          | (995  | )        |  |   | (1,103 | ) |  |   | (332  | )
|Net loss applicable to common stockholders               |  |                                       | (355  | )        |  |          | (995  | )        |  |   | (1,103 | ) |  |   | (332  | )
|Net loss per share applicable to common
    stockholders |  |                                       | (0.01 | )        |  |          | (0.03 | )        |  |   | (0.03  | ) |  |   | (0.01 | )

Certain amounts have been reclassified to conform
with current year presentation of annual financial statements.
The amounts reclassified from Research and Development to Cost
of Product Sales totaled, in the aggregate, $443,000 for the
quarters ended March 31, 2002, June 30, 2002, and
September 30, 2002. The amounts reclassified from Cost of
Product Sales to Selling, General and Administrative totaled, in
the aggregate, $110,000 for the quarters ended June 30,
2002, September 30, 2002 and December 31, 2002.

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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | 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 Item 1 Business of
Questcor, including without limitation Risk
Factors, as well as those discussed in any documents
incorporated by reference herein or therein.

We are a specialty pharmaceutical company that
acquires, markets and sells brand name prescription drugs
through our U.S. direct sales force and international
commercialization partners. We focus on the treatment of central
nervous system (CNS) diseases and
gastroenterological disorders which are served by a concentrated
group of physicians such as neurologists and
gastroenterologists. Our strategy is to acquire pharmaceutical
products that we believe have sales growth potential, are
promotionally responsive to a focused and targeted sales and
marketing effort and complement our existing products. We
currently market five products in the United States:



| |   |                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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®, the only prescription nasal gel
    used for the treatment of various Vitamin B-12 deficiencies
    including Vitamin B-12 deficiencies associated with Crohns
    disease, gastric bypass surgery and MS;                                                                                       
|
| |  | 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, an injectable agent that
    assesses 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.  

Due to minimal demand and increasing production
costs, we discontinued marketing and selling Inulin in September
2003.

In June 2003, we acquired Nascobal®, an FDA
approved nasal gel formulation of Cyanocobalamin USP (Vitamin
B-12), from Nastech Pharmaceutical Company, Inc.
(Nastech) for $14.2 million. We began
distributing Nascobal in July 2003. We are marketing Nascobal
for patients with Crohns Disease and MS, and patients who
are at high risk of developing severe deficiencies of Vitamin
B-12 due to a compromised ability to absorb Vitamin B-12 through
the gastrointestinal system. We are also marketing Nascobal for
patients who have undergone gastric bypass surgery or other
conditions that lead to a malabsorbtive state.

Consistent with our focus on sales and marketing,
our spending on research and development activities is minimal.
Expenses incurred for the Acthar manufacturing site transfer and
medical and regulatory affairs are classified as Research and
Development Expenses in the accompanying Consolidated Statements
of Operations. We have entered into agreements with
pharmaceutical and biotechnology companies to further the
development of certain acquired technology.

We have incurred an accumulated deficit of
$82.9 million at December 31, 2003. At
December 31, 2003, we had $3.2 million in cash, cash
equivalents and short-term investments, and in January 2004 we
raised an additional $2.4 million through the private
placement of common stock for cash and the surrender of warrants.

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, the availability of finished goods from our
sole-source manufacturers, the

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timing of certain expenses including the Acthar
site transfer costs, the acquisition of marketed products, the
establishment of strategic alliances and corporate partnering,
and the receipt of milestone payments.


Critical Accounting Policies

Our managements 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 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.



| |                                                  
| | -------------------------------------------------
| | Product Returns, Rebates and Sales
    Allowances

We have estimated allowances for product returns
from wholesalers and pharmacies, government chargebacks for
goods purchased by certain Federal government organizations
including the Veterans Administration, Medicaid rebates from all
states for goods purchased by patients covered by Medicaid, 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, government chargebacks and
rebates on specific terms for product returns, chargebacks 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 returns are exchanged for
replacement product (Exchange Policy). The estimated
costs for such potential exchanges, which include actual product
costs and related shipping charges, are included in Cost of
Product Sales. In estimating returns, for each product, 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 18 months to 3 years for all
products except Glofil), and (iii) changes in demand
measured by prescriptions as provided by an independent third
party source and our internal estimates. For Glofil, we accept
no returns for expired product. We continually assess our
historical experience including customers compliance with
the Exchange Policy, and we adjust our allowances as appropriate.

In December 2002, we noted that certain customers
were not complying with our Exchange Policy. These customers
were deducting from amounts owed to us the full price of expired
Acthar they planned to return to us. We reached an agreement
with these customers to reverse these short-remittances and to
accept replacement product for the Acthar expiring in November
2002 and May 2003. Certain customers received an administration
fee from us. It remains our customers standard practice to
deduct from payments to us the amount of the sales value of
expired product (returns receivable) that they have
requested for return. The returns receivable of $420,000 at
December 31, 2003 was an increase of $344,000 from the
December 31, 2002 balance of $76,000 primarily due to the
expiration of batches of Acthar in November 2002 and May 2003.
Customers have indicated that they will reimburse us for these
deductions upon the replacement of expired units in accordance
with our Exchange Policy, however, our experience has been the
timing of such reimbursements is slower than the collection of
our normal trade receivables. As of December 31, 2003,
replacement units have been shipped relating to over two thirds
of the amounts owing to us and we are seeking reimbursement from
these customers. As long as our customers standard
practice is to deduct amounts related to the return of expired
product, a returns receivable will arise. Should our customers
not comply with

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our Exchange Policy, the amounts deducted by them
for returns may not be collectible, and we would increase our
allowance for bad debts.


Our Exchange Policy is not commonplace in the
pharmaceutical industry as the standard policy is to issue
credit memorandums in exchange for expired product that is
returned. Our customers have expressed dissatisfaction with our
Exchange Policy, and although they have complied to date, our
ability to enforce this policy on customers whose influence and
resources are far greater than ours, is extremely limited. If
our customers do not comply with our policies, our options are
limited. We could either not sell our products to them (see
Wholesalers buying patterns, in the Risk Factor Section)
or we could be forced to change our policy to allow for the
issuance of credit memoranda in exchange for returned expired
products. Under such a policy, we would no longer issue
replacement product. The issuance of credit memoranda would
negatively impact cash flow in the short-term but may increase
future sales as shipment of replacement product at no cost would
no longer occur.

Should we be forced to change to a returns policy
in which credit memoranda are issued in exchange for expired
product, an allowance for returns (credit memorandums) would be
necessary and would be recorded with an offset to net product
sales at the time of the policy change. The allowance would be
based on an estimate of the future credit memorandums to be
issued based upon historical return rates by product, applied to
the quantity of product sold that has not yet expired. Further,
if such a policy change were made the currently recorded
allowance for product exchanges would be eliminated resulting in
a reduction of cost of product sales. On Acthar, the historical
return rate has been approximately 18 to 20% due to the short
shelf life of the product and the nature of the disease for
which it is presented. A change in our business policy to a
return for credit memoranda basis would have a significant
negative financial impact at the time of the change. Using
historical return rates for each product, if we adopted a policy
of issuing credit memorandums for expired product, allowances of
up to $2 million to $3 million might be needed. A
change in the business policy to issuing credit memorandums for
expired product would be considered a change in accounting
estimate and would be accounted for on a prospective basis. The
impact of a change to a return for credit memoranda policy would
be to reduce net product sales by the amount of the estimated
future credit memoranda to be issued offset by a reduction in
cost of product sales for the elimination of the allowance for
product replacement.

In March 2004, one of our three largest customers
communicated to us that they do not want to continue with the
Exchange Policy but desire a policy of issuing credit memoranda
for expired product. We will be meeting with this customer to
attempt to maintain our Exchange Policy but in the event we are
unsuccessful, we may be forced to change to a return for credit
memoranda policy.

In estimating Medicaid rebates, we match the
actual rebates to the actual sales on a product-by-product basis
to arrive at an actual rebate percentage. This historical
percentage is used to estimate a rebate percentage that is
applied to current period sales to arrive at the rebate expense
(allowance) for the period. In particular, we consider
allowable prices by Medicaid. In estimating government
chargeback allowances, we analyze actual chargeback amounts by
product and apply historical chargeback rates to sales to which
chargebacks apply, typically sales to the Veterans
Administration and other U.S. government organizations. We
continually assess our experience with Medicaid rebates and
government chargebacks and adjust the allowances accordingly.

For certain major customers, we grant payment
terms of 2%, net 30 days. Allowances for cash discounts are
estimated based upon historical experience and the amount of
trade accounts receivable subject to the cash discounts.

If actual product returns, government
chargebacks, Medicaid rebates and cash discounts are greater
than our estimates, or if our customers fail to adhere to our
Exchange Policy, additional allowances may be required. To date,
the actual amounts have approximated our estimates.



| |            
| | -----------
| | 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 expiration date,

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(ii) our sales forecasts, and
(iii) historical demand. Judgment is required in
determining whether the forecasted sales information is
sufficiently reliable to enable us to reasonably estimate
inventory obsolescence. If actual future usage and demand for
our products are less favorable than those projected by our
management, additional inventory write-offs may be required.


During fiscal year 2003, we acquired from Aventis
for $470,000 various materials (including Acthar API) which are
needed to produce both Acthar final product and API. As of
December 31, 2003, there was $320,000 of the Aventis raw
materials remaining in our inventory. The FDA approved our use
of Aventis API in the production of Acthar final product until
we have successfully transferred the production of API to a new
contract manufacturer. This approval is conditioned on yearly
testing of the API and the results meeting the current API
specification. In the future, if we are successful in
transferring the API production to our new contract
manufacturer, BioVectra, we may write off certain of the
remaining raw materials as excess inventory.



| |                  
| | -----------------
| | Intangible Assets

We have intangible assets related to purchased
technology, 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. In accordance with SFAS 144, 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. In accordance with
SFAS 142, we review goodwill and other intangible assets
with no definitive lives for impairment on an annual basis,
using the two-step approach. To date, no impairment has been
determined.

Results of Operations



| |                                                                              
| | -----------------------------------------------------------------------------
| | Year Ended December 31, 2003 Compared
    to the Year Ended December 31, 2002



| |               
| | --------------
| | Total Revenues

|                                             |  |              |        |           |  |            |        |   |  |   |      |   |  |  |     |   
|-------------------------------------------- |  | ------------ | ------ | --------- |  | ---------- | ------ | - |  | - | ---- | - |  |  | --- | --
|                                             |  |              |        |           |  |           
|                                             |  | Years Ended  |        |           |  |           
|                                             |  | December 31, |        |           |  |           
|                                             |  |              |        | Increase/ |  |           
|                                             |  | 2003         |        | 2002      |  | (Decrease) |        | %
|                                             |  |              |        |           |  |            |        |  
|                                             |  |              |        |          
|                                             |  | (in $000s)  |        |          
|Net product sales                            |  | $            | 13,655 |           |  | $          | 13,819 |   |  | $ | (164 | ) |  |  | (1  | )%
|Contract research, grant and royalty revenue |  |              | 58     |           |  |            | 208    |   |  |   | (150 | ) |  |  | (72 | )%
|Technology revenue                           |  |              | 350    |           |  |            | 450    |   |  |   | (100 | ) |  |  | (22 | )%
|Service revenue from a related party         |  |              |       |           |  |            | 200    |   |  |   | (200 | ) |  |  |    |   
|                                             |  |              |        |           |  |            |        |   |  |   |      |   |  |  |     |   
|Total Revenues                               |  | $            | 14,063 |           |  | $          | 14,677 |   |  | $ | (614 | ) |  |  | (4  | )%
|                                             |  |              |        |           |  |            |        |   |  |   |      |   |  |  |     |   

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Total revenues for the year ended
December 31, 2003 decreased $614,000, or 4%, from the year
ended December 31, 2002 due to decreases in net product
sales, contract research, grant and royalty revenue, technology
revenue and service revenue from a related party, as explained
below.



| |                  
| | -----------------
| | Net Product Sales

|                        |  |              |        |           |  |            |        |   |  |   |        |   |  |  |     |   
|----------------------- |  | ------------ | ------ | --------- |  | ---------- | ------ | - |  | - | ------ | - |  |  | --- | --
|                        |  |              |        |           |  |           
|                        |  | Years Ended  |        |           |  |           
|                        |  | December 31, |        |           |  |           
|                        |  |              |        | Increase/ |  |           
|                        |  | 2003         |        | 2002      |  | (Decrease) |        | %
|                        |  |              |        |           |  |            |        |  
|                        |  |              |        |          
|                        |  | (in $000s)  |        |          
|HP Acthar® Gel          |  | $            | 7,973  |           |  | $          | 9,009  |   |  | $ | (1,036 | ) |  |  | (11 | )%
|Nascobal®               |  |              | 2,099  |           |  |            |       |   |  |   | 2,099  |   |  |  | 100 | % 
|Ethamolin®              |  |              | 1,629  |           |  |            | 3,527  |   |  |   | (1,898 | ) |  |  | (54 | )%
|VSL#3®                  |  |              | 992    |           |  |            | 523    |   |  |   | 469    |   |  |  | 90  | % 
|Glofil®-125             |  |              | 887    |           |  |            | 732    |   |  |   | 155    |   |  |  | 21  | % 
|Inulin                  |  |              | 75     |           |  |            | 28     |   |  |   | 47     |   |  |  | 167 | % 
|                        |  |              |        |           |  |            |        |   |  |   |        |   |  |  |     |   
|Total Net Product Sales |  | $            | 13,655 |           |  | $          | 13,819 |   |  | $ | (164   | ) |  |  | (1  | )%
|                        |  |              |        |           |  |            |        |   |  |   |        |   |  |  |     |   



| |                                                                             
| | ----------------------------------------------------------------------------
| | Net Product Sales by product as a percentage
    of total net product sales:

|                 |  |              |     |      |  |  |     |  
|---------------- |  | ------------ | --- | ---- |  |  | --- | -
|                 |  |             
|                 |  | Years Ended 
|                 |  | December 31,
|                 |  |             
|                 |  | 2003         |     | 2002
|                 |  |              |     |     
|H.P. Acthar® Gel |  |              | 58  | %    |  |  | 65  | %
|Nascobal®        |  |              | 15  | %    |  |  |    |  
|Ethamolin®       |  |              | 12  | %    |  |  | 26  | %
|VSL#3®           |  |              | 7   | %    |  |  | 4   | %
|Glofil®-125      |  |              | 7   | %    |  |  | 5   | %
|Inulin           |  |              | 1   | %    |  |  |    |  
|                 |  |              |     |      |  |  |     |  
|                 |  |              | 100 | %    |  |  | 100 | %
|                 |  |              |     |      |  |  |     |  

For the year ended December 31, 2003, net
product sales decreased by $164,000, or 1%, from the year ended
December 31, 2002. The decrease in net product sales is
primarily the result of lower revenues from Acthar and Ethamolin
offset by the commencement of sales of Nascobal in July 2003.
During the year ended December 31, 2002 we shipped
backorders outstanding at December 31, 2001 amounting to
$334,000 for Acthar and $408,000 for Ethamolin. Without these
backorders, product revenues would have been $13,077,000 in the
year ended December 31, 2002. As of December 31, 2003,
we had orders from customers totaling $325,000 that were not
shipped until January 2004. Net product sales will fluctuate
quarter to quarter based on wholesale inventory levels, the
replacement of expired product and the timing of orders from
customers.



| |       
| | ------
| | Acthar

For the year ended December 31, 2003, net
product sales of Acthar decreased 11% from the year ended
December 31, 2002. The lower sales of Acthar in fiscal year
2003 was partially the result of the replacement of expired
vials of Acthar at no cost under our Exchange Policy, and the
decision in the first quarter of fiscal year 2003 to briefly
limit shipments of Acthar to critical care and emergency care
situations due to the relatively short dating of our inventories
and inventories at the wholesale level. During fiscal year 2003,
under our Exchange Policy we replaced vials of Acthar with an
estimated sales value of $2.3 million calculated using the
unit prices in effect at December 31, 2003. The replacement
of expired product displaced sales in fiscal year 2003 and is
expected to continue to displace sales as product expires and is
subsequently replaced. The decrease of unit sales over the prior
year was also partially due to a shipment in early fiscal year
2002 of

35



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##### Table of Contents



backorders totaling $334,000 outstanding as of
December 31, 2001. The estimated demand as measured by
prescriptions reported from an independent source increased by
6% in 2003 as compared to 2002.


Under our Exchange Policy for expired product,
during fiscal year 2003 we replaced vials of Acthar which
expired in November 2002 and May 2003. The next batches of
Acthar expire in January 2004 and December 2004 and replacements
for the expired Acthar relating to these batches will occur in
fiscal year 2004 and fiscal year 2005. During fiscal year 2002
under our Exchange Policy we shipped replacement units for
expired product with an estimated sales value of $116,000
calculated using unit sales prices in effect at
December 31, 2002. In fiscal year 2002 and fiscal year
2001, our Acthar vials sold had a one year shelf life and in the
first quarter fiscal year 2003 we began shipping Acthar with a
18 month shelf life. Due to the short shelf life of Acthar,
significant quantities could expire at the wholesaler or
pharmacy level, which would then be returned for replacement
product, under our Exchange Policy. The shipment of replacement
product, at no cost to the customers, displaces future sales.

In fiscal year 2004, due to a continued shift in
promotional efforts toward Nascobal and the return of supply of
a preferred competing product for Acthar, we expect
prescriptions for Acthar to drop below fiscal year 2003 levels.
Our Acthar promotional efforts will be designed to support
current prescribers of Acthar in neurology.



| |         
| | --------
| | Nascobal

Nascobal sales commenced in July 2003. Based on
the positive prescription trends of Nascobal in the fourth
quarter of fiscal year 2003, we intend to add promotional
resources to this product. As such, we expect revenue from
Nascobal to increase in fiscal year 2004 and become a larger
percentage of our total sales. We anticipate that as a
percentage of total sales, Nascobal will increase and Acthar
will decrease.



| |          
| | ---------
| | Ethamolin

For the year ended December 31, 2003, net
product sales of Ethamolin decreased 54% from the year ended
December 31, 2002, which was primarily the result of the
large purchase of Ethamolin by wholesalers in anticipation of
the price increase in June 2002 and shipment of backorders
existing at December 31, 2001. Effective June 24,
2002, we increased our list price for Ethamolin. From the date
of the notification of the price increase through June 30,
2002, we received $1,560,000 of Ethamolin orders, which we
believe were in excess of actual prescription needs and
negatively impacted sales in the remainder of fiscal year 2002
and fiscal year 2003. The decrease of sales of Ethamolin in
fiscal year 2003 over the prior year was also partially due to a
shipment in early 2002 of backorders totaling $408,000
outstanding as of December 31, 2001. The demand for all
sclerosing agents as measured by total prescriptions decreased
in fiscal year 2003 by approximately 36%, from fiscal year 2002,
and the decrease in demand for Ethamolin was approximately 37%.
In fiscal year 2003 we did not actively promote Ethamolin and we
do not expect to promote the product in fiscal year 2004.



| |      
| | -----
| | VSL#3

For the year ended December 31, 2003, net
product sales of VSL#3 increased by $469,000, to $992,000, from
$523,000 for the year ended December 31, 2002. The increase
was attributed to a full year of sales since VSL#3 was launched
in May 2002.



| |           
| | ----------
| | Glofil-125

For the year ended December 31, 2003, net
product sales of Glofil-125 increased by $155,000, to $887,000,
from net product sales of $732,000 for the year ended
December 31, 2002. The increase in net product sales was
due in part to the CRIC study that began in 2003. The CRIC study
is to enroll 3,000 people who are at risk for compromised renal
function, and follow them for more than five years. The testing
using Glofil-125 will occur at the enrollment of the trial and
at the end of the trial. In fiscal year 2003, we did not
actively promote Glofil and do not intend to actively promote it
in the future.

36



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##### Table of Contents





| |       
| | ------
| | Inulin

For the year ended December 31, 2003, sales
of Inulin increased by $47,000, to $75,000, from $28,000 for the
year ended December 31, 2002. However, due to minimal
demand and increasing cost of production, we discontinued
marketing and selling Inulin in September 2003.

We are reviewing the amount of inventory at the
wholesale level in order to help assess the demand for Acthar,
Ethamolin and Nascobal in fiscal year 2004. Quarterly revenues
will fluctuate based on buying patterns of the wholesalers,
expiration dates of product sold and timing of shipment of
replacement product under our Exchange Policy.

Contract Research, Grant and Royalty
Revenue

Contract research, grant and royalty revenue
decreased by $150,000, or 72%, to $58,000 for the year ended
December 31, 2003 from $208,000 for the year ended
December 31, 2002. This decrease was primarily the result
of receiving less reimbursement under our SBIR grant, which was
terminated on July 31, 2003, due to a decrease in activity
with our GERI compound research project.

Technology Revenue and Services Revenue from a
Related Party

For the year ended December 31, 2003, we
recognized $350,000 in technology revenue primarily from our
License Agreement with Fabre-Kramer and the sale of certain
patents. For the year ended December 31, 2002, we
recognized $450,000 in technology revenue related to our License
Agreements with Fabre Kramer and Ahn Gook. Services revenue from
a related party was $200,000 for the year ended
December 31, 2002. This amount represents the recognition
of revenue resulting from the $200,000 payment made by VSL for
certain promotional activities we undertook to support the
launch of VSL#3.

Cost of Product Sales

Cost of product sales increased $751,000, or 27%,
to $3,573,000 for the year ended December 31, 2003 from
$2,822,000 for the year ended December 31, 2002. Cost of
product sales includes material cost, packaging, warehousing and
distribution, product liability insurance, royalties, quality
control, quality assurance and write-offs of excess inventory.
The increase is primarily due to write-offs of excess inventory
and increases in our excess inventory allowance, increases in
per unit material costs and increases in costs of performing
product stability testing. The excess inventory write-offs and
allowances are primarily the result of the decision to
discontinue production and sales of Inulin and the short shelf
life of Acthar. We expect per unit material costs for Acthar to
increase in the future due to higher contract manufacturing and
laboratory costs. Cost of product sales as a percentage of net
product sales increased to 26% for the year ended
December 31, 2003 from 20% for the year ended
December 31, 2002. A change in the mix of products we sold
contributed to this change in the percentage of costs of product
sales to net product sales. 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 and Glofil-125, and we
distribute VSL#3 from our Union City facility. The decision to
outsource these functions and close the Carlsbad facility
resulted in reduced expense in the second half of 2003.

37



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##### Table of Contents



Gross Margins

|              |  |              |     |      |  |  |     |   
|------------- |  | ------------ | --- | ---- |  |  | --- | --
|              |  |             
|              |  | Years Ended 
|              |  | December 31,
|              |  |             
|Gross Margins |  | 2003         |     | 2002
|              |  |              |     |     
|HP Acthar Gel |  |              | 78  | %    |  |  | 83  | % 
|Nascobal      |  |              | 86  | %    |  |  |    |   
|Ethamolin     |  |              | 73  | %    |  |  | 81  | % 
|VSL#3         |  |              | 52  | %    |  |  | 61  | % 
|Glofil        |  |              | 50  | %    |  |  | 49  | % 
|Inulin        |  |              | (88 | )%   |  |  | (29 | )%
|All products  |  |              | 74  | %    |  |  | 80  | % 

Acthar and Ethamolin gross margins decreased due
to the periodic stability testing required subsequent to
manufacturing and the write-off and allowances from excessive
inventory. The transfer of the manufacturing of Acthar from
Aventis to new third party manufacturers will likely result in
higher unit costs, which would result in a decrease of our gross
margin on sales of Acthar. We commenced sales of Nascobal in
July 2003. Inulins gross margins decreased as a result of
the write-off of inventory upon termination of the product
offering. Stability testing is required on each production lot
of Acthar and Ethamolin and is conducted at third party
laboratories at periodic intervals subsequent to manufacturing.
Stability testing costs are expensed as incurred and are
expected to increase as greater quantities of Acthar and
Ethamolin are produced and become subject to testing. Total
gross margins have declined based upon the mix of products and
the reduction of margins on some individual products. Gross
margins do not include any allocation of the amortization of
purchased technology for the related project. The amortization
is included in the depreciation and amortization line item in
operating expenses.

Selling, General and Administrative

|                                            |  |              |        |      |  |          |        |   |  |   |      |   |  |  |    |   
|------------------------------------------- |  | ------------ | ------ | ---- |  | -------- | ------ | - |  | - | ---- | - |  |  | -- | --
|                                            |  |              |        |      |  |         
|                                            |  | Years Ended  |        |      |  |         
|                                            |  | December 31, |        |      |  |         
|                                            |  |              |        |      |  |         
|                                            |  | 2003         |        | 2002 |  | Decrease |        | %
|                                            |  |              |        |      |  |          |        |  
|                                            |  |              |        |     
|                                            |  | (in $000s)  |        |     
|Selling, general and administrative expense |  | $            | 10,400 |      |  | $        | 10,825 |   |  | $ | (425 | ) |  |  | (4 | )%
|                                            |  |              |        |      |  |          |        |   |  |   |      |   |  |  |    |   
|Percentage of total revenue                 |  |              | 74     | %    |  |          | 74%    |   |  |   |      |   |  |  |    |   

Selling, general and administrative expenses for
the year ended December 31, 2003 decreased 4% from the year
ended December 31, 2002. As a percentage of revenue,
selling, general and administrative expenses remained flat at
74% for the year ended December 31, 2003 from the year
ended December 31, 2002. The decrease in dollars is
primarily due to lower non-cash charges for stock-based
compensation, lower public relations and investor relations
expenses and decreases in management bonuses, totaling
approximately $1,036,000, offset by the full year impact of
increases to salary and other costs associated with the
expansion of our sales and marketing departments in support of
our newer products Acthar, Nascobal and VSL#3 totaling
approximately $385,000 and other general and administrative
costs. In addition, we had a headcount of 24 individuals to
support the commercial sales of our five products as of
December 31, 2003, compared to a headcount of 30
individuals to support the commercial sales of our five products
as of December 31, 2002.

Research and Development

Research and development expenses for the year
ended December 31, 2003 were $2,267,000 as compared to
$2,295,000 for the year ended December 31, 2002. The costs
included in research and development relate primarily to our
manufacturing site transfers and medical and regulatory affairs
compliance activities. In the year ended December 31, 2003,
a third party contract laboratory performed several tests as
part of our Acthar manufacturing site transfer. To date, this
laboratory has been unsuccessful in validating the assay in
order to

38



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##### Table of Contents



complete the transfer. Based in part on the
results of these tests, we were not able to complete the
transfer of the assay to a new contract laboratory. In the
fourth quarter of fiscal 2003, we temporarily suspended the
testing and instead completed a review of the results achieved
to date. We performed an analysis of the variables involved that
may have affected the validation of the assay. Beginning in
fiscal year 2004, we will resume the testing necessary to
transfer the assay to a new contract laboratory. 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.


During fiscal year 2003, our Carlsbad facility
was vacated and the functions performed there were outsourced to
third party contractors or transferred to the Union City
headquarters. The entire facility was subleased during fiscal
year 2003 and a liability of $171,000 was recorded for the net
present value of future rental payments, net of sublease
payments and the corresponding expense recorded to Research and
Development.

In fiscal years 2003 and 2002, our spending on
research and development programs was limited and will continue
to be minimal in the future. As such, we are seeking to
out-license the development of Emitasol (intransal
metoclopramide), a product that is approved in Italy and Korea
as an anti-emetic. The development of Hypnostat for the
treatment of sleep disorders and Panistat for the treatment of
panic disorders will be controlled by Fabre Kramer. The future
development of Emitasol will be dependent in part on our ability
to enter into a partnership arrangement. As we rely on current
and future strategic partners to develop and fund our
non-commercial projects, we are unable to project estimated
completion dates. We have limited control, if any, over these
programs due to our reliance on partners for their development.
Accordingly our ability to disclose historical and future costs
associated with these projects is limited.

Depreciation and Amortization

Depreciation and amortization expense increased
by 2% to $1,157,000 for the year ended December 31, 2003
from $1,138,000 for the year ended December 31, 2002. This
increase was due primarily to the amortization of the purchased
technology related to the Nascobal product acquisition (for
$14.2 million) in June 2003, offset by lower depreciation
due to assets becoming fully depreciated in fiscal years 2003
and 2002. The Nascobal purchased technology will be amortized
over 15 years. The net remaining balance of purchased
technology of $382,000 at December 31, 2002 was related to
Ethamolin and was fully amortized in fiscal year 2003.

Other Income and Expense Items

|                                                                       |  |              |      |           |  |            |      |   |  |   |      |   |  |  |     |   
|---------------------------------------------------------------------- |  | ------------ | ---- | --------- |  | ---------- | ---- | - |  | - | ---- | - |  |  | --- | --
|                                                                       |  |              |      |           |  |           
|                                                                       |  | Years Ended  |      |           |  |           
|                                                                       |  | December 31, |      |           |  |           
|                                                                       |  |              |      | Increase/ |  |           
|                                                                       |  | 2003         |      | 2002      |  | (Decrease) |      | %
|                                                                       |  |              |      |           |  |            |      |  
|                                                                       |  |              |      |          
|                                                                       |  | (in $000s)  |      |          
|Non-cash amortization of deemed discount on
    convertible debentures |  | $            | (522 | )         |  | $          | (415 | ) |  | $ | 107  |   |  |  | 26  | % 
|Interest income                                                        |  |              | 229  |           |  |            | 307  |   |  |   | (78  | ) |  |  | (25 | )%
|Interest expense                                                       |  |              | (333 | )         |  |            | (315 | ) |  |   | 18   |   |  |  | 6   | % 
|Other income                                                           |  |              | 1    |           |  |            | 120  |   |  |   | (119 | ) |  |  | (99 | )%
|Other expense                                                          |  |              | (92  | )         |  |            | (361 | ) |  |   | (269 | ) |  |  | (75 | )%
|Rental income, net                                                     |  |              | 260  |           |  |            | 282  |   |  |   | (22  | ) |  |  | (8  | )%

Non-cash amortization of deemed discount on
convertible debentures increased 26% for the year ended
December 31, 2003 as compared to the year ended
December 31, 2002. The convertible debentures were issued
in March 2002.

Interest income for the year ended
December 31, 2003 decreased by 25% from the year ended
December 31, 2002, primarily due to lower interest rates in
fiscal year 2003 compared to the same period in

39



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##### Table of Contents



2002. Interest expense increased by 6% for the
year ended December 31, 2003 as compared to the year ended
December 31, 2002. The increase was primarily due to the
current period representing a full years worth of interest
expense on the convertible debentures issued in March 2002.


Other income for the year ended December 31,
2003 decreased by 99% from the year ended December 31,
2002. During fiscal year 2002, we recognized other income as a
result of receipt of profits arising from short swing stock
trades executed by one of our 10% shareholders. Other expense
for the year ended December 31, 2003 decreased by 75% from
the year ended December 31, 2002. The decrease in other
expense is primarily due to a lower amount of loss recognized in
fiscal year 2003 related to our investment in the common stock
of Rigel Pharmaceuticals as compared to fiscal year 2002. We
liquidated our investment in Rigel common stock in the second
quarter of fiscal year 2003. As such, for the year ended
December 31, 2003 we recorded an other-than-temporary loss
of $51,000 and realized losses of $14,000 related to the common
stock investment as compared to a $367,000 other-than-temporary
loss recorded on the common stock investment in fiscal year 2002.

Rental income, net, for the year ended
December 31, 2003 decreased 8% from the year ended
December 31, 2002. Rental income, net, primarily arises
from the lease and sublease of our former headquarters facility
in Hayward, California. Although the current rental income from
the sublessee exceeds the current rental expense on the Hayward
facility, there can be no assurance our sublessee will not
default on the sublease agreement, and if they were to do so, we
would still be obligated to pay rent on this property.

Net Loss

For the year ended December 31, 2003, we
incurred a net loss of $3,791,000, as compared to a net loss of
$2,785,000 for the year ended December 31, 2002, an
increase of $1,006,000, or 36%. The increased net loss for
fiscal year 2003 compared to fiscal year 2002 was primarily the
result of lower total revenues and higher cost of product sales.

Series B Preferred Stock
Dividends

Non-cash deemed dividends of $1,394,000 at
December 31, 2003 are related to the beneficial conversion
feature in connection with the Series B Preferred Stock and
warrants issued in January 2003. A beneficial conversion feature
was recorded 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. In addition, on
June 13, 2003, we obtained a letter from our Series B
Preferred Stockholders whereby certain covenants were waived
until December 31, 2003. In exchange for such waiver, the
exercise price of the warrants was reduced. The beneficial
conversion feature was revalued using the new exercise price and
the increase in value was recorded as a dividend. In December
2003, a waiver was received from the Series B Preferred
Stockholders waiving certain covenants until January 31,
2004, at which time we were in compliance.

Preferred Stock dividends of $762,000 represent
the 8% cash dividends paid to the Series B Preferred
Stockholders. These dividends are required to be paid in cash
quarterly. The Series B Preferred Stock was issued in
January 2003.

Net Loss Applicable to Common
Shareholders

For the year ended December 31, 2003, we
incurred a net loss applicable to common stockholders of
$5,947,000, or $.14 per share, as compared to a net loss
applicable to common stockholders of $2,785,000, or
$0.07 per share for the year ended December 31, 2002,
an increase of $3,162,000. In fiscal year 2003 dividends on
Series B Preferred Stock of $762,000 and non-cash deemed
dividends related to the beneficial conversion feature of
Series B Preferred Stock of $1,394,000 were recorded in
arriving at the net loss applicable to common stockholders.

40



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##### Table of Contents





| |                                                                              
| | -----------------------------------------------------------------------------
| | Year Ended December 31, 2002 Compared
    to the Year Ended December 31, 2001



| |               
| | --------------
| | Total Revenues

|                                             |  |              |        |           |  |            |       |   |  |   |       |   |  |  |     |   
|-------------------------------------------- |  | ------------ | ------ | --------- |  | ---------- | ----- | - |  | - | ----- | - |  |  | --- | --
|                                             |  |              |        |           |  |           
|                                             |  | Year Ended   |        |           |  |           
|                                             |  | December 31, |        |           |  |           
|                                             |  |              |        | Increase/ |  |           
|                                             |  | 2002         |        | 2001      |  | (Decrease) |       | %
|                                             |  |              |        |           |  |            |       |  
|                                             |  |              |        |          
|                                             |  | (in $000s)  |        |          
|Net product sales                            |  | $            | 13,819 |           |  | $          | 5,196 |   |  | $ | 8,623 |   |  |  | 166 | % 
|Contract research, grant and royalty revenue |  |              | 208    |           |  |            | 381   |   |  |   | (173  | ) |  |  | (45 | )%
|Technology revenue                           |  |              | 450    |           |  |            | 90    |   |  |   | 360   |   |  |  | 400 | % 
|Services revenue from a related party        |  |              | 200    |           |  |            |      |   |  |   | 200   |   |  |  |    |   
|                                             |  |              |        |           |  |            |       |   |  |   |       |   |  |  |     |   
|Total revenues                               |  | $            | 14,677 |           |  | $          | 5,667 |   |  | $ | 9,010 |   |  |  | 159 | % 
|                                             |  |              |        |           |  |            |       |   |  |   |       |   |  |  |     |   

Total revenues for the year ended
December 31, 2002 increased 159% from total revenues for
the year ended December 31, 2001, primarily due to
increases of 166% for net product sales and increases in
technology revenue and services revenue from a related party as
described below.



| |                  
| | -----------------
| | Net Product Sales

|                        |  |              |        |           |  |            |       |   |  |   |       |   |  |  |      |   
|----------------------- |  | ------------ | ------ | --------- |  | ---------- | ----- | - |  | - | ----- | - |  |  | ---- | --
|                        |  |              |        |           |  |           
|                        |  | Years Ended  |        |           |  |           
|                        |  | December 31, |        |           |  |           
|                        |  |              |        | Increase/ |  |           
|                        |  | 2002         |        | 2001      |  | (Decrease) |       | %
|                        |  |              |        |           |  |            |       |  
|                        |  |              |        |          
|                        |  | (in $000s)  |        |          
|HP Acthar® Gel          |  | $            | 9,009  |           |  | $          | 2,141 |   |  | $ | 6,868 |   |  |  | 321% |   
|Ethamolin®              |  | $            | 3,527  |           |  | $          | 1,695 |   |  |   | 1,832 |   |  |  | 108% |   
|VSL#3®                  |  |              | 523    |           |  |            |      |   |  |   | 523   |   |  |  |     |   
|Glofil®-125             |  |              | 732    |           |  |            | 982   |   |  |   | (250  | ) |  |  | (25  | )%
|Inulin                  |  |              | 28     |           |  |            | 317   |   |  |   | (289  | ) |  |  | (91  | )%
|NeofloTM                |  |              |       |           |  |            | 61    |   |  |   | (61   | ) |  |  |     |   
|                        |  |              |        |           |  |            |       |   |  |   |       |   |  |  |      |   
|Total Net Product Sales |  | $            | 13,819 |           |  | $          | 5,196 |   |  | $ | 8,623 |   |  |  | 166% |   
|                        |  |              |        |           |  |            |       |   |  |   |       |   |  |  |      |   



| |                                                                             
| | ----------------------------------------------------------------------------
| | Net Product Sales by product as a percentage
    of total net product sales:

|                 |  |              |     |      |  |  |     |  
|---------------- |  | ------------ | --- | ---- |  |  | --- | -
|                 |  |             
|                 |  | Years Ended 
|                 |  | December 31,
|                 |  |             
|                 |  | 2002         |     | 2001
|                 |  |              |     |     
|H.P. Acthar® Gel |  |              | 65  | %    |  |  | 41  | %
|Ethamolin®       |  |              | 26  | %    |  |  | 33  | %
|VSL#3®           |  |              | 4   | %    |  |  |    |  
|Glofil®-125      |  |              | 5   | %    |  |  | 19  | %
|Inulin           |  |              |    |      |  |  | 6   | %
|NeofloTM         |  |              |    |      |  |  | 1   | %
|                 |  |              |     |      |  |  |     |  
|                 |  |              | 100 | %    |  |  | 100 | %
|                 |  |              |     |      |  |  |     |  

For the year ended December 31, 2002, net
product sales increased by $8,623,000, or 166%, to $13,819,000
from $5,196,000 for the year ended December 31, 2001. The
increase in net product sales was due primarily to increased
unit sales of Ethamolin and a full year of sales of Acthar,
which was introduced in the third quarter of 2001.

During 2002 under our Exchange Policy we shipped
replacement units for expired product with an estimated sales
value of $123,000 calculated using unit prices in effect at
December 31, 2002.

41



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##### Table of Contents



Acthar

Acthar net product sales increased by
$6.9 million in fiscal year 2002, from the net product
sales in fiscal year 2001. The increase was primarily the result
of a full year of Acthar sales in fiscal year 2002 as the
product was introduced in the third quarter of fiscal year 2001.
The increase of unit sales over the prior year was also
partially due to a shipment in early 2002 of backorders
outstanding as of December 31, 2001 totaling $334,000.

Ethamolin

Ethamolin net product sales increased by
$1.8 million, or 108%, in fiscal year 2002 as compared to
fiscal year 2001. The increase was primarily due to the
strategic buying by our customers in June 2002. Effective
June 24, 2002, we increased our list price for Ethamolin.
From the date of the notification of the price increase through
June 30, 2002, we received $1,560,000 of Ethamolin orders.
The increase of unit sales over the prior year was also
partially due to a shipment in early 2002 of backorders
outstanding as of December 31, 2001, totaling $408,000.

VSL#3

We commenced sales of VSL#3 in May 2002, and thus
there were no sales in fiscal year 2001.

Glofil-125

Glofil-125 net product sales decreased 25%
in fiscal year 2002, as compared to fiscal year 2001.

Inulin

Inulin net product sales decreased 91% in fiscal
year 2002 as compared to fiscal year 2001. Due to manufacturing
issues that developed in fiscal year 2002, Inulin was not
available for sale for part of fiscal year 2002 resulting in the
decrease in sales from fiscal year 2001.

Neoflo

Neoflo was discontinued as a product in fiscal
year 2001.

Contract Research, Royalty and Grant
Revenue

Contract research, royalty and grant revenue
decreased by $173,000, or 45%, to $208,000 for the year ended
December 31, 2002 from $381,000 for the year ended
December 31, 2001. This decrease was primarily the result
of receiving less reimbursement under our SBIR grant due to a
decrease in activity with our GERI compound research project
during the year ended December 31, 2002.

Technology Revenues and Services Revenue from
a Related Party

For the year ended December 31, 2002, we
recognized $450,000 in technology revenue related to our License
Agreements with Fabre Kramer and Ahn-Gook. For the year ended
December 31, 2001, we recognized $90,000 in technology
revenue related to a payment under our license agreement with
Tularik, Inc. for the sale of our antifungal drug discovery
program. This license agreement expired in accordance with its
terms in June 2002. Services revenue from a related party was
$200,000 for the year ended December 31, 2002. This amount
represents the recognition of revenue resulting from the
$200,000 payment made by VSL for certain promotional activities
we undertook to support the launch of VSL#3.

Cost of Product Sales

Cost of product sales increased to $2,822,000, or
43%, for the year ended December 31, 2002 from $1,978,000
for the year ended December 31, 2001. This increase was
primarily a result of greater material costs due to higher
product sales for the current period. However, cost of product
sales as a percentage of net

42



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##### Table of Contents



product sales decreased to 20% for the year ended
December 31, 2002 from 38% for the year ended
December 31, 2001, primarily due to a change in product mix.


Gross Margins

|                   |  |              |     |      |  |  |    |  
|------------------ |  | ------------ | --- | ---- |  |  | -- | -
|                   |  |             
|                   |  | Years Ended 
|                   |  | December 31,
|                   |  |             
|Gross Margins      |  | 2002         |     | 2001
|                   |  |              |     |     
|HP Acthar® Gel     |  |              | 83  | %    |  |  | 73 | %
|Ethamolin®         |  |              | 81  | %    |  |  | 71 | %
|VSL#3®             |  |              | 61  | %    |  |  |   |  
|Glofil®-125        |  |              | 49  | %    |  |  | 49 | %
|Inulin             |  |              | (29 | )%   |  |  | 48 | %
|Total all products |  |              | 80  | %    |  |  | 62 | %

Gross margins for the products other than VSL#3
and Inulin improved as a result of increased sales volume and
product price increases in fiscal year 2002. Inulins gross
margin decreased as a result of low sales volume coupled with
increased cost of product. VSL#3 was formally launched in May
2002.

Selling, General and Administrative

|                                    |  |              |        |      |  |          |       |   |  |   |       |  |  |  |    |  
|----------------------------------- |  | ------------ | ------ | ---- |  | -------- | ----- | - |  | - | ----- |  |  |  | -- | -
|                                    |  |              |        |      |  |         
|                                    |  | Years Ended  |        |      |  |         
|                                    |  | December 31, |        |      |  |         
|                                    |  |              |        |      |  |         
|                                    |  | 2002         |        | 2001 |  | Increase |       | %
|                                    |  |              |        |      |  |          |       |  
|                                    |  |              |        |     
|                                    |  | (in $000s)  |        |     
|Selling, general and administrative |  | $            | 10,825 |      |  | $        | 7,836 |   |  | $ | 2,989 |  |  |  | 38 | %
|                                    |  |              |        |      |  |          |       |   |  |   |       |  |  |  |    |  
|Percent of total revenues           |  |              | 74     | %    |  |          | 138   | % |  |   |       |  |  |  |    |  
|                                    |  |              |        |      |  |          |       |   |  |   |       |  |  |  |    |  

Selling, general and administrative expenses for
the year ended December 31, 2002 increased 38% from the
year ended December 31, 2001. However, as a percentage of
revenue, selling, general and administrative expenses decreased
to 74% for the year ended December 31, 2002 from 138% for
the year ended December 31, 2001. The increase in dollars
is primarily due to increased salary and other costs of
$1,361,000 associated with the expansion of our sales and
marketing departments, increased marketing costs of $1,151,000
to support our newer products, Acthar and VSL#3, and increased
general and administrative costs. We had a headcount of 30
individuals to support the commercial sales of our five products
as of December 31, 2002, compared to a headcount of 20
individuals to support the commercial sales of our four products
as of December 31, 2001. The percentage of selling, general
and administrative expenses for the year ended December 31,
2002 decreased to 74% of total revenues due to the increase
overall in revenues discussed above.

Research and Development

Research and development expenses, which are
limited to manufacturing, regulatory and medical affairs
compliance activities, for the year ended December 31, 2002
were $2,295,000, which represents a decrease of $57,000, or 2%,
as compared to $2,352,000 for the year ended December 31,
2001. The decrease was primarily due to lower salary and
associated expenses related to our research and development
activities, offset by increased manufacturing site development
costs related to the Acthar site transfer. The manufacturing
site development costs incurred for the year ended
December 31, 2002 relate primarily to site transfer and
validation costs for Acthar.

Depreciation and Amortization

Depreciation and amortization expense decreased
by 48% to $1,138,000 for the year ended December 31, 2002
from $2,207,000 for the year ended December 31, 2001,
primarily due to minimal purchases made in fiscal year 2002, as
well as assets becoming fully depreciated in the period and a
portion of purchased technology becoming fully amortized in
fiscal year 2002.

43



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##### Table of Contents



Other Income and Expense Items

|                                                                       |  |              |      |           |  |            |      |   |  |   |      |   |  |  |       |   
|---------------------------------------------------------------------- |  | ------------ | ---- | --------- |  | ---------- | ---- | - |  | - | ---- | - |  |  | ----- | --
|                                                                       |  |              |      |           |  |           
|                                                                       |  | Years Ended  |      |           |  |           
|                                                                       |  | December 31, |      |           |  |           
|                                                                       |  |              |      | Increase/ |  |           
|                                                                       |  | 2002         |      | 2001      |  | (Decrease) |      | %
|                                                                       |  |              |      |           |  |            |      |  
|                                                                       |  |              |      |          
|                                                                       |  | (in $000s)  |      |          
|Non-cash amortization of deemed discount on
    convertible debentures |  | $            | (415 | )         |  | $          |     |   |  | $ | 415  |   |  |  |      |   
|Interest income                                                        |  |              | 307  |           |  |            | 520  |   |  |   | (213 | ) |  |  | (41   | )%
|Interest expense                                                       |  |              | (315 | )         |  |            | (465 | ) |  |   | (150 | ) |  |  | (32   | )%
|Other income                                                           |  |              | 120  |           |  |            | 29   |   |  |   | 91   |   |  |  | 314   | % 
|Other expense                                                          |  |              | (361 | )         |  |            | (10  | ) |  |   | 351  |   |  |  | 3,510 | % 
|Rental income, net                                                     |  |              | 282  |           |  |            | 612  |   |  |   | (330 | ) |  |  | (54   | )%

Non-cash amortization of deemed discount on
convertible debentures for the year ended December 31, 2002
was $415,000 pertaining to amortization of the deemed discount
related to the convertible debentures. There was no similar
expense in the year ended December 31, 2001.

Interest income for the year ended
December 31, 2002 decreased by 41% from the year ended
December 31, 2001, primarily due to a lower return on
invested cash. Interest expense decreased by 32% for the year
ended December 31, 2002 as compared to the year ended
December 31, 2001 due to lower debt levels.

Other income for the year ended December 31,
2002 increased by $91,000 from the year ended December 31,
2001. During fiscal year 2002, we recognized other income as a
result of receipt of profits arising from short swing stock
trades executed by one of our 10% shareholders. Other expense
increased by $351,000 for the year ended December 31, 2002
as compared to the year ended December 31, 2001, primarily
due to a $367,000 other-than-temporary loss taken on our Rigel
equity securities investment.

Rental income, net, for the year ended
December 31, 2002 decreased $330,000 from the year ended
December 31, 2001. The decrease was primarily due to the
receipt in 2001 of a sublease termination fee of $130,000 by the
former sublessor of our Carlsbad facility and a $250,000 payment
receipt for vacating our Hayward facility in May 2001.

Net Loss and Net Loss Applicable to Common
Shareholders

For the year ended December 31, 2002, we
incurred a net loss applicable to common stockholders of
$2,785,000 or $0.07 per share, as compared to a net loss
applicable to common stockholders of $8,697,000 or
$0.28 per share for the year ended December 31, 2001,
a decrease of $5,912,000 or 68%. As there were no dividends
payable in fiscal year 2002 or fiscal year 2001 the net loss
applicable to common stockholders is the same as the net loss
for those years. The lower net loss is primarily the result of
higher total revenues offset by increased operating costs and
expenses.

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##### Table of Contents



Liquidity and Capital Resources

We have principally funded our activities to date
through various issuances of equity securities. Through
March 22, 2004, we have raised total net proceeds of
$63.0 million through various issuances of equity
securities.

|                                                                                                                              |                      |                    |       |         |   |      |       |        |   |   |        |        |  
|----------------------------------------------------------------------------------------------------------------------------- | -------------------- | ------------------ | ----- | ------- | - | ---- | ----- | ------ | - | - | ------ | ------ | -
|                                                                                                                              |                      |                   
|                                                                                                                              |                      | As of December 31,
|                                                                                                                              |                      |                   
|Liquidity and Capital Resources                                                                                               |                      | 2003               |       | 2002    |   | 2001
|                                                                                                                              |                      |                    |       |         |   |     
|                                                                                                                              |                      |                   
|                                                                                                                              |                      | (in $000s)       
|Cash, cash equivalents and short-term investments
    (includes compensating balances of $5,000,000 at
    December 31, 2001) |                      | $                  | 3,220 |         |   | $    | 7,506 |        |   | $ | 10,571 |       
|Working capital                                                                                                               |                      | $                  | 4,352 |         |   | $    | 7,018 |        |   | $ | 2,659  |       
|Cash provided by/(used in):                                                                                                   |                      |                    |       |         |   |      |       |        |   |   |        |       
|                                                                                                                              | Operating activities |                    | $     | (3,346  | ) |      | $     | (1,836 | ) |   | $      | (4,966 | )
|                                                                                                                              | Investing activities |                    | $     | (13,273 | ) |      | $     | (1,423 | ) |   | $      | 551    |  
|                                                                                                                              | Financing activities |                    | $     | 13,683  |   |      | $     | (768   | ) |   | $      | 7,780  |  

At December 31, 2003, we had cash, cash
equivalents and short-term investments of $3,220,000 compared to
$7,506,000 at December 31, 2002. In January 2004, we raised
an additional $2.4 million through the private placement of
common stock for cash and the surrender of outstanding warrants.
At December 31, 2003, our working capital was $4,352,000
compared to $7,018,000 at December 31, 2002. The decrease
in working capital was primarily due to the $14.3 million
we paid in fiscal year 2003 for the purchase of Nascobal and
funds used in operations, offset by net proceeds from the
issuance of $10 million of Series B Convertible
Preferred Stock in January 2003 and a $5 million private
placement of common stock and warrants in June 2003.

We used cash generated from product sales and
other revenue, proceeds from stock issuances and matured
short-term investments, and cash and short-term investments on
hand at the beginning of the year to fund operations, acquire
Nascobal, acquire short-term investments and for capital
expenditures during fiscal year 2003.

Net Cash Used In Operating
Activities

Net cash of $3.3 million was used to fund
operating activities during fiscal year 2003. Major uses of cash
in addition to the funding of the net loss of $3.8 million
were increases in accounts receivable of $571,000 and inventory
of $596,000. Accounts receivable increased primarily as a result
of the increase in short remittances for expired
product of $344,000 and inventory increased primarily due to the
purchase of Acthar raw materials from Aventis for $470,000. Our
goal is to increase net product sales in fiscal year 2004 over
fiscal year 2003 levels while maintaining operating costs and
expenses at a level that is consistent with that of 2003.

The operating loss in fiscal year 2003 included
cash outlays for the Acthar manufacturing site transfer We
expect to incur substantial future 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.

During fiscal year 2002 net cash of
$1.8 million was used to fund operating activities. Major
uses of cash in addition to the funding of the net loss of
$2.8 million were increases in accounts receivable of
$932,000, increases in inventory of $295,000 and increases in
prepaid expenses and other current assets of $509,000. Accounts
receivable increased primarily as a result of the increasing
sales in 2002 over 2001. Inventory increased primarily due to
the purchase of Acthar finished goods in fiscal year 2002.
Prepaid expenses and other current assets increased due to FDA
regulatory fees and prepaid financing costs which did not exist
in fiscal year 2001.

During fiscal year 2001 net cash of
$5.0 million was used to fund operating activities. The
major use of cash was the funding of the net loss of
$8.7 million. Also contributing to the use of cash was the
increase in accounts receivables due to higher sales in fiscal
year 2001 compared to fiscal year 2000, reduction of accrued

45



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##### Table of Contents



development costs offset by increasing
liabilities at December 31, 2001 including higher accounts
payable and accrued compensation.


Net Cash Used in Investing
Activities

Net cash used in investing activities was
$13.3 million for fiscal year 2003, primarily the result of
cash paid of $14.3 million for the purchase of Nascobal and
the purchase of property plant and equipment of $334,000 offset
by the net proceeds of $1.3 million from maturity of
short-term investments, net of purchases.

Net cash used in investing activities was
$1.4 million for fiscal year 2002, primarily the result of
$1.3 million for the purchase of short-term investments and
$355,000 in purchases of property, plant and equipment, offset
by $142,000 increase in deposits and other assets.

Net cash provided from investing activities was
$551,000 for fiscal year 2001, primarily the result of proceeds
from sales of short-term investments of $499,000 and increases
in deposits and other assets offset by purchases of property,
equipment and leasehold improvements of $183,000.

Net Cash Provided from Financing
Activities

Net cash provided from financing activities was
$13.7 million for fiscal year 2003. This was primarily the
result of net proceeds from the issuance of Series B
Convertible Preferred Stock of $9.4 million, net proceeds
from a private placement of common stock of $5 million and
short-term borrowings of $587,000 offset by the payment of
dividends on the Series B Preferred Stock of $749,000 and
repayments of short-term and long-term debt of $664,000.

Net cash was used in financing activities of
$768,000 for fiscal year 2002. This was primarily the result of
net proceeds from the issuance of convertible debentures of
$4 million, short term borrowing of $1,251,000 and issuance
of common stock of $560,000 offset by repayment of a note
payable to a bank of $5 million and the repayment of
short-term and long-term debt of $1,522,000.

Net cash was provided from financing activities
of $7.8 million for fiscal year 2001. This was primarily
the result of net proceeds from the issuance of common stock and
warrants of $7.3 million and the net proceeds of $960,000
from common stock to be issued offset by repayments of
short-term debt, long-term debt and capital lease obligations of
$470,000.

Cash and cash equivalents at December 31,
2003

Total net cash flows for fiscal year 2003
resulted in a net decrease of cash and cash equivalents of
$2.9 million for fiscal year 2003. The cash and cash
equivalents at December 31, 2003 are $3.2 million. In
January 2004, we entered into agreements with existing
shareholders to issue common stock in exchange for
$2.4 million and the surrender of outstanding warrants.

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##### Table of Contents



Contractual Obligations

|                                                                        |  |                        |        |         |  |              |       |              |  |         |        |  |  |   |       |  |  |   |       | 
|----------------------------------------------------------------------- |  | ---------------------- | ------ | ------- |  | ------------ | ----- | ------------ |  | ------- | ------ |  |  | - | ----- |  |  | - | ----- | 
|                                                                        |  |                       
|                                                                        |  | Payments Due by Period
|                                                                        |  |                       
|                                                                        |  |                        |        | 1 Year  |  | Greater than |       |              |  | After  
|                                                                        |  | Total                  |        | or Less |  | 1 to 3 Years |       | 4 to 5 Years |  | 5 Years
|                                                                        |  |                        |        |         |  |              |       |              |  |        
|                                                                        |  |                       
|                                                                        |  | (In thousands)        
|Short-term debt(1)                                                      |  | $                      | 140    |         |  | $            | 140   |              |  | $       |       |  |  | $ |      |  |  | $ |      | 
|Convertible debentures(2)                                               |  |                        | 4,000  |         |  |              |      |              |  |         | 4,000  |  |  |   |      |  |  |   |      | 
|Operating leases(3)                                                     |  |                        | 12,193 |         |  |              | 1,747 |              |  |         | 2,868  |  |  |   | 2,709 |  |  |   | 4,869 | 
|Contingent milestone payments for Nascobal
    spray(4)                 |  |                        | 4,000  |         |  |              |      |              |  |         | 4,000  |  |  |   |      |  |  |   |      | 
|Minimum payments remaining under supply agreement
    with BioVectra(5) |  |                        | 1,605  |         |  |              | 458   |              |  |         | 1,147  |  |  |   |      |  |  |   |      | 
|Annual employment agreement with CEO(6)                                 |  |                        | 458    |         |  |              | 458   |              |  |         |       |  |  |   |      |  |  |   |      | 
|Purchase orders(7)                                                      |  |                        | 203    |         |  |              | 203   |              |  |         |       |  |  |   |      |  |  |   |      | 
|                                                                        |  |                        |        |         |  |              |       |              |  |         |        |  |  |   |       |  |  |   |       | 
|Total contractual cash obligations                                      |  | $                      | 22,599 |         |  | $            | 3,006 |              |  | $       | 12,015 |  |  | $ | 2,709 |  |  | $ | 4,869 | 
|                                                                        |  |                        |        |         |  |              |       |              |  |         |        |  |  |   |       |  |  |   |       | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Short-term debt is principally notes payable
    related to our product liability and property and liability
    insurance policies which require monthly payments and will be
    paid in full during 2004.                                                                                                                                                                                                                                                                                                                                                                                 
|   
|(2) | In March 2002, we issued $4.0 million of
    8% convertible debentures to an institutional investor and
    Defiante Farmaceutica Unipessoal L.D.A. (Defiante),
    a wholly-owned subsidiary of Sigma-Tau Finanzaria S.p.A.
    (Sigma-Tau). We will pay interest on the debentures
    at a rate of 8% per annum on a quarterly basis. The
    debentures are convertible into shares of the Companys
    common stock at a fixed conversion price of $1.58 per share
    (subject to adjustment for stock splits and reclassifications).
    The debentures mature on March 15, 2005.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may redeem the debentures for cash prior to
    maturity after March 15, 2003, provided the average of the
    closing sale price of our common stock for the twenty
    (20) consecutive trading days prior to the delivery of the
    optional prepayment notice to the holders of the debentures is
    equal to or greater than $3.16 per share, and we have
    satisfied certain equity conditions. At the end of the term of
    the debentures, under certain circumstances, we may redeem any
    outstanding debentures for stock. We may redeem the
    institutional investors debentures for stock at maturity,
    provided the total aggregate number of shares of our common
    stock issued to them (including shares issuable upon conversion
    of the debenture and shares issuable upon exercise of their
    warrant) does not exceed 7,645,219 shares (representing
    19.999% of the total number of issued and outstanding shares of
    our common stock as of March 15, 2002). We may redeem
    Defiantes debenture for stock at maturity, provided the
    market price of our common stock at the time of redemption is
    greater than $1.50 per share (representing the five day
    average closing sale price of our common stock immediately prior
    to March 15, 2002).



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(3) | We lease four buildings with lease terms expiring
    in 2004 to 2012. Annual rent expense for all of our facilities,
    equipment and automobile leases in fiscal year 2003 were
    approximately $1,885,000. We lease our headquarters in Union
    City, California, with 23,000 square feet of office space
    under a lease agreement that expires in 2012. Our headquarters
    is currently occupied by our Executive, Finance and
    Administration, Sales and Marketing, Medical and Regulatory
    Affairs, distribution of VSL#3, Contract Manufacturing, and
    Quality Control and Quality Assurance departments. Annual rent
    payments for fiscal year 2004 for this facility are $485,000.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We lease a facility of 8,203 square feet in
    Carlsbad, California under a lease that expires in January 2006.
    During fiscal year 2003, the Carlsbad facility was vacated and
    our warehousing and distribution for all products, except VSL#3,
    were outsourced to third party contractors. VSL#3 is now
    distributed from our Union City facility. During fiscal year
    2003, we subleased 100% of the Carlsbad facility under two
    separate subleases expiring in January 2006 and January 2005. We
    anticipate that we will receive $149,000 in fiscal year 2004 as
    sublease income to be used to pay the annual rent of $228,000.

47



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##### Table of Contents





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have subleased laboratory space in Hayward,
    California for a term of six years and anticipate that we will
    receive $1,048,000 in fiscal year 2004 as sublease income to be
    used to pay the annual rental expense of $697,000. Our facility
    in Lees Summit, Missouri was closed in May 2001 and this
    facility has been subleased. Lease payments for the facility in
    Lees Summit, Missouri are $138,000 for fiscal year 2004
    and we anticipate $57,000 as sublease income to be used to pay
    the annual rental expense. We have also entered into various
    office equipment leases and automobile leases for our sales
    representatives, the terms of which are typically three years.



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(4) | In connection with our acquisition of Nascobal,
    we are also acquiring rights to Nascobal nasal spray, an
    improved dosage form, for which an NDA was filed by Nastech with
    the FDA in December 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. We understand that the FDAs
    target for review and action on NDA applications is ten months
    from the date of submission. Hence the NDA could be approved as
    early as the fourth quarter of 2004; however, we believe that
    the final approval is more likely to occur in the first half of
    fiscal year 2005. Further, subject to the approval of the NDA
    for the new Nascobal nasal spray dosage form and upon issuance
    of a U.S. patent for the new Nascobal nasal spray dosage
    form, we will be required to make a second $2 million
    payment. A provisional patent application for Nascobal nasal
    spray has been filed.                                                                                                                                                                                                                                                                                                                                                
|   
|(5) | We have signed an agreement with BioVectra dcl to
    produce the API used in Acthar. The agreement requires minimum
    production totaling $1.7 million during the term. During
    fiscal year 2003, we paid $115,000 under this agreement. The
    agreement terminates in December 2007 and includes two one-year
    extension options. The production of the first batch of API is
    scheduled to begin in 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   
|(6) | In August 1999, we entered into an employment
    agreement with Charles J. Casamento, our Chairman, President and
    Chief Executive Officer. The agreement automatically renews
    annually. The agreement provides for an annual base salary of
    $341,250 prior to January 1, 2000, and an annual base
    salary of not less than $375,000 thereafter, subject to annual
    review and increases. In January 2003, Mr. Casamentos
    annual base salary was increased to $458,500. The Employment
    Agreement provides Mr. Casamento with the opportunity to
    receive an additional annual bonus for each fiscal year with us.
    The amount of the bonus opportunity is 50% of the annual rate of
    base salary, and our Board of Directors determines the
    objectives which Mr. Casamento must achieve to receive all
    or a portion of this bonus opportunity for each fiscal year with
    us. The employment agreement also provides that, in the event
    Mr. Casamentos employment is terminated without
    cause, he will receive, as severance, continued payment of his
    then base salary for twenty four months and a pro-rated portion
    of his annual bonus following such termination. In addition,
    Mr. Casamento would be entitled to receive Questcor paid
    insurance coverage for 24 months and coverage at his
    election and expense for an additional 24 months thereafter.
|   
|(7) | Purchase orders issued as of December 31,
    2003 for which the goods have not yet been received or the
    services not yet rendered.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

Messrs. Morris and Beers are each party to
agreements that would provide certain benefits upon a change in
control of the Company. In the event a change in control occurs
and the employees employment with the Company is
terminated involuntarily other than for cause, the employee will
be entitled to receive a lump sum severance benefit in the
amount equal to the sum of: (i) twelve months of base
salary, and (ii) the employees pro-rated maximum
bonus opportunity for the fiscal year of the Company in which
the termination of his employment occurs. In addition, such
employees would be entitled to receive Company paid insurance
coverage for 12 months and coverage at their election and
expense for an additional 15 months. In the event
Mr. Morris is terminated other than for cause without a
change in control, he would receive a lump sum severance payment
equal to nine months base salary and the continuation of health
and medical benefits for nine months.

As of December 31, 2003 we had an agreement
with a bank for a revolving accounts receivable line of credit
for a maximum of $3,000,000 secured by a blanket lien on all of
our assets including intellectual property. There were no
borrowings under the line of credit during 2003 and in January
2004 we terminated the agreement and the blanket lien was
released.

48



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##### Table of Contents



Equity Transactions



| |                                                        
| | -------------------------------------------------------
| | Equity Transactions in Year Ended
    December 31, 2001

In April 2001, we entered into a Stock and
Warrant Purchase Agreement with Sigma-Tau Finance Holding S.A.
(Sigma-Tau) pursuant to which Sigma-Tau purchased
(i) an aggregate of 2,873,563 shares of common stock
at a purchase price of $0.52 per share, for an aggregate
purchase price of $1,500,000, and (ii) a warrant to
purchase an additional 2,873,563 shares of common stock at
a purchase price of $0.52 per share. In May 2001, as
required under the rules of AMEX, we sought and received
shareholder approval to allow for full exercise of the warrant.
In July 2001, Sigma-Tau assigned the warrant to Paolo Cavazza
and Claudio Cavazza, the principal shareholders of Sigma-Tau,
who exercised the warrant in full, purchasing
2,873,563 shares of common stock at a purchase price of
$0.52 per share, resulting in aggregate proceeds to us of
$1,500,000 (including the $100,000 originally paid by Sigma-Tau
to acquire the warrant).

In April 2001, we closed a financing with various
accredited investors which totaled $442,000. This investment
came from a group of individual investors. We issued an
aggregate of 816,800 shares of common stock and sold
warrants to purchase an additional 408,400 shares of common
stock with an exercise price equal to $0.64 per share. The
warrants are exercisable from the date of issuance until the
close of business on April 30, 2006.

In July 2001, concurrent with our agreement to
acquire Acthar from Aventis, we entered into a Stock Purchase
Agreement with Sigma-Tau pursuant to which Sigma-Tau purchased
5,279,034 shares of common stock at a purchase price of
$0.66 per share, for an aggregate purchase price of
$3,500,000.

In December 2001, we entered into a Promotion
Agreement effective in January 2002 with VSL
Pharmaceuticals, Inc., a private company owned in part by
the principal shareholders of Sigma-Tau, to promote, sell and
distribute the product VSL#3 in the U.S. In connection with
this Promotion Agreement, we entered into two Stock and Warrant
Purchase Agreements, one with Paolo Cavazza and one with Claudio
Cavazza, to purchase (i) an aggregate of
640,000 shares of common stock for a purchase price of
$1.50 per share (representing a twenty percent premium to
our market price for the five days prior to execution of the
Purchase Agreements), for an aggregate purchase price of
$960,000, and (ii) warrants, at an aggregate purchase price
of $300,000, to purchase an additional 1,800,000 shares of
common stock at a purchase price of $1.75 per share before
December 1, 2003. The warrants expired on December 1,
2003 without exercise. We issued the common stock related to
this transaction in February 2002.



| |                                                        
| | -------------------------------------------------------
| | Equity Transactions in Year Ended
    December 31, 2002

In March 2002, in two separate transactions, we
issued $4.0 million of 8% convertible debentures to an
institutional investor and Sigma-Tau. We pay interest on the
debentures at a rate of 8% per annum on a quarterly basis.
The debentures are convertible into shares of our common stock
at a fixed conversion price of $1.58 per share (subject to
adjustment for stock splits and reclassifications). At the end
of the term of the debenture, under certain circumstances, we
have the option to repay the principal in stock and, under
certain circumstances, we can also redeem the debenture for cash
prior to maturity. The debentures mature on March 15, 2005.
In conjunction with this transaction, we issued warrants to both
the institutional investor and Sigma-Tau to acquire an aggregate
of 1,518,987 shares of common stock at an exercise price of
$1.70 per share. In January 2004 the warrants to purchase
759,493 shares of common stock held by Sigma-Tau were
surrendered as consideration, along with cash for the issuance
of 759,493 shares of common stock. The remaining warrants
held by the institutional investor expire on March 15,
2006. In connection with the issuance of the debentures and
warrants, we recorded a deferred expense related to a beneficial
conversion feature of $1,484,000. This amount is amortized to
interest expense over the term of the debentures. Assuming the
conversion of the above-mentioned debenture by Sigma-Tau,
Sigma-Tau would own approximately 28% of our outstanding voting
capital stock as of March 22, 2004.

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| |                                                        
| | -------------------------------------------------------
| | Equity Transactions in Year Ended
    December 31, 2003

In January 2003, we completed a private placement
of Series B Convertible Preferred Stock and warrants to
purchase common stock to various institutional healthcare
investors. Our gross proceeds from the private placement were
$10 million. The Series B Preferred Stock had 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. In December 2003 Series B Preferred Stock
having a stated value of $900,000 and accrued and unpaid
dividends of $13,000, was converted into 976,770 shares of
common stock. 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 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. In January 2004 warrants to purchase
373,990 shares of common stock were surrendered as
consideration, along with cash, for the issuance of
373,990 shares of common stock.

In June 2003, we entered into agreements with the
holders of record of our 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 our acquisition of Nascobal and the use
of our 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 our being unable to satisfy the test set
forth in Sections 500 and 501 of the California
Corporations Code to allow for us 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) our assets (exclusive of goodwill, capitalized
research, and development expenses and deferred charges) equal
less than 125% of our liabilities (not including deferred taxes,
deferred income and other deferred credits) or (B) our
current assets equal less than 80% of our 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
our 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
we fail 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 us to use our 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 us 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 our ability to incur indebtedness and
create liens. In consideration of such agreements, we agreed to
adjust the exercise price of warrants to purchase
3,399,911 shares of our common stock previously issued by
us to the holders of Series B Preferred Stock from
$1.0824 per share to $0.9412 per share. On
December 23, 2003, a new waiver was signed by the holders
of Series B Preferred Stock which waived the Net Cash, Cash
Equivalents and

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Eligible Investment Balances among other
requirements until January 31, 2004 at which time we were
in compliance.


Also in June 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. In January
2004 warrants to purchase 2,512,368 shares of common stock
were surrendered as consideration, along with cash, for the
issuance of 2,512,368 shares of common stock.



| |                                                        
| | -------------------------------------------------------
| | Equity Transactions Subsequent to
    December 31, 2003

In January 2004 we entered into agreements with
existing shareholders to issue 4,878,201 shares of common
stock in exchange for $2,399,050 in cash and the surrender of
outstanding warrants to purchase 3,878,201 shares of common
stock. The warrants surrendered represented approximately 46% of
the warrants outstanding as of December 31, 2003. The
warrants surrendered were included as consideration at their
fair value of $743,000, which was determined using a
Black-Scholes valuation method. The purchase price of the common
stock, which was payable in cash and surrender of outstanding
warrants, was $0.644 per share, which was the volume
weighted average price of our common stock for the five trading
days prior to the agreement to the terms of the transaction.

American Stock Exchange Listing
Standards

In August 2002, we were notified by the American
Stock Exchange (AMEX) that certain of our financial
measures fell below certain of AMEXs continued listing
standards and we had therefore become subject to possible
delisting. On October 15, 2003, AMEX notified us that it
had completed its review of Questcor and determined that we had
regained compliance with AMEXs applicable continued
listing standards at that date.

Cash Requirements

Based on our internal forecasts and projections,
we believe that our cash on hand at December 31, 2003,
together with the $2.4 million of cash raised in our
January 2004 private placement of common stock, and the net cash
flows generated from operations, will be sufficient to fund
operations through at least December 31, 2004, unless a
substantial portion of our cash is used for product acquisition
or our 2004 revenues are less than we expect.

Our future funding requirements will depend on
many factors, including: the timing and extent of product sales;
returns of expired product; the acquisition and licensing of
products, technologies or compounds, if any; our ability to
manage growth; timing of payments to Nastech relating to the
nasal spray formulation of Nascobal; 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; any expansion
or acceleration of our development programs or optional
redemption events, and other factors.

If our revenues do not grow and provide cash flow
from operations in an amount sufficient to meet our obligations,
or if we are unable to maintain compliance with certain
covenants and thus avoid the payment of additional dividends of
6% to the holders of the Series B Convertible Preferred
Stock, or we do not have sufficient funds to make the contingent
payments, if, and when due to Nastech for the new nasal spray
form of Nascobal, or if we have insufficient funds to acquire
additional products or expand our operations, we will seek

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to raise additional capital through public or
private equity financing or from other sources in addition to
the equity financing raised in January 2004. However,
traditional asset based financing does not appear to be
available at this time. 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 we
will be able to obtain additional funds on desirable terms or at
all.


Income Taxes

As of December 31, 2003, we had federal and
state net operating loss carryforwards of approximately
$98 million and $27 million, respectively. We also had
federal and California research and development tax credits of
approximately $2 million and $1 million, respectively.
The federal and state net operating loss carryforwards and the
federal credit carryforwards expire at various dates beginning
in the years 2004 through 2023, if not utilized.

Recently Issued Accounting Standards

In May 2003, the Financial Accounting Standards
Board (the FASB) issued SFAS No. 150,
Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. This
Statement establishes new standards for how an issuer classifies
and measures certain financial instruments with characteristics
of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). This Statement is
effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after
June 15, 2003. The adoption of SFAS No. 150 on
July 1, 2003 did not have a material impact on our results
of operations or financial position as of December 31, 2003.

In January 2003, the FASB issued Interpretation
No. 46 (FIN 46), Consolidation of
Variable Interest Entities. FIN 46 requires that if
an entity has a controlling financial interest in a variable
interest entity, the assets, liabilities and results of
activities of the variable interest entity should be included in
the consolidated financial statements of the entity. FIN 46
as amended must be applied for interim or annual reporting
periods ending after March 15, 2004, and is effective
immediately for all new variable interest entities created or
acquired after January 31, 2003. The adoption of
FIN 46 did not impact our results of operations or
financial position as of December 31, 2003, as we are not a
party to any variable interest entities.

In July 2002, the FASB issued Statement of
Financial Accounting Standards No. 146
(SFAS No. 146), Accounting for Costs
Associated with Exit or Disposal Activities.
SFAS No. 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities
and nullifies EITF Issue No. 94-3
(EITF 94-3), Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring). The principal difference between
SFAS No. 146 and EITF 94-3 relates to
SFAS No. 146s timing for recognition of a
liability for a cost associated with an exit or disposal
activity. SFAS No. 146 requires that a liability for
an exit cost associated with an exit or disposal activity be
recognized when the liability is incurred. Under EITF 94-3
a liability for an exit cost, as generally defined in
EITF 94-3, was recognized at the date of an entitys
commitment to an exit plan. SFAS No. 146 is effective
for exit or disposal activities that are initiated after
December 31, 2002. During the year ended December 31,
2003, we transferred certain functions previously performed at
our Carlsbad, California facility (distribution, quality control
and quality assurance) to third party contractors or to our
Union City headquarters. Consequently, during fiscal year 2003,
we entered into sublease agreements with two sublessees for the
Carlsbad facility. We recognized losses relating to the lease
totaling $171,000 in fiscal year 2003. The loss associated with
the Carlsbad leases is included in research and development in
our consolidated statements of operations.

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|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    about Market Risk

Market Rate Risk

Our exposure to market rate risk for changes in
interest rates relates primarily to our investment portfolio. We
do not use derivative financial instruments in our investment
portfolio. We place our investments with high quality issuers
and follow internally developed guidelines to limit the amount
of credit exposure to any one issuer. Additionally, in an
attempt to limit interest rate risk, we follow guidelines to
limit the average and longest single maturity dates. We are
adverse to principal loss and ensure the safety and preservation
of our invested funds by limiting default, market and
reinvestment risk. Our investments include money market
accounts, commercial paper and corporate bonds. The table below
presents the amounts and related interest rates of our
investment portfolio and interest-bearing liabilities as of
December 31, 2003 and 2002.

|                           |  |                 |       |       |  |            |       |  |  |   |       | 
|-------------------------- |  | --------------- | ----- | ----- |  | ---------- | ----- |  |  | - | ----- | 
|                           |  |                 |       |       |  | Fair Value
|                           |  | 2003            |       | Total |  | 12/31/03  
|                           |  |                 |       |       |  |           
|                           |  |                 |       |      
|                           |  | (In thousands,  |       |      
|                           |  | except interest |       |      
|                           |  | rates)          |       |      
|ASSETS                     |  |                 |       |       |  |            |       |  |  |   |       | 
|Cash and cash equivalents  |  | $               | 3,220 |       |  | $          | 3,220 |  |  | $ | 3,220 | 
|Average interest rate      |  |                 | 1.13  | %     |  |            |      |  |  |   |      | 
|LIABILITIES                |  |                 |       |       |  |            |       |  |  |   |       | 
|Notes payable  short-term |  | $               | 140   |       |  | $          | 140   |  |  | $ | 140   | 
|Average interest rate      |  |                 | 7.64  | %     |  |            |      |  |  |   |      | 
|Convertible debentures     |  | $               | 4,000 |       |  | $          | 4,000 |  |  | $ | 4,000 | 
|Average interest rate      |  |                 | 8     | %     |  |            |      |  |  |   |      | 

|                           |  |                 |       |       |  |            |       |  |  |   |       | 
|-------------------------- |  | --------------- | ----- | ----- |  | ---------- | ----- |  |  | - | ----- | 
|                           |  |                 |       |       |  | Fair Value
|                           |  | 2002            |       | Total |  | 12/31/02  
|                           |  |                 |       |       |  |           
|                           |  |                 |       |      
|                           |  | (In thousands,  |       |      
|                           |  | except interest |       |      
|                           |  | rates)          |       |      
|ASSETS                     |  |                 |       |       |  |            |       |  |  |   |       | 
|Cash and cash equivalents  |  | $               | 7,506 |       |  | $          | 7,506 |  |  | $ | 7,506 | 
|Average interest rate      |  |                 | 1.63  | %     |  |            |      |  |  |   |      | 
|LIABILITIES                |  |                 |       |       |  |            |       |  |  |   |       | 
|Notes payable  short-term |  | $               | 218   |       |  | $          | 218   |  |  | $ | 218   | 
|Average interest rate      |  |                 | 10.31 | %     |  |            |      |  |  |   |      | 
|Convertible debentures     |  | $               | 4,000 |       |  | $          | 4,000 |  |  | $ | 4,000 | 
|Average interest rate      |  |                 | 8     | %     |  |            |      |  |  |   |      | 

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|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

QUESTCOR PHARMACEUTICALS, INC.

CONTENTS

|                                                      |                                                                                  |      |    |    | 
|----------------------------------------------------- | -------------------------------------------------------------------------------- | ---- | -- | -- | 
|                                                      |                                                                                  | Page
|                                                      |                                                                                  |     
|Report of Ernst & Young LLP, Independent
    Auditors |                                                                                  |      | 59 |   
|Audited Financial Statements                          |                                                                                  |      |    |   
|                                                      | Consolidated Balance Sheets                                                      |      |    | 60 | 
|                                                      | Consolidated Statements of Operations                                            |      |    | 61 | 
|                                                      | Consolidated Statement of Preferred Stock and
    Stockholders Equity (Deficit) |      |    | 62 | 
|                                                      | Consolidated Statements of Cash Flows                                            |      |    | 63 | 
|Notes to Consolidated Financial Statements            |                                                                                  |      | 64 |   
|Financial Statement Schedule                          |                                                                                  |      | 89 |   






|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes In and Disagreements with
    Accountants on Accounting and Financial Disclosure

Not Applicable.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

We maintain disclosure controls and procedures
that are designed to ensure that information required to be
disclosed in our 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 our
management, including our 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-15(b), we
carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures
as of the end of the period covered by this report. Based on the
foregoing, our Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures
were effective at the reasonable assurance level.

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




PART III.





|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

The information required is hereby incorporated
by reference from the information contained in our definitive
proxy statement (the Proxy Statement) with respect
to our 2004 Annual Meeting of Shareholders, filed with the
Commission pursuant to Regulation 14A under the headings
Nominees, Company Management, Code
of Business Conduct and Ethics and
Section 16(A) Beneficial Ownership Reporting
Compliance.

54



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##### Table of Contents








|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required by this item is hereby
incorporated by reference from information contained in the
Proxy Statement under the heading Compensation of
Directors and Executive Officers.






|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management

The information required by this item is hereby
incorporated by reference from information contained in the
Proxy Statement under the heading of Security Ownership of
Certain Beneficial Owners and Management.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The information required by this item is hereby
incorporated by reference from information contained in the
Proxy Statement under the heading Certain Relationships
and Related Transactions and Executive
Compensation.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

The information required by this item is hereby
incorporated by reference from information contained in the
Proxy Statement under the heading Ratification of
Selection of Independent Auditors.




PART IV.





|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

(a) The following documents are filed as
part of this Report:

1. Financial Statements. Our
financial statements and the Report of Ernst & Young
LLP, Independent Auditors, are included in Part IV of
this Report on the pages indicated:

|                                                      |  |      |    | 
|----------------------------------------------------- |  | ---- | -- | 
|                                                      |  | Page
|                                                      |  |     
|Report of Ernst & Young LLP, Independent
    Auditors |  |      | 59 | 
|Consolidated Balance Sheets                           |  |      | 60 | 
|Consolidated Statements of Operations                 |  |      | 61 | 
|Consolidated Statement of Stockholders
    Equity    |  |      | 62 | 
|Consolidated Statements of Cash Flows                 |  |      | 63 | 
|Notes to Financial Statements                         |  |      | 64 | 

2. Financial Statement Schedules. The
following financial statement schedule is included in
Item 15(a)(2): Valuation and Qualifying Accounts.

(b) Reports on Form 8-K

On October 21, 2003, we furnished on
Form 8-K, under Item 9, our press release of our
results for the quarter ended September 30, 2003.

(c) Exhibits

|        |   |             |  |                                                                                                                                                                                                                                                                                                   
|------- | - | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |   |            
|Number  |   | Description
|        |   |            
|        | 2 | .1(1)       |  | Merger agreement entered into August 4,
    1999, by and among Cypros Pharmaceutical Corporation, a
    California corporation (Parent), Cypros Acquisition
    Corporation, a Delaware corporation and a wholly owned
    subsidiary of Parent, and RiboGene, Inc., a Delaware
    corporation.
|        | 3 | .1(2)       |  | Amended and Restated Articles of Incorporation of
    the Company.                                                                                                                                                                                                                                
|        | 3 | .2(3)       |  | Certificate of Determination of Series B
    Convertible Preferred Stock of the Company.                                                                                                                                                                                                          
|        | 3 | .3(4)       |  | Certificate of Determination of Series C
    Junior Participating Preferred Stock of the Company.                                                                                                                                                                                                 

55



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|        |    |             |  |                                                                                                                                                                                               
|------- | -- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 3  | .4(5)       |  | Bylaws of the Company.                                                                                                                                                                        
|        | 4  | .1(6)       |  | Convertible Debenture between the Company and SF
    Capital Partners Ltd. dated March 15, 2002.                                                                                              
|        | 4  | .2(6)       |  | Convertible Debenture between the Company and
    Defiante Farmaceutica Unipessoal L.D.A. dated March 15,
    2002.                                                                           
|        | 10 | .1(7)       |  | Forms of Incentive Stock Option and Non-statutory
    Stock Option.                                                                                                                           
|        | 10 | .2(8)       |  | 1992 Employee Stock Option Plan, as amended.                                                                                                                                                  
|        | 10 | .3(9)       |  | 1993 Non-employee Directors Equity Incentive
    Plan, as amended and related form of Nonstatutory Stock Option.                                                                              
|        | 10 | .4(9)       |  | Employment Agreement dated as of August 4,
    1999 between the Company and Charles J. Casamento.                                                                                             
|        | 10 | .5(10)      |  | 2000 Employee Stock Purchase Plan.                                                                                                                                                            
|        | 10 | .6(11)      |  | Asset Purchase Agreement dated July 27, 2001
    between the Company and Aventis Pharmaceuticals
    Products, Inc.                                                                          
|        | 10 | .7(11)      |  | First Amendment to Asset Purchase Agreement dated
    January 29, 2002, between the Company and Aventis
    Pharmaceuticals Products, Inc.                                                   
|        | 10 | .8(11)      |  | Promotion Agreement dated December 1, 2001
    between the Company and VSL Pharmaceuticals, Inc.                                                                                             
|        | 10 | .9(11)      |  | First Amendment to Promotion Agreement dated
    June 27, 2002 between the Company and VSL
    Pharmaceuticals, Inc.                                                                         
|        | 10 | .10(12)     |  | Stock Purchase Agreement dated July 31, 2001
    between Registrant and Sigma-Tau Finance Holding S.A.                                                                                        
|        | 10 | .11(13)     |  | Warrant dated December 1, 2001 between the
    Company and Paolo Cavazza.                                                                                                                     
|        | 10 | .12(13)     |  | Warrant dated December 1, 2001 between the
    Company and Claudio Cavazza.                                                                                                                   
|        | 10 | .13(6)      |  | Securities Purchase Agreement between the Company
    and SF Capital Partners Ltd. dated March 15, 2002.                                                                                      
|        | 10 | .14(6)      |  | Registration Rights Agreement between the Company
    and SF Capital Partners Ltd. dated March 15, 2002.                                                                                      
|        | 10 | .15(6)      |  | Warrant between the Company and SF Capital
    Partners Ltd. dated March 15, 2002.                                                                                                            
|        | 10 | .16(6)      |  | Securities Purchase Agreement between the Company
    and Defiante Farmaceutica Unipessoal L.D.A. dated March 15,
    2002.                                                                   
|        | 10 | .17(6)      |  | Registration Rights Agreement between the Company
    and Defiante Farmaceutica Unipessoal L.D.A. dated March 15,
    2002.                                                                   
|        | 10 | .18(6)      |  | Warrant between the Company and Defiante
    Farmaceutica Unipessoal L.D.A. dated March 15, 2002.                                                                                             
|        | 10 | .19(3)      |  | Form of Common Stock Purchase Warrant dated
    January 15, 2003 issued by the Company to purchasers of
    Series B Convertible Preferred Stock.                                             
|        | 10 | .20(14)     |  | Amendment to Employment Agreement between the
    Company and Charles J. Casamento dated March 21, 2003.                                                                                      
|        | 10 | .21(4)      |  | Rights Agreement, dated as of February 11,
    2003, between the Company and Computershare Trust
    Company, Inc.                                                                            
|        | 10 | .22(3)      |  | Form of Subscription Agreement dated as of
    December 29, 2002 by and between the Company and purchasers
    of Series B Convertible Preferred Stock and Common Stock
    Purchase Warrants.
|        | 10 | .23(14)     |  | Letter Agreement dated May 2, 2000 between
    the Company and Kenneth R. Greathouse.                                                                                                         
|        | 10 | .24(14)     |  | Amendment to Letter Agreement dated
    March 21, 2003 between the Company and Kenneth R.
    Greathouse.                                                                                     
|        | 10 | .25(14)     |  | Letter Agreement dated August 24, 2001
    between the Company and Timothy E. Morris.                                                                                                         
|        | 10 | .26(14)     |  | Amendment to Letter Agreement dated
    November 7, 2001 between the Company and Timothy E. Morris.                                                                                           

56



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|        |     |             |  |                                                                                                            
|------- | --- | ----------- |  | -----------------------------------------------------------------------------------------------------------
|Exhibit |     |            
|Number  |     | Description
|        |     |            
|        | 10  | .27(14)     |  | Amendment to Letter Agreement dated
    March 21, 2003 between the Company and Timothy E. Morris.          
|        | 10  | .28*        |  | Letter Agreement dated September 2, 2003
    between the Company and R. Jerald Beers.                      
|        | 10  | .29*        |  | Amendment to Letter Agreement dated
    November 6, 2003 between the Company and R. Jerald Beers.          
|        | 10  | .30*        |  | Supply Agreement dated April 1, 2003 between
    the Company and BioVectra, dcl.                           
|        | 23  | .1*         |  | Consent of Ernst & Young
    LLP, Independent Auditors.                                                    
|        | 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.



---



| |   |                
| | - | ---------------
| | * | Filed herewith.



| |     |                                                                                                                                                                                             
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Filed as an exhibit to the Companys Annual
    Report on Form 10-K for the fiscal year ended
    December 31, 1999, and incorporated herein by reference.                                  
|
| | (2) | Filed as an exhibit to the Companys
    Registration Statement on Form S-8, Registration Statement
    No. 333-30558, filed on February 16, 2000, and
    incorporated herein by reference.
|
| | (3) | Filed as an exhibit to the Companys Current
    Report on Form 8-K filed on January 16, 2003, and
    incorporated herein by reference.                                                    
|
| | (4) | Filed as an exhibit to the Companys Current
    Report on Form 8-K filed on February 14, 2003, and
    incorporated herein by reference.                                                   
|
| | (5) | Filed as an exhibit to the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    September 30, 2002, and incorporated herein by reference.                                  
|
| | (6) | Filed as an exhibit to the Companys
    Registration Statement on Form S-3, Registration
    No. 333-85160, filed on March 28, 2002, and
    incorporated herein by reference.             
|
| | (7) | Filed as an exhibit to the Companys
    Registration Statement on Form S-1, Registration
    No. 33-51682, and incorporated herein by reference.                                           
|
| | (8) | Filed as an exhibit to the Companys Proxy
    Statement for the 2002 Annual Meeting of Shareholders, filed on
    March 28, 2002, and incorporated herein by reference.                    
|
| | (9) | Filed as an exhibit to the Companys
    Registration Statement Form S-4, Registration Statement
    No. 333-87611, filed on September 23, 1999, and
    incorporated herein by reference.  



|     |                                                                                                                                                                                              
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Filed as an exhibit to the Companys
    Registration Statement on Form S-8, Registration Statement
    No. 333-46990, filed on September 29, 2000, and
    incorporated herein by reference.
|    
|(11) | Filed as an exhibit to the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    June 30, 2002, and incorporated herein by reference.                                        
|    
|(12) | Filed as an exhibit to the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    June 30, 2001, and incorporated herein by reference.                                        
|    
|(13) | Filed as an exhibit to the Companys Annual
    Report on Form 10-K for the fiscal year ended
    December 31, 2001, and incorporated herein by reference.                                   
|    
|(14) | Filed as an exhibit to the Companys Annual
    Report on Form 10-K for the fiscal year ended
    December 31, 2002, and incorporated herein by reference.                                   



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

57



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the Registrant
has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.



| |                               
| | ------------------------------
| | QUESTCOR PHARMACEUTICALS, INC.



| |    |                         
| | -- | ------------------------
| | By | /s/ CHARLES J. CASAMENTO

| |                                                    
| | ---------------------------------------------------
| |                                                    
| | Charles J. Casamento                               
| | Chairman, President and Chief Executive
    Officer

Dated: March 30, 2004

POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each person
whose signature appears below constitutes and appoints Charles
J. Casamento and Timothy E. Morris, and each of them, his
attorney-in-fact, each with the power of substitution, for him
in any and all capacities, to sign any amendments to this
report, and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or
substitutes, may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

|                                             |  |                                                                                                                                  |  |                |  | 
|-------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|                                             |  |                                                                                                                                  |  |               
|Signature                                    |  | Title                                                                                                                            |  | Date          
|                                             |  |                                                                                                                                  |  |               
|                                            
|/s/ CHARLES J. CASAMENTOCharles J. Casamento |  | Chairman, President and Chief Executive Officer
    and Director (Principal Executive Officer)                                   |  | March 30, 2004
|                                            
|/s/ TIMOTHY E. MORRISTimothy E. Morris       |  | Senior Vice President, Finance &
    Administration and Chief Financial Officer (Principal Financial
    and Accounting Officer) |  | March 30, 2004
|                                            
|/s/ NEAL C. BRADSHERNeal C. Bradsher         |  | Director                                                                                                                         |  | March 30, 2004
|                                            
|/s/ BRIAN C. CUNNINGHAMBrian C. Cunningham   |  | Director                                                                                                                         |  | March 30, 2004
|                                            
|/s/ FRANK J. SASINOWSKIFrank J. Sasinowski   |  | Director                                                                                                                         |  | March 30, 2004
|                                            
|/s/ JON S. SAXEJon S. Saxe                   |  | Director                                                                                                                         |  | March 30, 2004
|                                            
|/s/ ROGER G. STOLLRoger G. Stoll, Ph.D.      |  | Director                                                                                                                         |  | March 30, 2004
|                                            
|/s/ VIRGIL D. THOMPSONVirgil D. Thompson     |  | Director                                                                                                                         |  | March 30, 2004

58



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REPORT OF ERNST & YOUNG
LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders

Questcor Pharmaceuticals, Inc.


We have audited the accompanying consolidated
balance sheets of Questcor Pharmaceuticals, Inc. as of
December 31, 2003 and 2002, and the related consolidated
statements of operations, preferred stock and stockholders
equity (deficit) and cash flows for each of the three years
in the period ended December 31, 2003. Our audits also
included the financial statement schedule listed in the Index at
Item 15(a). These financial statements and schedule are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements and schedule based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of Questcor
Pharmaceuticals, Inc. at December 31, 2003 and 2002,
and the consolidated results of its operations and its cash
flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion,
the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set
forth therein.

As discussed in Note 1 to the consolidated
financial statements, in 2002 the Company changed its method of
accounting for goodwill and other intangible assets.



| |                      
| | ---------------------
| | /s/ Ernst & Young LLP
| |                      

Palo Alto, California

February 12, 2004


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QUESTCOR PHARMACEUTICALS, INC.

CONSOLIDATED BALANCE SHEETS

|                                                                                                                                                                                                                                       |                                                                                                                                |                           |         |        |        |  |         |        |        | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------ | ------------------------- | ------- | ------ | ------ |  | ------- | ------ | ------ | 
|                                                                                                                                                                                                                                       |                                                                                                                                |                          
|                                                                                                                                                                                                                                       |                                                                                                                                | December 31,             
|                                                                                                                                                                                                                                       |                                                                                                                                |                          
|                                                                                                                                                                                                                                       |                                                                                                                                | 2003                      |         | 2002  
|                                                                                                                                                                                                                                       |                                                                                                                                |                           |         |       
|                                                                                                                                                                                                                                       |                                                                                                                                |                          
|                                                                                                                                                                                                                                       |                                                                                                                                | (In thousands, except    
|                                                                                                                                                                                                                                       |                                                                                                                                | share amounts)           
|ASSETS                                                                                                                                                                                                                                
|Current assets:                                                                                                                                                                                                                        |                                                                                                                                |                           |         |        |        |  |         |       
|                                                                                                                                                                                                                                       | Cash and cash equivalents                                                                                                      |                           | $       | 3,220  |        |  | $       | 6,156  |       
|                                                                                                                                                                                                                                       | Short-term investments                                                                                                         |                           |         |       |        |  |         | 1,350  |       
|                                                                                                                                                                                                                                       | Accounts receivable, net of allowance for
    doubtful accounts of $60 and $20 at December 31, 2003 and
    2002, respectively |                           |         | 2,161  |        |  |         | 1,590  |       
|                                                                                                                                                                                                                                       | Inventories                                                                                                                    |                           |         | 1,050  |        |  |         | 391    |       
|                                                                                                                                                                                                                                       | Prepaid expenses and other current assets                                                                                      |                           |         | 873    |        |  |         | 979    |       
|                                                                                                                                                                                                                                       |                                                                                                                                |                           |         |        |        |  |         |       
|                                                                                                                                                                                                                                       |                                                                                                                                | Total current assets      |         |        | 7,304  |  |         |        | 10,466 | 
|Property and equipment, net                                                                                                                                                                                                            |                                                                                                                                |                           | 609     |        |        |  | 585     |       
|Purchased technology, net                                                                                                                                                                                                              |                                                                                                                                |                           | 13,709  |        |        |  | 382     |       
|Goodwill and other indefinite lived intangible
    assets                                                                                                                                                                              |                                                                                                                                |                           | 479     |        |        |  | 479     |       
|Deposits and other assets                                                                                                                                                                                                              |                                                                                                                                |                           | 828     |        |        |  | 854     |       
|                                                                                                                                                                                                                                       |                                                                                                                                |                           |         |        |        |  |         |       
|                                                                                                                                                                                                                                       |                                                                                                                                | Total assets              |         | $      | 22,929 |  |         | $      | 12,766 | 
|                                                                                                                                                                                                                                       |                                                                                                                                |                           |         |        |        |  |         |       
|                                                                                                                                                                                                                                      
|LIABILITIES AND STOCKHOLDERS
    EQUITY                                                                                                                                                                                              
|Current liabilities:                                                                                                                                                                                                                   |                                                                                                                                |                           |         |        |        |  |         |       
|                                                                                                                                                                                                                                       | Accounts payable                                                                                                               |                           | $       | 1,402  |        |  | $       | 1,230  |       
|                                                                                                                                                                                                                                       | Accrued compensation                                                                                                           |                           |         | 358    |        |  |         | 794    |       
|                                                                                                                                                                                                                                       | Other accrued liabilities                                                                                                      |                           |         | 1,052  |        |  |         | 1,205  |       
|                                                                                                                                                                                                                                       | Short-term debt and current portion of long-term
    debt                                                                      |                           |         | 140    |        |  |         | 218    |       
|                                                                                                                                                                                                                                       | Current portion of capital lease obligations                                                                                   |                           |         |       |        |  |         | 1      |       
|                                                                                                                                                                                                                                       |                                                                                                                                |                           |         |        |        |  |         |       
|                                                                                                                                                                                                                                       |                                                                                                                                | Total current liabilities |         |        | 2,952  |  |         |        | 3,448  | 
|Convertible debentures, (face amount of $4,000),
    net of deemed discount of $598 and $1,092 at December 31,
    2003 and 2002, respectively                                                                                         |                                                                                                                                |                           | 3,402   |        |        |  | 2,908   |       
|Other non-current liabilities                                                                                                                                                                                                          |                                                                                                                                |                           | 916     |        |        |  | 833     |       
|Commitments and contingencies                                                                                                                                                                                                          |                                                                                                                                |                           |         |        |        |  |         |       
|Preferred stock, no par value,
    7,500,000 shares authorized; 2,155,715 Series A shares
    issued and outstanding at December 31, 2003 and 2002
    (aggregate liquidation preference of $10,000 at
    December 31, 2003 and 2002) |                                                                                                                                |                           | 5,081   |        |        |  | 5,081   |       
|Stockholders equity:                                                                                                                                                                                                                  |                                                                                                                                |                           |         |        |        |  |         |       
|Preferred stock, no par value, 9,100
    Series B shares issued and outstanding, net of issuance
    costs (aggregate liquidation preference of $9,100) at
    December 31, 2003                                                       |                                                                                                                                |                           | 8,278   |        |        |  |        |       
|Common stock, no par value,
    105,000,000 shares authorized; 45,387,802 and
    38,676,592 shares issued and outstanding at
    December 31, 2003 and 2002, respectively                                                             |                                                                                                                                |                           | 85,232  |        |        |  | 77,528  |       
|Deferred compensation                                                                                                                                                                                                                  |                                                                                                                                |                           | (17     | )      |        |  | (22     | )     
|Accumulated deficit                                                                                                                                                                                                                    |                                                                                                                                |                           | (82,915 | )      |        |  | (76,968 | )     
|Accumulated other comprehensive loss                                                                                                                                                                                                   |                                                                                                                                |                           |        |        |        |  | (42     | )     
|                                                                                                                                                                                                                                       |                                                                                                                                |                           |         |        |        |  |         |       
|                                                                                                                                                                                                                                       | Total stockholders equity                                                                                                     |                           |         | 10,578 |        |  |         | 496    |       
|                                                                                                                                                                                                                                       |                                                                                                                                |                           |         |        |        |  |         |       
|                                                                                                                                                                                                                                       | Total liabilities and stockholders equity                                                                                     |                           | $       | 22,929 |        |  | $       | 12,766 |       
|                                                                                                                                                                                                                                       |                                                                                                                                |                           |         |        |        |  |         |       

See accompanying notes.

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QUESTCOR PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                                                                    |                                              |                                 |                                    |        |        |        |        |        |        |        |        |       |       |        | 
|--------------------------------------------------------------------------------------------------- | -------------------------------------------- | ------------------------------- | ---------------------------------- | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ----- | ----- | ------ | 
|                                                                                                    |                                              |                                
|                                                                                                    |                                              | Years Ended December 31,       
|                                                                                                    |                                              |                                
|                                                                                                    |                                              | 2003                            |                                    | 2002   |        | 2001  
|                                                                                                    |                                              |                                 |                                    |        |        |       
|                                                                                                    |                                              |                                
|                                                                                                    |                                              | (In thousands, except per share
|                                                                                                    |                                              | amounts)                       
|Revenues:                                                                                           |                                              |                                 |                                    |        |        |        |        |        |        |        |        |      
|                                                                                                    | Net product sales                            |                                 | $                                  | 13,655 |        |        | $      | 13,819 |        |        | $      | 5,196 |      
|                                                                                                    | Contract research, grant and royalty revenue |                                 |                                    | 58     |        |        |        | 208    |        |        |        | 381   |      
|                                                                                                    | Technology revenue                           |                                 |                                    | 350    |        |        |        | 450    |        |        |        | 90    |      
|                                                                                                    | Services revenue from a related party        |                                 |                                    |       |        |        |        | 200    |        |        |        |      |      
|                                                                                                    |                                              |                                 |                                    |        |        |        |        |        |        |        |        |      
|                                                                                                    |                                              | Total revenues                  |                                    |        | 14,063 |        |        |        | 14,677 |        |        |       | 5,667 |       
|Operating costs and expenses:                                                                       |                                              |                                 |                                    |        |        |        |        |        |        |        |        |      
|                                                                                                    | Cost of product sales                        |                                 |                                    | 3,573  |        |        |        | 2,822  |        |        |        | 1,978 |      
|                                                                                                    | Selling, general and administrative          |                                 |                                    | 10,400 |        |        |        | 10,825 |        |        |        | 7,836 |      
|                                                                                                    | Research and development                     |                                 |                                    | 2,267  |        |        |        | 2,295  |        |        |        | 2,352 |      
|                                                                                                    | Depreciation and amortization                |                                 |                                    | 1,157  |        |        |        | 1,138  |        |        |        | 2,207 |      
|                                                                                                    | Loss on discontinued product line            |                                 |                                    |       |        |        |        |       |        |        |        | 677   |      
|                                                                                                    |                                              |                                 |                                    |        |        |        |        |        |        |        |        |      
|                                                                                                    |                                              |                                 | Total operating costs and expenses |        |        | 17,397 |        |        |        | 17,080 |        |       |       | 15,050 | 
|                                                                                                    |                                              |                                 |                                    |        |        |        |        |        |        |        |        |      
|Loss from operations                                                                                |                                              |                                 | (3,334                             | )      |        |        | (2,403 | )      |        |        | (9,383 | )    
|Non-cash amortization of deemed discount on
    convertible debentures                              |                                              |                                 | (522                               | )      |        |        | (415   | )      |        |        |       |      
|Interest income (expense), net                                                                      |                                              |                                 | (104                               | )      |        |        | (8     | )      |        |        | 55     |      
|Other income (expense), net                                                                         |                                              |                                 | (91                                | )      |        |        | (241   | )      |        |        | 19     |      
|Rental income, net                                                                                  |                                              |                                 | 260                                |        |        |        | 282    |        |        |        | 612    |      
|                                                                                                    |                                              |                                 |                                    |        |        |        |        |        |        |        |        |      
|Net loss                                                                                            |                                              |                                 | (3,791                             | )      |        |        | (2,785 | )      |        |        | (8,697 | )    
|Non-cash deemed dividend related to beneficial
    conversion feature of Series B Preferred Stock   |                                              |                                 | 1,394                              |        |        |        |       |        |        |        |       |      
|Dividends on Series B Preferred Stock                                                               |                                              |                                 | 762                                |        |        |        |       |        |        |        |       |      
|                                                                                                    |                                              |                                 |                                    |        |        |        |        |        |        |        |        |      
|Net loss applicable to common stockholders                                                          |                                              | $                               | (5,947                             | )      |        | $      | (2,785 | )      |        | $      | (8,697 | )    
|                                                                                                    |                                              |                                 |                                    |        |        |        |        |        |        |        |        |      
|Basic and diluted net loss per share applicable
    to common stockholders                          |                                              | $                               | (0.14                              | )      |        | $      | (0.07  | )      |        | $      | (0.28  | )    
|                                                                                                    |                                              |                                 |                                    |        |        |        |        |        |        |        |        |      
|Shares used in computing basic and diluted net
    loss per share applicable to common stockholders |                                              |                                 | 41,884                             |        |        |        | 38,407 |        |        |        | 31,425 |      
|                                                                                                    |                                              |                                 |                                    |        |        |        |        |        |        |        |        |      

See accompanying notes.

61



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QUESTCOR PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF PREFERRED
STOCK

AND STOCKHOLDERS EQUITY


|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                  |   |   |        |   |   |   |     |   |   |   |         |        |   |   |      |      |   |   |        |        |        |  
|---------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------- | ----------------------------- | --------- | -------- | - | ------------ | ----- | -------- | - | ----------- | ------ | ------------- | - | ------------ | ------ | ------- | - | ----------- | ---------- | ---------------- | - | - | ------ | - | - | - | --- | - | - | - | ------- | ------ | - | - | ---- | ---- | - | - | ------ | ------ | ------ | -
|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |             
|                                                                                               |                                                                               | Preferred Stock               |           |          |   |              |       |          |   |             |        |               |   |             
|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |             
|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        | Accumulated   |   |             
|                                                                                               |                                                                               | Series A                      |           | Series B |   | Common Stock |       |          |   |             |        | Other         |   | Total       
|                                                                                               |                                                                               |                               |           |          |   |              |       | Deferred |   | Accumulated |        | Comprehensive |   | Stockholders
|                                                                                               |                                                                               | Shares                        |           | Amount   |   | Shares       |       | Amount   |   | Shares      |        | Amount        |   | Compensation |        | Deficit |   | Gain/(Loss) |            | Equity/(Deficit)
|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                 
|                                                                                               |                                                                               |                              
|                                                                                               |                                                                               | (In thousands, except shares)
|Balances at December 31, 2000                                                                  |                                                                               |                               | 2,155,715 |          |   | $            | 5,081 |          |   |             |       |               |   | $            |       |         |   |             | 25,303,091 |                  |   | $ | 66,152 |   |   | $ | (71 | ) |   | $ | (65,486 | )      |   | $ | 332  |      |   | $ | 927    |       
|Deferred compensation offset by cancellation of
    unvested options to a director             |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   | (26    | ) |   |   | 26  |   |   |   |        |        |   |   |     |      |   |   |       |       
|Stock compensation for options and warrants
    granted to consultants                         |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   | 601    |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 601    |       
|Amortization of deferred compensation                                                          |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   |       |   |   |   | 25  |   |   |   |        |        |   |   |     |      |   |   | 25     |       
|Issuance of shares pursuant to employee stock
    purchase plan                                |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             | 193,214    |                  |   |   | 112    |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 112    |       
|Issuance of common stock to investors, net of
    issuance costs                               |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             | 8,969,397  |                  |   |   | 5,270  |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 5,270  |       
|Issuance of common stock upon exercise of warrant                                              |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             | 2,873,563  |                  |   |   | 1,500  |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 1,500  |       
|Issuance of common stock upon exercise of stock
    options                                    |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             | 50,338     |                  |   |   | 58     |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 58     |       
|Warrant issuances for cash                                                                     |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   | 351    |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 351    |       
|Comprehensive income (loss)                                                                    |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                  |   |   |        |   |   |   |     |   |   |   |         |        |   |   |      |      |   |   |        |       
|                                                                                               | Net unrealized loss on investments                                            |                               |           |         |   |              |       |         |   |             |        |              |   |              |        |        |   |             |            |                 |   |   |        |  |   |   |     |  |   |   |         |       |   |   |      | (447 | ) |   |        | (447   | )     
|                                                                                               | Net loss                                                                      |                               |           |         |   |              |       |         |   |             |        |              |   |              |        |        |   |             |            |                 |   |   |        |  |   |   |     |  |   |   |         | (8,697 | ) |   |      |     |   |   |        | (8,697 | )     
|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                  |   |   |        |   |   |   |     |   |   |   |         |        |   |   |      |      |   |   |        |       
|                                                                                               |                                                                               | Total comprehensive loss:     |           |          |  |              |       |          |  |             |        |               |  |              |        |         |  |             |            |                  |  |   |        |   |  |   |     |   |  |   |         |        |  |   |      |      |  |   |        |        | (9,144 | )
|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                  |   |   |        |   |   |   |     |   |   |   |         |        |   |   |      |      |   |   |        |       
|Balances at December 31, 2001                                                                  |                                                                               |                               | 2,155,715 |          |   |              | 5,081 |          |   |             |        |               |   |              |        |         |   |             | 37,389,603 |                  |   |   | 74,018 |   |   |   | (20 | ) |   |   | (74,183 | )      |   |   | (115 | )    |   |   | (300   | )     
|Deemed discount on convertible debentures                                                      |                                                                               |                               |           |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   | 1,484  |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 1,484  |       
|Stock compensation for options and warrants
    granted to consultants                         |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   | 405    |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 405    |       
|Deferred compensation                                                                          |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   | 19     |   |   |   | (19 | ) |   |   |        |        |   |   |     |      |   |   |       |       
|Amortization of deferred compensation                                                          |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   |       |   |   |   | 17  |   |   |   |        |        |   |   |     |      |   |   | 17     |       
|Issuance of shares pursuant to employee stock
    purchase plan                                |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             | 313,114    |                  |   |   | 146    |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 146    |       
|Issuance of common stock to investors                                                          |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             | 640,000    |                  |   |   | 960    |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 960    |       
|Issuance of common stock upon exercise of stock
    options                                    |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             | 355,432    |                  |   |   | 414    |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 414    |       
|Cancellation of shares                                                                         |                                                                               |                               |           |          |   |              |       |          |   |             |       |               |   |              |       |         |   |             | (21,557    | )                |   |   |       |   |   |   |    |   |   |   |        |        |   |   |      |      |   |   |        |       
|Warrant issuances associated with convertible
    debentures                                   |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   | 82     |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 82     |       
|Comprehensive income (loss)                                                                    |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                  |   |   |        |   |   |   |     |   |   |   |         |        |   |   |      |      |   |   |        |       
|                                                                                               | Other-than-temporary loss on investments                                      |                               |           |         |   |              |       |         |   |             |        |              |   |              |        |        |   |             |            |                 |   |   |        |  |   |   |     |  |   |   |         |       |   |   |      | 367  |   |   |        | 367    |       
|                                                                                               | Net unrealized loss on investments                                            |                               |           |         |   |              |       |         |   |             |        |              |   |              |        |        |   |             |            |                 |   |   |        |  |   |   |     |  |   |   |         |       |   |   |      | (294 | ) |   |        | (294   | )     
|                                                                                               | Net loss                                                                      |                               |           |         |   |              |       |         |   |             |        |              |   |              |        |        |   |             |            |                 |   |   |        |  |   |   |     |  |   |   |         | (2,785 | ) |   |      |     |   |   |        | (2,785 | )     
|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                  |   |   |        |   |   |   |     |   |   |   |         |        |   |   |      |      |   |   |        |       
|                                                                                               |                                                                               | Total comprehensive loss:     |           |          |  |              |       |          |  |             |        |               |  |              |        |         |  |             |            |                  |  |   |        |   |  |   |     |   |  |   |         |        |  |   |      |      |  |   |        |        | (2,712 | )
|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                  |   |   |        |   |   |   |     |   |   |   |         |        |   |   |      |      |   |   |        |       
|Balances at December 31, 2002                                                                  |                                                                               |                               | 2,155,715 |          |   |              | 5,081 |          |   |             |       |               |   |              |       |         |   |             | 38,676,592 |                  |   |   | 77,528 |   |   |   | (22 | ) |   |   | (76,968 | )      |   |   | (42  | )    |   |   | 496    |       
|Stock compensation for options and warrants
    granted to consultants and employees           |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   | 50     |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 50     |       
|Deferred compensation                                                                          |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   | 15     |   |   |   | (15 | ) |   |   |        |        |   |   |     |      |   |   |       |       
|Amortization of deferred compensation                                                          |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   |       |   |   |   | 20  |   |   |   |        |        |   |   |     |      |   |   | 20     |       
|Issuance of shares pursuant to employee stock
    purchase plan                                |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             | 93,123     |                  |   |   | 68     |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 68     |       
|Issuance of common stock to investors                                                          |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             | 4,979,360  |                  |   |   | 4,826  |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 4,826  |       
|Issuance of common stock upon cashless exercise
    of warrant                                 |                                                                               |                               |           |          |   |              |       |          |   |             |       |               |   |              |       |         |   |             | 387,995    |                  |   |   |       |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   |       |       
|Issuance of common stock upon exercise of stock
    options                                    |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             | 273,962    |                  |   |   | 212    |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 212    |       
|Issuance of Series B preferred stock, net of
    issuance costs                                |                                                                               |                               |          |          |   |              |      |          |   |             | 10,000 |               |   |              | 9,404  |         |   |             |           |                  |   |   |       |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 9,404  |       
|Warrants issued on Series B preferred stock                                                    |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              | (1,620 | )       |   |             |           |                  |   |   | 1,620  |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   |       |       
|Issuance of common stock upon conversion of
    Series B preferred stock                       |                                                                               |                               |          |          |   |              |      |          |   |             | (900   | )             |   |              | (900   | )       |   |             | 956,225    |                  |   |   | 900    |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   |       |       
|Issuance of common stock upon conversion of
    accrued dividends for Series B preferred stock |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             | 20,545     |                  |   |   | 13     |   |   |   |    |   |   |   |        |        |   |   |     |      |   |   | 13     |       
|Deemed dividends on Series B preferred stock                                                   |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              | 1,394  |         |   |             |           |                  |   |   |       |   |   |   |    |   |   |   | (1,394  | )      |   |   |     |      |   |   |       |       
|Dividends recorded                                                                             |                                                                               |                               |          |          |   |              |      |          |   |             |       |               |   |              |       |         |   |             |           |                  |   |   |       |   |   |   |    |   |   |   | (762    | )      |   |   |     |      |   |   | (762   | )     
|Comprehensive income (loss)                                                                    |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                  |   |   |        |   |   |   |     |   |   |   |         |        |   |   |      |      |   |   |        |       
|                                                                                               | Other-than-temporary loss on investments                                      |                               |           |         |   |              |       |         |   |             |        |              |   |              |        |        |   |             |            |                 |   |   |        |  |   |   |     |  |   |   |         |       |   |   |      | 51   |   |   |        | 51     |       
|                                                                                               | Reclassification of net unrealized loss on
    investments into realized loss |                               |           |         |   |              |       |         |   |             |        |              |   |              |        |        |   |             |            |                 |   |   |        |  |   |   |     |  |   |   |         |       |   |   |      | (9   | ) |   |        | (9     | )     
|                                                                                               | Net loss                                                                      |                               |           |         |   |              |       |         |   |             |        |              |   |              |        |        |   |             |            |                 |   |   |        |  |   |   |     |  |   |   |         | (3,791 | ) |   |      |     |   |   |        | (3,791 | )     
|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                  |   |   |        |   |   |   |     |   |   |   |         |        |   |   |      |      |   |   |        |       
|                                                                                               |                                                                               | Total comprehensive loss:     |           |          |  |              |       |          |  |             |        |               |  |              |        |         |  |             |            |                  |  |   |        |   |  |   |     |   |  |   |         |        |   |   |      |      |   |   |        |        | (3,749 | )
|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                  |   |   |        |   |   |   |     |   |   |   |         |        |   |   |      |      |   |   |        |       
|Balances at December 31, 2003                                                                  |                                                                               |                               | 2,155,715 |          |   | $            | 5,081 |          |   |             | 9,100  |               |   | $            | 8,278  |         |   |             | 45,387,802 |                  |   | $ | 85,232 |   |   | $ | (17 | ) |   | $ | (82,915 | )      |   | $ |     |      |   | $ | 10,578 |       
|                                                                                               |                                                                               |                               |           |          |   |              |       |          |   |             |        |               |   |              |        |         |   |             |            |                  |   |   |        |   |   |   |     |   |   |   |         |        |   |   |      |      |   |   |        |       

See accompanying notes.

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QUESTCOR PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                                          |                                                               |                          |         |       |   |      |        |       |   |   |        |       |  
|----------------------------------------------------------------------------------------- | ------------------------------------------------------------- | ------------------------ | ------- | ----- | - | ---- | ------ | ----- | - | - | ------ | ----- | -
|                                                                                          |                                                               |                         
|                                                                                          |                                                               | Years Ended December 31,
|                                                                                          |                                                               |                         
|                                                                                          |                                                               | 2003                     |         | 2002  |   | 2001
|                                                                                          |                                                               |                          |         |       |   |     
|                                                                                          |                                                               |                         
|                                                                                          |                                                               | (In thousands)          
|Cash Flows Used in Operating
    Activities                                               |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Net loss                                                                                  |                                                               | $                        | (3,791  | )     |   | $    | (2,785 | )     |   | $ | (8,697 | )    
|Adjustments to reconcile net loss to net cash
    used in operating activities:           |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|                                                                                          | Stock-based compensation expense                              |                          |         | 75    |   |      |        | 381   |   |   |        | 601   |  
|                                                                                          | Amortization of deemed discount on convertible
    debentures |                          |         | 522   |   |      |        | 415   |   |   |        |      |  
|                                                                                          | Amortization of deferred compensation                         |                          |         | 20    |   |      |        | 17    |   |   |        | 25    |  
|                                                                                          | Depreciation and amortization                                 |                          |         | 1,157 |   |      |        | 1,138 |   |   |        | 2,207 |  
|                                                                                          | Other-than-temporary loss on investment                       |                          |         | 51    |   |      |        | 367   |   |   |        |      |  
|                                                                                          | Loss (gain) on the sale/disposal of equipment                 |                          |         | 26    |   |      |        | (37   | ) |   |        | 43    |  
|                                                                                          | Loss (gain) on the sale of investment                         |                          |         | 14    |   |      |        |      |   |   |        |      |  
|                                                                                          | Loss on discontinued product line                             |                          |         |      |   |      |        |      |   |   |        | 677   |  
|                                                                                          | Write down of licenses and patents                            |                          |         |      |   |      |        |      |   |   |        | 81    |  
|Changes in operating assets and liabilities:                                              |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|                                                                                          | Accounts receivable                                           |                          |         | (571  | ) |      |        | (932  | ) |   |        | (487  | )
|                                                                                          | Inventories                                                   |                          |         | (596  | ) |      |        | (295  | ) |   |        | (40   | )
|                                                                                          | Prepaid expenses and other current assets                     |                          |         | 81    |   |      |        | (509  | ) |   |        | 112   |  
|                                                                                          | Accounts payable                                              |                          |         | 172   |   |      |        | 135   |   |   |        | 619   |  
|                                                                                          | Accrued compensation                                          |                          |         | (436  | ) |      |        | 219   |   |   |        | 183   |  
|                                                                                          | Accrued development costs                                     |                          |         |      |   |      |        |      |   |   |        | (541  | )
|                                                                                          | Other accrued liabilities                                     |                          |         | (153  | ) |      |        | 149   |   |   |        | 136   |  
|                                                                                          | Other non-current liabilities                                 |                          |         | 83    |   |      |        | (99   | ) |   |        | 115   |  
|                                                                                          |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Net cash used in operating activities                                                     |                                                               |                          | (3,346  | )     |   |      | (1,836 | )     |   |   | (4,966 | )    
|Cash flows from Investing Activities                                                      |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Acquisition of purchased technology                                                       |                                                               |                          | (14,289 | )     |   |      |       |       |   |   |       |      
|Purchase of short-term investments                                                        |                                                               |                          | (3,009  | )     |   |      | (1,261 | )     |   |   |       |      
|Proceeds from the sale and maturities of
    short-term investments                       |                                                               |                          | 4,337   |       |   |      |       |       |   |   | 499    |      
|Purchase of property, equipment and leasehold
    improvements                            |                                                               |                          | (334    | )     |   |      | (355   | )     |   |   | (183   | )    
|Proceeds from the sale of equipment                                                       |                                                               |                          | 24      |       |   |      | 51     |       |   |   | 44     |      
|Increase (decrease) in deposits and other assets                                          |                                                               |                          | (2      | )     |   |      | 142    |       |   |   | 191    |      
|                                                                                          |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Net cash (used in) provided by investing
    activities                                   |                                                               |                          | (13,273 | )     |   |      | (1,423 | )     |   |   | 551    |      
|Cash Flows from Financing Activities                                                      |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Issuance of common stock and warrants, net                                                |                                                               |                          | 5,106   |       |   |      | 560    |       |   |   | 7,290  |      
|Net proceeds from common stock to be issued                                               |                                                               |                          |        |       |   |      |       |       |   |   | 960    |      
|Issuance of preferred stock, net                                                          |                                                               |                          | 9,404   |       |   |      |       |       |   |   |       |      
|Payment of preferred stock dividends                                                      |                                                               |                          | (749    | )     |   |      |       |       |   |   |       |      
|Issuance of convertible debentures                                                        |                                                               |                          |        |       |   |      | 4,000  |       |   |   |       |      
|Short-term borrowings                                                                     |                                                               |                          | 587     |       |   |      | 1,251  |       |   |   |       |      
|Repayment of note payable to bank                                                         |                                                               |                          |        |       |   |      | (5,000 | )     |   |   |       |      
|Repayment of short-term and long-term debt                                                |                                                               |                          | (664    | )     |   |      | (1,522 | )     |   |   | (382   | )    
|Repayments of capital lease obligations                                                   |                                                               |                          | (1      | )     |   |      | (57    | )     |   |   | (88    | )    
|                                                                                          |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Net cash provided by (used in) financing
    activities                                   |                                                               |                          | 13,683  |       |   |      | (768   | )     |   |   | 7,780  |      
|                                                                                          |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Increase (decrease) in cash and cash equivalents                                          |                                                               |                          | (2,936  | )     |   |      | (4,027 | )     |   |   | 3,365  |      
|Cash and cash equivalents at beginning of period                                          |                                                               |                          | 6,156   |       |   |      | 10,183 |       |   |   | 6,818  |      
|                                                                                          |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Cash and cash equivalents at end of period                                                |                                                               | $                        | 3,220   |       |   | $    | 6,156  |       |   | $ | 10,183 |      
|                                                                                          |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Supplemental Disclosures of Cash Flow
    Information:                                    |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Cash paid for interest                                                                    |                                                               | $                        | 413     |       |   | $    | 238    |       |   | $ | 466    |      
|                                                                                          |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Non-cash Investing and Financing
    Activities:                                          |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Warrant issued in connection with convertible
    debentures                              |                                                               |                          |        |       |   | $    | 82     |       |   | $ |       |      
|                                                                                          |                                                               |                          |         |       |   |      |        |       |   |   |        |      
|Common stock issued upon conversion of accrued
    dividends for Series B preferred stock |                                                               | $                        | 13      |       |   | $    |       |       |   | $ |       |      
|                                                                                          |                                                               |                          |         |       |   |      |        |       |   |   |        |      

See accompanying notes.

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QUESTCOR PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

1.     Organization
and Summary of Significant Accounting Policies



| |                                       
| | --------------------------------------
| | Organization and Business
    Activity

Questcor Pharmaceuticals, Inc. (the
Company) is a specialty pharmaceutical company that
acquires, markets and sells brand name prescription drugs
through a U.S. direct sales force and international
commercialization partners. The Company focuses on the treatment
of central nervous system (CNS) diseases and
gastroenterological disorders which are served by a concentrated
group of physicians such as neurologists and
gastroenterologists. The Companys strategy is to acquire
pharmaceutical products that it believes have sales growth
potential, are promotionally responsive to a focused and
targeted sales and marketing effort, and complement the
Companys existing products. In addition, through corporate
collaborations, the Company intends to develop new patented
intranasal formulations of medications previously approved by
the Food and Drug Administration (FDA). The Company
currently markets five 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®, the only
prescription 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, an injectable agent that assesses 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.
Due to minimal demand and increasing production costs, the
Company discontinued marketing and selling Inulin in September
2003.

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 distributing Nascobal
in July 2003. The Company markets Nascobal for patients with MS
and Crohns Disease, since these patients are at high risk
of developing 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 HypnostatTM (an
intranasal triazolam for the treatment of insomnia) and
PanistatTM (an intranasal alprazolam for the
treatment of panic disorders). The consolidated financial
statements include the accounts of the Company and its
wholly-owned subsidiaries. All significant inter-company
accounts and transactions have been eliminated.

Questcor Pharmaceuticals, Inc. is the
surviving corporation of a merger between Cypros Pharmaceutical
Corporation and RiboGene, Inc. The merger was completed on
November 17, 1999.



| |                                     
| | ------------------------------------
| | Need to Raise Additional
    Capital

The accompanying financial statements have been
prepared assuming that the Company will continue as a going
concern. The Company has incurred significant net losses and
negative cash flows from operations since its inception. At
December 31, 2003, the Company had an accumulated deficit
of $82.9 million. Management believes that cash on hand at
December 31, 2003, together with the $2.4 million of
cash raised in its January 2004 private placement of common
stock, and the net cash flows that will be generated from
operations, will be sufficient to fund operations through at
least December 31, 2004, unless a substantial portion of
its cash is used for product acquisition or 2004 revenues are
less than expected. If the Companys revenues do not grow
and provide cash flows from operations in an amount sufficient
to meet its obligations, it will seek to raise additional
capital through public or private equity financing or from other
sources, in addition to the equity financing raised in January
2004, if available on terms acceptable to the Company.

64



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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                 
| | ----------------
| | Use of Estimates

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



| |                                                
| | -----------------------------------------------
| | 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. The Company determines the
appropriate classification of investment securities at the time
of purchase and reaffirms such designation as of each balance
sheet date. Available-for-sale securities are carried at fair
value, with the unrealized gains and losses, if any, reported in
a separate component of stockholders equity. The cost of
securities sold is based on the specific identification method.
Realized gains and losses, if any, are included in the Statement
of Operations, in Other income (expense), net.



| |                      
| | ---------------------
| | Concentration of Risk

Financial instruments which subject the Company
to potential credit risk consist of cash, cash equivalents,
short-term investments and accounts receivable. The Company
invests its cash in high credit quality government and corporate
debt instruments and believes the financial risks associated
with these instruments are minimal. The Company extends credit
to its customers, primarily large drug wholesalers and
distributors and certain hospitals and treatment centers, in
connection with its product sales. The Company has not
experienced significant credit losses on its customer accounts,
with the exception of the product sales to NutraMax on which the
Company wrote off $29,000 in 2001. Three customers accounted for
the majority of our net product sales as follows:

|                       |  |              |     |      |  |      |     |   |  |  |     |  
|---------------------- |  | ------------ | --- | ---- |  | ---- | --- | - |  |  | --- | -
|                       |  |             
|                       |  | Years Ended 
|                       |  | December 31,
|                       |  |             
|% of Net Product Sales |  | 2003         |     | 2002 |  | 2001
|                       |  |              |     |      |  |     
|Customer A             |  |              | 35  | %    |  |      | 30  | % |  |  | 22  | %
|Customer B             |  |              | 25  | %    |  |      | 34  | % |  |  | 27  | %
|Customer C             |  |              | 18  | %    |  |      | 20  | % |  |  | 21  | %
|Other customers        |  |              | 22  | %    |  |      | 16  | % |  |  | 30  | %
|                       |  |              |     |      |  |      |     |   |  |  |     |  
|                       |  |              | 100 | %    |  |      | 100 | % |  |  | 100 | %
|                       |  |              |     |      |  |      |     |   |  |  |     |  

The Company relies on third party sole-source
manufacturers to produce its finished goods and raw materials.
Third party manufacturers may not be able to meet the
Companys needs with respect to timing, quantity or
quality. All of the Companys manufacturers are sole-source
manufacturers and no alternative suppliers exist.



| |            
| | -----------
| | Inventories

Inventories are stated at the lower of cost
(first-in, first-out method) or market value. Inventory reserves
are provided for on a product-by-product basis, based upon the
expiration date of products, inventory levels in relation to
forecasted sales volume, and historical demand for products.

65



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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                       
| | ----------------------
| | Property and Equipment

Property and equipment are stated at cost and
depreciated over the estimated useful lives of the assets
(generally three to eight years) using the straight-line method.
Leasehold improvements are amortized over the lesser of the
estimated useful lives (five years) or the remaining term of the
lease.



| |                                           
| | ------------------------------------------
| | Intangible and Other Long-Lived
    Assets

Intangible assets consist of goodwill, assembled
workforce and purchased technology. The goodwill and other
indefinite lived intangible assets were generated from the
merger with RiboGene.

Purchased technology associated with the
acquisitions of Nascobal, Glofil-125, Inulin, and Ethamolin
is stated at cost and amortized over the estimated sales life of
the product (fifteen years for Nascobal and seven years for
others). The Company periodically reviews the useful lives of
its intangible and long-lived assets, which may result in future
adjustments to the amortization periods. As of December 31,
2003, the purchased technology only relates to Nascobal, as
prior purchased technology is fully amortized.

In July 2001, the Financial Accounting Standards
Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 141,
Business Combinations, and SFAS No. 142,
Goodwill and Other Intangible Assets.
SFAS No. 141 specifies the criteria that intangible
assets acquired in a purchase business combination must meet to
be recognized and reported apart from goodwill, noting that any
purchase price allocable to an assembled workforce may not be
accounted for separately. SFAS No. 142 requires, among
other things, that the assembled workforce be reclassified to
goodwill and that goodwill (including the assembled workforce)
and intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least
annually in accordance with SFAS No. 142. The Company
adopted the provisions of SFAS No. 141 immediately and
SFAS No. 142 effective January 1, 2002.



| |                                    
| | -----------------------------------
| | Impairment of Long-Lived
    Assets

Long-lived assets are reviewed for impairment
whenever events or changes in circumstances indicate that their
carrying amounts may not be recoverable. Recoverability of
assets is measured by comparison of the carrying amount of the
asset to the net undiscounted future cash flows expected to be
generated from the asset. If the future undiscounted cash flows
are not sufficient to recover the carrying value of the assets,
the assets carrying value is adjusted to fair value.

In October 2001, the FASB issued
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets which supercedes
SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed
Of. SFAS No. 144 retains the requirements of
SFAS No. 121 to (a) recognize an impairment loss
only if the carrying amount of a long-lived asset is not
recoverable from its undiscounted cash flows and
(b) measure an impairment loss as the difference between
the carrying amount and the fair value of the asset.
SFAS No. 144 excludes goodwill from its scope.

The Company regularly evaluates its long-lived
assets for indicators of possible impairment. To date, except
for the discontinued product line (see Note 12), no
impairment has been recorded.



| |                    
| | -------------------
| | Revenue Recognition

Revenues from product sales of Acthar, Nascobal,
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 payment
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 payment

66



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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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. Allowances for Medicaid rebates, government
chargebacks and product returns are $615,000 and $447,000 at
December 31, 2003 and 2002, respectively, and are included
in Other Accrued Liabilities. 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

Shipping and handling costs are included in
Cost of Product Sales.



| |                         
| | ------------------------
| | Research and Development

Research and development expenditures, including
direct and allocated expenses, are charged to expense as
incurred.



| |                                                         
| | --------------------------------------------------------
| | 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 for the year ended December 31, 2003,
the calculation of diluted earnings per share applicable to
common stockholders would have included, if dilutive, the effect
of the outstanding 9,757,502 stock options, 11,824,220
convertible preferred shares, 2,531,646 shares issuable
upon conversion of debentures, placement unit options for
127,676 shares and 8,437,608 warrants. For the year ended
December 31, 2002, the calculation of diluted earnings per
share applicable to common stockholders would have included, if
dilutive, the effect of the outstanding 8,942,262 stock options,
2,155,715 convertible preferred shares, 2,531,646 shares
issuable upon conversion of debentures, placement unit options
for 986,898 shares and 4,851,201 warrants. For the year
ended December 31, 2001, the calculation of diluted

67



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##### Table of Contents



QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

earnings per share applicable to common
stockholders would have included, if dilutive, the effect of the
outstanding 6,878,466 stock options, 2,155,715 convertible
preferred shares, placement unit options for 986,898 shares
and 3,185,185 warrants.



| |                         
| | ------------------------
| | 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 SFAS No. 123, Accounting for
Stock-Based Compensation, the Company has elected to
follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees 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 fair value
of the Companys common stock on the date options were
granted and the exercise price. For purposes of disclosures
pursuant to SFAS No. 123, as amended by SFAS No.
148, Accounting for Stock-Based Compensation 
Transition and Disclosure, 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 No. 123 and Emerging Issues Task Force
(EITF) 96-18, Accounting for Equity
Instruments that are Issued to Other than Employees for
Acquiring, or in conjunction with Selling Goods or
Services, 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.

The following table illustrates the effect on net
loss per share applicable to common stockholders if the Company
had applied the fair value recognition provisions of
SFAS No. 123 to stock-based employee compensation (in
thousands, except per share amounts):

|                                                                            |                                                                                                               |                          |        |        |   |      |        |        |   |   |        |        |  
|--------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------- | ------------------------ | ------ | ------ | - | ---- | ------ | ------ | - | - | ------ | ------ | -
|                                                                            |                                                                                                               |                         
|                                                                            |                                                                                                               | Years Ended December 31,
|                                                                            |                                                                                                               |                         
|                                                                            |                                                                                                               | 2003                     |        | 2002   |   | 2001
|                                                                            |                                                                                                               |                          |        |        |   |     
|Net loss applicable to common stockholders, as
    reported                 |                                                                                                               | $                        | (5,947 | )      |   | $    | (2,785 | )      |   | $ | (8,697 | )     
|                                                                            | Add: Stock-based employee compensation expense
    included in reported net loss                              |                          |        | 58     |   |      |        | 17     |   |   |        | 25     |  
|                                                                            | Deduct: Total stock-based employee compensation
    expense determined under fair value method for all awards |                          |        | (1,439 | ) |      |        | (1,508 | ) |   |        | (1,308 | )
|                                                                            |                                                                                                               |                          |        |        |   |      |        |        |   |   |        |       
|Net loss applicable to common stockholders, pro
    forma                   |                                                                                                               | $                        | (7,328 | )      |   | $    | (4,276 | )      |   | $ | (9,980 | )     
|                                                                            |                                                                                                               |                          |        |        |   |      |        |        |   |   |        |       
|Basic and diluted net loss per share applicable
    to common stockholders: |                                                                                                               |                          |        |        |   |      |        |        |   |   |        |       
|                                                                            | As reported                                                                                                   |                          | $      | (0.14  | ) |      | $      | (0.07  | ) |   | $      | (0.28  | )
|                                                                            |                                                                                                               |                          |        |        |   |      |        |        |   |   |        |       
|                                                                            | Pro forma                                                                                                     |                          | $      | (0.17  | ) |      | $      | (0.11  | ) |   | $      | (0.32  | )
|                                                                            |                                                                                                               |                          |        |        |   |      |        |        |   |   |        |       



| |                     
| | --------------------
| | Comprehensive Income

SFAS No. 130, Reporting
Comprehensive Income established standards for the
reporting and display of comprehensive income and its components
(revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. The Company provides the
required disclosure in the Consolidated Statements of Preferred
Stock and Stockholders Equity.

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                    
| | -------------------
| | Segment Information

The Company has determined that it operates in
one business segment.

Net product sales consists of the following:

|               |  |                          |        |      |  |      |        |  |  |   |       | 
|-------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ |  |  | - | ----- | 
|               |  |                         
|               |  | Years Ended December 31,
|               |  |                         
|               |  | 2003                     |        | 2002 |  | 2001
|               |  |                          |        |      |  |     
|               |  |                         
|               |  | (in $000s)             
|HP Acthar® Gel |  | $                        | 7,973  |      |  | $    | 9,009  |  |  | $ | 2,141 | 
|Nascobal®      |  |                          | 2,099  |      |  |      |       |  |  |   |      | 
|Ethamolin®     |  |                          | 1,629  |      |  |      | 3,527  |  |  |   | 1,695 | 
|VSL#3®         |  |                          | 992    |      |  |      | 523    |  |  |   |      | 
|Glofil®-125    |  |                          | 887    |      |  |      | 732    |  |  |   | 982   | 
|Inulin         |  |                          | 75     |      |  |      | 28     |  |  |   | 317   | 
|NeofloTM       |  |                          |       |      |  |      |       |  |  |   | 61    | 
|               |  |                          |        |      |  |      |        |  |  |   |       | 
|               |  | $                        | 13,655 |      |  | $    | 13,819 |  |  | $ | 5,196 | 
|               |  |                          |        |      |  |      |        |  |  |   |       | 



| |                                         
| | ----------------------------------------
| | Recently Issued Accounting
    Standards

In May 2003, the FASB issued
SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity. This Statement establishes new standards for how
an issuer classifies and measures certain financial instruments
with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within
its scope as a liability (or an asset in some circumstances).
This Statement is effective for financial instruments entered
into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of SFAS No. 150
on July 1, 2003 did not have a material impact on the
consolidated financial statements as of December 31, 2003.

In January 2003, the FASB issued Interpretation
No. 46 (FIN 46), Consolidation of Variable
Interest Entities. FIN 46 requires that if an entity has a
controlling financial interest in a variable interest entity,
the assets, liabilities and results of activities of the
variable interest entity should be included in the consolidated
financial statements of the entity. FIN 46 as amended must
be applied for interim or annual reporting periods ending after
March 15, 2004, and is effective immediately for all new
variable interest entities created or acquired after
January 31, 2003. The adoption of FIN 46 did not
impact the Companys results of operations or financial
position as of December 31, 2003, as it is not a party to
any variable interest entities.

In July 2002, the FASB issued Statement of
Financial Accounting Standards No. 146, Accounting
for Costs Associated with Exit or Disposal Activities
(SFAS No. 146). SFAS No. 146
addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies EITF
Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring) (EITF 94-3). The principal
difference between SFAS No. 146 and EITF 94-3
relates to SFAS No. 146s timing for recognition
of a liability for a cost associated with an exit or disposal
activity. SFAS No. 146 requires that a liability for
an exit cost associated with an exit or disposal activity be
recognized when the liability is incurred. Under EITF 94-3
a liability for an exit cost, as generally defined in
EITF 94-3, was recognized at the date of an entitys
commitment to an exit plan. SFAS No. 146 is effective
for exit or disposal activities that are initiated after
December 31, 2002. During the year ended December 31,
2003, the Company transferred certain functions previously
performed at its Carlsbad, California facility (distribution,
quality control and quality assurance) to third party
contractors or to its Union City headquarters. Consequently,
during 2003, the Company entered into sublease agreements with
two sublessees for the Carlsbad facility. The Company recognized
losses relating to the leases totaling

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

$171,000 in fiscal year 2003. The loss associated
with the leases is included in Research and Development in the
accompanying Consolidated Statements of Operations. In addition,
the Company amortized the remaining net book value of the
Carlsbad facility leasehold improvements of $23,000 in 2003.



| |                  
| | -----------------
| | Reclassifications

Certain amounts in the prior years
financial statements have been reclassified to conform with the
current year presentation. The amount reclassified from Cost of
Product Sales to Selling, General and Administrative Expense in
the Consolidated Statements of Operations totaled $110,000 for
the year ended December 31, 2002. The amount reclassified
from Research and Development to Cost of Product Sales in the
Consolidated Statements of Operations totaled $495,000 for the
year ended December 31, 2001. Amounts previously reported
as Sales and Marketing, and General and Administrative, have
been combined as Selling, General and Administrative.

2.     Development
and Collaboration Agreements

In June 2002, the Company signed a definitive
License Agreement with Fabre Kramer Pharmaceuticals, Inc
(Fabre Kramer) of Houston, TX, for the exclusive
worldwide development and commercialization of
HypnostatTM (intranasal triazolam) for insomnia and
PanistatTM (intranasal alprazolam) for panic
disorders. Immediately after the agreement was signed, the
Company received a cash payment of $250,000 from Fabre Kramer
for the transfer of all technology related to the products. The
Company has no continuing obligations related to the transfer of
the technology. The Company is entitled to future payments from
Fabre Kramer when specific developmental milestones are met. In
addition, the Company is entitled to a share of future worldwide
product-related Fabre-Kramer revenues, based on a percentage of
total revenues. This License Agreement is the final result of
the Letter of Understanding originally signed in June 2001 and
modified in January 2002. Under the License Agreement, Fabre
Kramer assumed the responsibility for the development of
HypnostatTM and PanistatTM.

In December 2001, the Company entered into a
promotion agreement (effective January 2002) with VSL
Pharmaceuticals, Inc. (VSL), a private company
owned in part by the major shareholders of Sigma Tau. Effective
January 1, 2004, the promotion agreement and all amendments
were assigned by VSL to Sigma Tau Pharmaceuticals, Inc. As
Sigma Tau owns common stock of the Company as of
December 31, 2003, VSL and Sigma Tau
Pharmaceuticals, Inc. are deemed to be related parties of
the Company. On June 27, 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. 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 was $992,000 and $523,000 for
the years ended December 31, 2003 and 2002, respectively,
and is included in Net Product Sales. An access fee
is paid quarterly to VSL, which varies based upon sales and
costs incurred by the Company. Additionally, under these
agreements, VSL has paid the Company $200,000 in exchange for
services provided by the Company to launch the VSL#3 product
which was recognized in full as of December 31, 2002 and is
included in Services Revenue from a Related Party in
the Consolidated Statements of Operations. The term of the
agreement is three years; however, VSL is entitled to
unilaterally terminate the agreement by providing written notice
to the Company after the one-year anniversary of the effective
date. The VSL#3 product was formally launched on May 23,
2002. As of December 31, 2003 and 2002, the Company owes
VSL $188,000 and $254,000, respectively, which is included in
Accounts Payable in the accompanying Consolidated Balance Sheets.

The Company entered into a License Agreement in
December 2000 with Ahn-Gook Pharmaceutical Co., Ltd
(Ahn-Gook) for marketing intranasal metoclopramide,
to be marketed in Korea under the trade name Emitasol. Ahn-Gook
intends to manufacture Emitasol in Korea. This product had been
sold in the past as

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Pramidin in Italy. Ahn-Gook received government
approval to market Emitasol in 2002. The Company received an
up-front cash payment of $50,000 in December 2000, which was
recognized as revenue in 2002 upon completion of the agreement
obligation. In addition, the Company received a payment of
$150,000 upon transfer of technology to Ahn-Gook in December
2002 and will earn royalties based on actual sales in Korea. The
License Agreement was amended in December 2002 to include twelve
additional countries in Asia. The Company will receive an
upfront payment and additional royalties upon commercialization
of Emitasol in each of these new countries. Ahn-Gook began sales
of Emitasol in the Republic of Korea in the first half of 2003.
Through 2003, the sales of the product are minimal.

As a result of the merger with RiboGene, the
Company assumed an option and license agreement entered into
with Roberts Pharmaceutical Corporation, a subsidiary of Shire
Pharmaceuticals Ltd, (Shire) in July 1998 for the
development of Emitasol, an intranasally administered drug being
developed for the treatment of diabetic gastroparesis and for
the prevention of delayed onset emesis. Under the terms of the
agreement, Shire had the option to acquire exclusive North
American rights to Emitasol. This option expired in July 2001.
Under the collaboration agreement, the Company was obligated to
fund one-half of the clinical development expenses for Emitasol
up to an aggregate of $7.0 million. Through
December 31, 2003, the Company has made development
payments for Emitasol, under the terms of the agreement with
Shire, totaling $4.7 million, consisting of
$4.2 million paid to Shire and approximately $500,000 paid
to other parties for allowable expenses including patent and
trademark costs. Shire asserts that the Company owes $248,000 in
development expenses incurred by it under the collaboration
agreement prior to the expiration of the option, which the
Company has accrued for as of December 31, 2003. The
Company had Shire return certain items to the Company, including
the transfer of the Investigational New Drug applications
relating to Emitasol and the assignment of the intellectual
property relating to Emitasol generated in the course of the
development program. Shire also holds all 2,155,715 outstanding
shares of the Companys Series A preferred stock which
it originally acquired from RiboGene for a payment of
$10 million.

3.     Product
Acquisition

In July 2001, the Company entered into an Asset
Purchase agreement with Aventis Pharmaceuticals Inc.
(Aventis) to acquire the worldwide rights to Acthar
as well as inventory and certain assets used to manufacture
Acthar. Acthar is a corticotropin product that has been used, as
part of a special program administered by the National
Organization for Rare Disorders (NORD), to treat
seriously ill children with a seizure complex, referred to as
infantile spasm or West Syndrome, a potentially fatal disorder,
and patients with Multiple Sclerosis who experience severe and
painful episodes of flare. The Company paid an
upfront fee and has agreed to pay an annual royalty on net sales
above a predetermined amount. As part of the agreement, Aventis
manufactured the finished goods from existing inventory of the
active pharmaceutical ingredient (the API) through
July 2002. The Company began shipping Acthar in the third
quarter of 2001.

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, an
additional cash payment of $3 million in the third quarter
and an additional $2.2 million cash payment in December
2003 (a total of $14.2 million). 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) was filed by Nastech with the FDA
at the end of 2003. 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 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.

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The Company accounted for the Nascobal 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 was $514,000 for the year
ended December 31, 2003. Amortization expense will be
approximately $948,000 per year from 2004 through 2017, and
approximately $434,000 for 2018.

4.     Investments

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

|                  |                    |                |   |                 |  |            |   |   |  |  |   |       | 
|----------------- | ------------------ | -------------- | - | --------------- |  | ---------- | - | - |  |  | - | ----- | 
|                  |                    | Gross          |   | Gross           |  | Estimated 
|December 31, 2003 |                    | Amortized Cost |   | Unrealized Loss |  | Fair Value
|                  |                    |                |   |                 |  |           
|Cash equivalents: |                    |                |   |                 |  |            |   |   |  |  |   |      
|                  | Money market funds |                | $ | 2,301           |  |            | $ |  |  |  | $ | 2,301 | 
|                  |                    |                |   |                 |  |            |   |   |  |  |   |      

|                        |                              |                |       |                 |  |            |     |     |   |   |       |       | 
|----------------------- | ---------------------------- | -------------- | ----- | --------------- |  | ---------- | --- | --- | - | - | ----- | ----- | 
|                        |                              | 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 and, in 2002, the Company recognized an
other-than-temporary loss of $367,000 related to its equity
investment in Rigel Pharmaceuticals.

The net realized gains on sales of available for
sale investments were not material in fiscal years 2003, 2002
and 2001.

5.     Inventories

Inventories consist of the following (in
thousands):

|                                                   |  |              |       |      |  |   |     |  
|-------------------------------------------------- |  | ------------ | ----- | ---- |  | - | --- | -
|                                                   |  |             
|                                                   |  | December 31,
|                                                   |  |             
|                                                   |  | 2003         |       | 2002
|                                                   |  |              |       |     
|Raw materials                                      |  | $            | 534   |      |  | $ | 70  |  
|Work in Process                                    |  |              | 197   |      |  |   |    |  
|Finished goods                                     |  |              | 660   |      |  |   | 397 |  
|Less allowance for excess and obsolete inventories |  |              | (341  | )    |  |   | (76 | )
|                                                   |  |              |       |      |  |   |     |  
|                                                   |  | $            | 1,050 |      |  | $ | 391 |  
|                                                   |  |              |       |      |  |   |     |  

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

6.     Property and
Equipment

Property and equipment consist of the following
(in thousands):

|                                               |  |              |       |      |  |   |        |  
|---------------------------------------------- |  | ------------ | ----- | ---- |  | - | ------ | -
|                                               |  |             
|                                               |  | December 31,
|                                               |  |             
|                                               |  | 2003         |       | 2002
|                                               |  |              |       |     
|Laboratory equipment                           |  | $            | 9     |      |  | $ | 364    |  
|Manufacturing equipment                        |  |              | 272   |      |  |   | 100    |  
|Office equipment, furniture and fixtures       |  |              | 799   |      |  |   | 1,196  |  
|Leasehold improvements                         |  |              | 329   |      |  |   | 251    |  
|                                               |  |              |       |      |  |   |        |  
|                                               |  |              | 1,409 |      |  |   | 1,911  |  
|Less accumulated depreciation and amortization |  |              | (800  | )    |  |   | (1,326 | )
|                                               |  |              |       |      |  |   |        |  
|                                               |  | $            | 609   |      |  | $ | 585    |  
|                                               |  |              |       |      |  |   |        |  

Depreciation and amortization expense for
property and equipment totaled $260,000, $361,000 and $580,000
for the years ended December 31, 2003, 2002 and 2001,
respectively.

During 2003, the Carlsbad facility was vacated
and equipment with a net book value of $9,000 no longer used,
was written off.

7.     Purchased
Technology and Other Intangible Assets

Goodwill and other intangibles consist of the
following (in thousands):

|                              |  |              |        |      |  |   |        |  
|----------------------------- |  | ------------ | ------ | ---- |  | - | ------ | -
|                              |  |             
|                              |  | December 31,
|                              |  |             
|                              |  | 2003         |        | 2002
|                              |  |              |        |     
|Goodwill                      |  | $            | 1,023  |      |  | $ | 1,023  |  
|Purchased technology          |  |              | 14,223 |      |  |   | 3,684  |  
|Assembled workforce           |  |              | 616    |      |  |   | 616    |  
|                              |  |              |        |      |  |   |        |  
|                              |  |              | 15,862 |      |  |   | 5,323  |  
|Less accumulated amortization |  |              | (1,674 | )    |  |   | (4,462 | )
|                              |  |              |        |      |  |   |        |  
|                              |  | $            | 14,188 |      |  | $ | 861    |  
|                              |  |              |        |      |  |   |        |  

Goodwill and assembled workforce no longer
subject to amortization amounted to $479,000 at
December 31, 2003 and 2002. Purchased technology at
December 31, 2003 includes $14,223,000 related to the
Nascobal acquisition. Purchased technology of $3,684,000 and
$3,068,000 were fully amortized in 2003 and 2002, respectively,
and written off accordingly. Amortization of purchased
technology relating to products totaled $897,000, $777,000 and
$1,054,000 for the years ended December 31, 2003, 2002, and
2001, respectively, and is included in Depreciation and
Amortization in the accompanying Consolidated Statements of
Operations. The remaining net balance of $382,000 at
December 31, 2002 relates to purchased technology which was
amortized over the estimated sales life of the associated
product (seven years), and was amortized in full during 2003,
and written off accordingly.

In accordance with SFAS No. 141 and
No. 142, the Company discontinued the amortization of
goodwill and assembled workforce on January 1, 2002. The
Company performed its annual impairment test of goodwill and
assembled workforce, which did not result in an impairment
charge. The Company will continue to monitor the carrying value
of goodwill through the annual impairment tests.

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

A reconciliation of previously reported net loss
and net loss per share to the amounts and the basic and diluted
net loss per share applicable to common stockholders adjusted
for the exclusion of goodwill amortization follows (in
thousands, except per share amounts):

|                                                                            |                                                                   |                          |        |        |   |      |        |        |   |   |        |        |  
|--------------------------------------------------------------------------- | ----------------------------------------------------------------- | ------------------------ | ------ | ------ | - | ---- | ------ | ------ | - | - | ------ | ------ | -
|                                                                            |                                                                   |                         
|                                                                            |                                                                   | Years Ended December 31,
|                                                                            |                                                                   |                         
|                                                                            |                                                                   | 2003                     |        | 2002   |   | 2001
|                                                                            |                                                                   |                          |        |        |   |     
|Net Loss:                                                                   |                                                                   |                          |        |        |   |      |        |        |   |   |        |       
|Reported net loss applicable to common
    stockholders                     |                                                                   | $                        | (5,947 | )      |   | $    | (2,785 | )      |   | $ | (8,697 | )     
|                                                                            | Add back: Goodwill amortization                                   |                          |        |       |   |      |        |       |   |   |        | 546    |  
|                                                                            |                                                                   |                          |        |        |   |      |        |        |   |   |        |       
|                                                                            | Adjusted net loss applicable to common
    stockholders           |                          | $      | (5,947 | ) |      | $      | (2,785 | ) |   | $      | (8,151 | )
|                                                                            |                                                                   |                          |        |        |   |      |        |        |   |   |        |       
|Basic and diluted net loss per share
    applicable to common stockholders: |                                                                   |                          |        |        |   |      |        |        |   |   |        |       
|Reported net loss per share applicable to common
    stockholders           |                                                                   | $                        | (0.14  | )      |   | $    | (0.07  | )      |   | $ | (0.28  | )     
|                                                                            | Add back: Goodwill amortization                                   |                          |        |       |   |      |        |       |   |   |        | 0.02   |  
|                                                                            |                                                                   |                          |        |        |   |      |        |        |   |   |        |       
|                                                                            | Adjusted net loss per share applicable to common
    stockholders |                          | $      | (0.14  | ) |      | $      | (0.07  | ) |   | $      | (0.26  | )
|                                                                            |                                                                   |                          |        |        |   |      |        |        |   |   |        |       

8.     Convertible
Debentures

In March 2002, the Company issued
$4.0 million of 8% convertible debentures to an
institutional investor, and Defiante Farmaceutica Unipessoal
L.D.A. (Defiante), a wholly-owned subsidiary of
Sigma-Tau Finanzaria S.p.A (Sigma-Tau). The Company
will pay interest on the debentures at a rate of 8% per
annum on a quarterly basis. The debentures are convertible into
shares of the Companys common stock at a fixed conversion
price of $1.58 per share (subject to adjustment for stock
splits and reclassifications). The debentures mature on
March 15, 2005.

The Company may redeem the debentures for cash
prior to maturity after March 15, 2003, provided the
average of the closing sale price of the Companys common
stock for the twenty (20) consecutive trading days prior to
the delivery of the optional prepayment notice to the holders of
the debentures is equal to or greater than $3.16 per share,
and the Company has satisfied certain equity conditions. At the
end of the term of the debentures, under certain circumstances,
the Company may redeem any outstanding debentures for stock. The
Company may redeem the institutional investors debentures
for stock at maturity, provided the total aggregate number of
shares of the Companys common stock issued to them
(including shares issuable upon conversion of their debenture
and shares issuable upon exercise of their warrant) does not
exceed 7,645,219 shares (representing 19.999% of the total
number of issued and outstanding shares of the Companys
common stock as of March 15, 2002). The Company may redeem
Defiantes debenture for stock at maturity, provided the
market price of the Companys common stock at the time of
redemption is greater than $1.50 per share (representing
the five day average closing sale price of the Companys
common stock immediately prior to March 15, 2002).

The Company issued warrants to the institutional
investor, Defiante and the placement agent to acquire an
aggregate of 1,618,987 shares of common stock at an
exercise price of $1.70 per share. The warrants expire on
March 15, 2006. The warrants issued to the institutional
investor and Defiante were assigned a value of $843,000. The
warrants issued to the placement agent were assigned a value of
$82,000. The warrants were valued using the Black-Scholes method
with the following assumptions: a risk-free interest rate of 5%;
an expiration date of March 15, 2006; volatility of 0.72;
and a dividend yield of 0%. In connection with the issuance of
the debentures and warrants, the Company recorded $641,000
related to the beneficial conversion feature on the convertible
debentures. The total amount of the deemed discount on the
convertible debentures as a result of the warrant issuance and
the beneficial conversion feature amounts to $1,484,000. The
beneficial

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

conversion feature and warrant value is amortized
over the term of the debentures. The unamortized balance is
$598,000 and $1,092,000 at December 31, 2003 and
December 31, 2002, respectively.

9.     Long-Term
Debt

Long-term debt consists of the following (in
thousands):

|                                                                                                                                              |       |              |       |              |  |   |       |       | 
|--------------------------------------------------------------------------------------------------------------------------------------------- | ----- | ------------ | ----- | ------------ |  | - | ----- | ----- | 
|                                                                                                                                              |       | December 31, |       | December 31,
|                                                                                                                                              |       | 2003         |       | 2002        
|                                                                                                                                              |       |              |       |             
|Convertible debentures (net of deemed discount of
    $598 and $1,092 at December 31, 2003 and 2002,
    respectively) bearing interest of 8% |       | $            | 3,402 |              |  | $ | 2,908 |      
|Notes payable for product liability insurance,
    bearing interest at 5.25%                                                                  |       |              | 82    |              |  |   | 97    |      
|Notes payable for property and liability
    insurance, bearing interest at 6.43%                                                             |       |              | 58    |              |  |   |      |      
|Notes payable for equipment financing                                                                                                         |       |              |      |              |  |   | 121   |      
|                                                                                                                                              |       |              |       |              |  |   |       |      
|                                                                                                                                              |       |              | 3,542 |              |  |   | 3,126 |      
|Less current portion                                                                                                                          |       |              | (140  | )            |  |   | (218  | )    
|                                                                                                                                              |       |              |       |              |  |   |       |      
|                                                                                                                                              | Total |              | $     | 3,402        |  |   | $     | 2,908 | 
|                                                                                                                                              |       |              |       |              |  |   |       |      

The amounts due for notes payable for product
liability and property and liability insurance in 2004 are
$140,000. The convertible debentures are due in March 2005.

The fair value of notes payable is estimated
based on current interest rates available to the Company for
debt instruments of similar terms, degrees of risk and remaining
maturities. The carrying value of these obligations, approximate
their respective fair values as of December 31, 2003 and
2002. Interest expense was $333,000, $315,000 and $465,000 for
the years ended December 31, 2003, 2002 and 2001,
respectively.

On January 2, 2002, the Company entered into
a revolving accounts receivable line of credit with Pacific
Business Funding, a division of Greater Bay Bancorp, the parent
company of Cupertino National Bank. 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 December 31, 2003. The line of credit
is secured by a blanket lien on all assets including
intellectual property. As of December 31, 2003, $1,421,000
was available for borrowing under the line of credit. The
Company terminated this line of credit in January 2004 and the
associated blanket lien was terminated accordingly.

10.     Indemnifications,
Commitments and Contingencies



| |                 
| | ----------------
| | Indemnifications

The Company, as permitted under California law
and in accordance with its Bylaws, indemnifies its officers and
directors for certain events or occurrences while the officer or
director is or was serving at the Companys request in such
capacity. The potential future indemnification limit is to the
fullest extent permissible under California law; however, the
Company has a director and officer insurance policy that limits
its exposure and may enable it to recover a portion of any
future amounts paid. The Company believes the fair value of
these indemnification agreements is minimal. Accordingly, the
Company has no liabilities recorded for these agreements as of
December 31, 2003.

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

From time to time, the Company may become
involved in claims and other legal matters arising in the
ordinary course of business. Management is not currently aware
of any matters that will have a material adverse affect on the
financial position, results of operations or cash flows of the
Company.



| |       
| | ------
| | Leases

The Company leases its office and distribution
facilities under operating lease agreements, the terms of which
range from 5 years to 15 years. The Company has also
entered into automobile and office equipment leases, the terms
of which range from three to five years. Minimum future
obligations under the operating leases as of December 31,
2003 are as follows (in thousands):

|                         |  |           |        |          |  |            |        |       |  |   |     |  |  |   |       | 
|------------------------ |  | --------- | ------ | -------- |  | ---------- | ------ | ----- |  | - | --- |  |  | - | ----- | 
|                         |  |           |        |          |  | Automobile |        |      
|                         |  | Facility  |        |          |  | and Office |        |      
|                         |  | Operating |        | Sublease |  | Equipment  |        |      
|Year ending December 31, |  | Leases    |        | Income   |  | Leases     |        | TOTAL
|                         |  |           |        |          |  |            |        |      
|2004                     |  | $         | 1,549  |          |  | $          | (1,254 | )     |  | $ | 198 |  |  | $ | 493   | 
|2005                     |  |           | 1,466  |          |  |            | (1,256 | )     |  |   | 92  |  |  |   | 302   | 
|2006                     |  |           | 1,294  |          |  |            | (577   | )     |  |   | 16  |  |  |   | 733   | 
|2007                     |  |           | 1,322  |          |  |            |       |       |  |   | 8   |  |  |   | 1,330 | 
|2008                     |  |           | 1,373  |          |  |            |       |       |  |   | 6   |  |  |   | 1,379 | 
|Thereafter               |  |           | 4,869  |          |  |            |       |       |  |   |    |  |  |   | 4,869 | 
|                         |  |           |        |          |  |            |        |       |  |   |     |  |  |   |       | 
|                         |  | $         | 11,873 |          |  | $          | (3,087 | )     |  | $ | 320 |  |  | $ | 9,106 | 
|                         |  |           |        |          |  |            |        |       |  |   |     |  |  |   |       | 

In July 2000, the Company entered into an
agreement to sublease 15,000 square feet of laboratory and
office space including subleasing its laboratory equipment for
its Hayward, California facility. Due to the termination of the
Companys drug discovery programs, the space and equipment
were no longer needed. The current sublessee of the Hayward
facility subleased and fully occupied the 30,000 square
feet facility after the Companys relocation occurred in
May 2001.

On October 26, 2000, the Company entered
into an agreement to lease a new facility in Union City,
California. The initial lease term is for 120 months, with
an option for an additional five years. As a condition of this
agreement, the Company provided an irrevocable Letter of Credit
in the amount of $659,000, with the face value of the Letter of
Credit, subject to certain conditions, declining thereafter. The
Company entered into this new lease agreement in order to take
advantage of lower rent costs as laboratory space was no longer
necessary. This letter of credit is included in Deposits and
Other Assets on the Consolidated Balance Sheets.

In May 2001, we closed our Neoflo manufacturing
facility located in Lees Summit, Missouri. The lease
period ends in December 2004 and during 2003, we subleased the
space through December 2004.

During 2003, the Carlsbad facility was vacated
and the warehousing and distribution for all products, except
VSL#3, were transferred to third party contractors. During 2003,
the Company subleased the entire facility under two separate
subleases expiring in December 2004 and January 2006. In
accordance with SFAS No. 146, the Company recorded a
liability of $171,000 for the net present value of the remaining
lease payment net of sublease revenue and the related expense
was recorded to Research and Development.

Rent expense for facility, equipment and
automobile leases totaled $1,885,000, $1,771,000 and $1,573,000
for the years ended December 31, 2003, 2002 and 2001,
respectively. Rent expense comprises the cost associated with
three buildings leased by the Company including its current
headquarters located in Union City, California, its former
headquarters in Hayward, California, and its former distribution
facility in Carlsbad, California and automobile and office
equipment leases. Net rental income totaled $260,000, $282,000
and $612,000 for the years ended December 31, 2003, 2002
and 2001, respectively. The Company has entered into various
automobile leases for its sales representatives.

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |              
| | -------------
| | Contingencies

From time to time, the Company may become
involved in claims and other legal matters arising in the
ordinary course of business. Management is not currently aware
of any matters that will have a material adverse affect on the
financial position, results of operations or cash flows of the
Company.



| |            
| | -----------
| | Commitments

We have signed an agreement with BioVectra dcl to
produce the API used in Acthar. The agreement requires minimum
production totaling $1.7 million during the term. During
fiscal year 2003, we paid $115,000 under this agreement. The
agreement terminates in December 2007 and includes two one-year
extension options. The production of the first batch of API is
scheduled to begin in 2004.

11.     Preferred
Stock and Stockholders Equity



| |                
| | ---------------
| | Preferred Stock

Pursuant to its Amended and Restated Articles of
Incorporation, the Company is authorized to issue up to
7,500,000 shares of Preferred Stock in one or more series
and has issued 2,155,715 shares of its Series A
Preferred Stock and 10,000 shares of its Series B
Preferred Stock as of December 31, 2003. The holders of
outstanding shares of Series A Preferred Stock are entitled
to receive dividends concurrently with the Common Stock, if any,
as may be declared from time to time by the Board of Directors
out of assets legally available therefrom. The holders of
Series A Preferred Stock are entitled to the number of
votes equal to the number of shares of Common Stock into which
each share of Series A Preferred Stock could be converted
on the record date. Each share of Series A Preferred Stock
is convertible, at the option of the holder of such share, into
one share of Common Stock, subject to adjustments for stock
splits, stock dividends or combinations of outstanding shares of
Common Stock. The Articles of Incorporation authorize the
issuance of Preferred Stock in classes, and the Board of
Directors may designate and determine the voting rights,
redemption rights, conversion rights and other rights relating
to such class of Preferred Stock, and to issue such stock in
either public or private transactions.

The Series A Preferred Stock has a
liquidation preference equal to $4.64 per share plus all
declared and unpaid dividends which is payable upon the
occurrence of a liquidation, consolidation, merger or the sale
of substantially all of the Companys stock or assets. The
Company excluded the Series A Preferred Stock from total
stockholders equity due to the nature of the liquidation
preference of the preferred stock.

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 had an
aggregate stated value at the time of issuance 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. During December 2003 Series B
Preferred Stock with a stated value of $900,000 plus accrued
dividends of $13,000 were converted into 976,770 shares of
common stock. The Company has the right commencing on
January 1,

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 December 31, 2003, the
redemption value of the Series B Preferred Stock was
$9.1 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 risk free

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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.

In June 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. In December
2003 we entered into a new waiver agreement with the holders of
the Series B Preferred Stock to waive the Net Cash, Cash
Equivalents and Eligible Investment Balances among other
requirements until January 31, 2004, at which time the
Company was in compliance.

As a result of the decrease to the exercise price
of the warrants in June 2003, 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 applicable to common
stockholders.

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |             
| | ------------
| | Common Stock

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.

The holders of outstanding shares of the
Companys Common Stock are entitled to receive ratably such
dividends, if any, as may be declared from time to time by the
Board of Directors out of assets legally available therefore,
subject to the payment of preferential dividends with respect to
any Preferred Stock that may be outstanding. In the event of a
liquidation, dissolution and winding-up of the Company, the
holders of outstanding Common Stock are entitled to share
ratably in all assets available for distribution to the Common
Stock shareholders after payment of all liabilities of the
Company, subject to rights of the Preferred Stock. The holders
of the Common Stock are entitled to one vote per share.

In June 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. The purchasers of Common Stock
also received for no additional consideration warrants
exercisable for an aggregate of 2,987,616 shares of Common
Stock for the five days prior to and including the close of the
private placement. The warrants expire in June 2008.

In December 2001, the Company entered into a
Promotion Agreement (effective January 2002) with VSL
Pharmaceuticals, Inc., a private company owned in part by
the principal shareholders of Sigma-Tau, to promote, sell and
distribute the product VSL#3 in the U.S. Effective
January 1, 2004, the Promotion Agreement and all amendments
were assigned by VSL Pharmaceuticals, Inc. to Sigma-Tau
Pharmaceuticals, Inc. In connection with this Promotion
Agreement, the Company entered into two Stock and Warrant
Purchase Agreements, one with Paolo Cavazza and one with Claudio
Cavazza, to purchase (i) an aggregate of
640,000 shares of common stock for a purchase price of
$1.50 per share (representing a twenty percent premium to
its market price for the five days prior to execution of the
Purchase Agreements), for an aggregate purchase price of
$960,000, and (ii) warrants, at an aggregate purchase price
of $300,000, to purchase an additional 1,800,000 shares of
common stock at a purchase price of $1.75 per share which
expired on December 1, 2003. The Company issued the common
stock related to this transaction in February 2002.

In July 2001, the Company entered into a Stock
Purchase Agreement with Sigma-Tau pursuant to which Sigma-Tau
purchased 5,279,034 shares of common stock at a purchase
price of $0.66 per share, for an aggregate purchase price
of $3,500,000.

In April 2001, the Company entered into a Stock
and Warrant Purchase Agreement with Sigma-Tau pursuant to which
Sigma-Tau purchased (i) an aggregate of
2,873,563 shares of common stock at a purchase price of
$0.52 per share, for an aggregate purchase price of
$1,500,000, and (ii) a warrant to purchase an additional
2,873,563 shares of common stock at a purchase price of
$0.52 per share. In May 2001, as required under the rules
of AMEX, the Company sought and received shareholder approval to
allow for full exercise of the warrant. In July 2001, Sigma-Tau
assigned the warrant to Paolo Cavazza and Claudio Cavazza, the
principal shareholders of Sigma-Tau, who exercised the warrant
in full, purchasing 2,873,563 shares of common stock at a
purchase price of $0.52 per share, resulting in aggregate
proceeds to the Company of $1,500,000 (including the $100,000
originally paid by Sigma-Tau to acquire the warrant).

Also, in April 2001, the Company closed a
financing which totaled $442,000. This investment came from a
group of individual investors. The Company issued an aggregate
of 816,800 shares of common stock and sold warrants to
purchase an additional 408,400 shares of common stock with
an exercise price of these warrants of $0.64 per share. The
warrants are exercisable from the date of issuance until the
close of business on April 30, 2006.

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                             
| | ----------------------------
| | Placement Agent Unit Options

As part of the acquisition of RiboGene, the
Company assumed placement agent options from a 1997 offering of
preferred stock by RiboGene. At December 31, 2003, options
to purchase 127,676 shares of common stock were outstanding
at an aggregate exercise price of approximately $82,000. These
options expire in December 2007.



| |         
| | --------
| | Warrants

The Company has 8,437,608 warrants outstanding at
December 31, 2003 at a weighted average exercise price per
share of common stock of $1.20 and a weighted average remaining
contractual life of 4.5 years. Exercise prices for the
warrants outstanding as of December 31, 2003 are as follows:

|               |  |             |           |             |  |            |           |  |  |  |           | 
|-------------- |  | ----------- | --------- | ----------- |  | ---------- | --------- |  |  |  | --------- | 
|               |  | Number      |           |             |  | Expiration
|Exercise Price |  | Outstanding |           | Date Issued |  | Date      
|               |  |             |           |             |  |           
|$0.64          |  |             | 408,400   |             |  |            | 4/30/2001 |  |  |  | 4/30/2006 | 
|$0.94          |  |             | 3,399,911 |             |  |            | 1/15/2003 |  |  |  | 1/15/2007 | 
|$1.26          |  |             | 2,987,616 |             |  |            | 6/11/2003 |  |  |  | 6/11/2008 | 
|$1.31          |  |             | 20,000    |             |  |            | 7/31/2000 |  |  |  | 5/18/2004 | 
|$1.70          |  |             | 1,618,987 |             |  |            | 3/15/2002 |  |  |  | 3/15/2006 | 
|$31.51         |  |             | 2,694     |             |  |            | 3/12/1997 |  |  |  | 3/12/2007 | 
|               |  |             |           |             |  |            |           |  |  |  |           | 
|               |  |             | 8,437,608 |             |  |            |           |  |  |  |           | 
|               |  |             |           |             |  |            |           |  |  |  |           | 

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 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.



| |                   
| | ------------------
| | Stock Option Plans

For the years ended December 31, 2003, 2002
and 2001, the Company recorded amortization of deferred stock
compensation of $20,000, $17,000, and $25,000, respectively. As
of December 31, 2003 the Company had $17,000 of remaining
unamortized deferred compensation. This amount is included as a
deduction of stockholders equity and is being amortized
over the vesting period of the underlying options.

Pro forma information regarding net loss
applicable to common stockholders and net loss applicable to
common stockholders per share as required by
SFAS No. 123 and amended by SFAS No. 148, as
disclosed in Note 1, has been determined as if the Company
accounted for its employee stock options under the fair value
method set forth in SFAS No. 123. The Black-Scholes
option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including the
expected stock price volatility. Because the Companys
employee stock options have characteristics significantly
different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair
value estimate, in managements opinion, the existing
models do not necessarily provide a single

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

reliable measure of the fair value of its
employee stock options. For purposes of pro forma disclosures,
the estimated fair value of the options is amortized to expense
over the options vesting periods.

|                                |  |              |     |      |  |      |     |   |  |  |     |  
|------------------------------- |  | ------------ | --- | ---- |  | ---- | --- | - |  |  | --- | -
|                                |  |             
|                                |  | Years Ended 
|                                |  | December 31,
|                                |  |             
|                                |  | 2003         |     | 2002 |  | 2001
|                                |  |              |     |      |  |     
|Expected stock price volatility |  |              | 67  | %    |  |      | 82  | % |  |  | 86  | %
|Risk-free interest rate         |  |              | 3   | %    |  |      | 5   | % |  |  | 5   | %
|Expected life (in years)        |  |              | 3.9 |      |  |      | 4.0 |   |  |  | 3.1 |  
|Expected dividend yield         |  |              |    |      |  |      |    |   |  |  |    |  

In September 2000, the Company adopted the
Employee Stock Purchase Plan (ESPP) and as of
December 31, 2002 all shares of common stock had been
issued under the original ESPP. In May 2003, the Companys
2003 Employee Stock Purchase Plan (the 2003 ESPP)
was approved by the shareholders and 900,000 shares of
common stock have been reserved for issuance under the plan. The
ESPP provides for payroll deductions for eligible employees to
purchase common stock at the lesser of (i) 85% of the fair
market value of the common stock on the offering date and
(ii) 85% of the fair market value of the common stock on
the purchase date. The first purchase date was December 31,
2000 on which 93,666 shares were purchased at
$0.53 per share. During the year ended December 31,
2001, 193,214 shares were purchased under this plan at an
average purchase price of $0.58 per share. During the year
ended December 31, 2002, 313,114 shares were purchased
under this plan at an average purchase price of $0.52 per
share. During the year ended December 31, 2003,
93,123 shares were purchased under the 2003 ESPP at an
average purchase price of $0.73 per share.

As of December 31, 2001,
12,500,000 shares of common stock were reserved for
issuance under the 1992 Employee Stock Option Plan (the
1992 Plan). In December 2002, the Board of Directors
temporarily reduced the number of shares available for grant
under the 1992 Plan by 1,220,053 shares. This resulted in
11,279,947 shares of common stock authorized under the 1992
Plan as of December 31, 2002. In 2003,
1,220,053 shares were reinstated to the 1992 Plan resulting
in 12,500,000 shares reserved for issuance. In May 2003,
the aggregate number of shares of Common Stock authorized for
issuance under the 1992 Plan was increased by
1,000,000 shares from 12,500,000 shares to
13,500,000 shares. The 1992 Plan provides for the grant of
incentive and nonstatutory stock options with various vesting
periods, generally four years, to employees, directors and
consultants. The exercise price of incentive stock options must
equal at least the fair market value on the date of grant, and
the exercise price of nonstatutory stock options may be no less
than 85% of the fair market value on the date of grant. The
maximum term of options granted under the 1992 Plan is ten years.

As of December 31, 2002,
1,250,000 shares of common stock were reserved for issuance
under the 1993 Non Employee Directors Stock Option Plan
(the Directors Plan). The maximum term of
options granted under the 1993 Directors Plan is ten years. The
Directors Plan expired in 2003 (See Note 18,
Subsequent Events).

The Company compensates its non-employee
directors for their service on the Board of Directors with an
initial grant of an option to purchase 25,000 shares of
common stock. Such option grant has an exercise price equal to
85% of the fair market value of the common stock on the date of
the grant and vests in 48 equal monthly installments commencing
on the date of the grant, provided the non-employee director
serves continuously on the Board of Directors during such time.

In November 2003, the Board of Directors approved
an annual salary of $45,000 to the Companys Lead Director,
Brian C. Cunningham, of which he received $3,750 as compensation
for service as Lead Director during fiscal year 2003. Each other
outside director received $2,500 for each Board of
Directors meeting attended during fiscal year 2003.
Members of committees of the Board of Directors, including the
Lead

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Director, received $1,000 for each committee
meeting attended, with committee chairmen receiving
$1,500 per meeting attended. Additionally, the
Companys Lead Director was granted an option to purchase
30,000 shares of common stock upon appointment as Lead
Director at an exercise price equal to the fair market value of
the common stock on the date of the grant, 10,000 shares of
which vested immediately, and the remainder of which vest in 48
equal monthly installments commencing on the date of the grant,
provided that he serves continuously on the Board of Directors
during such time. For service as a director in 2003 each outside
director was granted an option to purchase 10,000 shares of
common stock. Such option grants had an exercise price equal to
85% of the fair market value of the common stock on the date of
the grant and vest in 48 equal monthly installments commencing
on the date of the grant, provided the non-employee director
serves continuously on the Board of Directors during such time.
For service on a committee of the Board of Directors in 2003,
members of committees were granted an option to purchase
15,000 shares of common stock and chairmen of committees
were granted an additional option to purchase 7,500 shares
of common stock. Such option grants had an exercise price equal
to 100% of the fair market value of the common stock on the date
of the grant and became fully vested at the time of grant.

For the calendar year 2002, each outside director
received $1,000 for each Board of Directors meeting
attended during fiscal year 2002. Additionally, for service as a
director in 2002, each outside director was granted an
additional option under the 1992 Plan to purchase
30,000 shares of Common Stock at an exercise price equal to
the then fair market value of the Common Stock. Such option
grant is now fully vested as to each director. For the calendar
year 2001, the Company compensated members of the Board of
Directors for attending the Board of Directors meetings, by
granting them 30,000 options each to purchase common stock in
lieu of the $2,000 payment per meeting. The options were issued
under the 1992 Plan and vest over twelve months.

The Company also reimburses its directors who are
not employees for their reasonable expenses incurred in
attending meetings. Directors who are officers of the Company
receive no additional compensation for Board service.

The following table summarizes stock option
activity under the 1992 and 1993 Plans:

|                             |           |             |           |                  |   |   |      |      | 
|---------------------------- | --------- | ----------- | --------- | ---------------- | - | - | ---- | ---- | 
|                             |           | Options     |           | Weighted Average
|                             |           | Outstanding |           | Exercise Price  
|                             |           |             |           |                 
|Balance at December 31, 2001 |           |             | 6,878,466 |                  |   | $ | 1.65 |     
|                             | Granted   |             |           | 3,128,923        |   |   | $    | 1.31 | 
|                             | Exercised |             |           | (355,432         | ) |   | $    | 1.16 | 
|                             | Canceled  |             |           | (709,695         | ) |   | $    | 3.30 | 
|                             |           |             |           |                  |   |   |      |     
|Balance at December 31, 2002 |           |             | 8,942,262 |                  |   | $ | 1.41 |     
|                             | Granted   |             |           | 2,170,555        |   |   | $    | 0.83 | 
|                             | Exercised |             |           | (273,962         | ) |   | $    | 0.77 | 
|                             | Canceled  |             |           | (1,081,353       | ) |   | $    | 1.67 | 
|                             |           |             |           |                  |   |   |      |     
|Balance at December 31, 2003 |           |             | 9,757,502 |                  |   | $ | 1.27 |     
|                             |           |             |           |                  |   |   |      |     

At December 31, 2003, 2002 and 2001, options
to purchase 5,308,931 shares, 4,296,617 shares and
3,346,440 shares, respectively, of common stock were
exercisable and there were 3,080,311 shares available for
future grant under the 1992 Plan and none available for future
grant under the 1993 Plan as of December 31, 2003. The
weighted average fair values of options granted was $0.44, $0.83
and $0.59 for the years ended December 31, 2003, 2002 and
2001, respectively.

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

During 2003, 2002 and 2001, there were 20,000,
40,000 and 743,633 options granted to consultants, respectively.
These options are re-measured as they vest, using the
Black-Scholes pricing model, and the resulting value is
recognized as expense over the period of services received. For
the years ended December 31, 2003, 2002 and 2001 the
Company recorded $95,000, $381,000, and $601,000, respectively,
as compensation expense.

Exercise prices and weighted average remaining
contractual life for the options outstanding as of
December 31, 2003 are as follows:

|                        |  |                     |           |                     |  |                  |      |             |  |                  |      |  |  |  |           |  |  |   |      | 
|----------------------- |  | ------------------- | --------- | ------------------- |  | ---------------- | ---- | ----------- |  | ---------------- | ---- |  |  |  | --------- |  |  | - | ---- | 
|                        |  |                     |           |                     |  |                 
|                        |  | Options Outstanding |           |                    
|                        |  |                     |           | Options Exercisable
|                        |  |                     |           | Weighted Average    |  |                  |      |            
|                        |  | Number              |           | Remaining           |  | Weighted Average |      | Number      |  | Weighted Average
|Range of Exercise Price |  | Outstanding         |           | Contractual Life    |  | Exercise Price   |      | Exercisable |  | Exercise Price  
|                        |  |                     |           |                     |  |                  |      |             |  |                 
|$0.47  $0.67           |  |                     | 989,453   |                     |  |                  | 8.60 |             |  | $                | 0.61 |  |  |  | 320,558   |  |  | $ | 0.61 | 
|$0.75  $0.82           |  |                     | 1,070,729 |                     |  |                  | 7.77 |             |  | $                | 0.77 |  |  |  | 549,582   |  |  | $ | 0.76 | 
|$0.84  $0.94           |  |                     | 1,380,000 |                     |  |                  | 9.19 |             |  | $                | 0.88 |  |  |  | 263,434   |  |  | $ | 0.90 | 
|$0.97  $1.02           |  |                     | 1,093,727 |                     |  |                  | 8.40 |             |  | $                | 1.00 |  |  |  | 432,685   |  |  | $ | 1.00 | 
|$1.03  $1.24           |  |                     | 607,520   |                     |  |                  | 7.24 |             |  | $                | 1.12 |  |  |  | 556,285   |  |  | $ | 1.12 | 
|$1.24  $1.25           |  |                     | 1,212,365 |                     |  |                  | 5.90 |             |  | $                | 1.25 |  |  |  | 1,075,768 |  |  | $ | 1.25 | 
|$1.27  $1.48           |  |                     | 379,485   |                     |  |                  | 7.01 |             |  | $                | 1.36 |  |  |  | 355,108   |  |  | $ | 1.36 | 
|$1.50  $1.75           |  |                     | 2,184,876 |                     |  |                  | 7.29 |             |  | $                | 1.56 |  |  |  | 967,277   |  |  | $ | 1.61 | 
|$1.78  $2.78           |  |                     | 406,594   |                     |  |                  | 4.74 |             |  | $                | 2.24 |  |  |  | 355,481   |  |  | $ | 2.28 | 
|$3.08  $4.94           |  |                     | 432,753   |                     |  |                  | 4.12 |             |  | $                | 3.68 |  |  |  | 432,753   |  |  | $ | 3.68 | 
|                        |  |                     |           |                     |  |                  |      |             |  |                  |      |  |  |  |           |  |  |   |      | 
|                        |  |                     | 9,757,502 |                     |  |                  | 7.43 |             |  | $                | 1.27 |  |  |  | 5,308,931 |  |  | $ | 1.45 | 
|                        |  |                     |           |                     |  |                  |      |             |  |                  |      |  |  |  |           |  |  |   |      | 



| |                
| | ---------------
| | Reserved Shares

The Company has reserved shares of common stock
for future issuance as follows:

|                                                         |  |              |            | 
|-------------------------------------------------------- |  | ------------ | ---------- | 
|                                                         |  | December 31,
|                                                         |  | 2003        
|                                                         |  |             
|Outstanding options                                      |  |              | 9,757,502  | 
|Convertible preferred stock issued and outstanding       |  |              | 11,824,220 | 
|Convertible debentures                                   |  |              | 2,531,646  | 
|Placement agent unit options                             |  |              | 127,676    | 
|Common stock warrants                                    |  |              | 8,437,608  | 
|Reserved for future grant or sale under option
    plans |  |              | 3,080,311  | 
|                                                         |  |              |            | 
|                                                         |  |              | 35,758,963 | 
|                                                         |  |              |            | 

12.     Discontinued
Product Line

In May 2000, the Companys sole customer for
its NeofloTM product, NutraMax Products, Inc.,
filed a voluntary petition under Chapter 11 of the
U.S. Bankruptcy Code. The NutraMax bankruptcy filing had a
negative impact on the Companys sales and cash flow during
calendar year 2000 and first quarter of 2001. On April 2,
2001, the U.S. Bankruptcy Court granted NutraMax a motion
to terminate the Companys supply agreement effective that
date. In May 2001, the Company closed its Lees Summit
manufacturing facility where the NeofloTM product was
being produced. As of December 31, 2001, there were no
definitive purchasers of the NeofloTM product and its
related assets, and as a result, the Company recorded a loss on
the

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

discontinuance of the NeofloTM product
line of $677,000. The loss of $677,000 represents a write-down
of the assets of approximately $262,000 consisting mainly of
manufacturing equipment directly related to the
NeofloTM product line and estimated remaining lease
payments of $415,000 for the Lees Summit facility.

13.     Income
Taxes

As of December 31, 2003, the Company had
federal and state net operating loss carryforwards of
approximately $98 million and $27 million,
respectively. The Company also had federal and California
research and development tax credits of approximately
$2 million and $1 million, respectively. The federal
and state net operating loss carryforwards and the federal
credit carryforwards expire at various dates beginning in the
years 2004 through 2023, if not utilized.

Utilization of the Companys net operating
loss and credit carryforwards may be subject to substantial
annual limitations due to the ownership change limitations
provided by the Internal Revenue Code and similar state
provisions. Such an annual limitation could result in the
expiration of the net operating loss and credit carryforwards
before utilization.

Deferred income taxes reflect the net tax effects
of temporary differences between the carrying amounts of assets
for financial reporting and the amount used for income tax
purposes. Significant components of the Companys deferred
tax assets for federal and state income taxes are as follows (in
thousands):

|                          |                                               |              |         |              |  |   |         |        | 
|------------------------- | --------------------------------------------- | ------------ | ------- | ------------ |  | - | ------- | ------ | 
|                          |                                               | December 31, |         | December 31,
|                          |                                               | 2003         |         | 2002        
|                          |                                               |              |         |             
|Deferred tax liabilities: |                                               |              |         |              |  |   |         |       
|                          | Goodwill and purchased intangibles            |              | $       | 200          |  |   | $       | 200    | 
|                          |                                               |              |         |              |  |   |         |       
|Deferred tax assets:      |                                               |              |         |              |  |   |         |       
|                          | Net operating loss carryforwards              |              | $       | 35,000       |  |   | $       | 33,200 | 
|                          | Research and development credits              |              |         | 1,400        |  |   |         | 1,300  | 
|                          | Capitalized research and development expenses |              |         | 700          |  |   |         | 1,100  | 
|                          | Acquired research and development             |              |         | 1,800        |  |   |         | 800    | 
|                          | Other, net                                    |              |         | 1,000        |  |   |         | 1,000  | 
|                          |                                               |              |         |              |  |   |         |       
|Total deferred tax assets |                                               |              | 39,900  |              |  |   | 37,400  |       
|Valuation allowance       |                                               |              | (39,700 | )            |  |   | (37,200 | )     
|                          |                                               |              |         |              |  |   |         |       
|Net deferred taxes        |                                               | $            |        |              |  | $ |        |       
|                          |                                               |              |         |              |  |   |         |       

Due to the Companys lack of earnings
history, the net deferred tax assets have been fully offset by a
valuation allowance. The valuation allowance increased by
$2,500,000 in 2003, decreased by $300,000 in 2002, and increased
by $200,000 during 2001.

14.     Other 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 31% of the Companys outstanding stock as of
December 31, 2003. In June 2002, the Company signed an
amendment to the promotion agreement. Effective January 1,
2004, the promotion agreement and all amendments were assigned
by VSL to Sigma Tau Pharmaceuticals, Inc. 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

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

shipped to the customer. The Company does not
accept returns of VSL#3. VSL#3 revenue for the years ended
December 31, 2003 and 2002 was $992,000 and $523,000,
respectively, and is included in Net Product Sales. Included in
Accounts Payable are $188,000 and $254,000 for amounts owed to
VSL at December 31, 2003 and 2002, respectively. 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 year ended
December 31, 2003 the amount of the access fee was $59,000
and is included in Selling, General and Administrative expense
in the accompanying Consolidated Statements of Operations. For
the year ended December 31, 2002 the amount of costs
incurred by the Company was greater than the amount owing to
VSL. This net reimbursement to the Company for 2002 was $107,000
and is included as a deduction in Selling, General and
Administrative expense in the Consolidated Statements of
Operations, as VSL reimbursed the Company for these costs.
During the years ended December 31, 2003 and 2002, the
Company paid $466,000 and $72,000, respectively, to VSL for the
purchase of VSL#3 product and access fees.

In January 2002, the Company entered into a
royalty agreement with Glenridge Pharmaceuticals LLC
(Glenridge). Kenneth R. Greathouse, the
Companys former Vice President of Commercial Operations,
is a part owner of Glenridge. As of December 31, 2003,
Mr. Greathouse is an employee of Questcor but is no longer
a Vice President. This agreement calls for the payment of
royalties on a quarterly basis on the net sales of Acthar. The
Company paid Glenridge $297,000 and $443,000 in the years ended
December 31, 2003 and 2002, respectively, related to
royalties on Acthar® sales. The Company accrued $69,000 and
$95,000 for royalties earned but unpaid as of December 31,
2003 and 2002, respectively, which are included in Other Accrued
Liabilities on the accompanying Consolidated Balance Sheets.

15.     Defined
Contribution Plan

The Company sponsors a defined-contribution
savings plan under Section 401(k) of the Internal Revenue
Code covering substantially all full-time U.S. employees.
Participating employees may contribute up to 15% of their
eligible compensation up to the annual Internal Revenue Service
contribution limit. The Plan was adopted in 2000. The Company
matched employee contributions according to specified formulas
and contributed $68,000, $98,000 and $48,000 for the years ended
December 31, 2003, 2002, and 2001, respectively. For the
year ended December 31, 2003, the Company ceased to match
employee contributions halfway through the year.

16.     Comprehensive
Loss

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

|                                                                        |  |                          |        |      |  |      |        |   |  |   |        |  
|----------------------------------------------------------------------- |  | ------------------------ | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                                                        |  |                         
|                                                                        |  | Years Ended December 31,
|                                                                        |  |                         
|                                                                        |  | 2003                     |        | 2002 |  | 2001
|                                                                        |  |                          |        |      |  |     
|Net loss                                                                |  | $                        | (3,791 | )    |  | $    | (2,785 | ) |  | $ | (8,697 | )
|Change in unrealized gains(losses) on
    available-for-sale securities |  |                          | 42     |      |  |      | 73     |   |  |   | (447   | )
|                                                                        |  |                          |        |      |  |      |        |   |  |   |        |  
|Comprehensive loss                                                      |  | $                        | (3,749 | )    |  | $    | (2,712 | ) |  | $ | (9,144 | )
|                                                                        |  |                          |        |      |  |      |        |   |  |   |        |  

17.     Shareholders
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

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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
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), 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.

18.     Subsequent
Events



| |                                      
| | -------------------------------------
| | Private Placement of Common
    Stock

In January 2004 the Company entered into
agreements with existing shareholders to issue
4,878,201 shares of common stock in exchange for $2,399,050
in cash and the surrender of outstanding warrants to purchase
3,878,201 shares of common stock. The warrants retired
represented approximately 46% of the Companys warrants
outstanding as of December 31, 2003. The warrants
surrendered were included as consideration at their fair value
of $743,000 which was determined using a Black-Scholes valuation
method. The purchase price of the common stock, which was
payable in cash and surrender of outstanding warrants, was
$0.644 per share, which was the volume weighted average
price of the Companys common stock for the five trading
days prior to the agreement to the terms of the transaction.
Sigma-Tau purchased 759,493 shares of common stock through
consideration of $489,000 of cash and the surrender of 759,493
warrants to purchase common shares.

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QUESTCOR PHARMACEUTICALS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                      
| | -------------------------------------
| | 2004 Directors Stock Option
    Plan

In February 2004, the Board of Directors adopted
the 2004 Non-Employee Directors Equity Incentive Plan (the
2004 Plan). The adoption of the 2004 Plan is subject
to shareholder approval at the Companys 2004 Annual
Meeting of Shareholders. Under the terms of the 2004 Plan,
1,250,000 shares of the Companys common stock would
be authorized for grants of non-qualified stock options to
non-employee directors of the Company. The 2004 Plan provides
for the granting of 25,000 options to purchase common stock upon
appointment as a non-employee director and an additional 15,000
options each January thereafter upon reappointment. Such option
grants will vest over four years and the exercise price of the
options is 85% of the fair market value on the date of grant.
Additionally, the 2004 Plan provides for the annual granting of
10,000 options to members of committees of the Board of
Directors and 7,500 options to chairmen of committees. Such
option grants will have an exercise price equal to 100% of the
fair market value of the Companys common stock on the date
of the grant and will become fully vested at the time of grant.
The maximum term of the options granted under the 2004 Plan is
ten years.

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QUESTCOR PHARMACEUTICALS, INC.

FINANCIAL STATEMENT SCHEDULES (ITEM
15(a)(2))

SCHEDULE II VALUATION AND QUALIFYING
ACCOUNTS

Years Ended December 31, 2003, 2002 and
2001


|                                                 |                   |                |   |              |  |            |   |            |   |  |   |       |  |  |   |     | 
|------------------------------------------------ | ----------------- | -------------- | - | ------------ |  | ---------- | - | ---------- | - |  | - | ----- |  |  | - | --- | 
|                                                 |                   |                |   | Additions/   |  |            |   |           
|                                                 |                   | Balance at     |   | (Deductions) |  | Deductions |   | Balance at
|                                                 |                   | Beginning      |   | Charged to   |  | and        |   | End of    
|                                                 |                   | Period         |   | Income       |  | Write-offs |   | Period    
|                                                 |                   |                |   |              |  |            |   |           
|                                                 |                   |               
|                                                 |                   | (In thousands)
|Reserves for uncollectible accounts              |                   |                |   |              |  |            |   |            |   |  |   |       |  |  |   |    
|                                                 | December 31, 2003 |                | $ | 20           |  |            | $ | 43         |   |  | $ | 3     |  |  | $ | 60  | 
|                                                 | December 31, 2002 |                | $ | 78           |  |            | $ | (40        | ) |  | $ | 18    |  |  | $ | 20  | 
|                                                 | December 31, 2001 |                | $ | 56           |  |            | $ | 51         |   |  | $ | 29    |  |  | $ | 78  | 
|Reserves for obsolete and excess inventories     |                   |                |   |              |  |            |   |            |   |  |   |       |  |  |   |    
|                                                 | December 31, 2003 |                | $ | 76           |  |            | $ | 406        |   |  | $ | 141   |  |  | $ | 341 | 
|                                                 | December 31, 2002 |                | $ | 56           |  |            | $ | 72         |   |  | $ | 52    |  |  | $ | 76  | 
|                                                 | December 31, 2001 |                | $ | 28           |  |            | $ | 45         |   |  | $ | 17    |  |  | $ | 56  | 
|Reserves for sales and product return allowances |                   |                |   |              |  |            |   |            |   |  |   |       |  |  |   |    
|                                                 | December 31, 2003 |                | $ | 447          |  |            | $ | 1,472      |   |  | $ | 1,304 |  |  | $ | 615 | 
|                                                 | December 31, 2002 |                | $ | 221          |  |            | $ | 1,143      |   |  | $ | 917   |  |  | $ | 447 | 
|                                                 | December 31, 2001 |                | $ |             |  |            | $ | 271        |   |  | $ | 50    |  |  | $ | 221 | 

All other financial statement schedules are
omitted because the information described therein is not
applicable, not required or is furnished in the financial
statements or notes thereto.

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EXHIBIT INDEX

|        |    |             |  |                                                                                                                                                                                                                                                                                                   
|------- | -- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 2  | .1(1)       |  | Merger agreement entered into August 4,
    1999, by and among Cypros Pharmaceutical Corporation, a
    California corporation (Parent), Cypros Acquisition
    Corporation, a Delaware corporation and a wholly owned
    subsidiary of Parent, and RiboGene, Inc., a Delaware
    corporation.
|        | 3  | .1(2)       |  | Amended and Restated Articles of Incorporation of
    the Company.                                                                                                                                                                                                                                
|        | 3  | .2(3)       |  | Certificate of Determination of Series B
    Convertible Preferred Stock of the Company.                                                                                                                                                                                                          
|        | 3  | .3(4)       |  | Certificate of Determination of Series C
    Junior Participating Preferred Stock of the Company.                                                                                                                                                                                                 
|        | 3  | .4(5)       |  | Bylaws of the Company.                                                                                                                                                                                                                                                                            
|        | 4  | .1(6)       |  | Convertible Debenture between the Company and SF
    Capital Partners Ltd. dated March 15, 2002.                                                                                                                                                                                                  
|        | 4  | .2(6)       |  | Convertible Debenture between the Company and
    Defiante Farmaceutica Unipessoal L.D.A. dated March 15,
    2002.                                                                                                                                                                               
|        | 10 | .1(7)       |  | Forms of Incentive Stock Option and Non-statutory
    Stock Option.                                                                                                                                                                                                                               
|        | 10 | .2(8)       |  | 1992 Employee Stock Option Plan, as amended.                                                                                                                                                                                                                                                      
|        | 10 | .3(9)       |  | 1993 Non-employee Directors Equity Incentive
    Plan, as amended and related form of Nonstatutory Stock Option.                                                                                                                                                                                  
|        | 10 | .4(9)       |  | Employment Agreement dated as of August 4,
    1999 between the Company and Charles J. Casamento.                                                                                                                                                                                                 
|        | 10 | .5(10)      |  | 2000 Employee Stock Purchase Plan.                                                                                                                                                                                                                                                                
|        | 10 | .6(11)      |  | Asset Purchase Agreement dated July 27, 2001
    between the Company and Aventis Pharmaceuticals
    Products, Inc.                                                                                                                                                                              
|        | 10 | .7(11)      |  | First Amendment to Asset Purchase Agreement dated
    January 29, 2002, between the Company and Aventis
    Pharmaceuticals Products, Inc.                                                                                                                                                       
|        | 10 | .8(11)      |  | Promotion Agreement dated December 1, 2001
    between the Company and VSL Pharmaceuticals, Inc.                                                                                                                                                                                                 
|        | 10 | .9(11)      |  | First Amendment to Promotion Agreement dated
    June 27, 2002 between the Company and VSL
    Pharmaceuticals, Inc.                                                                                                                                                                             
|        | 10 | .10(12)     |  | Stock Purchase Agreement dated July 31, 2001
    between Registrant and Sigma-Tau Finance Holding S.A.                                                                                                                                                                                            
|        | 10 | .11(13)     |  | Warrant dated December 1, 2001 between the
    Company and Paolo Cavazza.                                                                                                                                                                                                                         
|        | 10 | .12(13)     |  | Warrant dated December 1, 2001 between the
    Company and Claudio Cavazza.                                                                                                                                                                                                                       
|        | 10 | .13(6)      |  | Securities Purchase Agreement between the Company
    and SF Capital Partners Ltd. dated March 15, 2002.                                                                                                                                                                                          
|        | 10 | .14(6)      |  | Registration Rights Agreement between the Company
    and SF Capital Partners Ltd. dated March 15, 2002.                                                                                                                                                                                          
|        | 10 | .15(6)      |  | Warrant between the Company and SF Capital
    Partners Ltd. dated March 15, 2002.                                                                                                                                                                                                                
|        | 10 | .16(6)      |  | Securities Purchase Agreement between the Company
    and Defiante Farmaceutica Unipessoal L.D.A. dated March 15,
    2002.                                                                                                                                                                       
|        | 10 | .17(6)      |  | Registration Rights Agreement between the Company
    and Defiante Farmaceutica Unipessoal L.D.A. dated March 15,
    2002.                                                                                                                                                                       
|        | 10 | .18(6)      |  | Warrant between the Company and Defiante
    Farmaceutica Unipessoal L.D.A. dated March 15, 2002.                                                                                                                                                                                                 
|        | 10 | .19(3)      |  | Form of Common Stock Purchase Warrant dated
    January 15, 2003 issued by the Company to purchasers of
    Series B Convertible Preferred Stock.                                                                                                                                                 
|        | 10 | .20(14)     |  | Amendment to Employment Agreement between the
    Company and Charles J. Casamento dated March 21, 2003.                                                                                                                                                                                          
|        | 10 | .21(4)      |  | Rights Agreement, dated as of February 11,
    2003, between the Company and Computershare Trust
    Company, Inc.                                                                                                                                                                                
|        | 10 | .22(3)      |  | Form of Subscription Agreement dated as of
    December 29, 2002 by and between the Company and purchasers
    of Series B Convertible Preferred Stock and Common Stock
    Purchase Warrants.                                                                                                    



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##### Table of Contents



|        |     |             |  |                                                                                                            
|------- | --- | ----------- |  | -----------------------------------------------------------------------------------------------------------
|Exhibit |     |            
|Number  |     | Description
|        |     |            
|        | 10  | .23(14)     |  | Letter Agreement dated May 2, 2000 between
    the Company and Kenneth R. Greathouse.                      
|        | 10  | .24(14)     |  | Amendment to Letter Agreement dated
    March 21, 2003 between the Company and Kenneth R.
    Greathouse.  
|        | 10  | .25(14)     |  | Letter Agreement dated August 24, 2001
    between the Company and Timothy E. Morris.                      
|        | 10  | .26(14)     |  | Amendment to Letter Agreement dated
    November 7, 2001 between the Company and Timothy E. Morris.        
|        | 10  | .27(14)     |  | Amendment to Letter Agreement dated
    March 21, 2003 between the Company and Timothy E. Morris.          
|        | 10  | .28*        |  | Letter Agreement dated September 2, 2003
    between the Company and R. Jerald Beers.                      
|        | 10  | .29*        |  | Amendment to Letter Agreement dated
    November 6, 2003 between the Company and R. Jerald Beers.          
|        | 10  | .30*        |  | Supply Agreement dated April 1, 2003 between
    the Company and BioVectra, dcl.                           
|        | 23  | .1*         |  | Consent of Ernst & Young
    LLP, Independent Auditors.                                                    
|        | 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.



---



| |   |                
| | - | ---------------
| | * | Filed herewith.



| |     |                                                                                                                                                                                             
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Filed as an exhibit to the Companys Annual
    Report on Form 10-K for the fiscal year ended
    December 31, 1999, and incorporated herein by reference.                                  
|
| | (2) | Filed as an exhibit to the Companys
    Registration Statement on Form S-8, Registration Statement
    No. 333-30558, filed on February 16, 2000, and
    incorporated herein by reference.
|
| | (3) | Filed as an exhibit to the Companys Current
    Report on Form 8-K filed on January 16, 2003, and
    incorporated herein by reference.                                                    
|
| | (4) | Filed as an exhibit to the Companys Current
    Report on Form 8-K filed on February 14, 2003, and
    incorporated herein by reference.                                                   
|
| | (5) | Filed as an exhibit to the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    September 30, 2002, and incorporated herein by reference.                                  
|
| | (6) | Filed as an exhibit to the Companys
    Registration Statement on Form S-3, Registration
    No. 333-85160, filed on March 28, 2002, and
    incorporated herein by reference.             
|
| | (7) | Filed as an exhibit to the Companys
    Registration Statement on Form S-1, Registration
    No. 33-51682, and incorporated herein by reference.                                           
|
| | (8) | Filed as an exhibit to the Companys Proxy
    Statement for the 2002 Annual Meeting of Shareholders, filed on
    March 28, 2002, and incorporated herein by reference.                    
|
| | (9) | Filed as an exhibit to the Companys
    Registration Statement Form S-4, Registration Statement
    No. 333-87611, filed on September 23, 1999, and
    incorporated herein by reference.  



|     |                                                                                                                                                                                              
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Filed as an exhibit to the Companys
    Registration Statement on Form S-8, Registration Statement
    No. 333-46990, filed on September 29, 2000, and
    incorporated herein by reference.
|    
|(11) | Filed as an exhibit to the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    June 30, 2002, and incorporated herein by reference.                                        
|    
|(12) | Filed as an exhibit to the Companys
    Quarterly Report on Form 10-Q for the quarter ended
    June 30, 2001, and incorporated herein by reference.                                        
|    
|(14) | Filed as an exhibit to the Companys Annual
    Report on Form 10-K for the fiscal year ended
    December 31, 2001, and incorporated herein by reference.                                   
|    
|(14) | Filed as an exhibit to the Companys Annual
    Report on Form 10-K for the fiscal year ended
    December 31, 2002, and incorporated herein by reference.                                   



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