Edgar Filing: ORPHAN MEDICAL INC

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

(MARK ONE)

[X] ANNUAL REPORT PURSUANT SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 0-24760
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ORPHAN MEDICAL, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 41-1784594
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)

13911 RIDGEDALE DRIVE, SUITE 250 (952) 513-6900
MINNETONKA, MN 55305 (Registrant's telephone number, including area
(Address of principal executive offices and code)
zip code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $.01
PAR VALUE

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark 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 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. [ ]

Aggregate market value of common stock held by non-affiliates of
Registrant, based upon the last sale price of the Common Stock reported on the
Nasdaq National Market tier of The Nasdaq Stock Market on March 18, 2002 was
$133,768,000. Common stock outstanding at March 18, 2002 was 10,290,000 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Definitive Proxy Statement filed with the
Securities and Exchange Commission in connection with the solicitation of
proxies for the Registrant's Annual Meeting of Stockholders to be held on May
23, 2002 are incorporated by reference in Part III, Items 10, 11, 12 and 13 of
this Form 10-K.
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PART I.

This Annual Report on Form 10-K contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. All
forward-looking statements are inherently uncertain as they are based on current
expectations and assumptions concerning future events or future performance of
the Company. Readers are cautioned not to place undue reliance on these
forward-looking statements, which are only predictions and speak only as of the
date hereof. Forward-looking statements are not descriptions of historical
facts. The words or phrases "will likely result", "look for", "may result",
"will continue", "is anticipated", "expect", "project", or similar expressions
are intended to identify forward-looking statements, and are subject to numerous
known and unknown risks and uncertainties. Actual results could differ
materially from those currently anticipated due to a number of factors,
including those identified in the section entitled "Risk Factors" in this Annual
Report on Form 10-K, and in the Company's other filings with the Securities and
Exchange Commission. The Company undertakes no obligation to update or publicly
announce revisions to any forward-looking statements to reflect future events or
developments.

Antizol(R), Antizol-Vet(R), Caprogel(TM), Busulfex(R), Intrachol(TM),
Cystadane(R), Elliotts B(R) Solution, Sucraid(R), Xyrem(R), MedExpand(TM) ,
"The" Orphan Drug Company(TM), Orphan Medical, Inc.(R) and Dedicated to Patients
with Uncommon Diseases(R) are trademarks of the Company.

ITEM 1. BUSINESS

OVERVIEW

Orphan Medical, Inc. (the "Company") acquires, develops and markets
pharmaceutical products of high medical value for patients within selected
therapeutic areas. A pharmaceutical product has high medical value if it offers
a major improvement in the safety or efficacy of patient treatment. The Company
currently concentrates its efforts on drugs with high medical value that may be
marketed within three therapeutic areas: Antidotes, Oncology Support, and Sleep
Disorders. Antizol and Busulfex are available commercially and are the Company's
lead products in its Antidotes and Oncology Support therapeutic areas,
respectively. Xyrem is an investigational drug and is expected to be the
Company's lead product in its Sleep Disorders therapeutic area. In addition, the
Company manufactures and distributes Cystadane and Sucraid that treat two rare
congenital diseases. Antizol-Vet is marketed through separate channels to the
veterinary community. Although Cystadane, Sucraid, and Antizol-Vet do not fall
into the selected therapeutic areas, the Company offers and expects to continue
offering these products because they have high medical value and require limited
resources to market and distribute.

Each of the Company's target therapeutic areas is characterized by a
well-defined patient population that is treated by a well-defined group of
medical specialists. The Company believes this targeted marketing approach makes
a large sales force unnecessary to market the Company's products because
marketing efforts can be focused on a limited number of medical specialists or
patients. The high medical value of the Company's products facilitates marketing
efforts directed toward users and prescribers. The Company intends to promote
awareness of the key advantages of Orphan Medical branded products within
Antidotes, Oncology Support, and Sleep Disorders for marketed products through
its marketing and sales efforts. The Company's marketing and sales efforts
differentiate its products on the basis of quality, potentially improved medical
outcomes, and cost effectiveness. The Company uses established distributors of
pharmaceutical products for its currently marketed products in a manner similar
to that of most other pharmaceutical companies.

The Company believes its approach to pharmaceutical product development
reduces the time, costs and risks traditionally involved in bringing
pharmaceutical products to market. In general, the Company does not conduct
basic research and does not attempt to discover new drugs. The Company's
strategy is to acquire licenses to develop new products, or develop existing
known therapeutic substances for new indications, and market products that
preferably have existing clinical data that indicate therapeutic value and
safety. In addition, the Company considers acquiring products that have already
received marketing approval from the U.S. Food and Drug Administration (the
"FDA"). The Company uses contract development, manufacturing, and consulting
companies to assist it in its product development activities.

The Company operates within a single industry segment: pharmaceutical
product development, marketing and sales. To date, the Company has obtained
marketing approval from the FDA for six New Drug Applications ("NDA").

The Company's products are commercially available in the United States and
several foreign countries. Revenues from sales of the Company's approved
products within the United States were approximately 84.9% of total 2001
revenues, and revenues from sales outside the United States were approximately
15.1% of total 2001 revenues.

A Treatment Investigational New Drug ("IND") application for Xyrem was
approved by the FDA in December 1998 and the Company began shipping Xyrem in
February 1999 for use in its Treatment IND clinical trials. The Treatment IND
allows the Company to seek payments for Xyrem used by patients enrolled in the
Treatment IND clinical trials and to obtain additional clinical safety data for
Xyrem. The Company submitted its NDA for Xyrem on October 2, 2000. The NDA was
granted priority review status by the FDA, meaning the FDA had a goal of
reaching a decision to either approve or disapprove or delay a decision
regarding the NDA within 180 days of submission. On March 2, 2001, the FDA
granted a 90 day extension to the Company's NDA in order that the Company could
submit additional data requested by the FDA. On June 6, 2001, the FDA held a
meeting of the Peripheral and Central Nervous System Advisory Committee to
consider Xyrem. The Advisory Committee voted affirmatively that Xyrem was
effective in treating cataplexy, but was split on the issue of Xyrem's safety
due to the relatively small size of the safety database. As a result, the FDA
issued an Approvable Letter for Xyrem on July 2, 2001. The Approvable Letter
defined issues that required resolution before approval could be granted for the
treatment of cataplexy. On October 23, 2001, the Company announced that the FDA
had accepted the Company's response, in the form of an amendment, to the
Approvable Letter. The amendment represented the Company's complete response to
the issues contained in the FDA's Approvable Letter. The amendment includes
revisions to product labeling and the risk management program, a safety update
of ongoing clinical trials, and respiratory data collected during all night
polysomnographic recordings of narcolepsy patients in a clinical trial completed
in late 2000. The Company believes it has addressed all questions and issues the
FDA may have regarding the NDA for Xyrem. The FDA assigned April 9, 2002 as its
action deadline for this NDA.

As a growing specialty pharmaceutical company, the Company did not achieve
profitability in 2001 and does not expect to do so in 2002. The Company has
significant capital requirements to support product development and marketing
efforts until profitability is achieved. In December 2001, the Company completed
the sale of 1,706,999 newly issued shares of common stock yielding net proceeds
of $13.0 million.

STRATEGIC BACKGROUND

In the 1950s and early 1960s, drug development was relatively inexpensive
and regulatory approval was straightforward. Pharmaceutical companies marketed
their products through sales forces directly to physicians who generally had
independent responsibility for prescription and purchase decisions. In the
1970s, however, regulatory standards and competition increased and the price of
research and development and manufacturing rose dramatically. In the 1980s and
1990s, prescription decisions by physicians were constrained by managed care
entities and drug companies revised their targeted rates-of-return or financial
"hurdle rates", as well as other selection criteria, to avoid developing drugs
whose incremental profit contributions were considered insufficient to provide
acceptable returns on investment. Many of the drugs that did not meet these
criteria were drugs that treat diseases affecting smaller patient populations.
As a consequence, new drugs for such diseases were less likely to be developed
by larger companies. Some research institutions, universities and small
companies, however, have continued to develop and conduct clinical trials on
these types of drugs.

The Company's business strategy is based on several factors relating to
these and other changes in the health care and pharmaceutical industries:

- Larger pharmaceutical companies generally have increased their financial
return rates, seek new products with annual revenues greater than $300
million and avoid developing new products that address diseases outside
their therapeutic areas of focus. As a result, the Company believes many
developmental products of high medical value are available for licensing.
If these products are intended
2

to address smaller markets, they may be eligible for orphan drug designation.
Many of these products have already been developed to the point where the time
and cost required to bring the product to market can be reasonably estimated.

- The knowledge and skills required to address many aspects of drug
development are available on a contract basis from outside companies or
individuals.

- To address rapidly changing market forces, alternative means of marketing
and distributing pharmaceuticals have been created. The advent of the
Internet has dramatically increased the availability of information,
including information related to health and health care products. Many
products, particularly those targeted to smaller, well-defined markets,
do not require a large, specialized sales force and can be marketed
through direct means such as exhibits at professional meetings, direct
mailings, telemarketing, continuing medical education programs, and the
Internet. In addition, these products can be effectively distributed
through companies that are proficient in distribution of pharmaceutical
products to smaller patient populations.

In response to these changes, the Company has adopted a business strategy
that is centered on products of high medical value within well-defined strategic
therapeutic areas. The Company uses the knowledge and skills available on a
contract basis where necessary, and uses alternative marketing and distribution
channels.

BUSINESS STRATEGY

The Company focuses on products of high medical value intended to address
inadequately treated or uncommon diseases within selected therapeutic areas. A
drug has high medical value if it offers a major improvement in the safety or
efficacy of current patient treatments. In addition to products with high
medical value, the Company seeks pharmaceutical products that have readily
measured clinical endpoints, existing positive clinical data, proprietary
attributes, eligibility for insurance reimbursement, and that offer attractive
financial returns. The Company generally does not conduct basic research to
discover new drugs, but instead seeks to acquire and further develop products
that already have some data that indicate the presence of therapeutic value and
safety. The Company's strategy of developing and marketing high medical value
drugs with these clinical characteristics is intended to achieve the following
benefits:

- Regulatory Requirements and Review -- Drugs of high medical value have a
greater likelihood of receiving expedited review by the FDA. If these
drugs also have smaller patient populations, the number of patients
required for clinical trials is generally reduced.

- Product Development Time and Cost -- The Company attempts to concentrate
resources and project management attention on a single medical indication
in order to limit the amount of clinical information required by the FDA
to clear a product for marketing. The time and cost of development is
directly related to the amount of clinical information required for
regulatory approval.

- Limited Infrastructure -- The Company believes that high quality
pharmaceutical products can be developed efficiently and economically
using well established independent contractors directed by its
experienced staff. Accordingly, the Company uses the available pool of
contract development, manufacturing, distribution and consulting
companies to assist in product development and marketing activities. This
approach allows the Company to avoid the costs, time and financial risks
associated with developing an extensive infrastructure to perform these
functions internally.

- Marketing Strategy -- To assess the viability potential product, the
Company considers questions such as these:

* Are there unmet therapeutic needs as defined by the customer (the
patient or the health care practitioner)?

* Are there other product development or product acquisition
opportunities that complement the product or does the product fit in
the Company's selected therapeutic areas of focus?

* Can the product's brand be established and command significant market
share?

- Direct Sales -- The Company has built a small, specialized sales force to
promote Antizol and Busulfex. The sales force has extensive knowledge of
the Antidote and Oncology Support therapeutic areas, as well as extensive
marketing and business experience. The Company's sales force utilizes a
consultative, customer-oriented approach to selling. The Company expects
to utilize a similar sales force approach with the Sleep Disorders
therapeutic area, but will also use a contract sales organization to
supplement the efforts of its sales force.

- Alliances -- The high medical value of the Company's products has
interested other companies seeking to market the Company's products
outside the United States. To date, the Company has agreements with nine
companies relating to five of the Company's products. The Company also
believes that its relationships with these and other partners, may
provide strategic benefits, possibly in the area of product acquisition
opportunities or in market share penetration programs.

- Attraction of Potential New Products -- As the Company's strategy and
focus on pharmaceutical products of high medical value within a selected
therapeutic area becomes better known and understood by others in the
research and development community, and as the Company further proves its
ability to market and sell into a therapeutic area, the Company expects
more product development or acquisition opportunities will be presented
to it in the future.

RISK MANAGEMENT

The Company's strategy has been designed, in part, to manage its overall
business risk. The Company has pursued three distinct therapeutic areas rather
than concentrating its resources on a single therapeutic area or a single
platform technology. To reduce its product development risk, the Company
generally seeks to develop products that (1) are known to the medical community
and to the FDA, (2) have a straightforward formulation that can be readily
manufactured with established technologies, and (3) do not require excessively
specialized processes for development or manufacture. In addition, the Company
generally seeks to acquire products that are already in Phase II or Phase III
clinical trials, or in an earlier stage of development with proof of concept
established. When a product is licensed without the equivalent of Phase II or
III data, the Company may conduct one or more "proof of concept" to better
assess the likelihood of efficacy or safety. Each such pilot trial is narrowly
defined and has a separate budget that to date has not exceeded $500,000. The
Company does not conduct extensive basic research to discover new chemical
entities. The Company may also purchase rights to approved products. To reduce
its marketing risk, the Company generally attempts to obtain some form of
proprietary protection, such as orphan drug status, patent protection, exclusive
licensing agreements, predominant market penetration or sole supplier
agreements.

PROPRIETARY RIGHTS

The Company believes it is important that its products receive patent
protection, orphan drug status or possess other attributes that limit potential
competition. When available and appropriate, the Company will seek orphan drug
status to enhance or provide proprietary protection to a product. A drug that
has orphan drug designation and which is the first product to receive marketing
approval for its product claim, indication or application, receives orphan drug
status and is entitled to a seven-year exclusive marketing period in the United
States for that product claim, indication or application, subject to certain
limitations. The Company currently has five products with orphan drug status.
Applications for Orphan Drug designation will be made where appropriate and
available for any additional indications or products that may be licensed in the
future.

To encourage the continued development of drugs for smaller patient
populations, the federal government enacted the Orphan Drug Act of 1983. This
Act provides incentives to companies to develop and market drugs for diseases or
conditions that are known to affect fewer than 200,000 people in the United
States. A company must request orphan drug designation before an NDA is
approved, and after the FDA grants orphan drug designation, the generic identity
of the therapeutic agent (drug) and its potential orphan use (market) are
published by the FDA. Orphan Drug designation does not convey any advantage in,
or shorten the duration of, the regulatory approval process. The FDA may grant
Orphan Drug designation to more than one company of an identical drug for the
same designated indication, however under current law, orphan drug status is
granted

to the first company receiving FDA marketing approval for a specific indication
of a drug with orphan drug designation. A company receiving orphan drug status
for a designated indication is entitled to a seven-year exclusive marketing
period in the United States for the drug with the approved indication, subject
to certain limitations. Orphan drug status, however does not prevent subsequent
approval of a different drug for the same designated indication, nor subsequent
approval of the same drug for a different designated indication, nor provide any
marketing exclusivity in foreign markets. Since 1983, the FDA has assigned
orphan drug designation to more than 650 potential products. Orphan Drug
protection is available in Japan and the European Union under requirements
similar to those in the United States.

The license agreement pursuant to which the Company has acquired rights to
develop and market Busulfex provides for an assignment of the licensor's
proprietary rights, including patent and technology rights. With respect to
additional products it may license in the future, if any, the Company expects
that such licenses will include, if such rights are available, an assignment of
the licensor's proprietary rights with respect to the licensed product. Foreign
patent applications have been filed for Busulfex and Xyrem. In 2000, the Company
obtained the rights to patents in the United States and Europe covering the use
of gamma hydroxbutyrate ("GHB") in the treatment of fibromyalgia. The Company
has licensed the rights to two patents related to a new potential development
opportunity. The Company is evaluating a development program for this product.
The Company evaluates the desirability of registering approved patents or other
forms of protection for its products in individual foreign markets based on the
expected costs and relative benefits of attaining such protection.

THE REGULATORY PROCESS

Pharmaceutical products intended for therapeutic use in humans are governed
by extensive FDA regulations in the United States and by comparable regulations
in foreign countries. The process of seeking and obtaining FDA approval for an
unapproved new human pharmaceutical product generally takes many years and
involves the expenditure of substantial resources and considerable risk.

The process before a drug product can be marketed in the United States
includes (i) pre-clinical laboratory and animal safety tests, (ii) the
submission to the FDA of an IND application, (iii) clinical and other studies to
assess safety and parameters of use, (iv) adequate and well-controlled clinical
trials to establish the safety and effectiveness of the drug product, (v) the
submission to the FDA of an NDA, (vi) FDA approval of the NDA prior to any
commercial sale or shipment of the product and (vii) marketing of the drug.

Upon the successful completion of clinical testing, a marketing application
(e.g., NDA) is submitted to the FDA for approval. This application requires
detailed data on the results of pre-clinical testing, clinical testing and the
composition of the product; specimen labeling to be used with the drug;
information on manufacturing methods; and samples of the product. Since the
passage of the Prescription Drug User Fee Act ("PDUFA"), the FDA typically takes
from six to eighteen months to review an NDA after it has been accepted for
filing. Following its review of a marketing application, the FDA invariably
raises questions or requests additional information. The NDA approval process
can, accordingly, be very lengthy. Further, there is no assurance that the FDA
will ultimately approve an NDA. The FDA can also determine that a drug is
"approvable" contingent on satisfactory review of additional information
requested by the FDA. If the FDA approves the NDA, the new product may be
marketed for the applications or treatments that have been approved by the FDA.
The claims with which a product can be marketed are also subject to review and
approval by the Division of Drug Marketing, Advertising and Communications
("DDMAC"), the FDA's marketing surveillance department within the Center for
Drugs. The FDA often clears a product for marketing with a modification, or
restriction to the proposed label claims or requires that post-marketing
surveillance, or Phase IV testing, to be conducted. The method and system of a
drug's distribution can also be controlled by the FDA if approved under Subpart
H regulations.

OPERATING FUNCTIONS

The Company has structured its operating functions to support its business
strategy. Following is a general explanation of the typical steps in the
Company's processes of product acquisition, development and marketing.

PRODUCT ACQUISITION

The Company actively searches for product licensing opportunities. The
continual acquisition of products for development and/or commercialization is a
key element of the Company's growth strategy. The Company attracts product
acquisition proposals through a network of customer and industry contacts,
licensing brokers and a growing awareness of its activities by governmental,
academic and industry sources. Since its inception, the Company has evaluated
many product opportunities. To date, sixteen products have been acquired, with
seven of these products currently under development or being marketed.

The Company seeks to acquire pharmaceutical products within selected
therapeutic areas that, in the Company's opinion, generally:

- Are of high medical value as defined by the customer (physician or
patient) within a therapeutic area;

- Treat diseases that affect distinct patient populations;

- Are prescribed by physician specialists;

- Can be marketed with a relatively small, specialized sales team to health
care specialists, health care institutions, and patients;

- Are likely to be eligible for reimbursement by third-party payors;

- Have or are candidates for patent protection, orphan drug designation or
have other characteristics that enhance the Company's competitive
position;

- Treat diseases that have clinical endpoints (i.e., signs or symptoms)
that are readily measured;

- Are conventional pharmaceutical products that are relatively
straightforward in formulation and development, and do not involve the
application of new technologies;

- Are in Phase II or Phase III clinical trials and have a relatively high
likelihood of obtaining the approval of the FDA within three to four
years of acquisition;

- Offer attractive potential financial returns with relatively inexpensive
development costs; and

- Compliment other products in an existing therapeutic area or can be
grouped with other products to build a new therapeutic area.

In selecting products for potential inclusion in its portfolio, the Company
focuses on acquiring rights to medicines that serve niche or defined patient
populations. Major drug companies are less likely to focus on these niche
markets because they do not believe these markets will produce acceptable
revenues and returns. This reluctance limits the number of potential sources of
competition. In addition, a product designed for smaller patient populations is
often eligible for orphan drug designation. By obtaining orphan drug
designation, the Company is granted exclusive marketing rights in the United
States for seven years, subject to certain limitations, after an NDA for a
product is approved, if the Company is the first to receive approval for the
designated drug and indication.

The Company seeks to acquire potential products that already have, or will
not require, a substantial quantity of clinical data to demonstrate their
relative efficacy and safety. The Company also searches for product candidates
that represent new delivery methods or dosage forms of previously approved or
known compounds because the Company believes these types of products are more
likely to be quickly approved by the FDA and accepted by the medical community.
In addition, the Company attempts to develop medicines where clear clinical
endpoints can demonstrate their effectiveness. Generally, the Company seeks to
acquire products that can be developed to the point of FDA approval within three
to four years of their acquisition. The Company also focuses its development
efforts on one indication and, when possible, one dosage form to

minimize development costs. Potential additional indications or dosage forms
will only be evaluated after the primary NDA is submitted or approved.

An additional element of the Company's product development strategy is to
acquire products that have proprietary protection or for which the Company can
obtain some degree of proprietary protection. The Company seeks to accomplish
this goal by selecting products that are eligible for Orphan Drug designation,
are covered by patents or are the subject of an exclusive license from a sole
supplier or a manufacturer with specialized or proprietary processes. The
availability or likelihood of adequate levels of reimbursement from third-party
payors is also an important factor in product acquisition decisions.

Company management reviews new product opportunities and makes
recommendations to the Board of Directors regarding the license or acquisition
of additional products. The product review process generally involves
discussions with customers (physicians and patients) within a specific
therapeutic area to identify unmet needs, and with the initial product developer
and experts in the disease treated by the drug; review of research publications
and other databases to gauge competitive activities; market research aimed at
identifying potential acceptance by the end user; technical evaluations to
determine manufacturability and cost; expected FDA regulatory requirements to
obtain acceptable marketing or promotional claims; and a legal review of any
relevant proprietary rights. If this review indicates that the proposed product
meets the Company's selection criteria, efforts to negotiate a license are
initiated. Generally, the Company seeks to obtain licenses that require a
minimal signing fee, are subject to commercially acceptable royalty levels and,
where appropriate, provide for the continued involvement of the original
developer in the development process through a consulting or similar
arrangement.

The Company is continually seeking and evaluating additional proposed
products within the selected therapeutic areas. Should the Company be
unsuccessful in acquiring additional proposed products for development and
commercialization within a selected therapeutic area, the Company may reassess
the viability of the selected therapeutic area and redefine the selected
therapeutic area to expand the number of potential products that might satisfy
the Company's acquisition criteria for a viable therapeutic area to ensure
adequate future growth of the Company.

PRODUCT DEVELOPMENT

Pharmaceutical product development is one of the Company's principal
activities. The Company has incurred $41.5 million in research and development
expense through December 31, 2001. In addition, the Company estimates that it
will incur at least an additional $5.0 million in research and development
expense relating to the six products it currently markets, obtain FDA approval
for marketing Xyrem and to begin evaluation of additional Xyrem indications.

A major element of the Company's product development strategy is to use
third-parties or contract research organizations (CROs) to assist in the conduct
of safety and efficacy testing and clinical studies, to assist the Company in
guiding products through the FDA review and approval process, and to manufacture
and distribute any FDA approved products. The Company believes that maintaining
a minimal infrastructure will enable it to develop products efficiently and cost
effectively. To facilitate this strategy, the Company uses a team approach to
develop its proposed products. A development team is organized and managed by
senior staff. The development team is cross-functional and includes in-house
experts, as well as appropriate outside consultants, to manage all development
activities as well as market planning with respect to a proposed product. A
development team designs a development plan, which will support the proposed
indication and marketing claims, and creates and manages a financial budget for
the proposed product and contracts with outside development agents and
consultants to arrange for the necessary clinical and toxicology studies,
manufacturing arrangements and FDA filings. Upon approval of the NDA by the FDA,
the Company's marketing and sales staff manages marketing and sales of the
proposed product.

The Company believes the use of third parties to develop and manufacture
its products has several advantages. This approach allows a greater pool of
resources to be concentrated on a product than if these functions were performed
by internal personnel who were required to support all of the Company's
products. Although this approach allows the Company to avoid the expense
associated with developing a large internal
7

infrastructure to support its product development efforts, it results in the
Company being dependent on the ability of outside parties to perform certain
critical functions. Over time, the Company expects to build internal
capabilities to replace certain functions currently being performed by outside
parties.

The Company's approach to product development requires project management
by professionals with substantial industry experience. The Company believes it
has in-house experts in areas of critical importance to all of its proposed
products who can be consulted by the development teams. These areas include
regulatory affairs, marketing and sales, quality assurance, manufacturing,
clinical trials management, finance, information systems and general management.

The product development process is designed to identify problems associated
with a proposed product's clinical aspects. The Company attempts to reduce the
risk that a proposed product will not be accepted in the marketplace by
conducting market research and defining commercial strategy with a product's
development. A drug development portfolio cannot be completely insulated from
potential clinical and marketing failures. It is likely that some proposed
products selected for development by the Company will not produce the clinical
or revenue results expected. To date, the Company has discontinued development
activities with respect to eleven proposed products because the estimated
financial returns of these proposed products were deemed unacceptable by
management.

MANUFACTURING

The Company does not have and does not intend to establish any internal
product testing, drug or chemical synthesis of bulk drug substance, and
manufacturing capability for drug product. Manufacturers of the Company's
products are subject to applicable Good Manufacturing Processes ("GMP") as
required by FDA regulations, or other rules and regulations prescribed by
foreign regulatory authorities. The Company is negotiating or has entered into
bulk drug supply and drug product manufacturing agreements with third parties
for all of its FDA approved products and is dependent on such third parties for
continued compliance with GMP and applicable foreign standards. The Company
believes that qualified manufacturers will continue to be available in the
future, at a reasonable cost to the Company, although there can be no assurance
that this will be the case.

Due to FDA mandated dating requirements and the limited market size for the
Company's approved products, the Company may be subject to complex manufacturing
logistics, minimum order quantities that could result in excess inventory as
determined under the Company's accounting policy, unsalable inventory as a
result of product expiring prior to use, and competition with others for
manufacturing services when needed or expected. The Company has a production
planning program to assess and manage the manufacturing logistics amongst the
vendors supplying the required finished product components of bulk drug
substance, drug product and packaging.

The Company is substantially dependent on its contract drug product
manufacturers. These manufacturers have been approved by the FDA for the
production of the Company's approved products. Following is a listing of the
Company's contract drug product manufacturers:

CONTRACT DRUG PRODUCT MANUFACTURER MARKETED AND PROPOSED PRODUCTS
---------------------------------- ------------------------------

An affiliate of Boehringer Ingelheim Antizol, Antizol-Vet, Elliotts B Solution, and
Busulfex
NutraMax, Inc. Sucraid
Proclinical, Inc. Cystadane
DSM Pharmaceuticals, Inc. Xyrem (Treatment IND supplies)

In addition to the contract drug product manufacturers, the Company is
substantially dependent on Ash Stevens, Inc. ("Ash Stevens") and Lonza, Inc.
("Lonza"). Ash Stevens is the Company's sole supplier of bulk drug substance for
the manufacture of Antizol, Antizol-Vet, and Busulfex; while Lonza is the
Company's sole supplier of bulk drug substance for the manufacture of Xyrem for
use in clinical trials and is anticipated to be the sole supplier of any
approved product.

MARKETING -- UNITED STATES

The Company has designed its product selection strategy to maximize the
success of its marketing efforts. By having products that current and potential
customers have identified as having "high medical value", the Company believes
it should be able to more easily attract the attention of targeted segments of
the medical community. The Company also believes that its focus on well-defined
physician and patient populations will allow the use of a relatively small,
focused sales force instead of a large, generalized sales force. Because of the
distinct nature of most of its potential markets, the Company expects to be able
to concentrate its marketing efforts on a limited number of medical specialists,
or on patients themselves.

As part of its marketing efforts, the Company identifies and defines
appropriate therapeutic areas, identifies customer needs within each therapeutic
area, identifies specific product acquisition candidates within each therapeutic
area, works with the development team to insure clinical data are collected that
supports the desired indication and marketing claims, and if FDA approval is
obtained, designs and implements marketing plans for each of its approved
products. Market research is conducted to analyze the potential of products
prior to their acquisition. Once a product is acquired and is being developed,
further market research is completed and, based on this analysis, the product's
marketing plan is developed. Upon submission of the NDA to the FDA, the product
management responsibilities transition from the development team to the
Company's marketing and sales staff. The development group continues to provide
support where needed to enhance marketing and sales efforts. This group is
responsible for all aspects of a product's marketing and sales, including
product forecasting, positioning, price, promotion and physical distribution to
successfully launch and commercialize the product. Senior sales and marketing
employees lead a cross functional team of internal and external personnel to
implement a product's marketing and commercialization plan. In addition,
marketing and sales staff also supports the Company's international sales
efforts through support of and interfacing with international partners.

MARKETING -- FOREIGN

In general, the Company expects to out-license foreign marketing, sales and
distribution rights after an NDA is submitted or approved in the United States.
The Company contracts with foreign companies (usually pharmaceutical companies)
to market and distribute its products. The Company considers Europe and Asia to
be its most attractive foreign markets. The Company has entered into marketing,
sales and distribution agreements for Antizol, Cystadane and Sucraid in Europe,
for Cystadane and Sucraid in Australia and New Zealand, for Busulfex, Cystadane,
Elliotts B Solution and Sucraid in Israel, for Antizol and Cystadane in Canada,
and for Elliotts B Solution in Central America. In October 1999, the Company
signed a definitive agreement with Pierre Fabre Medicament, granting the French
company exclusive rights to market and distribute Busulfex in 21 European
countries, as well as Argentina and South Africa. Upon approval, Pierre Fabre, a
private company with sales in excess of $1 billion and approximately 8,300
employees, will market Busulfex to transplant centers through its 75 oncology
marketing and sales personnel. The Company has an agreement with IDIS World
Medicine to distribute Busulfex on a "named patient basis" to requesting
physicians outside of the United States, Canada and Israel, and other approved
products in territories where the Company's other products are not approved and
where the Company does not have a distribution partner. The Company began
shipments to IDIS in January 2000.

In December 2000, the Company signed a definitive agreement with Kirin
Brewing Co., LTD to market and distribute Busulfex in Asia including Japan, the
Peoples Republic of China, South Korea and Taiwan. Kirin is a diversified
company with more than $14 billion worldwide revenues in the food and beverage
industry. Kirin expanded into the pharmaceutical business in 1982 and has a
strong presence in the fields of nephrology, cancer and cell production,
immunology and allergy.

The Company's practice is to negotiate contracts with foreign distributors
that generally provide for minimum order and sales performance. Minimum fees
negotiated with foreign parties to date are not material and are not refundable,
nor subject to future performance criteria. The foreign contracting party is
responsible for obtaining marketing approval for the Company's product to which
the agreement relates and the Company is responsible for providing selected U.S.
regulatory information to the foreign party on request. The Company

cannot unilaterally terminate these agreements without established evidence of
default, but these agreements do expire over a defined period of time and the
Company may seek other foreign parties to provide comparable services upon
expiration if not satisfied with the performance of its partners. The principal
benefit a foreign party receives from entering into these agreements with the
Company and paying the minimum fees, if any, is a contracted price for
acquisition of product from the Company because the Company is the sole supplier
of its approved products on a worldwide basis.

DISTRIBUTION

The Company does not currently intend to develop internal distribution
capabilities because the Company believes its relatively low-volume products can
be more economically and efficiently distributed through third party
distribution organizations. Cystadane is principally distributed directly to
patients through a third party mail order pharmacy, Chronimed, Inc. Elliotts B
Solution, Antizol and Busulfex are primarily used in a hospital setting and are
distributed by CORD Logistics, Inc, an affiliate of Cardinal Health. This
distribution system allows the sale of these products directly into hospitals
or, if customers prefer, through their primary wholesaler. Antizol-Vet is a
product used in veterinary clinics and is distributed by CORD Logistics, Inc, an
affiliate of Cardinal Health to individual veterinary clinics and a network of
veterinary wholesalers.

COMPETITION

Potential competitors in the United States are numerous and include
pharmaceutical, chemical and biotechnology companies. The Company experiences
competition in several specific areas, including, but not limited to, those
described below.

- Product Acquisition -- The Company competes with other entities in
acquiring product rights from other companies, universities, other
research institutions, as well as from other potential licensors.

- Product Development Resources -- The Company competes for certain
resources, such as the services of clinical investigators, contract
manufacturers, advisors and other consultants. The Company will generally
have little or no control over the allocation of such resources.

- Orphan Drug Designation -- The Company is aware of two other companies
that have received orphan drug designation for products similar to two of
the Company's products. Sparta Pharmaceutical (acquired by SuperGen in
1999) and Teva (formerly Biocraft) have been granted orphan drug
designations for their intravenous busulfan and sodium oxybate,
respectively. Intravenous busulfan and sodium oxybate are their
equivalent of the Company's Busulfex and Xyrem products, respectively.
The Company does not believe SuperGen is developing an intravenous
busulfan. In 1999, the Company entered into an agreement with Teva, that,
in effect, transfers Teva's development data to the Company. While the
Company is not aware of others holding or seeking orphan drug
designations for products that would compete with the Company's products
for NDA approval, there can be no assurance that the Company's products
will not have such competition for the protection conferred by orphan
drug status.

- Marketing and Sales -- Each of the Company's current products will face
competition from other products or from other therapeutic alternatives.
In general, the Company's products will compete against products whose
marketers have substantially greater resources, including large
specialized sales forces, than the Company.

- Manufacturing -- The Company may also compete for limited manufacturing
capacity or availability.

GOVERNMENT REGULATION

GENERAL

Political, economic and regulatory influences are subjecting the health
care industry in the United States to fundamental change. Several potential
approaches are under consideration, including mandated basic health care
benefits, controls on health care spending through limitations on the growth of
private health
10

insurance premiums and Medicare and Medicaid spending, price discounts from drug
manufacturers, the creation of large purchasing groups and other significant
changes to the health care delivery system. In addition, some states have
adopted or are considering price controls and various health care reform
proposals. The Company anticipates that Congress and state legislatures will
continue to review and assess alternative health care delivery systems and
payment methods and that public debate of these issues will likely continue in
the future. Because of uncertainties regarding the ultimate features of reform
initiatives and their enactment and implementation, the Company cannot predict
which, if any, of such reform proposals will be adopted, when they may be
adopted or what impact they may have on the Company or its prospects.

REIMBURSEMENT

Employers, through payments to their employee benefit plans, bear a
significant share of the health care costs of their employees. These plans are
typically administered by insurance companies, health maintenance organizations,
preferred provider organizations and other third-party payors. Health care
services and products, including pharmaceutical products, are also paid for by
government agencies, such as Medicaid. Employers and the payors involved in
providing or administering health care benefits are increasingly turning to
"managed care" systems to control health care costs. Under these systems, the
administrative requirements and standards of care are established by the health
care purchasers and providers and the benefit level depends on the negotiated
price. Managed care systems usually limit treatment options to approved
therapeutic regimens and "formularies," or lists of approved drugs and medical
products.

Inclusion or listing on the formularies of managed care groups is important
to the commercial success of a prescription medicine. A pharmaceutical must be
included on a third-party payor's formulary or must be deemed "medically
necessary" to be eligible for reimbursement by that payor. In deciding whether a
drug is to be included on a formulary, payors will generally consider its
therapeutic value and cost in comparison to other available treatments. The
Company believes that the proprietary nature and medical usefulness of its
products should assist it in its efforts to have its products approved for
reimbursement. No assurance can be given, however, that the Company's products
will be approved for reimbursement by third-party payors at acceptable levels,
or at all.

PRODUCT APPROVALS

The Company's products require FDA approval in the United States and
comparable approvals in foreign markets before they can be marketed. The
development of investigational products and the marketing and supply of approved
products require continuing compliance with FDA regulations on the part of the
Company as well as its manufacturers and distributors.

SCHEDULED PRODUCTS

Products that are designated "controlled" substances also require
compliance with regulations administered by the U.S. Drug Enforcement Agency
("DEA"), and similar regulations administered by state regulatory agencies.
Xyrem's active ingredient is sodium oxybate, or GHB. PL 106-172, a public law
which makes illicit GHB (gamma hydroxybutyrate) a Schedule I substance but
designates FDA-approved GHB medicines Schedule III substances, was enacted in
February 2000. Schedule I is the designation by which illegal and non-approved
drugs are controlled. Schedule III includes additional handling and distribution
requirements.

Each state has the ability to schedule products more strictly than the
federally designated Schedule. Most states have adopted, either administratively
or legislatively, the I/III schedule as described above. The Company continues
its efforts to ensure consistency across all states by the time of commercial
launch.

MANUFACTURING REGULATION

All facilities and manufacturing processes used to manufacture products for
clinical use or sale in the United States must be operated in conformity with
Good Manufacturing Practices (GMP). These represent the FDA requirements
governing the production of pharmaceutical products. FDA approval is required
before a contract manufacturer can implement most changes in manufacturing
procedures for any of the Company's
11

approved products. The Company has established a quality assurance program to
monitor third-party manufacturers of its products to promote compliance by such
manufacturers with domestic and foreign regulations (based on country of use).
In addition, FDA approval is required to change contract manufacturers of
approved products. Obtaining the FDA's approval for a change in manufacturing
procedures or change in manufacturers could cause production delays and loss of
revenue.

FOREIGN REGULATION

Products marketed outside of the United States are subject to regulatory
approval requirements similar to those required in the United States, although
the requirements governing the conduct of clinical trials, product licensing,
pricing and reimbursement vary widely from country to country. No action can be
taken to market any product in a country until an appropriate application has
been approved by the regulatory authorities in that country. The current
approval process varies from country to country, and the time spent in gaining
approval varies from that required for FDA approval. In certain European
countries, the price of a product must also be approved. The pricing review
period often begins after market approval is granted. The Company intends to use
foreign partners to apply for foreign marketing approvals.

INSURANCE

Providing health care products entails an inherent risk of liability. In
recent years, participants in the health care industry have been subject to a
large number of lawsuits alleging malpractice, product liability or related
legal theories, many of which involve large claims and significant defense
costs. The Company may from time to time be subject to such suits as a result of
the nature of its business. The Company carries product liability insurance
coverage in the aggregate amount of $20 million. The Company also carries a $10
million general business insurance policy. The Company does not carry any
insurance to cover the financial risks associated with a potential FDA mandated
recall of an approved product. There can be no assurance, however, that such
insurance policies will be sufficient to fully indemnify the Company against any
asserted claims or that such insurance will continue to be available.

HUMAN RESOURCES

The Company has fifty-eight full-time and eight part-time employees. The
Company believes that its relationship with its employees is good. None of the
Company's employees are represented by a labor union.

TRADE SECRETS

The Company also relies on trade secrets and proprietary know-how to
protect certain of its technologies and potential products. The Company requires
employees, consultants and advisors to enter into confidentiality agreements
that prohibit disclosure to any third party or use of proprietary information,
secrets and know-how for commercial purposes. Company employees also agree to
disclose and assign to the Company all methods, improvements, modifications,
developments, discoveries and inventions conceived during their employment that
relate to the Company's business.

GRANTS

The FDA Office of Orphan Drug Products and the Small Business
Administration offer grants to companies whose efforts meet certain
requirements. From July 1, 1995 through December 31, 1998, the Company collected
approximately $1,567,000 in grant proceeds with respect to approximately
$1,567,000 in grant related disbursements for certain products. The grant
proceeds collected by the Company are non-refundable. There can be no assurance
that additional grants from these agencies will be made available to the Company
in subsequent periods. The Company currently has no active grants.

DISCONTINUED DEVELOPMENT PRODUCTS

As of December 31, 2001, the Company has discontinued development
activities on eleven proposed products. During 1997, the Company discontinued
development activities on the following proposed products: Colomed, Caprogel,
Clonidine, alpha-galactosidase A, colloidal bismuth subcitrate, Intrachol,
Repliderm, 5FU (5-fluorouracil), and other indications of Cystadane. In December
1998, the Company sold its rights to colloidal bismuth subcitrate for $750,000,
and is evaluating the potential value of its rights to one or more of the other
proposed products that were discontinued in 1997. Depending on the availability
of financing in subsequent periods, the Company may continue development of one
or more of the proposed products that have been discontinued based on the
criteria described under the Product Acquisition section. In addition, prior to
1997, the Company discontinued development activities on two proposed products,
which proved to have little potential future value.

PRODUCTS

The following tables summarize certain information relating to the
Company's products:

MARKETED PRODUCTS
------------------------------------------------------------------------------------------------
U.S. PATENT ORPHAN
NDA ISSUED OR DRUG
APPROVAL APPLIED STATUS
APPROVED PRODUCT APPLICATION DATE FOR **
---------------- ----------- --------- ----------- -----------

Antizol(R) (fomepizole) Antidote for ethylene December No Granted
Injection (Antidotes) glycol (antifreeze) or 1997
suspected ethylene glycol
ingestion in humans
Antidote for methanol or December No Granted
suspected methanol 2000
ingestion in humans
Busulfex(R) (busulfan) For use in combination with February Yes Granted
Injection (Oncology cyclophosphamide as a 1999
Support) conditioning regimen prior
to allogenic hematopoietic
cell transplantation for
chronic myelogenous
leukemia ("CML")
Elliotts B(R) Solution Diluent for intrathecally September No Granted
(buffered intrathecal administered methotrexate 1996
electrolyte/ dextrose sodium and cyarabine
solution)
Cystadane(R) (betaine Homocystinuria, a genetic October No Granted
anhydrous for oral disease 1996
solution)
Antizol-Vet(R) (fomepizole) Antidote for ethylene November No Five year
for Injection glycol (antifreeze) or 1996 period of
suspected ethylene glycol exclusivity
ingestion in dogs
Sucraid(R) (sacrosidase) Sucrase deficiency, a April No Granted
oral solution genetic disease 1998

PRODUCTS UNDER DEVELOPMENT
----------------------------------------------------------------------------------------------------
U.S. PATENT
PHASE OF ISSUED OR ORPHAN DRUG
DEVELOPMENT APPLIED DESIGNATION
INVESTIGATIONAL PRODUCTS PROPOSED APPLICATION * FOR **
------------------------ -------------------- ----------- ----------- -----------

Xyrem(R) (sodium oxybate) Under investigation for the (1) Yes Yes
oral Solution (Sleep treatment of narcolepsy
Disorders)

---------------

* Development Phases are discussed under "Business -- The Regulatory Process".

** Orphan Drug Designation and Status are discussed under "Business --
Proprietary Rights"

(1) New Drug Application submitted October 2, 2000, approvable letter issued
July 2, 2001.

APPROVED PRODUCTS

ANTIZOL (FOMEPIZOLE) INJECTION

Antizol received marketing clearance from the FDA in December 1997 for
suspected or confirmed ethylene glycol poisonings and December 2000 for
suspected or confirmed methanol poisonings. The Company commenced shipping
Antizol in December 1997. Antizol is primarily used in a hospital setting and is
distributed for the Company by an affiliate of Cardinal Health. When ingested by
humans, ethylene glycol (found in antifreeze) and methanol (found in windshield
wiper fluid) can lead to death or permanent and serious physical damage. In a
survey conducted in 1999 by the American Association of Poison Control Centers,
over 6,300 cases of ethylene glycol poisoning were reported to United States
poison control centers. In the same year, there were approximately 600
treatments for such poisonings. The Company believes that hospital pharmacies
will continue to stock Antizol because it is important to treat poisoned
patients very quickly in order to improve the chances of successful recovery.
For 2001, Antizol contributed approximately 43% of the Company's total revenues.
The Company estimates that 30% of the 5,100 hospitals with emergency rooms
currently stock the product. The Company expects to see limited incremental
stocking by hospitals in 2002. Future sales will be based more on usage as
stocking levels are expected to plateau. The Company has also received marketing
approval for Antizol in Canada for the treatment of suspected or confirmed
ethylene glycol poisonings.

The Company has obtained orphan drug status for Antizol as an antidote to
treat ethylene glycol and methanol poisonings, which provides marketing
exclusivity to the Company through December 2004 for ethylene glycol and
December 2007 for methanol. Fomepizole, the active ingredient in Antizol, is a
known compound and is not patentable. The Company has contracted with a third
party for the production of Antizol under GMP conditions. The Company, through a
sublicense agreement with Mericon Investment Group, Inc. ("MIG"), has an
exclusive, worldwide license to develop and market Antizol, which expires in
July 2013, subject to a five year renewal through July 2018 exercisable by MIG
at the request of the Company.

BUSULFEX (BUSULFAN) INJECTION

Following an accelerated six-month priority review, the Company received
regulatory approval from the FDA in February 1999 to market Busulfex in the
United States. The FDA approved Busulfex for use in combination with
cyclophosphamide as a conditioning regimen prior to allogeneic hematopoietic
progenitor cell transplantation for chronic myelogenous leukemia ("CML"). The
first commercial sales of Busulfex occurred in February 1999, within two weeks
of FDA approval. Busulfex also received marketing approval in Canada in
September 1999, in Israel in February 2000 and in South Korea in December 2001.
The indications approved in Canada, Israel and South Korea provide for use of
Busulfex as a conditioning regimen prior to bone marrow or hematopoietic
progenitor cell transplantation, when used in combination with other
chemotherapeutic agents and/or radiotherapy. Included in the Canadian indication
are acute lymphocytic leukemia, non-lymphocytic leukemia, acute myeloid
leukemia, non-Hodgkin's lymphoma, Hodgkin's disease, multiple myeloma,
myelodysplastic syndrome, breast cancer, ovarian cancer and several genetic
diseases.

In December 2000, the Company signed a definitive agreement granting Kirin
Brewery Co., LTD exclusive rights to market and distribute Busulfex in Asia.
Kirin is a diversified company with annual sales of more than $14 billion
worldwide in the food and beverage industry. Kirin expanded into the
pharmaceutical industry in 1982 and has established a strong presence in the
fields of nephrology, cancer and cell production, immunology and allergy. The
Company began shipments of clinical trial materials to Kirin in 2001.

In October 1999, the Company signed a definitive agreement with Pierre
Fabre Medicament, granting the French company exclusive rights to market and
distribute Busulfex in 21 European countries, Argentina, and South Africa.
Pierre Fabre will market Busulfex to transplant centers through 75 oncology
marketing and sales personnel. The Company signed an agreement with IDIS World
Medicine in December 1999 to distribute Busulfex on a named patient basis to
requesting physicians outside of the United States, Canada and Israel. The
Company began shipments to IDIS in January 2000. An NDA was submitted in Europe
in late 2001. The Company does not expect approval until late 2002 or early 2003
at the earliest.

Bone marrow and peripheral stem cell transplants are collectively known as
hematopoietic progenitor cell transplants, but are more commonly referred to as
stem cell or bone marrow transplants. This year approximately 20,000 stem cell
transplants are expected to be performed in the United States, with another
20,000 expected to be performed outside the United States. One of the many
complex steps in performing a stem cell transplant includes using high doses of
chemotherapeutic drugs, such as Busulfex, and/or radiation as a "conditioning
regimen" to destroy the abnormal cancer cells in the bone marrow and to create
"space" for the engraftment of transplanted stem cells. The stem cell transplant
then replaces the diseased or damaged marrow to grow into healthy marrow. Of the
20,000 procedures expected to be performed in the United States, more than 4,000
of these may receive some form of busulfan, as part of the pre-transplantation
conditioning regimen. The Company is marketing Busulfex to hematologists and
oncologists who perform stem cell transplants at cancer treatment centers.

Adoption of Busulfex into standard busulfan-based regimens has been steady,
and several clinicians in leading institutions have initiated new research
protocols using Busulfex to enhance the conditioning regimen, based on clinical
data and experience with Busulfex. Several leading United States research
centers have indicated to the Company that they have initiated or intend to
initiate new study protocols specifying the use of Busulfex.

Many other drugs are currently being developed for use in the BMT area.
Although most of these new drugs are used for a different purpose during the
bone marrow transplant and not in the conditioning regimen, some of them may
compete with Busulfex. The Company is aware that SuperGen Inc., which acquired
Sparta Pharmaceutical in 1999, now owns rights to another form of intravenous
busulfan which was in development by Sparta prior to its acquisition. SuperGen
holds orphan drug designation for its intravenous busulfan and could seek orphan
drug status for a similar or different indication, if SuperGen were to proceed
with development of its intravenous formulation and if the FDA approves an NDA
for such a product.

The Company has obtained orphan drug status for Busulfex for the approved
indication, which provides marketing exclusivity for that indication to the
Company through February 2006. The Company has contracted with a third party for
the production of Busulfex under GMP conditions. In addition, the Company has an
exclusive, worldwide license except for Australia from M.D. Anderson Cancer
Center, The University of Texas, and The University of Houston (collectively,
the "busulfan licensors") to develop and market this intravenous form of
busulfan, which is effective for the term of busulfan licensors' patent rights.
The busulfan licensors have been granted two U.S. patents covering the licensed
product's formulation and its use in bone marrow transplants and other
conditions, which expire in September 2016 and July 2015, respectively. The
product is distributed for the Company by an affiliate of Cardinal Health

ELLIOTTS B SOLUTION (BUFFERED INTRATHECAL ELECTROLYTE/DEXTROSE INJECTION)

Elliotts B Solution received marketing clearance from the FDA in September
1996. The first commercial sales of Elliotts B Solution occurred in December
1996. Elliotts B Solution is primarily used in a hospital setting and is
distributed for the Company by an affiliate of Cardinal Health. Elliotts B
Solution is a buffered diluent for the intrathecal administration (injection
into the fluid space surrounding the central nervous
15

system) of chemotherapeutic agents. Intrathecal injections are most commonly
made in treating acute lymphoblastic leukemia ("ALL"). ALL is the most prevalent
form of leukemia in children. Due to advances in chemotherapy, the cure rate for
ALL has improved dramatically in the past 30 years, going from almost zero to
nearly 75% today. As a part of modern chemotherapy, doctors often administer a
series of up to 20 injections of methotrexate sodium into the cerebrospinal
fluid of patients. Elliotts B Solution is comparable in pH, electrolyte
composition, glucose content and osmolarity to cerebrospinal fluid. It is
estimated that cerebrospinal injections of methotrexate sodium are administered
to about 6,000 people in the United States on an annual basis. Elliotts B
Solution revenues have not been material nor does the Company expect that
revenues to be material to the Company's financial results.

The Company has obtained orphan drug status for the use of Elliotts B
Solution as a diluent for methotrexate sodium or cytarabine, which provides
marketing exclusivity through September 2003. Elliotts B Solution is a known
compound that has been used previously for the intrathecal administration of
chemotherapeutic agents and is, therefore, not patentable. The Company has
contracted with a third party for the production of Elliotts B Solution under
GMP conditions. No license was required for the Company to develop and market
Elliotts B Solution.

OTHER APPROVED PRODUCTS

CYSTADANE (BETAINE ANHYDROUS FOR ORAL SOLUTION)

Cystadane received marketing clearance from the FDA in October 1996. The
first commercial sales of Cystadane occurred in December 1996. Cystadane is
principally distributed on a non-exclusive basis by Chronimed Inc. directly to
patients in the United States through its mail order pharmacy. The Company
believes that the small size of the market and the high medical value of
Cystadane justify the limited resources required by the Company to continue
making this product available to patients. It is the first agent approved by the
FDA for the treatment of homocystinuria, an inherited metabolic disease. The
clinical consequences are wide-ranging and include dislocation of the ocular
lens, early (under age 30) thromboembolism, developmental and mental retardation
and reduced life span related to elevated plasma homocysteine levels. It has
been estimated that homocystinuria occurs about once in every 200,000 live
births worldwide. There are estimated to be 1,000 patients with homocystinuria
in the United States. The annual market potential for Cystadane is approximately
$500,000 in the United States. The Company does have some sales revenue
generated outside of the United States. Cystadane revenues met the Company's
expectations in 2001 and are expected to grow slightly in subsequent periods.

The Company has obtained orphan drug status for Cystadane for the treatment
of homocystinuria, which provides marketing exclusivity to the Company through
October 2003. Betaine anhydrous, the active ingredient in Cystadane, is a known
compound and is not patentable. The Company has contracted with a third party
for the production of Cystadane under GMP conditions. No license was required
for the Company to develop and market Cystadane.

The Company is not currently sponsoring any clinical trials with/for
Cystadane. The Company is aware, however, of clinical trials being conducted by
independent investigators to assess the safety and efficacy of Cystadane as a
stand alone or adjunctive therapy for the following indications: Non-alcoholic
steatohepatitis, Rett syndrome, rheumatoid arthritis and hyperhomocystinemia.
The Company does not expect that the results of any of these clinical trials to
significantly enhance or decrease the current limited market potential for
Cystadane on the near future.

ANTIZOL-VET (FOMEPIZOLE) FOR INJECTION

In November 1996, the Center for Veterinary Medicine of the FDA approved
Antizol-Vet as a treatment for dogs that have ingested or are suspected of
having ingested ethylene glycol. The first commercial sales of Antizol-Vet
occurred in January 1997. It is estimated that at least 10,000 cases of ethylene
glycol poisoning occur in dogs each year. The earlier an ethylene glycol
poisoned dog is treated with Antizol-Vet, the more likely that there will be a
positive outcome. The annual market potential for Antizol-Vet is expected to be
under $300,000. The Company has found that stocking of this product has been
limited due to its high cost,
16

but it is ordered when a poisoning occurs. Antizol-Vet revenues met the
Company's expectations in 2001 and are expected to remain constant or decline in
subsequent periods.

Federal law provided the Company with a marketing exclusivity period
through November 2001 for the use of Antizol-Vet in dogs for the approved
indication. Fomepizole, the active ingredient in Antizol, is a known compound
and is not patentable. The Company has contracted with a third party for the
production of Antizol-Vet under GMP conditions.

The Company has partnered with several leading regional and national
veterinary wholesalers to distribute Antizol-Vet to veterinary clinics. It is
believed that the current partners effectively and efficiently encompass the
entire country with limited sales territory overlap, thus helping prevent
downward retail pricing pressures. The Company does not anticipate adding
additional distribution partners.

SUCRAID (SACROSIDASE) ORAL SOLUTION

Sucraid received marketing clearance from the FDA in April 1998. The first
commercial sales of Sucraid occurred in July 1998. Sucraid is principally
distributed by an affiliate of Cardinal Health directly to patients in the
United States. The FDA approved Sucraid to be used for oral replacement therapy
of genetically determined sucrase deficiency, which is part of congenital
sucrase isomaltase deficiency (CSID). Sucraid is used as a replacement for an
enzyme in the small intestine that is necessary for the digestion of sucrose,
which is common table sugar. The Company believes that the small size of the
market and the high medical value of Sucraid justify the limited resources
required by the Company for making this product available to patients. The
annual market potential for Sucraid is expected to be approximately $500,000 in
the United States. Sucraid revenues met the Company's expectations and are
expected to grow slightly in 2002.

The primary symptoms of CSID include severe watery diarrhea, chronic
malabsorption and, in infants and toddlers, failure to thrive. Other common
symptoms include nausea, vomiting, abdominal cramps and abdominal pain following
the consumption of foods containing sucrose. Prior to the approval of Sucraid,
the only specific treatment of CSID available to patients was the life-long
adherence to a sucrose-free diet. Compliance with a sucrose-free diet is very
difficult because sucrose is found in many foods in the typical American diet.
Nonspecific symptomatic treatments include antidiarrheal, antispasmodic and
antiflatulence drugs, all of which are limited in their efficacy. Sucraid is a
specific replacement of the missing enzyme responsible for CSID.

Sacrosidase, the active ingredient in Sucraid, is a known compound and is
not patentable. The Company has obtained orphan drug status for Sucraid for the
approved indication, which provides marketing exclusivity to the Company through
April 2005. The Company has contracted with a third party for the production of
Sucraid under GMP conditions. In addition, the Company has an exclusive,
worldwide license from Hartford Hospital to develop and market Sucraid, which
expires in April 2005. The license provides for two five year extension options,
the first through April 2010 and the second through April 2015, unless either
party decides to terminate the license within 90 days prior to April 2005 or
April 2010.

SLEEP DISORDERS -- INVESTIGATIONAL PRODUCT

XYREM (SODIUM OXYBATE) ORAL SOLUTION

Narcolepsy is a chronic neurologic sleep disorder in which sleep is
"fragmented", that is, does not occur in an integrated and cohesive manner. This
fragmentation results in excessive daytime sleepiness, unavoidable daytime sleep
attacks, cataplexy or sudden loss of muscle control provoked by emotions, sleep
paralysis or brief periods of muscle paralysis and hallucinations, or vivid and
sometimes frightening dreaming when falling asleep or waking up. Other related
symptoms include broken night-time sleep, disturbances of auditory and visual
perception, and lapses of consciousness and memory problems. These symptoms can
lead to a variety of complications, such as limitations on education and
employment opportunities, driving or machine accidents, difficulties at work
resulting in disability, forced retirement or job dismissal, and depression.
Narcolepsy is thought to affect 140,000 to 180,000 persons in the United States.
Approximately 75,000 of these patients are thought to be diagnosed. Narcolepsy
patients usually begin to develop symptoms between the ages of 15-25,

with a smaller number developing symptoms between the ages of 35-45. Symptoms
have been reported in patients as young as five years of age.

The usual treatment for narcolepsy includes symptomatic treatment of
excessive daytime sleepiness and sleep attacks with stimulants or wakefulness
promoting agents. The symptoms of cataplexy, sleep paralysis and hypnagogic
hallucinations are typically treated with tricyclic antidepressants ("TCAs") or
selective serotonin reuptake inhibitors ("SSRIs"). These treatment regimens, in
addition to limited efficacy, are often unsatisfactory for a number of other
reasons. Amphetamines and other stimulants often cause undesirable side effects
such as insomnia, hypertension, palpitations, irritability and, at higher doses,
may mimic the symptoms of schizophrenia. Patients often build tolerance to the
TCAs and SSRIs and doses are increased to obtain clinical effectiveness at high
doses. These medications can cause the side effects of dry mouth, impotence,
loss of libido, and increased heart rate. Clinical results with Xyrem suggest
that it is effective in the treatment of narcolepsy symptoms. Administered at
night, it is believed to consolidate sleep and has been shown to reduce
cataplexy attacks, and to reduce the severity of daytime sleepiness when used in
combination with stimulants during the day. More than 300 narcolepsy patients
have been exposed to clinical doses with an acceptable side effect profile.
Xyrem does not appear to have the side effects associated with TCAs and SSRIs.
Narcoleptic patients could be treated with Xyrem at night and, if needed, with
stimulants during waking hours.

During 1998, the Company completed a clinical trial with over 130 patients
at 18 sleep centers, which assessed Xyrem at different dose levels against
placebo. When compared against placebo, higher doses of Xyrem demonstrated a
reduction in the number and severity of cataplexy attacks per week, the primary
measure of efficacy in this clinical trial. The secondary measure of efficacy
was the reduction of excessive daytime sleepiness, as measured by the Epworth
Sleepiness Scale, a subjective, but validated measure of EDS. At higher doses,
Xyrem appeared to reduce EDS beyond the improvement provided by stimulants which
patients continued to take during the trial.

During the first quarter of 1999, the Company commenced a Treatment IND
program, which is a clinical trial, to collect additional clinical safety data
necessary for the submission of an NDA. The FDA permits an investigational drug,
like Xyrem, to be used under a Treatment IND if there is sufficient evidence of
safety and effectiveness and the drug is intended to treat a serious disease.
The FDA also authorized the Company to seek reimbursement from patients and
their insurance providers for the use of Xyrem in this trial, which has allowed
the education of certain third party payors regarding Xyrem.

Gamma hydroxybutyrate (GHB) is the active ingredient in Xyrem. Illicitly
produced GHB has been reported to be a drug of abuse. On February 18, 2000, the
President signed PL 106-172, a public law which makes GHB a Schedule I
substance. Schedule I is the designation by which illegal drugs are controlled.
The bill further delineates GHB products being studied under Food and Drug
Administration (FDA) approved protocols or approved for commercial sale as
Schedule III substances.

Each state has the ability to schedule products more strictly or equivalent
to the Federally designated schedule. Most states have adopted, either
administratively or legislatively, the I/III schedule as described above. The
Company continues its efforts to ensure consistency across all states by the
time of commercial launch.

Sodium oxybate (GHB), the active ingredient in Xyrem, is a known compound
and is not patentable. The Company has received an orphan drug designation for
its proposed use of Xyrem. No license was required for the Company to develop
Xyrem nor will a license be required to market Xyrem, if approved by the FDA.
The Company has contracted with third party bulk drug and drug product
manufacturers for the production of Xyrem.

The Company submitted its NDA for Xyrem on October 2, 2000. The NDA was
granted priority review status by the FDA, meaning the FDA had a goal of
reaching a decision to either approve or disapprove or delay a decision
regarding the NDA within 180 days of submission. On March 2, 2001, the FDA
granted a 90 day extension to the Company's NDA in order that the Company could
submit additional data requested by the FDA. On June 6, 2001, the FDA held a
meeting of the Peripheral and Central Nervous System Advisory Committee to
consider Xyrem. The Advisory Committee voted affirmatively that Xyrem was

effective in treating cataplexy, but was split on the issue of Xyrem's safety
due to the relatively small size of the safety database. As a result, the FDA
issued an Approvable Letter for Xyrem on July 2, 2001. The Approvable Letter
defined issues that required resolution before approval could be granted for the
treatment of cataplexy. On October 23, 2001, the Company announced that the FDA
had accepted the Company's response, in the form of an amendment, to the
Approvable Letter. The amendment represented the Company's complete response to
the issues contained in the FDA's Approvable Letter. The amendment includes
revisions to product labeling and the risk management program, a safety update
of ongoing clinical trials, and respiratory data collected during all night
polysomnographic recordings of narcolepsy patients in a clinical trial completed
in late 2000. The Company believes it has addressed all questions and issues the
FDA may have regarding the NDA for Xyrem. The FDA assigned April 9, 2002 as its
action deadline for this NDA.

The Company is conducting a Phase III (b) third clinical trial for Xyrem,
which the FDA has previously indicated is not required for the Company's NDA
submission. This controlled clinical trial assesses the efficacy of Xyrem for
treating excessive daytime sleepiness (EDS) related to narcolepsy as its primary
endpoint. This trial is expected to be completed in late 2002.

RISK FACTORS

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

WE HAVE A HISTORY OF LOSSES.

We have been unprofitable since our inception in 1994. We expect operating
losses in 2002 because anticipated gross profits from product revenues will not
offset our operating expenses and additional spending to continue drug
development activities. The amount of these losses may vary significantly from
year-to-year and quarter-to-quarter. Our actual losses will depend on, among
other factors, the timing of product development, regulatory approval, and
market demand for our Food and Drug Administration ("FDA") approved products. We
cannot assure you that we will ever generate sufficient product revenues to
achieve profitability.

THERE ARE RESTRICTIONS ON OUR ABILITY TO RAISE ADDITIONAL CAPITAL. IF WE ARE
UNABLE TO OBTAIN ADDITIONAL FINANCING, WE MAY NOT BE ABLE TO SUPPORT OUR CURRENT
OR FUTURE BUSINESS OPERATIONS.

On July 23, 1998, we completed the private sale to UBS Capital II, LLC of
$7.5 million of Senior Convertible Preferred Stock. On August 2, 1999, we
completed another private sale to UBS Capital II of $3.0 million of Series B
Convertible Preferred Stock. In conjunction with the issuance of the preferred
shares, we agreed to several restrictions and covenants, and granted certain
voting and other rights to the holders of the preferred shares. On December 7,
2001, we completed the private sale of 1.7 million shares of common stock to a
group of investors led by Alta BioPharma Partners II, L.P. In connection with
this sale, UBS Capital II agreed to forfeit its right as a preferred stockholder
to enforce the restrictions and covenants relating to our ability to incur
additional indebtedness and issue additional equity securities. However, we are
still subject to other restrictions and covenants relating to the preferred
stock, and these restrictions could make it more difficult and more costly for
us to obtain additional capital.

We expect our spending for research and development and sales and marketing
to increase significantly in fiscal 2002. Although we believe that we have
sufficient capital to meet our business objectives in fiscal 2002, if we expand
our business plan, or unanticipated events occur, we may need additional
capital. We cannot assure you that additional sources of capital will be
available to us, or if available, on terms acceptable to us. If we issue
additional equity securities, your ownership interest may be diluted.

THE MARKET PRICE OF OUR COMMON STOCK COULD FLUCTUATE IN RESPONSE TO QUARTERLY
OPERATING RESULTS AND OTHER FACTORS.

The market price of our common stock could fluctuate significantly in
response to a number of factors, including:

- our quarterly financial performance;

- announcements by us or our competitors of new product developments or
clinical testing results;

- governmental approvals, refusals to approve, regulations or actions;

- developments or disputes relating to patents or proprietary rights;

- public concern over the safety of therapies; and

- small float or number of shares of our common stock available for sale
and trade.

The market value and liquidity of the public float for our common stock
could be adversely affected in the event we no longer meet the Nasdaq's
requirements for continued listing on the National Market. For continued listing
on the Nasdaq National Market, a company must satisfy a number of requirements,
which in our case includes either: (1) net tangible assets in excess of $4.0
million as reported on Form 10-Q or Form 10-K or (2) a market capitalization of
at least $50.0 million. Net tangible assets are defined as total assets less the
sum of total liabilities and intangible assets. Market capitalization is defined
as total outstanding shares multiplied by the last sales price quoted by Nasdaq.
Although we currently meet the requirements for listing on the Nasdaq National
Market, we cannot assure you that we will continue to meet these requirements.
The Nasdaq National Market has issued new listing qualifications which will
become effective November 2002, and which will replace the net tangible asset
requirement with a minimum net equity requirements of $10.0 million. At
September 30, 2001, we met the new listing qualifications with respect to market
capitalization. We cannot assure you that we will continue to meet the new
listing qualification requirements.

The market price of our common stock may also fluctuate significantly in
response to other factors over which we have no control and that may not be
directly related to us. Fluctuations or decreases in the trading price of our
common stock may adversely affect your ability to trade your shares and you may
lose all or a part of your investment. In addition, fluctuations and decreases
in our stock price could adversely impact our business and our ability to raise
capital through additional equity financings.

THERE IS A LIMITED MARKET FOR OUR PRODUCTS.

While we will seek to obtain and market products that address diseases that
affect patient populations larger than those affected by orphan diseases
(200,000 or fewer patients in the United States), many of our opportunities will
address orphan diseases. Most orphan drugs have a potential United States market
of less than $25 million annually and many address annual markets of less than
$1 million. We cannot assure you that sales of our products will be adequate to
make us profitable even if the products are accepted by medical specialists and
used by patients.

WE RELY ON THE LIMITED PROTECTION OF THE ORPHAN DRUG ACT.

UNITED STATES

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

The first step in obtaining the limited protection under the Orphan Drug
Act is obtaining "orphan drug designation" for a product from the FDA. After the
FDA grants orphan drug designation, it publishes the generic identity of the
therapeutic agent and the potential orphan use specified in the request. Orphan
drug

designation does not constitute FDA approval, nor does it provide any advantage
in, or shorten the duration of, the regulatory approval process.

The second step in obtaining limited protection under the Orphan Drug Act
for a specific product is acquiring the FDA's recognition of "orphan drug
status." This step involves submission of a New Drug Application ("NDA") to the
FDA containing all clinical study results, safety and manufacturing information
and requesting approval to market a drug for the designated indication. The FDA
will grant orphan drug status to the first company to receive approval of an NDA
for the designated indication. Orphan drug status gives a company the exclusive
right to market the approved product in the United States for a period of seven
years, subject to certain limitations. Obtaining orphan drug status for a
particular product may not, however, prevent another company from developing or
marketing the same drug having a different formation or composition for the same
or different indication. In addition, orphan drug status does not provide any
marketing exclusivity in foreign markets. While obtaining FDA approval to market
a product with orphan drug status can be advantageous, we cannot assure you that
the scope of protection or the level of marketing exclusivity will remain in
effect in the future or will have meaningful or material value to us. Although
certain foreign countries provide exclusivity, development and marketing
benefits for orphan drugs, we cannot assure you that such benefits can be
obtained or, if obtained, will be of material value to us.

We have obtained orphan drug status for Antizol, Elliotts B Solution,
Cystadane, Sucraid, and Busulfex. We have obtained orphan drug designation for
Xyrem, our narcolepsy drug and our NDA requesting orphan drug status for Xyrem
is currently under review by the FDA. If the FDA approves another company's NDA
for sodium oxybate (the generic identity of the therapeutic agent for Xyrem) for
the same indication as Xyrem prior to approving our NDA for Xyrem, that company
will be entitled to exclusive marketing rights for sodium oxybate, and the FDA
would not approve our application to market Xyrem for seven years, if at all. We
are aware that the FDA has granted Teva (formerly Biocraft) orphan drug
designation for the use of sodium oxybate to treat the symptoms of narcolepsy,
however, we have obtained the exclusive right to use Teva's data for one
controlled study included in our NDA submission. While we are not aware of any
activities to develop sodium oxybate by any other U.S. company, we cannot assure
you that such activities are not being conducted, or that the FDA will approve
our NDA for Xyrem first for the designated indication. We also cannot assure you
that the FDA will not grant orphan drug designation and orphan drug status to
other competing products before or after approving our NDA for Xyrem.

Even if the FDA approves an NDA for a drug with an orphan drug designation,
the FDA may still approve the same drug for a different indication, or a
molecular variation of the same drug for the same indication. We are aware that
the FDA has granted Sparta Pharmaceutical, which was acquired by SuperGen Inc.,
orphan drug designation for an intravenous busulfan with an indication closely
related to the indication for our product Busulfex. If the FDA approves an NDA
for SuperGen's product for a different indication, SuperGen could seek orphan
drug status for that product, which competes with Busulfex. In addition, the FDA
does not restrict doctors from prescribing an approved drug for uses not
approved by the FDA. Thus, a doctor could prescribe another company's drug for
indications for which our product has received FDA approval and orphan drug
status. Significant "off label" use, that is, prescribing approved drugs for
unapproved uses, could adversely affect the marketing potential of any of our
products that have received orphan drug status and NDA approval by the FDA.

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

EUROPE

The European orphan drug act provides for up to ten years of market
exclusivity for a pharmaceutical product that meets the requirement of the
European orphan drug act. For a pharmaceutical product to qualify under the act,
the prevalence (or incidence), of the condition being treated must not exceed
five patients per 10,000 population. Our European partners have submitted and
obtained orphan drug designation under the act for Busulfex and Cystadane, and
in May 2001 we were granted orphan drug designation under the act for Antizol
for use in methanol poisonings. While these products are currently designated as
orphan drugs, we cannot assure you that these products will continue to qualify
for orphan drug protection in Europe or that we will be able to obtain orphan
drug protection in Europe for other or future products. We also cannot provide
you any assurance that another company will not obtain an approval which would
block us from marketing our products in Europe.

THE SALE OF OUR PRODUCTS IS DEPENDENT UPON GOVERNMENTAL APPROVAL.

Government regulation in the United States and abroad is a significant
factor in the testing, production and marketing of our products. Each product
must undergo an extensive regulatory review process conducted by FDA and by
comparable agencies in other countries. We cannot market any pharmaceutical
product we develop or license as a prescription product in any jurisdiction,
including foreign countries, without regulatory approval. The approval process
can take many years and requires the expenditure of substantial resources.

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

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

GOVERNMENTAL APPROVAL OF OUR PRODUCTS DOES NOT GUARANTEE FINANCIAL SUCCESS.

Six of our products have been approved for marketing by regulatory
authorities in the United States or elsewhere. Even if we obtain FDA approval to
market Xyrem, we cannot assure you that Xyrem or our other products will be
commercially successful or achieve the expected financial results. We may
encounter unanticipated problems relating to the development, manufacturing,
distribution and marketing of our products. Some of these problems may be beyond
our financial and technical capacity to solve. The failure to adequately address
any such problems could have a material adverse effect on our business and our
prospects. In addition, the efforts of government entities and third party
payors to contain or reduce the costs of health care may adversely affect our
sales and limit the commercial success of our products.

We cannot completely insulate our drug development portfolio from the
possibility of clinical or commercial failures. Some products that we have
selected for development may not produce the results expected during clinical
trials or receive FDA approval. Drugs approved by the FDA may not generate
product sales of an acceptable level. We have discontinued the development of
eleven products from our portfolio since inception, primarily to focus our
development efforts and resources on those products that fit within our three
selected strategic therapeutic market segments: Antidote; Oncology Support; and
Sleep Disorders or for which we believe there is an opportunity for growth or
profitability. We cannot assure you that any of these discontinued products
currently, or may in the future, have any value. Depending on available
financing, we may develop one or more of these discontinued products in the
future. We cannot assure you that we will

continue development of our current or any proposed products, or that we will
continue marketing all of our FDA approved products.

SIGNIFICANT GOVERNMENT REGULATION CONTINUES ONCE A PRODUCT IS APPROVED FOR SALE.

After the FDA's Division of Drug Marketing approves a drug, the FDA's
Advertising and Communication division must accept the drug's marketing claims,
which are the basis for the drug's labeling, advertising and promotion. We
cannot assure you that the FDA will approve our proposed marketing claims.
Failure to obtain approval of our proposed marketing claims could have a
material adverse effect on our business and prospects.

The FDA requires that we conduct "post-marketing adverse event surveillance
programs" to monitor any side effects that occur after any of our drug products
are approved for marketing. If the surveillance program indicates unsafe side
effects, the FDA may recall the product, and suspend or terminate our
authorization to market the product. The FDA also regulates the manufacturing
process for an approved drug. The FDA may impose restrictions or sanctions upon
the subsequent discovery of previously unknown problems with a product or
manufacturer. One possible sanction is requiring the withdrawal of such product
from the market. The FDA must approve any change in manufacturer as well as most
changes in the manufacturing process prior to implementation. Obtaining the
FDA's approval for a change in manufacturing procedures or change in
manufacturers is a lengthy process and could cause production delays and loss of
sales, which would have a material adverse effect on our business and our
prospects. To date, none of our products have been subject to an FDA recall. We
cannot assure you that our products will not be subject to an FDA recall in the
future.

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

WE DEPEND ON OTHERS FOR PRODUCT DEVELOPMENT OPPORTUNITIES.

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

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

- if we breach the contract;

- if we become insolvent or bankrupt;

- if we do not apply specified minimum resources and efforts to develop the
compound under license; or

- if we do not achieve certain minimum royalty payments, or in some cases,
minimum sales levels.

We cannot assure you that we will meet, or continue to meet, the
requirements specified in our current or any future license agreements. We
cannot assure you that if any agreement is terminated, we will be able to enter
into a similar agreement on terms as favorable as those contained in our
existing license agreement.

WE DEPEND ON OTHERS TO MANUFACTURE AND SUPPLY THE PRODUCTS WE MARKET.

We do not have, and do not intend to establish, any internal product
testing, synthesis of bulk drug substance, or manufacturing capability for drug
product. Accordingly, we depend on others to supply and manufacture the
components incorporated into all of our finished products. The inability to
secure contracts for these components on acceptable terms could adversely affect
our ability to develop and market our products.

Failure by parties with whom we contract to adequately perform their
responsibilities may delay our submission of products for regulatory approval,
impair our ability to deliver our products on a timely basis, or otherwise
adversely affect our business and our prospects.

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

BULK DRUG SUPPLY

Bulk drug substance is the active chemical compound used in the manufacture
of our drug products. We depend substantially on Ash Stevens, Inc. for the
supply of bulk drug substance used in Busulfex, Antizol, and Antizol-Vet. If we
were to lose Ash Stevens as a supplier, we would be required to identify a new
supplier for the bulk drug substance used in products that provided
approximately 88% of our total revenues in 2000 and 90% of our total revenues in
1999, and which are expected to account for approximately 85% of our revenues in
2001. We depend substantially on Lonza, Inc. for the supply of bulk drug
substance used in Xyrem. If we were to lose Lonza as a supplier, we would be
required to identify a new supplier before an NDA is submitted for Xyrem. We
also cannot assure you that our bulk drug supply arrangements with Ash Stevens
and Lonza, or any other future such supplier, might not change in the future. We
cannot assure you that any change would not adversely affect production of
Busulfex, Antizol, Antizol-Vet, Xyrem, or any other drug the Company might
attempt to develop or market.

DRUG PRODUCT MANUFACTURE

From bulk drug substance, drug product manufacturers formulate a finished
drug product and package the product for sale or for use in clinical trials. We
depend substantially on an affiliate of Boehringer Ingelheim for drug product
manufacturing of Busulfex, Antizol, and Antizol-Vet. Upon FDA approval of Xyrem,
an affiliate of DSM, N.V. has been authorized to manufacture Xyrem. If we were
to lose Boehringer as a manufacturer, we would be required to identify a new
manufacturer for drug products that provided approximately 88% of our total
revenues in 2000 and 90% of our total revenues in 1999, and which are expected
to account for approximately 85% of our total revenues in 2001. We cannot assure
you that our drug product manufacturing arrangements with Boehringer and DSM,
N.V. will not change or that the manufacturing services will continue to be
available on terms satisfactory to us. Any change in our manufacturing
agreements with Boehringer and DSM, N.V could adversely affect production of
Busulfex, Antizol, Antizol-Vet or Xyrem, or any other drug that we might attempt
to develop or market, which could have a material adverse effect on our business
and prospects.

WE CANNOT CONTROL OUR CONTRACTORS' COMPLIANCE WITH APPLICABLE REGULATIONS.

The FDA defines and regulates good manufacturing practices to which bulk
drug suppliers and drug product manufacturers are subject. The Drug Enforcement
Agency (DEA) defines and regulates the handling and reporting requirements for
certain drugs which have abuse potential, known as "scheduled drugs." Foreign
regulatory authorities prescribe similar rules and regulations. Our supply and
manufacturing contractors must comply with these regulatory prescriptions.
Failure by our contractors to comply with FDA or DEA requirements or applicable
foreign requirements could significantly delay our ability to commercialize or
continue to market our products. Either result could have a material adverse
effect on our business and prospects. Our contractors failure to comply with
good marketing practices or other legal requirements could also result in
seizure of violative products, injunctive actions brought by the federal
government or criminal and civil liability for Orphan, our officers, or our
employees. We cannot assure you that we will be able to maintain relationships
either domestically or abroad with contractors whose facilities and procedures
comply with, or will continue to comply with, FDA or DEA requirements or
applicable foreign requirements.

WE DEPEND UPON OTHERS FOR DISTRIBUTION OF OUR PRODUCTS.

We have an agreement with CORD Logistics, Inc., a subsidiary of Cardinal
Health, Inc., to provide integrated distribution and operations services to
support transactions between us and our wholesalers, specialty distributors, and
direct customers. CORD also provides reimbursement management, patient
assistance and information hotline services and specialty distribution and
marketing services to physician practices with respect to our products. CORD
currently distributes Busulfex, Cystadane, Elliotts B Solution, Antizol,
Antizol-Vet, and Sucraid. CORD may also distribute future products should those
products receive marketing clearance from the FDA. We are substantially
dependent on CORD's ability to successfully distribute Busulfex, Elliotts B
Solution, Antizol, Antizol-Vet, and Sucraid and other potential products.

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

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

WE DEPEND ON FOREIGN COMPANIES TO SELL OUR PRODUCTS OUTSIDE OF THE UNITED STATES
AND OUR INABILITY TO ESTABLISH AND MAINTAIN MARKETING ALLIANCES WITH FOREIGN
COMPANIES COULD ADVERSELY AFFECT OUR BUSINESS.

Our strategy to sell our products outside of the United States is to
license foreign marketing and distribution rights to a foreign company after a
NDA is submitted to, or approved by, the FDA in the United States. We consider
Europe, Asia and Canada our most attractive foreign markets. Our current foreign
developments are:

- Europe. We have licensed the marketing and distribution rights for
Busulfex, Antizol, Cystadane and Sucraid in Europe. If our licensees'
registration and distribution efforts are not successful, it may be
difficult for us to contract with other distributors in Europe for these
products. Distribution of all products except Antizol is limited to
"named patient" or "emergency use" basis until full regulatory approval
is obtained. Antizol has been approved for use in the United Kingdom but
is limited to "named patient" or "emergency use." Emergency use
distribution of our products is expected to result in limited revenues
for us.

- Asia. We have licensed marketing and distribution rights for Busulfex in
Japan, the Peoples Republic of China, Taiwan and South Korea. Use and
distribution of all products in these countries, except South Korea, is
limited to clinical trials until full regulatory approval is obtained.
Revenues prior to full approval are not expected to be material. Full
regulatory approval for marketing of these products in

South Korea was obtained in late 2001. We do not expect to generate
material revenues from our South Korean marketing and distribution
activities.

- Canada. We have licensed marketing and distribution rights for Antizol.
We do not expect to generate material revenues from these marketing and
distribution activities.

- Australia and New Zealand. We have licensed marketing and distribution
rights for Cystadane and Sucraid in Australia and New Zealand. We do not
expect to generate material revenues from these marketing and
distribution activities.

- Central America. We have licensed marketing and distribution rights for
Elliotts B Solution in Central America. We do not expect to generate
material revenues from these marketing and distribution activities.

- Israel. We have licensed marketing and distribution rights for Antizol,
Busulfex, Cystadane, Elliotts B Solution and Sucraid in Israel. Full
regulatory approval for all products except Antizol was obtained in
February 2000. Antizol has been submitted for approval. We do not expect
to generate material revenues from these marketing and distribution
activities.

- Turkey. We have licensed marketing and distribution rights for Busulfex
in Turkey. We do not expect to generate material revenues from these
marketing and distribution activities.

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

OUR PRODUCTS MIGHT BE RECALLED.

A product can be recalled at our discretion or at the discretion of the
FDA, the U.S. Federal Trade Commission, or other government agencies having
regulatory authority for marketed products. A recall may occur due to disputed
labeling claims, manufacturing issues, quality defects, or other reasons. We
cannot assure you that a product recall will not occur. We do not carry any
insurance to cover the risk of a potential product recall. Any product recall
could have a material adverse effect on our business and prospects. To date,
none of our products have been subject to an FDA recall. We cannot assure you
that our products will not be subject to an FDA recall in the future.

THE PRICES WE CHARGE FOR OUR PRODUCTS ARE SUBJECT TO GOVERNMENTAL REGULATION
WHICH COULD ADVERSELY AFFECT OUR ABILITY TO RECOVER OUR PRODUCT DEVELOPMENT
COSTS AND OUR FINANCIAL PERFORMANCE.

The flexibility of prices that we can charge for our products depends on
government regulation, both in the United States and abroad, and on other third
parties. One important factor is the extent to which reimbursement for our
products will be available to patients from government health administration
authorities, private health insurers and other third-party payors. Government
officials and private health insurers are increasingly challenging the price of
medical products and services. We cannot predict the level of pricing
flexibility we will have with respect to our products or whether we, or users of
our products, will be reimbursed for newly approved health care products.

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

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

WE MAY BE UNABLE TO PROTECT OUR PROPRIETARY INFORMATION, WHICH COULD NEGATIVELY
AFFECT OUR ABILITY TO COMPETE IN THE PHARMACEUTICAL INDUSTRY.

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

- to obtain, and enforce proprietary protection for our products under
United States and foreign patent laws and other intellectual property
laws;

- to preserve the confidentiality of our trade secrets; and

- to operate without infringing the proprietary rights of third parties.

We evaluate the desirability of seeking patent or other forms of protection
for our products in foreign markets based on the expected costs and relative
benefits of attaining such protection. We cannot assure you that any patents
will be issued from any applications or that any patents issued to us will
afford us adequate protection or competitive advantage. Also, we cannot assure
you that any issued patents will not be challenged, invalidated, infringed or
circumvented. Parties not affiliated with us have obtained or may obtain United
States or foreign patents, or possess or may possess proprietary rights,
relating to our products. We cannot assure you that patents now in existence or
later issued to others will not adversely affect the development or
commercialization of our products.

We believe that the active ingredients or compounds in our FDA approved and
proposed products, Cystadane, Elliotts B Solution, Antizol, Antizol-Vet, Xyrem
and Sucraid, are in the public domain and are not currently subject to patent
protection in the United States. However, we have filed a patent application
with respect to our formulation of Xyrem oral solution. A United States patents
issued to The University of Texas System and The University of
Houston-University Park, the group from whom we license the formulation for
Busulfex, covers our formulation and use of Busulfex. We could, however, incur
substantial costs asserting any infringement claims that we may have against
others.

We seek to protect our proprietary information and technology, in part,
through confidentiality agreements and inventors' rights agreements with our
employees. We cannot assure you that these agreements will not be breached, that
we will have adequate remedies for any breach, or that our trade secrets will
not otherwise be disclosed to or discovered by our competitors. We also cannot
assure you that our planned activities will not infringe patents owned by
others. We could incur substantial costs in defending infringement suits brought
against us. We also could incur substantial costs in connection with any suits
relating to matters for which we have agreed to indemnify our licensors or
distributors. An adverse outcome in any such litigation could have a material
adverse effect on our business and prospects. In addition, we often must obtain
licenses under patents or other proprietary rights of third parties. We cannot
assure you that we can obtain any such licenses on acceptable terms, if at all.
If we cannot obtain required licenses on acceptable terms, we could encounter
substantial difficulties in developing, manufacturing or marketing one or more
of our products.

WE FACE INTENSE COMPETITION IN THE PHARMACEUTICAL INDUSTRY.

Competition in the pharmaceutical industry is intense. Potential
competitors in the United States are numerous and include pharmaceutical,
chemical and biotechnology companies. Many of these companies have substantially
greater capital resources, marketing experience, research and development staffs
and facilities than we do. We seek to limit potential sources of competition by
developing products that are eligible for orphan drug designation and NDA
approval or other forms of protection. We cannot assure you, however, that our
competitors will not succeed in developing similar technologies and products
more rapidly than we
27

can. Similarly, we cannot assure you that these competing technologies and
products will not be more effective than any of those that we have developed or
are currently developing.

IF WE ARE UNABLE TO RESPONSE TO RAPIDLY CHANGING TECHNOLOGIES AND OTHER
DEVELOPMENTS, WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY.

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

WE FACE SUBSTANTIAL PRODUCT LIABILITY AND INSURANCE RISKS.

Testing and selling health care products entails the inherent risk of
product liability claims. The cost of product liability insurance coverage has
increased and is likely to continue to increase in the future. Substantial
increases in insurance premium costs in many cases have rendered coverage
economically impractical. We currently carry product liability coverage in the
aggregate amount of $20 million for all claims made in any policy year. Although
to date we have not been the subject of any product liability or other claims,
we cannot assure you that we will be able to maintain product liability
insurance on acceptable terms or that our insurance will provide adequate
coverage against potential claims. A successful uninsured product liability or
other claim against us could have a material adverse effect on our business and
prospects.

ITEM 2. PROPERTIES

The Company currently occupies approximately 15,000 square feet of leased
office space located in Minnetonka, Minnesota at a monthly rent of approximately
$25,000, including operating expenses. This lease expires on October 31, 2003.

ITEM 3. LEGAL PROCEEDINGS

None.

ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

None.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock trades on the National Market tier of The Nasdaq
Stock Market under the symbol ORPH. The following table sets forth the quarterly
high and low sales prices for the Company's Common Stock for the years ended
December 31, 2001 and December 31, 2000.

HIGH LOW
------- ------

YEAR ENDED DECEMBER 31, 2001
January 1 through March 31................................ $18.375 $6.375
April 1, through June 30.................................. $15.000 $9.500
July 1 through September 30............................... $12.200 $6.500
October 1 through December 31............................. $14.100 $7.240
YEAR ENDED DECEMBER 31, 2000
January 1 through March 31................................ $19.250 $4.688
April 1 through June 30................................... $11.000 $5.750
July 1 through September 30............................... $13.000 $9.125
October 1 through December 31............................. $16.000 $9.625

As of March 20, 2002, the Company's Common Stock was held by 275
shareholders of record and the Company estimates that there were approximately
3,000 beneficial owners of its Common Stock on such date.

The Company has never declared or paid any dividends and does not
anticipate paying dividends on its Common Stock in the foreseeable future. The
Company currently intends to retain future earnings, if any, for use in the
Company's business. The payment of any future dividends on its Common Stock will
be determined by the Board of Directors in light of conditions then existing,
including the Company's earnings, financial condition and requirements,
restrictions in financing agreements, business conditions and other factors.

ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data of the Company as of December 31,
2001 and 2000 and for the three years ended December 31, 2001, 2000 and 1999,
are derived from, and are qualified by reference to, the financial statements of
the Company audited by Ernst & Young LLP, independent auditors, included
elsewhere in this Form 10-K. The selected financial data as of December 31,
1999, 1998 and 1997 and for each of the two years ending December 31, 1998 and
1997 are derived from financial statements which are not included herein. The
information set forth below should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations," the
Financial Statements and Notes thereto and other financial information included
elsewhere in this Form 10-K.

FINANCIAL POSITION

DECEMBER 31,
----------------------------------------------------------------------
2001 2000 1999 1998 1997
----------- ----------- ------------ ------------ ------------

Cash, cash equivalents and
available-for-sale
securities................. $19,011,245 $11,417,254 $ 4,032,914 $ 7,521,483 $ 7,169,230
Working capital.............. 18,010,707 10,266,029 3,161,324 5,274,550 4,479,714
Total assets................. 22,346,276 15,296,885 6,241,178 9,046,730 8,238,950
Accumulated deficit.......... (54,073,165) (47,178,667) (40,243,874) (34,433,640) (26,196,538)
Total shareholders' equity... 18,394,207 10,742,927 3,561,208 5,575,577 3,645,902

FINANCIAL RESULTS

FOR THE FOR THE FOR THE FOR THE FOR THE
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2001 2000 1999 1998 1997
------------ ------------ ------------ ------------ ------------

Revenues....................... $11,274,110 $11,185,634 $ 6,457,406 $ 5,048,308 $ 654,838
Cost of sales.................. 1,591,826 1,532,446 803,562 1,118,644 317,727
Gross profit................... 9,682,284 9,653,188 5,653,844 3,929,664 337,111
Operating expenses
Research and development..... 4,933,278 6,832,130 4,975,706 6,611,011 6,482,004
Sales and marketing.......... 6,259,045 5,606,506 3,430,539 2,739,299 1,158,988
General and administrative... 4,807,847 4,094,905 2,756,827 2,994,341 2,461,344
Contract termination fee....... -- -- -- -- 2,172,000
Loss from operations........... (6,317,886) (6,880,353) (5,509,228) (8,414,987) (11,937,225)
Other income, net.............. 321,315 793,238 287,989 177,885 549,356
Net loss....................... (5,996,571) (6,087,115) (5,221,239) (8,237,102) (11,387,869)
Less:
Preferred stock dividend..... 903,053 872,024 682,872 249,658 --
Net loss applicable to common
shareholders................. $(6,899,624) $(6,959,139) $(5,904,111) $(8,486,760) $(11,387,869)
Basic and diluted loss per
common share................. $ (0.80) $ (0.86) $ (0.90) $ (1.36) $ (1.87)
Weighted average shares
outstanding.................. 8,597,331 8,135,224 6,587,790 6,236,897 6,074,342

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

GENERAL

Since its inception, the activities of the Company have consisted primarily
of obtaining the rights for developing and marketing proposed pharmaceutical
products, managing the development of these products and preparing for and
initiating the commercial introduction of six products. The Company operates in
a single business segment: pharmaceutical products. The Company has experienced
recurring losses from operations and has generated an accumulated deficit
through December 31, 2001 of $54.1 million. In addition, the Company expects to
incur additional losses from operations in 2002.

RECENT DEVELOPMENTS

On October 2, 2000 the Company announced the submission to the FDA of a new
drug application (NDA) for Xyrem(R) (sodium oxybate) oral solution as a
treatment for symptoms in narcolepsy. On March 2, 2001, the FDA granted a 90 day
extension to the Company's NDA in order that the Company could submit additional
data requested by the FDA. On June 6, 2001, the FDA held a meeting of the
Peripheral and

Central Nervous System Advisory Committee to consider Xyrem. The Advisory
Committee voted affirmatively that Xyrem was effective in treating cataplexy,
but was split on the issue of Xyrem's safety due to the relatively small size of
the safety database. As a result, the FDA issued an Approvable Letter for Xyrem
on July 2, 2001. The Approvable Letter defined issues that required resolution
before approval could be granted for the treatment of cataplexy. On October 23,
2001, the Company announced that the FDA had accepted the Company's response, in
the form of an amendment, to the Approvable Letter. The amendment represented
the Company's complete response to the issues contained in the FDA's Approvable
Letter. The amendment includes revisions to product labeling and the risk
management program, a safety update of ongoing clinical trials, and respiratory
data collected during all night polysomnographic recordings of narcolepsy
patients in a clinical trial completed in late 2000. The Company believes it has
addressed all questions and issues the FDA may have regarding the NDA for Xyrem.
The FDA assigned April 9, 2002 as its new action deadline for this NDA.

On December 10, 2001 the Company announced that it had raised $14.1 million
in gross proceeds through a private placement of approximately 1.7 million
shares of newly issued common stock at a price of $8.25 per share to Alta
BioPharma Partners II, L.P., Alta Embarcadero BioPharma Partners II, LLC and
funds managed by current investors OrbiMed Advisors LLC and Medical Strategy.
The Company has registered the shares under the Securities Act of 1933, as
amended. Thomas Weisel Partners LLC acted as the Company's agent and financial
advisor in the transaction.

CRITICAL ACCOUNTING POLICIES

REVENUE RECOGNITION

Sales are recognized at the time a product is shipped to the Company's
customers and are recorded net of reserves for estimated returns of expired
product and discounts. The Company is obligated to accept from all domestic
customers the return of products that have reached their expiration date. The
Company is not obligated to accept exchange of outdated product from its
international distribution partners. The Company monitors the return of product
and modifies its accrual for outdated product returns as necessary. Management
bases the reserve on historical experience and these estimates are subject to
change.

ACCOUNTS RECEIVABLE ALLOWANCE

The Company determines an allowance amount based upon an analysis of the
collectibility of specific accounts and the aging of the accounts receivable.
There is a concentration of sales to larger medical wholesalers and
distributors. The Company performs periodic credit evaluations of its customers'
financial condition. Receivables are generally due within 30 days of the invoice
date. Credit losses relating to customers have not been material since the
Company's inception.

INVENTORIES

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

RESULTS OF OPERATIONS

TWELVE MONTHS ENDED DECEMBER 31, 2001 VS. TWELVE MONTHS ENDED DECEMBER 31,
2000

Revenues increased from $11.2 million for the twelve months ended December
31, 2000 to $11.3 million for the twelve months ended December 31, 2001, an
increase of $0.1 million or 1%. Sales of both Antizol and Busulfex exceeded
revenue expectations in 2001. Busulfex continues to gain acceptance in major
cancer treatment centers and Antizol has become a standard of care in the
treatment of ethylene glycol and methanol poisonings. International sales of the
Company's products decreased in 2001 due primarily to a delay in the shipment of
clinical trial supply product requested by an international partner. The sales
of Cystadane, Sucraid Antizol-Vet and Elliotts B met the Company's expectations
in 2001 but are not expected to increase significantly in 2002. Revenues will
fluctuate from quarter to quarter and from year to year depending on, among
other factors, demand for the Company's products, new product introductions and
the Company's ability to optimize distribution of its approved products.

Cost of sales increased from $1.5 million for the twelve months ended
December 31, 2000 to $1.6 million for the twelve months ended December 31, 2001,
an increase of $0.1 million or 4%. This increase is primarily attributable to
the increase in sales in 2001. The gross margins for both 2001 and 2000 were
86%. Cost of sales as a percentage of revenues will fluctuate from quarter to
quarter and from year to year depending on, among other factors, demand for the
Company's products, new product introductions and the mix of approved products
shipped.

Research and development expense decreased from $6.8 million for the twelve
months ended December 31, 2000 to $4.9 million for the twelve months ended
December 31, 2001, a decrease of $1.9 million or 27%. The decrease is the result
of reduced research and development spending on Xyrem during 2001. The Company's
efforts in 2001 were primarily focused on supporting the Xyrem NDA submission.
Prior year spending included amounts for clinical trials included in the NDA
submission. The Phase III(b) trial for Xyrem now underway will increase research
and development spending in subsequent quarters as will additional trials and
data updates requested by the FDA. Clinical spending for these activities will
be dependent on a number of factors, including among others, the number of human
subjects screened and enrolled in the trials, and the number of active clinical
sites.

Sales and marketing expense increased from $5.6 million for the twelve
months ended December 31, 2000 to $6.3 million for the twelve months ended
December 31, 2001, an increase of $0.7 million or 12%. This increase is largely
attributable to significantly higher spending for pre-approval marketing
activities relating to Xyrem. The Company expects sales and marketing expenses
to increase further in 2002 because of additional marketing and sales efforts
for the anticipated commercialization of Xyrem in 2002.

General and administrative expense increased from $4.1 million for the
twelve months ended December 31, 2000 to $4.8 million for the twelve months
ended December 31, 2001, an increase of $0.7 million or 17%. Approximately 34%
of the increase in general and administrative expenses is related to
compensation expense associated with stock options. The balance of the increase
is related to building infrastructure, including the addition of staff to
prepare for the anticipated launch of Xyrem. General and administrative expenses
are expected to increase above current levels in subsequent quarters.

Other income is interest income from investment activities. Other income
decreased from $0.8 million for the twelve months ended December 31, 2000 to
$0.3 million for the twelve months ended December 31, 2001. This decrease is the
result of cash used to fund development and working capital activities of the
Company. In addition, interest rates on invested funds have been declining,
reducing the yields received. Other income is expected to increase in 2002 as a
result of the additional cash made available by the equity transaction completed
in December 2001.

Preferred stock dividends relate to shares of Senior Convertible Preferred
Stock issued on July 23, 1998 and shares of Series B Convertible Preferred Stock
issued on August 2, 1999. Both classes have dividend rates of 7.5%. Preferred
stock dividends were $0.9 million for the twelve months ended December 31, 2001
and 2000. Preferred stock dividends, which commenced on February 1, 1999 for the
Senior Convertible Preferred and on February 1, 2000 for the Series B
Convertible Preferred Stock, are payable in arrears on August 1 and February 1
of each year. The Company previously satisfied its dividend payment obligation
by issuing additional preferred stock, as permitted by the terms of the Senior
Convertible Stock. The Company intends to continue to satisfy its future
dividend payment obligations by the issuance of unregistered common shares of
stock for the Senior Convertible Preferred Stock and additional shares of
preferred stock for the Series B Convertible Preferred Stock, which will cause
preferred stock dividends to increase in subsequent quarters.

Net loss applicable to common stockholders was $(6.9) million for the
twelve months ended December 31, 2001 compared to a net loss of $(7.0) million
for the twelve months ended December 31, 2000. Basic and diluted loss per common
share for these respective periods were $(0.80) and $(0.86), based on weighted
average number of common shares outstanding of 8,597,331 and 8,135,224,
respectively.

TWELVE MONTHS ENDED DECEMBER 31, 2000 VS. TWELVE MONTHS ENDED DECEMBER 31, 1999

Revenues increased from $6.5 million for the twelve months ended December
31, 1999 to $11.2 million for the twelve months ended December 31, 2000, an
increase of $4.7 million or 73%. Sales of both Antizol and Busulfex exceeded
expectations in 2000. Busulfex continues to gain acceptance in the major cancer
treatment centers and Antizol has become a standard of care in the treatment of
ethylene glycol and methanol poisonings. The Company expects Antizol revenues to
decline slightly in 2001 because most hospitals that were expected to stock
Antizol have done so, and future orders will most likely be based on use.
International sales of the Company's products increased in 2000. The sales of
Cystadane, Sucraid Antizol-Vet and Elliotts B met the Company's expectations in
2000 and are not expected to increase significantly in 2001. Revenues will
fluctuate from quarter to quarter and from year to year depending on, among
other factors, demand for the Company's products, new product introductions and
the Company's ability to optimize distribution of its approved products.

Cost of sales increased from $0.8 million or 12% of revenues for the twelve
months ended December 31, 1999 to $1.5 million or 14% of revenues for the twelve
months ended December 31, 2000, an increase of $0.7 million or 88%. The increase
is primarily attributable to the increase in sales in 2000. Cost of sales as a
percentage of revenues will fluctuate from quarter to quarter and from year to
year depending on, among other factors, demand for the Company's products, new
product introductions and the mix of approved products shipped.

Research and development expense increased from $5.0 million for the twelve
months ended December 31, 1999 to $6.8 million for the twelve months ended
December 31, 2000, an increase of $1.8 million or 36%. Development activities
for Xyrem, principally clinical and toxicology spending, increased significantly
over 1999 levels due to the commencement in 2000 of additional Xyrem clinical
trials supporting additional future Xyrem claims and the completion of the
submission of the NDA for Xyrem on October 2, 2000.

Sales and marketing expense increased from $3.4 million for the twelve
months ended December 31, 1999 to $5.6 million for the twelve months ended
December 31, 2000, an increase of $2.2 million or 65%. This increase is largely
attributable to significantly higher spending related to the pre-approval market
activities related to Xyrem and on-going marketing activities for Busulfex. The
Company expects sales and marketing expenses to increase further in 2001 because
of the anticipated commercialization of Xyrem in 2001 and additional support for
the currently approved products.

General and administrative expense increased from $2.8 million for the
twelve months ended December 31, 1999 to $4.1 million for the twelve months
ended December 31, 2000, an increase of $1.3 million or 46%. This increase
related to building infrastructure, including the addition of staff to prepare
for the anticipated launch of Xyrem. General and administrative expenses are not
expected to increase significantly above current levels in subsequent quarters.

Other income is interest income from investment activities. Other income
increased from $0.3 million for the twelve months ended December 31, 1999 to
$0.8 million for the twelve months ended December 31, 2000. As a result of
higher levels of invested funds from the proceeds of the private placement in
February 2000, interest income has increased during 2000. Other income is
expected to decrease during 2001 as invested funds are used to fund operations
during the year.

Net loss applicable to common shareholders was $(7.0) million for the
twelve months ended December 31, 2000 compared to a net loss of $(5.9) million
for the twelve months ended December 31, 1999. Basic and diluted loss per common
share for these respective periods were $(0.86) and $(0.90), based on weighted
average number of common shares outstanding of 8,135,224 and 6,587,790,
respectively.

LIQUIDITY AND CAPITAL RESOURCES

Since its formation in July 1994, the Company has financed its operations
principally from net proceeds from several public and private financings,
interest income and product sales. The various public and private placement
transactions since inception resulted in aggregate net proceeds, after
commissions and expenses, of $60.5 million. These net proceeds include the
private placement of 1.7 million shares of newly issued common stock with net
proceeds of $13.0 million in December 2001.

Net working capital (current assets less current liabilities) increased to
$18.0 million at December 31, 2001 from $10.3 million at December 31, 2000.
Cash, cash equivalents, and available-for-sale securities increased from $11.4
million at December 31, 2000 to $19.0 million at December 31, 2001. The Company
invests excess cash in short-term, interest-bearing, investment grade
securities.

The Company has a commercial revolving line of credit with a bank which
expires on June 15, 2002. The maximum amount available to the Company under this
line of credit is $1,000,000, subject to certain limitations based on the
Company's cash collateral. The Company intends to renew this line of credit
facility. However the Company cannot assure that the bank will do so, or that it
will do so on terms acceptable to the Company. In connection with a financing
transaction completed in August 1999, the Company received a $2.05 million
commitment in the form of a line of credit from UBS Capital. This line was
eliminated in connection with a financing transaction in December 2001. The
Company had not borrowed under the UBS Capital agreement. In addition, the
Company has not borrowed under the bank arrangement.

The Company's commitments for outside development spending increased to
$4.0 million at December 31, 2001 from $3.9 million at December 31, 2000. The
increase is principally attributable to the timing of the initiation of clinical
trials for Xyrem development activities. The Company expects development
spending to increase as the Xyrem Phase III(b) clinical trial progresses and
post approval surveillance studies are completed. In addition, the Company
continues to look at new product opportunities and any new initiatives will
increase development spending.

The Company expects spending in 2002 for research and development, sales
and marketing, and administration to increase significantly over 2001 levels.
Management believes the Company's current working capital and anticipated
operating cash flows from product sales will be sufficient to fund its
operations through December 31, 2002.

For continued listing on the NASDAQ National Market, a company must satisfy
a number of requirements, which in the Company's case include either: (1) net
tangible assets in excess of $4.0 million or (2) a market capitalization of at
least $50.0 million. Net tangible assets are defined as total assets less the
sum of total liabilities and intangible assets. The Company met both of the
thresholds at December 31, 2001. The Company's net tangible assets at December
31, 2001 equaled approximately $18.4 million and the Company's market
capitalization was approximately $135.0 million (based on the last sale price of
$13.15 and 10,263,961 shares outstanding as of December 31, 2001). Although the
Company does not expect to be profitable in 2002, the Company nevertheless
expects to continue to meet the net tangible asset requirement for listing on
the NASDAQ National Market. However there can be no assurance that the Company
will continue to have adequate capital to meet the net tangible asset
requirement through the year 2002 and thereafter. The NASDAQ National Market
issued new listing qualifications, which will become effective November 2002,
and which will replace the net asset requirement with a minimum net equity
requirement of $10.0 million. At December 31, 2001, the Company meets the new
listing requirements.

In connection with the 1998 and 1999 private placements of convertible
preferred stock, the Company agreed to certain restrictions and covenants that
could limit its ability to obtain additional financing. Even

without these restrictions, the Company can make no assurances that additional
financing opportunities will be available or, if available, on acceptable terms.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's investments consist of debt securities with contractual
maturities of less than one year. Therefore, the Company does not believe its
operations are exposed to significant market risk relating to interest rates.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements of the Company as of and for the year ended
December 31, 2001 begin on page F-1 of this Annual Report.

ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

(a) Directors of the Registrant.

The information required by this item is incorporated by reference from the
information under the caption "Election of Directors" contained in the Company's
Proxy Statement to be filed with the Securities and Exchange Commission in
connection with the solicitation of proxies for the Company's Annual Meeting of
Stockholders to be held on May 23, 2002 (the "Proxy Statement").

(b) Executive Officers of the Registrant.

The executive officers of the Company and their ages as of March 1, 2002
are as follows:

NAME AGE TITLE
---- --- -------------------------------------------------

John Howell Bullion............. 50 Chief Executive Officer and Chairman of the Board
William Houghton, M.D........... 59 Chief Operating Officer
Dayton T. Reardan, Ph.D......... 46 Vice President of Regulatory Affairs
Pamela J. Stahl................. 36 Vice President of Commercial Operations
Timothy G. McGrath.............. 37 Vice President and Chief Financial Officer

Executive officers of the Company serve at the discretion of the Board of
Directors with no fixed term. There are no family relationships between or among
any of the executive officers or directors of the Company.

Mr. Bullion has been Chief Executive Officer of the Company since June 24,
1994 and Chairman of the Board of Directors since December 30, 1998. Mr. Bullion
is a co-founder of Chronimed Inc., the company from which Orphan Medical, Inc.
was spun-off in 1994. Prior to joining the Company, Mr. Bullion served as
President of Bluestem Partners, an investment and consulting company, as
President of Dahl & Associates, a soil and ground water remediation company and
President of Concurrent Knowledge Systems, Inc., a software development company.
Mr. Bullion also served as partner and Vice President with First Bank System
Venture Capital Company for seven years.

Dr. Houghton has been the Company's Chief Operating Officer since August
1998. Prior to joining the Company, Dr. Houghton was employed in a variety of
positions at Iotek, Inc. from April 1995 to August 1998, most recently as Chief
Scientific Officer and Vice President of Clinical and Regulatory Affairs. At
Iotek, Dr. Houghton was responsible for all research activities, regulatory and
clinical research, and served as the medical liaison with Iotek's Medical
Advisory Board. From February 1984 to March 1995, Dr. Houghton held a variety of
management positions with Abbott Australasia and Abbott Laboratories in the
United States.

Dr. Reardan has been the Company's Vice President of Regulatory Affairs
since May 1995 and had been the Director of Regulatory Affairs since joining the
Company in 1994. From 1993 to 1994, Dr. Reardon was Director of Development at
CV Therapeutics. From 1984 to 1993, Dr. Reardon held a variety of management
positions at Xoma Corporation.

Ms. Stahl has been the Company's Vice President of Commercial Operations
since October 2001. From February 2000 to September 2001, Ms. Stahl held a
number of positions at America TeleCare, Inc., most recently as Vice President
of Sales where she had responsibility for sales, marketing, and distribution.
From 1992 through January 2000, Ms. Stahl held several management positions in
sales, managed care, and sales training at AstraZeneca L.P. where she was a
member of the team that launched Prilosec(R), the leading treatment of acid
related disorders. Ms. Stahl has also worked at Merck & Co., Inc. in sales and
training positions supporting Zocor(R) and Pepcid(R).

Mr. McGrath has been the Company's Vice President and Chief Financial
Officer since October 1999. Mr. McGrath had worked as consultant providing
financial services to growing companies in the Minneapolis and Saint Paul area.
From 1994 to 1998, he was Vice President of Finance at E. W. Blanch Holdings,
Inc., a

publicly traded provider of integrated risk management and distribution
services. Prior to joining E.W. Blanch Holdings, Mr. McGrath was with Ernst &
Young LLP in Minneapolis, Minnesota.

The information required by this item is incorporated by reference from the
information under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance" contained in the Proxy Statement.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference from the
information under the caption "Executive Compensation" contained in the Proxy
Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

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

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is incorporated by reference from the
information contained under the caption "Certain Relationships and Related
Transactions" contained in the Proxy Statement.

PART IV

ITEM 14. FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1). Financial Statements

PAGE NUMBER
IN THIS
DESCRIPTION ANNUAL REPORT
----------- -------------

Audited Financial Statements:
Report of Independent Auditors............................
F-1
Balance Sheets............................................
F-2
Statements of Operations..................................
F-3
Statements of Cash Flows..................................
F-4
Statement of Changes in Shareholders' Equity..............
F-5
Notes to Financial Statements.............................
F-6 to F-14

(a)(2). Financial Statement Schedules

The following Financial Statement Schedule should be read in conjunction
with the Audited Financial Statements referred to under Item 14(a)(1) above.
Financial statement schedules other than those provided have been omitted since
they are not required or are not applicable or the required information is shown
in the financial statements or related notes.

Schedule II -- Valuation and Qualifying Accounts.......................F-15

(a)(3). Listing of Exhibits

EXHIBIT METHOD OF
NUMBER DESCRIPTION FILING
------- ----------- ---------

3.1 Certificate of Incorporation of Orphan Medical, Inc.
("OMI")..................................................... *
3.2 Bylaws of OMI............................................... *
4.1 OMI 1994 Stock Option Plan.................................. (1)
4.2 OMI Employee Incentive Stock Option Agreement............... (1)
4.3 OMI Non-Incentive Stock Option Agreement.................... (1)
4.4 OMI Non-Incentive Stock Option Agreement for Non-Employee
Directors................................................... (1)
4.5 Specimen Stock Certificate of OMI Common Stock.............. *
10.1 Marketing and Distribution Agreement between OMI and
Chronimed effective July 2, 1994............................ (1)
10.2 Transfer Agreement between OMI and Chronimed effective July
1, 1994..................................................... (1)
10.3 Distribution and Spin-off Agreement between OMI and
Chronimed effective July 2, 1994............................ (1)
10.4 Administrative Services Agreement between OMI and Chronimed
effective July 2, 1994...................................... (1)
10.5 Security Agreement between OMI and Chronimed effective July
2, 1994..................................................... (1)
10.6 Aminocaproic Acid License Agreement between Chronimed and
Virginia's Center for Innovative Technology dated September
17, 1993.................................................... (1)
10.7 Patent and Technology License Agreement for Busulfan between
Chronimed and The University of Texas M.D., Anderson Cancer
Center, the Board of Regents of the University of Texas
System and the University of Houston effective February 14,
1994........................................................ (1)
10.8 Letter Agreement regarding L-Cycloserine between Chronimed
and Dr. Meier Lev dated December 29, 1993................... (1)

EXHIBIT METHOD OF
NUMBER DESCRIPTION FILING
------- ----------- ---------

10.09 Sublicense Agreement regarding 4-Methylpyrazole between
Chronimed and Mericon Investment Group, Inc. dated December
17, 1993.................................................... (1)
10.10 License Agreement regarding Short Chain Fatty Acids between
Chronimed and Richard Breuer dated March 2, 1994............ (1)
10.11.1 Employment Agreement between OMI and John Howell Bullion
dated October 29, 1999...................................... (16)
10.12 Employment Agreement between OMI and Bertram A. Spilker,
Ph.D., M.D. dated August 31, 1994........................... (1)
10.13 Assumption Agreement and Consent to Assignments regarding
Short Chain Fatty Acids between OMI and Richard Breuer dated
September 30, 1994.......................................... (2)
10.14 Assumption Agreement and Consent to Assignment regarding
Aminocaproic Acid between OMI and Virginia's Center for
Innovative Technology dated September 30, 1994.............. (2)
10.15 Assumption Agreement and Consent to Assignment regarding
4-Methylpyrazole between OMI and Mericon Investment Group,
Inc. dated October 5, 1994.................................. (2)
10.16 License Agreement regarding 4-Methylpyrazole between Kenneth
McMartin and Mericon Investment Group, Inc. dated July 6,
1993........................................................ (2)
10.17 License Agreement regarding Glucaric Acid between OMI and
Ohio State University Research Foundation dated December 28,
1994........................................................ (2)
10.18 Manufacturing Development and Supply Agreement regarding
Aminocaproic Acid between OMI and Lifecore Biomedical, Inc.
dated December 21, 1994..................................... (2)
10.19 Marketing Agreement regarding Cystagon between OMI and
Chronimed dated October 19, 1994............................ (2)
10.20 Assumption Agreement and Consent to Assignment regarding
Busulfan between OMI and the University of Texas, M.D.,
Anderson Cancer Center, the Board of Regents of the
University of Texas System and the University of Houston
dated October 18, 1994...................................... (2)
10.21 License Agreement regarding Catrix between OMI and
Lescarden, Inc. dated October 28, 1994...................... (2)
10.22 License Agreement regarding Sucrase between OMI and Hartford
Hospital dated December 30, 1994............................ (2)
10.23 Option to Acquire License regarding Tretinoin between OMI
and James Hannan dated February 6, 1995..................... (2)
10.24 Consulting Agreement between OMI and William B. Adams dated
November 15, 1994........................................... (3)
10.27 Agreement regarding Cystagon between Chronimed and Mylan
Pharmaceutical dated October 17, 1994....................... (2)
10.29 Agreement between OMI and David A. Feste effective July 1,
1995........................................................ (4)
10.30 Development and License Agreement regarding Choline Chloride
between OMI and Alan Buchman, Donald J. Jenden, Marvin E.
Ament and Mark D. Dubin dated May 11, 1995.................. (4)
10.31 Addendum to License Agreement regarding Short Chain Fatty
Acids between OMI and Richard Breuer dated May 12, 1995..... (4)
10.32 Addendum to Administrative Services Agreement between OMI
and Chronimed dated August 2, 1995.......................... (4)
10.33 Amendment to Aminocaproic Acid License Agreement between OMI
and Virginia's Center for Innovative Technology dated
September 17, 1993.......................................... (5)
10.34 Amendment No. 1 to Marketing and Distribution Agreement
between OMI and Chronimed dated July 2, 1994................ (5)

EXHIBIT METHOD OF
NUMBER DESCRIPTION FILING
------- ----------- ---------

10.35 Amendment to Marketing Agreement regarding Cystagon between
OMI and Chronimed dated October 19, 1994.................... (5)
10.36 IRS tax qualification letter dated January 10, 1996
regarding the favorable determination of the tax status of
the OMI 401(k) Savings Plan................................. (5)
10.38 Form of License Agreement regarding Colloidal Bismuth
Subcitrate between OMI and Josman Laboratories, Inc. dated
March 4, 1996............................................... (5)
10.39 Agreement between OMI and Chronimed dated June 3, 1996 to
amend Marketing and Distribution Agreement dated July 2,
1996........................................................ (6)
10.40 Cystadane Agreement between the OMI and Chronimed dated
October 11, 1996............................................ (7)
10.41 License Agreement regarding alpha galactosidase A between
OMI and Research Corporation Technologies, Inc. dated March
15, 1996.................................................... (8)
10.42 License Agreement regarding 5-fluorouracil between OMI and
the University of Miami and its Department of Ohpthalmology
dated December 6, 1996...................................... (8)
10.43 Collaborative Development Agreement regarding Clonidine
between OMI and Medtronic, Inc. dated November 27, 1996..... (8)
10.44 Distribution Agreement between OMI and W. A. Butler Company
dated November 26, 1996..................................... (8)
10.45 Distribution Services Agreement between OMI and Cardinal
Health dated June 1, 1997................................... (9)
10.46 Termination Agreement between OMI and Chronimed dated as of
June 27, 1997............................................... (10)
10.47 Loan Agreement and Security Agreement between OMI and
Riverside Bank dated May 15, 1998........................... (11)
10.48 Stock Purchase Agreement between OMI and UBS Capital II LLC
dated July 23, 1998......................................... (11)
10.49 Supplement to Termination Agreement between OMI and
Chronimed dated December 7, 1998............................ (12)
10.50 Supplement II to Termination Agreement between OMI and
Chronimed dated February 9, 1999............................ (13)
10.51 Purchase Agreement between OMI and UTECH, LLC dated December
30, 1998 regarding the sale and assignment to UTECH LLC of
license rights to Colloidal Bismuth Subcitrate.............. (14)
10.52 Common Stock Purchase Warrant between OMI and R.J. Steichen
dated January 1, 1999....................................... (14)
10.53 Purchase Agreement and Letter of Intent between OMI and
Caduceus Capital Trust, Caduceus Capital II L.P.,
PaineWebber Eucalyptus Fund LLC, and PaineWebber Eucalyptus
Fund Ltd.................................................... (16)
10.54 Purchase Agreement and Letter of Intent between DG LUX
LACUNA APO BIOTECH FUND..................................... (16)
10.55 Stock Purchase Agreement between OMI and UBS Capital II LLC
dated August 2, 1999........................................ (15)
10.56 Promissory Note between OMI and UBS Capital II LLC dated
August 2, 1999.............................................. (15)
10.57 Warrant to purchase shares of Series C Convertible Preferred
Stock or Series D Non-Voting Preferred Stock................ (15)
10.58 Warrant to purchase shares Series D Non-Voting Preferred
Stock....................................................... (15)
10.59 Form of Change in Control Agreement to be entered into
between the OMI and Certain Executives...................... (16)
10.60 Stock Purchase Agreement dated December 7, 2001 between OMI,
Alta BioPharma Partners II, L.P., Alta Embarcadero BioPharma
Partners II, LLC and the other investors named therein...... *

EXHIBIT METHOD OF
NUMBER DESCRIPTION FILING
------- ----------- ---------

10.61 Agreement dated December 7, 2001 between OMI and UBS Capital
II LLC...................................................... *
10.62 Management Rights Agreement dated December 6, 2001 between
OMI and Alta BioPharma Partners II, L.P. ................... *
23.1 Consent of Ernst & Young LLP................................ *
24 Power of Attorney........................................... *

---------------

* Filed herewith.

(1) Incorporated by reference to the corresponding exhibit numbers in OMI's
Registration Statement on Form 10 filed on August 31, 1994, Commission File
No. 0-24760.

(2) Incorporated by reference to the corresponding exhibit numbers in OMI's
Registration Statement on Form S-1 filed on March 3, 1995, Commission File
No. 0-24760.

(3) Incorporated by reference to the corresponding exhibit number in OMI's
Quarterly Report on Form 10-Q for the quarter ended December 30, 1994,
Commission File No. 0-24760.

(4) Incorporated by reference to the corresponding exhibit numbers in OMI's
Annual Report on Form 10-K filed for the year ended June 30, 1995,
Commission File No. 0-24760.

(5) Incorporated by reference to the corresponding exhibit numbers in OMI's
Registration Statement on Form S-1 filed on March 11, 1996, Commission File
No. 0-24760.

(6) Incorporated by reference to the corresponding exhibit number in OMI's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1996,
Commission File No. 0-24760.

(7) Incorporated by reference to the corresponding exhibit number in OMI's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1996,
Commission File No. 0-24760.

(8) Incorporated by reference to the corresponding exhibit numbers in OMI's
Annual Report on Form 10-K filed for the year ended December 31, 1996,
Commission File No. 0-24760.

(9) Incorporated by reference to the corresponding exhibit number in OMI's
Quarterly Report on Form 10-Q for the quarter ended March 31, 1997,
Commission File No. 0-24760.

(10) Incorporated by reference to the corresponding exhibit numbers in OMI's
Annual Report on Form 10-K filed for the year ended December 31, 1997,
Commission File No. 0-24760.

(11) Incorporated by reference to the corresponding exhibit numbers in OMI's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998,
Commission File No. 0-24760.

(12) Incorporated by reference to the similarly described exhibit included with
OMI's Current Report on Form 8-K dated December 7, 1998, Commission File
No. 0-24760.

(13) Incorporated by reference to the similarly described exhibit included with
OMI's Current Report on Form 8-K dated February 9, 1999, Commission File
No. 0-24760.

(14) Incorporated by reference to the similarly described exhibit included with
OMI's Annual Report on Form 10-K for the year ended December 31, 1998,
Commission File No. 0-24760.

(15) Incorporated by reference to the similarly described exhibit included with
OMI's Current Report on Form 10-Q for the quarter ended June 30, 1999,
Commission File No. 0-24760.

(16) Incorporated by reference to the similarly described exhibit included with
OMI's Annual Report on Form 10-K for the year ended December 31, 1999,
Commission File No. 0-24760.

(b). Reports on Form 8-K

None.

(c). Exhibits

See Item 14(a)(3) above.

(d). Financial Statement Schedules

See Item 14(a)(2) above.

SIGNATURES

Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of Minnetonka, State of Minnesota, on April 1, 2002.

ORPHAN MEDICAL, INC.

By: /s/ JOHN HOWELL BULLION
------------------------------------
John Howell Bullion
Chief Executive Officer

By: /s/ TIMOTHY MCGRATH
------------------------------------
Timothy McGrath
Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report on Form 10-K has been signed by the following persons in the
capacities and on the date indicated.

NAME TITLE DATE
---- ----- ----

/s/ JOHN HOWELL BULLION Chief Executive Officer, Secretary April 1, 2002
------------------------------------------------ (principal executive officer) and
John Howell Bullion Director

* Director March 26, 2002
------------------------------------------------
Farah Champsi

* Director March 27, 2002
------------------------------------------------
Michael Greene

* Director March 26, 2002
------------------------------------------------
Thomas King

* Director April 1, 2002
------------------------------------------------
W. Leigh Thompson, Ph.D. M.D.

* Director March 30, 2002
------------------------------------------------
Julius Vida, Ph.D., M.B.A.

* Director March 26, 2002
------------------------------------------------
William M. Wardell, Ph.D., M.D.

---------------

* John Howell Bullion, pursuant to the Powers of Attorney executed by each of
the officers and directors above whose name is marked by a "*", by signing his
name hereto, does hereby sign and execute this Annual Report on Form 10-K on
behalf of each of the officers and directors in the capacities in which the
name of each appears above.

REPORT OF INDEPENDENT AUDITORS

Board of Directors and Shareholders
Orphan Medical, Inc.

We have audited the accompanying balance sheets of Orphan Medical, Inc. as
of December 31, 2001 and 2000, and the related statements of operations, changes
in shareholders' equity, and cash flows for each of the three years in the
period ended December 31, 2001. Our audits also included the financial statement
schedule listed in item 14(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 financial position of Orphan Medical, Inc. at
December 31, 2001 and 2000, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2001, in conformity
with accounting principles generally accepted in the United States. Also in our
opinion, the financial statement schedule referred to above, when considered in
relation to the basic financial statements taken as a whole, presents fairly in
all material aspects the information set forth therein.

Minneapolis, Minnesota
February 15, 2002

F-1

ORPHAN MEDICAL, INC.

BALANCE SHEETS

DECEMBER 31,
---------------------------
2001 2000
------------ ------------

ASSETS

Current assets:
Cash and cash equivalents................................. $ 19,011,245 $ 1,115,319
Available-for-sale securities............................. -- 10,301,935
Accounts receivable, less allowance for doubtful accounts
of $25,000 and $116,200 for 2001 and 2000,
respectively........................................... 1,645,749 1,578,544
Inventories............................................... 1,242,120 1,602,949
Prepaid expenses and other................................ 63,662 221,240
------------ ------------
Total current assets........................................ 21,962,776 14,819,987
Property and equipment:
Property and equipment.................................... 1,056,642 968,118
Accumulated depreciation.................................. (673,142) (504,187)
------------ ------------
383,500 463,931
Other assets................................................ -- 12,967
------------ ------------
Total assets................................................ $ 22,346,276 $ 15,296,885
============ ============

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,152,426 $ 1,758,807
Accrued royalties......................................... 204,790 151,025
Accrued compensation...................................... 1,065,662 806,839
Deferred revenues......................................... 431,310 500,850
Accrued expenses.......................................... 1,097,881 1,336,437
------------ ------------
Total current liabilities................................... 3,952,069 4,553,958
Commitments
Shareholders' equity:
Senior Convertible Preferred Stock, $.01 par value; 14,400
shares authorized; 8,706 shares issued and
outstanding............................................ 87 87
Series B Convertible Preferred Stock, $.01 par value;
5,000 shares authorized; 3,417 and 3,174 shares issued
and outstanding........................................ 34 32
Series C Convertible Preferred Stock, $.01 par value;
4,000 shares authorized; 0 shares issued and
outstanding............................................ -- --
Series D Convertible Preferred Stock, $.01 par value;
1,500,000 shares authorized; 0 shares issued and
outstanding............................................ -- --
Common stock, $.01 par value; 25,000,000 shares
authorized; 10,263,961 and 8,442,759 issued and
outstanding............................................ 102,639 84,427
Additional paid-in capital................................ 72,364,612 57,849,390
Accumulated deficit....................................... (54,073,165) (47,178,667)
Unrealized gain (loss) on available-for-sale securities... -- (12,342)
------------ ------------
Total shareholders' equity.................................. 18,394,207 10,742,927
------------ ------------
Total liabilities and shareholders' equity.................. $ 22,346,276 $ 15,296,885
============ ============

See accompanying notes.
F-2

ORPHAN MEDICAL, INC.

STATEMENTS OF OPERATIONS

FOR THE YEAR FOR THE YEAR FOR THE YEAR
ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2001 2000 1999
------------ ------------ ------------

Revenues.............................................. $11,274,110 $11,185,634 $ 6,457,406
Cost of sales......................................... 1,591,826 1,532,446 803,562
----------- ----------- -----------
Gross profit.......................................... 9,682,284 9,653,188 5,653,844
Operating expenses:
Research and development............................ 4,933,278 6,832,130 4,975,706
Sales and marketing................................. 6,259,045 5,606,506 3,430,539
General and administrative.......................... 4,807,847 4,094,905 2,756,827
----------- ----------- -----------
Loss from operations.................................. (6,317,886) (6,880,353) (5,509,228)
Other income:
Interest, net....................................... 321,315 793,238 287,989
----------- ----------- -----------
Net loss.............................................. (5,996,571) (6,087,115) (5,221,239)
Less: Preferred stock dividends....................... 903,053 872,024 682,872
----------- ----------- -----------
Net loss applicable to common shareholders............ $(6,899,624) $(6,959,139) $(5,904,111)
=========== =========== ===========
Basic and diluted loss per common share applicable to
common shareholders................................. $ (0.80) $ (0.86) $ (0.90)
=========== =========== ===========
Weighted average number of shares outstanding......... 8,597,331 8,135,224 6,587,790
=========== =========== ===========

See accompanying notes.
F-3

ORPHAN MEDICAL, INC.

STATEMENTS OF CASH FLOWS

FOR THE YEAR FOR THE YEAR FOR THE YEAR
ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2001 2000 1999
------------ ------------ ------------

OPERATING ACTIVITIES
Net loss............................................. $(5,996,571) $ (6,087,115) $(5,221,239)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization................... 168,955 141,783 115,777
Compensatory options............................ 239,887 196,390 51,196
Changes in operating assets and liabilities:
Accounts payable.............................. (606,381) 1,194,705 (22,714)
Accrued expenses and deferred revenue......... 4,492 679,283 (768,469)
Inventories................................... 360,829 (1,057,406) (432,818)
Accounts receivable and other................. 103,340 (502,963) (124,996)
----------- ------------ -----------
Net cash used in operating activities................ (5,725,449) (5,435,323) (6,403,263)
INVESTING ACTIVITIES
Purchase of property and equipment................... (88,524) (252,781) (158,980)
Purchase of short-term investments................... -- (27,778,944) (8,735,566)
Maturities of short term investments................. 10,314,277 21,296,658 9,447,288
----------- ------------ -----------
Net cash (used in) provided by investing
activities......................................... 10,225,753 (6,735,067) 552,742
FINANCING ACTIVITIES
Proceeds from common stock offering.................. 12,994,122 10,692,154 --
Proceeds from the issuance of shares under the
Employee Stock Purchase Plan....................... 134,288 398,596 --
Proceeds from stock option and warrants.............. 267,414 1,992,313 876,546
Net proceeds from Preferred Stock offerings.......... -- -- 2,876,869
Preferred stock dividend............................. (202) (3,032) (995)
Common stock redemption.............................. -- -- (676,563)
----------- ------------ -----------
Net cash provided by financing activities............ 13,395,622 13,080,031 3,075,857
----------- ------------ -----------
Increase(decrease) in cash and cash equivalents...... 17,895,926 909,641 (2,774,664)
Cash and cash equivalents at the beginning of year... 1,115,319 205,678 2,980,342
----------- ------------ -----------
Cash and cash equivalents at the end of year......... $19,011,245 $ 1,115,319 $ 205,678
=========== ============ ===========
SCHEDULE OF NONCASH INVESTING AND FINANCING
ACTIVITIES
Warrants issued for line of credit................... $ -- $ -- $ 82,000
Issuance of preferred stock dividends................ 897,725 841,999 588,000

See accompanying notes.
F-4

ORPHAN MEDICAL, INC.

STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY

ACCUMULATED
PREFERRED STOCK COMMON STOCK ADDITIONAL OTHER
--------------- --------------------- PAID-IN ACCUMULATED COMPREHENSIVE
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT LOSS TOTAL
------ ------ ---------- -------- ----------- ------------ ------------- -----------

Balance at December 31,
1998....................... 7,500 $ 75 6,560,096 $ 65,601 $39,946,113 $(34,433,640) $ (2,572) $ 5,575,577
Net proceeds from private
offering of 2,950 shares
of Series B Convertible
Preferred Stock.......... 2,950 30 -- -- 2,876,838 -- -- 2,876,868
Options and warrants
exercised................ -- -- 173,834 1,738 874,809 -- -- 876,547
Repurchase of Chronimed
stock.................... -- -- (127,723) (1,277) (675,286) -- -- (676,563)
Compensatory options....... -- -- -- -- 51,196 -- -- 51,196
Warrants issued for line of
credit................... -- -- -- -- 82,000 -- -- 82,000
Preferred stock
dividends................ 588 6 -- -- 587,994 (588,995) (995)
Comprehensive loss:
Net loss................... -- -- -- -- -- (5,221,239) -- (5,221,239)
Unrealized loss on
available-for-sale
securities............... -- -- -- -- -- -- (2,183) (2,183)
-----------
Subtotal -- comprehensive
loss................... (5,223,422)
------ ---- ---------- -------- ----------- ------------ -------- -----------
Balance at December 31,
1999....................... 11,038 111 6,606,207 66,062 43,743,664 (40,243,874) (4,755) 3,561,208
Net proceeds from private
offering of 1,365,000
shares of Common Stock... -- -- 1,365,000 13,650 10,678,504 -- -- 10,692,154
Options and warrants
exercised................ -- -- 384,746 3,847 1,991,113 (2,647) -- 1,992,313
Proceeds from Employee
Stock Purchase Plan...... -- -- 86,806 868 397,728 -- -- 398,596
Options issued for
services................. -- -- -- -- 196,390 -- -- 196,390
Preferred stock
dividends................ 842 8 -- -- 841,991 (845,031) -- (3,032)
Comprehensive loss:
Net loss................... -- -- -- -- -- (6,087,115) -- (6,087,115)
Unrealized loss on
available-for-sale
securities............... -- -- -- -- -- -- (7,587) (7,587)
-----------
Subtotal -- comprehensive
loss................... (6,094,702)
------ ---- ---------- -------- ----------- ------------ -------- -----------
Balance at December 31,
2000....................... 11,880 119 8,442,759 84,427 57,849,390 (47,178,667) (12,342) 10,742,927
Net proceeds from private
offering of 1,706,999
shares of Common Stock... -- -- 1,706,999 17,070 12,977,052 -- -- 12,994,122
Options and warrants
exercised................ -- -- 41,700 417 266,997 -- -- 267,414
Proceeds from Employee
Stock Purchase Plan...... -- -- 19,210 192 134,096 -- -- 134,288
Compensatory options....... -- -- -- -- 239,887 -- -- 239,887
Preferred stock
dividends................ 243 2 53,293 533 897,190 (897,927) -- (202)
Comprehensive loss:
Net loss................... -- -- -- -- -- (5,996,571) -- (5,996,571)
Unrealized loss on
available-for-sale
securities............... -- -- -- -- -- -- 12,342 12,342
-----------
Subtotal -- comprehensive
loss................... (5,984,229)
------ ---- ---------- -------- ----------- ------------ -------- -----------
Balance at December 31,
2001....................... 12,123 $121 10,263,961 $102,639 $72,364,612 $(54,073,165) $ -- $18,394,207
====== ==== ========== ======== =========== ============ ======== ===========

See accompanying notes.
F-5

ORPHAN MEDICAL, INC.

NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2001

1. BUSINESS ACTIVITY

Orphan Medical, Inc. (the "Company") acquires, develops, and markets
products of high medical value intended to address inadequately treated or
uncommon diseases within selected therapeutic areas segments. A drug has high
medical value if it offers a major improvement in the safety or efficacy of
patient treatment and has no substantially equivalent substitute. The Company
operated within a single segment, pharmaceutical product development, and had
six approved products commercially available in the United States and several
foreign countries.

As of December 31, 2001, the Company had not completed product development,
obtained required regulatory approvals or verified the market acceptance and
demand for Xyrem(R) (sodium oxybate) oral solution, one of its three principal
products. Antizol(R) (fomepizole) Injection, Busulfex(R) (busulfan) Injection
and Xyrem are the Company's principal products. In February 1999, the U.S. Food
and Drug Administration (the "FDA") approved the Company's New Drug Application
("NDA") for Busulfex and the Company began commercial shipments of Busulfex to
distributors and wholesalers during the same month. In addition, a Treatment
Investigational New Drug ("IND") application for Xyrem was approved by the FDA
in December 1998 and the Company began shipping Xyrem in February 1999, for use
in its Treatment IND clinical trials which continue at December 31, 2001. The
Treatment IND allows the Company to seek payments for Xyrem used by patients
enrolled in the Treatment IND clinical trials, as well as gain additional
clinical safety data that are expected to support the Company's NDA filing for
Xyrem. The Company submitted its NDA for Xyrem on October 2, 2000. The FDA
granted the application priority review status giving the FDA a goal of
completing its review within 180 days. The FDA issued an Approvable Letter on
July 7, 2001. The Company's complete response was accepted by the FDA on October
23, 2001. The FDA's action deadline is April 2002.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

USE OF ESTIMATES

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

REVENUE RECOGNITION

Deferred revenue represents prepayment from customers for products not yet
shipped.

CASH EQUIVALENTS AND AVAILABLE-FOR-SALE SECURITIES

The Company considers all highly liquid investments with remaining
maturities of 90 days or less when purchased to be cash equivalents. The Company
considers all highly liquid investments with remaining maturities of more than
90 days when purchased to be available-for-sale securities. Cash equivalents are
carried at cost plus accrued interest, which approximates market value. The
Company records unrealized gain or loss, if any, on available-for-sale
securities as a separate component of shareholders' equity.

F-6

ORPHAN MEDICAL, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

CONCENTRATION OF CREDIT RISK

The Company invests its excess cash in U.S. government agency securities,
investment grade commercial paper, and other money market instruments and has
established guidelines relative to diversification and maturities in an effort
to maintain safety and liquidity. These guidelines are periodically reviewed to
take advantage of trends in yields and interest rates. The Company has not
experienced any significant losses on its cash equivalents or available-for-sale
securities.

ACCOUNTS RECEIVABLE ALLOWANCE

INVENTORIES

DECEMBER 31,
-----------------------
2001 2000
---------- ----------

Raw materials and packaging................................. $ 981,583 $1,213,464
Finished goods.............................................. 260,537 389,485
---------- ----------
$1,242,120 $1,602,949
========== ==========

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Maintenance and repairs are
expensed as incurred. Depreciation is computed using the straight-line method
over the assets' estimated useful lives of three to seven years.

RESEARCH AND DEVELOPMENT COSTS

All research and development costs are charged to operations as incurred.
Research and development costs consist principally of preclinical and clinical
testing costs, certain salary and related expenses, bulk drug and drug product
costs incurred in support of clinical testing and for validation lots required
by the FDA, toxicology studies and various technical consulting costs.

GRANT AWARDS

The FDA Office of Orphan Drug Products and the Small Business
Administration provide, upon application and approval, non-refundable grant
awards in support of certain research and development activities. Cash proceeds
collected pursuant to the terms of such grant awards are accounted for on a
reimbursement basis. The Company has no such grants as of December 31, 2001.

INCOME TAXES

The Company accounts for income taxes using the liability method. Deferred
income taxes are provided for temporary differences between the financial
reporting and tax bases of assets and liabilities.

F-7

ORPHAN MEDICAL, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

STOCK BASED COMPENSATION

The Company accounts for its stock option plans under the
intrinsic-value-based method prescribed by Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees." The Company has adopted the
disclosure only provision of Statement of Financial Accounting Standards No.
123, "Accounting for Stock Based Compensation."

LOSS PER SHARE

Basic and diluted loss per common share applicable to common shareholders
are based upon the weighted average number of Common Stock shares outstanding
during the respective period. Basic loss per share excludes any dilutive effects
of options, convertible senior preferred stock and warrants. Basic and diluted
loss per share are the same for the reported periods because the effect of stock
options, warrants, and convertible securities is anti-dilutive.

RECLASSIFICATIONS

Certain prior year balances have been reclassified in order to conform with
the current year presentation. These reclassifications have no impact on net
loss or shareholders' equity as previously reported.

3. AVAILABLE-FOR-SALE SECURITIES

The amortized cost and estimated market value of available-for-sale
securities, all of which have contractual maturities of one year or less, are as
follows:

GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES MARKET VALUE
----------- ---------- ---------- ------------

As of December 31, 2000
Commercial paper.................... $ 4,362,738 $ -- $ 5,140 $ 4,357,598
U.S. Government securities.......... 5,951,539 -- 7,202 5,944,337
----------- ----- ------- -----------
$10,314,277 $ -- $12,342 $10,301,935
=========== ===== ======= ===========

4. OPERATING LEASES

The Company has a non-cancelable operating lease for office space that
expires on October 31, 2003. The Company also has an operating lease for certain
office equipment expiring April 2003. Future minimum lease payments, including
current real estate taxes and operating expenses under the facility lease and
the equipment lease are $287,500 and $224,500 for the years ended December 31,
2002 and 2003 respectively. Total rent expense was approximately $302,900,
$239,100, and $142,600 for the years ended December 31, 2001, 2000, and 1999,
respectively.

5. BORROWINGS

The Company has a commercial revolving line of credit with a bank, which
expires in June 2002. The maximum amount available to the Company under this
arrangement is $1,000,000, subject to certain limitations. The Company's
indebtedness to the bank may not exceed the lesser of (1) 75 percent of the
Company's trade accounts receivable that have been outstanding for 90 days or
less or (2) $1,000,000. Advances are charged a variable rate of interest equal
to the prime rate plus one half of a percent. Through December 31, 2001, the
Company has not borrowed under this arrangement.

F-8

ORPHAN MEDICAL, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

6. INCOME TAXES

As of December 31, 2001, the Company had net operating loss (NOL)
carryforwards of approximately $42,237,000, credit for increasing research
activities (the "R&D credit") carryforwards of approximately $359,000 and orphan
drug credit carryforwards of approximately $8,915,000, available to reduce its
future tax liabilities. These carryforwards will begin expiring after 2010. For
the years ended December 31, 2001 and 2000, a valuation allowance of $23,954,000
and $21,418,000, respectively, has been recognized to offset the deferred tax
assets related to these carryforwards.

No current income taxes have been provided for the years ended December 31,
2001, 2000 and 1999 as the Company had a loss for both financial reporting and
tax purposes.

Significant components of the Company's net deferred tax assets are as
follows:

DECEMBER 31, 2001 DECEMBER 31, 2000
----------------- -----------------

Deferred tax assets:
Net operating loss carryforwards.................. $ 14,361,000 $ 12,737,000
R&D and orphan drug credit carryforwards.......... 9,274,000 8,405,000
Inventory reserves................................ 168,000 114,000
All other reserves................................ 154,000 163,000
Deferred tax liabilities:
Depreciation...................................... (3,000) (1,000)
Valuation allowance for deferred tax assets......... (23,954,000) (21,418,000)
------------ ------------
Net deferred tax assets............................. $ -- $ --
============ ============

As a result of the 1995 public stock offering, the Company exceeded the
limits allowable under Section 382 of the Internal Revenue Code related to
changes in ownership percentage which governs future utilization of NOL, R&D
credit, and orphan drug credit carryforwards (collectively, "tax benefit
carryforwards"). The effect of this occurrence is to limit the annual
utilization of a portion of the Company's tax benefit carryforwards attributable
to the period prior to the change in ownership. Should another change in
ownership occur, future utilization of the Company's tax benefit carryforwards
may be subject to additional limitations under Section 382.

7. EMPLOYEE BENEFIT PLANS

The Company maintains a 401(k) Savings Plan, which is funded by elective
salary deferrals by employees. The Plan covers substantially all employees
meeting minimum eligibility requirements. The Plan does not require mandatory
contributions by the Company, but discretionary contributions may be made at the
election of the Company. The Company has not made any provision for
discretionary contributions to the Plan.

On January 4, 2000, shareholders approved the Orphan Medical, Inc. Employee
Stock Purchase Plan to be funded by employee contributions, generally through
payroll deductions. All employees are eligible subject to certain requirements.
The purchase price is 85% of the lower of the average of the high and the low
trade on the first and last trading day of each purchase period, defined as each
calendar quarter. The Company reserved 200,000 shares of its common stock for
future issuance at the Plan's inception. From the Plan's inception through
December 31, 2001, there have been 106,016 shares issued under the Plan.

F-9

ORPHAN MEDICAL, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

8. STOCK OPTIONS

The Company has one stock option plan for employees and non-employees, the
1994 Stock Option Plan (the "Plan"). The Plan provides the Company may grant
employee incentive stock options and non-qualified stock options at a price of
not less than 100% of fair market value. Options are exercisable as prescribed
by the Plan and expire up to fifteen years from the grant date for non-qualified
stock options and up to ten years from the grant date for employee incentive
stock options. At December 31, 2001, the Plan has 2,675,000 shares of Common
Stock reserved for issuance.

Options outstanding were granted as follows:

PLAN
----------- WEIGHTED
OPTIONS AVERAGE
OUTSTANDING EXERCISE PRICE
----------- --------------

Balance at December 31, 1998................................ 1,428,647 $ 5.66
Options granted........................................... 234,305 6.39
Options canceled.......................................... (22,500) 5.51
Options exercised......................................... (168,834) 5.04
---------
Balance at December 31, 1999................................ 1,471,618 5.85
Options granted........................................... 40,750 11.08
Options canceled.......................................... (15,300) 10.85
Options exercised......................................... (179,010) 5.10
---------
Balance at December 31, 2000................................ 1,318,058 6.05
Options granted........................................... 259,883 11.49
Options canceled.......................................... (9,263) 5.82
Options exercised......................................... (41,700) 6.52
---------
Balance at December 31, 2001................................ 1,526,978 $ 6.97
=========

The following table summarizes information about the stock options
outstanding at December 31, 2001:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------ ----------------------------
WEIGHTED
AVERAGE
REMAINING WEIGHTED WEIGHTED
RANGE OF NUMBER CONTRACTUAL AVERAGE NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
--------------- ----------- ----------- -------------- ----------- --------------

$4.19-$5.00.............. 533,500 2.83 years $5.00 533,500 $5.00
$5.38-$6.75.............. 398,395 3.81 years 5.96 371,695 5.95
$6.83-$18.31............. 595,083 8.49 years 9.41 346,577 8.45
--------- ---------
$4.19-$18.31............. 1,526,978 $6.97 1,251,772 $6.24
========= =========

Fully vested and exercisable options were 1,251,772, 1,098,258, and 1,107,518,
as of December 31, 2001, 2000, and 1999, respectively. The weighted average
exercise prices for the fully vested and exercisable options as of December 31,
2001, 2000, and 1999 were $6.24, $5.85, and $5.57 respectively.

PRO FORMA INFORMATION

The Company applies the intrinsic-value method in accounting for stock
issued to employees and directors. Accordingly, compensation expense is
recognized only when options are granted with a discounted exercise price. Any
such compensation expense is recognized ratably over the associated service
period, which is generally the option vesting period.

F-10

ORPHAN MEDICAL, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Pro forma net loss and loss per share information, as required by Statement
of Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation" (SFAS 123), has been determined as if the Company had accounted
for employee stock options under the fair value method. The fair value of these
options was estimated at grant date using a Black-Scholes option pricing model
with the following assumptions for 2001, 2000, and 1999, respectively

2001 2000 1999
-------- -------- --------

Expected dividend yield................................ 0.00% 0.00% 0.00%
Expected stock price volatility........................ 73% 72% 57%
Risk-free interest rate................................ 5.75% 6.00% 5.88%
Expected life of options............................... 10 years 10 years 10 years

The weighted average fair value of the options granted in 2001, 2000, and
1999 was $9.33, $9.13, and $3.55, respectively, as computed as described above.

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over a four year average vesting period. The
Company's pro forma net loss for 2001, 2000, and 1999 was $(7,932,893),
$(7,687,948), and $(6,014,176), and pro forma net loss per share was $(0.92),
$(0.95), and $(0.91), respectively.

The Company granted 15,000 options to purchase unregistered common stock to
a consultant in December 2000. These options were granted at $13.6875, the
closing price of the Company's common stock on the date of grant. The options
vest under certain conditions. The fair value of these options is being charged
to expense over the vesting period of the options.

9. SHAREHOLDERS' EQUITY

On July 23, 1998 the Company issued $7.5 million of Senior Convertible
Preferred Stock (the "Preferred Shares") in a private placement. The Company
realized net cash proceeds of $7.1 million from the sale of the Preferred Shares
after the payment of related offering expenses. The Preferred Shares were
initially convertible, at the option of the holders, into shares of the
Company's Common Stock at a price equal to $8.50 per share. The August 1999
financing, as discussed in the following paragraph, triggered antidilution
provisions relating to the $8.1 million of the Senior Preferred Stock held as of
August 1 (after giving effect to the semi-annual in-kind dividend
distributions), which resulted in a decrease in the conversion price of those
shares from $8.50 to $8.14 per share. The Preferred Shares have anti-dilution
protection and bear a dividend of 7.5% per annum, payable semi annually, which
during the first two years may by paid either in cash or by issuing additional
Preferred Shares. In the third year and thereafter, the dividend may be paid
either in cash or by issuing Common Stock valued at the then current market
price. At the Company's option upon their maturity in July 2008, the Preferred
Shares must be (a) converted into Common Stock, subject to a $3.0 million
conversion fee payable in cash or by issuing additional Common Shares, or (b)
redeemed for cash at $1,000 per share plus accrued dividends. The holders of the
Preferred Shares are entitled to and have exercised their right to designate an
individual to serve on the Company's Board of Directors.

On August 2, 1999, the Company completed a $5.0 million financing
transaction in a private placement. The funding consisted of a purchase of 2,950
shares of the Company's Series B Convertible Preferred Stock for an aggregate
purchase price of $2.95 million and a commitment of $2.05 million of debt in the
form of a line of credit. The Company had not borrowed on this line of credit
and it was eliminated as a part of the December 2001 financing transaction. The
Series B Convertible Preferred Stock ("Series B Preferred Shares") may be
converted prior to August 2, 2009 into shares of the Company's Common Stock at a
price of $6.50 per share. The Series B Preferred Shares have anti-dilution
protection and bear a dividend of 7.5% per annum, payable semi annually, which
during the first two years may by paid either in cash or by issuing

F-11

ORPHAN MEDICAL, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

additional Series B Preferred Shares. In the third year and thereafter, the
dividend may be paid either in cash or by issuing Common Stock valued at the
then current market price. At the Company's option upon their maturity in August
2009, the Series B Preferred Shares must be (a) converted into Common Stock,
subject to a $1.2 million conversion fee payable in cash or by issuing
additional Common Shares, or (b) redeemed for cash at $1,000 per share plus
accrued dividends.

In conjunction with the issuance of the preferred shares, the Company
agreed to several restrictions and covenants, and granted certain voting and
other rights to the holders of the preferred shares. One of these restrictions
is that the Company cannot incur additional indebtedness, except for
indebtedness secured solely by our trade receivables, until the Company has
profitable operations, subject to certain limitations. Another important
restriction is that, without the approval of a majority of the preferred
stockholders, the Company cannot issue additional equity securities unless the
selling price per share exceeds the then conversion price of the outstanding
convertible preferred stock or the sale of equity is accomplished in a public
offering.

On February 23, 2000, the Company completed the sale of 1,265,000 shares of
its Common Stock at a price of $8.00 per share. The Company received net
proceeds of $9.7 million from the transaction and registered the shares under
the Securities Act of 1933, as amended.

On February 25, 2000, the Company completed the sale of 100,000 shares of
its Common Stock at a price of $10.00 per share. The Company received proceeds
of $1.0 million from the transaction and registered the shares under the
Securities Act of 1933, as amended.

On December 6, 2001, the Company completed the sale of 1,706,999 shares of
its Common Stock at a price of $8.25 per share. The Company received net
proceeds of $13.0 million from the transaction and registered the shares under
the Securities Act of 1933, as amended.

10. STOCK WARRANTS

The Company issued warrants to the underwriter related to the Company's
1995 public stock offering to purchase 222,500 shares of Common Stock at a price
of $5.20 per share. These warrants were exercised in 2000. In 1999, the Company
issued warrants to the underwriter related to the Company's 1995 public offering
to purchase 10,000 shares of Common Stock at $8.50 per share. At December 31,
2001, the Company had warrants outstanding to purchase 5,000 shares of Common
Stock, all of which are currently exercisable.

In connection with the August 1999 financing, the Company issued two
seven-year warrants. One of the warrants entitles the holder to receive, upon
payment of the $2.05 million exercise price, either 2,050 shares of Series C
Convertible Preferred Stock (which is similar to the Series B Convertible
Preferred Stock and which is convertible to shares of the Company's Series D
Non-Voting Preferred Stock at a conversion price of $6.50 per share) or 315,385
shares of Series D Non-Voting Preferred Stock (which is equivalent to common
stock except that it has no voting rights) or a combination of Series C
Convertible Preferred Stock and Series D Non-Voting Preferred Stock, so long as
the combined purchase price for the shares does not exceed $2.05 million. The
second warrant, issued in relation to the line of credit, entitled the holder to
purchase 282,353 shares of Series D Non-Voting Preferred Stock at an exercise
price of $4.25 per share. The value of the warrants was $82,000 and was
amortized over the term of the line of credit to interest expense. All of these
warrants are outstanding at December 31, 2001. These warrants are not
exercisable until July 23, 2002.

11. RESEARCH AND DEVELOPMENT COMMITMENTS

The Company has various commitments under agreements with outside
consultants, contract drug developers and manufacturers, technical service
companies, and drug distributors. In addition, the Company has commitments under
license and research agreements. The Company does not have any joint venture
agreements nor does it have any arrangements to perform research and development
for other parties. The
F-12

ORPHAN MEDICAL, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

Company recognizes the costs associated with these commitments as incurred based
on the accrual method of accounting. Expenditures associated with these
commitments totaled approximately $3,000,000, $4,900,000, and $3,600,000 for the
years ended December 31, 2001, 2000, and 1999, respectively. The Company's
commitment to incur additional expenditures in subsequent periods for
development activities totaled approximately $4,045,000 $3,907,000, and
$1,602,000 at December 31, 2001, 2000, and 1999, respectively. Commitments for
research and development expenditures will likely fluctuate from year to year
depending on, among other factors, the timing of new product development, if
any, and clinical trial activity.

12. CONTRACT TERMINATION FEE

The Company and Chronimed Inc. ("Chronimed") entered into an Agreement
dated June 27, 1997, in which Chronimed agreed to terminate certain agreements
that had been in existence since the spin-off of the Company from Chronimed in
1994. Among the terminated agreements was the Marketing and Distribution
Agreement dated July 2, 1994, as amended, under which Chronimed had the
exclusive right to market and distribute certain of Orphan Medical's products,
including Busulfex and Antizol. In consideration for terminating these
agreements, the Company agreed to pay Chronimed compensation equal to
$2,500,000, consisting of cash and shares of the Company's Common Stock. On
February 9, 1999, the Company completed the acquisition from Chronimed of the
remaining 127,723 unregistered shares of the Company's Common Stock. The Company
paid Chronimed $338,281 on February 9, 1999 and $338,282 on March 31, 1999 to
satisfy all of its obligations under the June 1997 Termination Agreement.

13. GEOGRAPHIC INFORMATION

The Company operates in two geographic regions, domestic and international.
The Company's international sales are primarily in Europe and Canada. The
Company has no assets outside of the United States. The following is a summary
of net sales by geographic region for the years ended December 31, 2001, 2000
and 1999, respectively.

2001 2000 1999
----------- ----------- ----------

Domestic....................................... $ 9,566,099 $ 9,226,618 $5,790,118
International.................................. 1,708,011 1,959,016 667,288
----------- ----------- ----------
Total.......................................... $11,274,110 $11,185,634 $6,457,406
=========== =========== ==========

14. QUARTERLY FINANCIAL INFORMATION

The following are unaudited quarterly results of operations for the years
ended December 31, 2001 and 2000.

QUARTER ENDED
--------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
2001 2001 2001 2001
----------- ----------- ------------- ------------

Revenues......................... $ 2,341,510 $ 2,424,843 $ 2,940,438 $ 3,567,319
Gross profit..................... 2,051,844 1,990,264 2,531,306 3,108,870
Net loss......................... (1,390,474) (1,709,289) (1,833,281) (1,063,527)
Less: Preferred stock
dividends...................... 221,129 224,383 228,366 229,175
Net loss attributable to common
shareholders................... (1,611,603) (1,933,672) (2,061,647) (1,292,702)
Basic and diluted loss per common
share.......................... (0.19) (0.23) (0.24) (0.15)

F-13

ORPHAN MEDICAL, INC.

NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

QUARTER ENDED
----------------------------------------------------------
MARCH 31, SEPTEMBER 30, DECEMBER 31,
2000 JUNE 30, 2000 2000 2000
----------- ------------- ------------- ------------

Revenues......................... $ 2,742,456 $ 3,025,127 $ 2,610,662 $ 2,807,389
Gross profit..................... 2,283,103 2,591,435 2,169,975 2,608,675
Net loss......................... (897,845) (1,006,516) (1,724,650) (2,458,104)
Less: Preferred stock
dividends...................... 211,426 214,156 221,861 224,581
Net loss attributable to common
shareholders................... (1,109,271) (1,220,672) (1,946,511) (2,682,685)
Basic and diluted loss per common
share.......................... (0.15) (0.15) (0.23) (0.32)

F-14

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

ORPHAN MEDICAL, INC.

ADDITIONS
------------------------
CHARGED TO CHARGED TO
BALANCE AT COSTS OTHER
BEGINNING OF AND ACCOUNTS -- DEDUCTIONS -- BALANCE AT END
DESCRIPTION PERIOD EXPENSES DESCRIBE DESCRIBE(1) OF PERIOD
----------- ------------ ---------- ----------- ------------- --------------

YEAR ENDED DECEMBER 31, 2001
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful
accounts..................... $116,200 $ 56,408 $147,608 $ 25,000
Allowance for excess
inventory.................... 334,602 $158,395 492,997
YEAR ENDED DECEMBER 31, 2000
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful
accounts..................... $113,000 $ 3,200 $ -- $116,200
Allowance for excess
inventory.................... 376,593 41,991 334,602
YEAR ENDED DECEMBER 31, 1999
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful
accounts..................... 48,620 64,380 -- -- 113,000
Allowance for excess
inventory.................... 497,200 -- -- 120,607 376,593

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(1) Recovery of amounts previously reserved.

F-15