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Executives

Doug Sherk – IR

Don Bailey – President and CEO

Steve Cartt – COO

David Young - Chief Scientific Officer

Mike Mulroy – CFO

Analysts

Steve Byrne – Bank of America

Mario Corso - Mizuho USA

Rebecca Forest - Piper Jaffray

Christina [Sabor] - Lazard Capital Markets

James Molloy - Janney Capital Markets

Juan Sanchez - Ladenburg Thalmann

Yale Jen – ROTH Capital

Tim Chiang - GRT Capital

Questcor Pharmaceuticals (QCOR) Q4 2012 Results Earnings Call February 26, 2013 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to your Questcor Pharmaceutical’s fourth quarter 2012 earnings conference call. [Operator instructions.] I would now like to turn the conference over to your host, Mr. Doug Sherk. You may begin.

Doug Sherk

Thank you, operator, and good afternoon, everyone. Thank you for joining us today for the Questcor Pharmaceutical’s conference call to discuss the fourth quarter and full year 2012 financial results and earnings. This afternoon as the market closed, Questcor issued its earnings release, which is posted on the company’s website at www.questcor.com.

Today’s call is also being broadcast live via webcast, which is available at the Questcor website. A slide presentation will accompany today’s remarks by management. To access both the webcast and the presentation slides, go to Questcor’s website, click the Investor Relations link, and then click on Events and Presentations.

For those of you listening to today’s call via telephone, you can review the accompanying presentation slides on the webcast, as I’ve just reviewed. Just make sure you choose the “no audio/slides only” option. There will be a taped replay of this call, which will be available approximately one hour after the call’s conclusion and will remain available for seven days. The operator will provide the replay instructions at the end of today’s call.

Before we get started, I’d like to remind you that during the course of this conference call, the company will make projections and forward-looking statements regarding future events. We encourage you to review the company’s past and future filings with the SEC, including without limitation the company’s Forms 10-K and 10-Q, which identify the specific factors that may cause actual results or events to differ materially from those described in these forward-looking statements.

These factors include Questcor’s reliance on Acthar for substantially all of its net sales and profits, its ability to receive strong levels of reimbursement from third-party payers, and risks associated with Questcor’s R&D program.

The company’s 10-K for 2012 is planned to be filed with the SEC later this week. The company will also make comments about the level of net sales in the therapeutic areas in which Acthar is used to treat patients. Please note that the commentary regarding this subject is based on internal company estimates and these estimates could turn out to be incorrect.

During the question and answer today, please keep your questions to two, and then re-queue for any additional questions. With that, I’d like to turn the call over to Don Bailey, president and chief executive officer of Questcor Pharmaceuticals.

Don Bailey

Thanks, Doug. Good afternoon everyone. With me today are Steve Cartt, our chief operating officer; Dr. David Young, our chief scientific officer; and Mike Mulroy, our chief financial officer. They will each be making prepared remarks, then I will wrap things up and we’ll take your questions.

I am pleased to report that we had a very strong fourth quarter, finishing off what was an exceptional year for Questcor. Our focus on helping more patients with serious unmet medical needs led to record financial results as an increasing number of neurologists, nephrologists, and more recently, rheumatologists believe that their patients can benefit from Acthar.

In the fourth quarter, we shipped a record 6,330 vials of Acthar, resulting in a more than doubling of net sales year over year. We saw growth in both prescriptions and vial shipments, contributing to the record level of net sales, earnings, and cash flow from operations.

Continued expanded use in nephrotic syndrome, MS, and a strong contribution from our newest market, rheumatology, were the primary drivers for the sales increase we experienced during the fourth quarter of 2012 from the fourth quarter of 2011.

We believe Acthar’s therapeutic usefulness, the devastating nature of the on-label indications we are targeting, and the very limited number of approved therapeutic options have contributed to the growth in these areas of the business.

2012 was a solid year of growth for our company. We grew sales over 130%, and increased earnings 160%. We accomplished this while more than doubling our investment in R&D. Investing in R&D remains a top priority, as we look to further improve and confirm our understanding of Acthar’s unique properties and how they may benefit many difficult to treat patients who are not responding to other treatments. Dr. David Young will provide some insights into our R&D programs and plans after Steve Cartt updates you on our commercial progress.

We also took steps to secure our long term future and diversify our business with the acquisition of BioVectra and the appointment of Michael Aldridge to lead our strategic development function. Michael will be spearheading initiatives to further build out our portfolio with products complementary to Acthar and evaluating expansion opportunities for Acthar outside the U.S.

In addition to our multiple types of investments in our business and the future of Acthar, returning capital to shareholders is also a top priority. Over the past year, we returned $262 million to shareholders through the repurchase of 6.8 million shares and initiated a regular quarterly dividend. Our basic shares outstanding declined by over 5 million shares during 2012. Additionally, today we announced a 25% increase in our quarterly dividend, from $0.20 to $0.25 per share.

Let me turn the call over to the rest of the team to provide more detail on our results. I’ll get back on at the end to provide an update on our outlook. Steve?

Steve Cartt

Thanks, Don, and good afternoon everyone. I’ll provide a review of the fourth quarter results for our key markets, nephrology, MS relapse, rheumatology, which is our newest market, and infantile spasms.

Let me start with nephrology, which is now our largest market, with estimated sales in the quarter of between $70 million and $75 million, or very roughly 45% of Acthar net sales. Recall that only five quarters ago, following a small pilot effort, we launched our sales force in nephrology with 28 reps. At that time, the MS market was our largest source of revenue by a wide margin, but due to rapid growth, nephrology is now our largest market and the main driver of our revenue growth.

In fact, Acthar net revenue from nephrology is now substantially more than from MS, as prescriptions for nephrotic syndrome reached record levels in the fourth quarter, and have continued to grow into Q1. We believe this growth is due to nephrologists’ recognizing the need for additional treatment options in nephrotic syndrome patients, particularly those who have already tried first line therapy and are in need of another FDA approved treatment alternative.

Nephrotic syndrome can often lead to loss of kidney function and ultimately end-stage renal disease, which requires a kidney transplant or much more commonly requires lifelong renal dialysis. Patients on dialysis frequently suffer from multiple other associated medical problems, including serious infections and hospitalizations, as well as a substantially reduced quality of life and life expectancy.

Because of this, nephrologists work hard to successfully treat their nephrotic syndrome patients, despite there being few effective therapies available. For their part, insurers typically support these efforts, because of the high inherent healthcare costs and poor health outcomes resulting from deterioration of kidney function and the onset of end-stage renal disease.

With Acthar, the commonly recommended treatment regimen based on published, clinical experience is a full course of therapy averaging 10 vials over 6 months. In actual practice, we believe an average prescription consists of about 7.5 to 8 vials, dispensed over a several month period.

Moving on to our neurology business, Acthar sales in MS also remained solid, with estimated fourth quarter sales between $55 million and $60 million, or very roughly 35% of net sales. This estimated net sales number represents a greater than 40% increase over the same period last year.

There were several factors behind this year over year growth: increasing Acthar experience among neurologists for the treatment of relapses, increased awareness about how best to incorporate Acthar into their neurology practices, our expanded field force calling on more neurologists, and continued favorable insurance coverage for MS relapse patients with demonstrated need. All of these factors contributed to the continued year over year growth.

It is worth noting that MS relapse sales softened a bit from third quarter to fourth quarter, we estimate by around 8%. But we don’t believe it was due to any significant changes in reimbursement as the percentage of scripts getting reimbursed remain good.

The fourth quarter softness in MS, which has continued into the first part of Q1, could be related to seasonal effects that may influence the frequency of flares occurring during winter months. Regardless, for growing products such as Acthar, with multiple commercialized indications, it is common to sometimes see temporary dips in quarterly prescriptions for a particular therapeutic area or indication. This only serves to highlight the value of the Acthar diversification we have established across multiple therapeutic areas over the last few years.

In the fourth quarter, we were able to generate record net sales, despite a bit of softness in one of our key markets, as solid growth in nephrotic syndrome and rheumatology more than compensated for MS.

A key priority of ours continues to be educating both physicians and patients about how Acthar is a viable treatment option for MS relapses and should be considered for patients who are in need of another FDA approved treatment alternative. Based on the estimated 100,000 relapses annually in the U.S., we believe there remains a large pool of patients that could benefit from Acthar, and that this pool of patients provides us the potential for further growth in MS.

As a reminder, even with ongoing MS disease modification therapy, including the newer drugs that have recently become available, patients still have relapses. Relapses can be quite disabling, often leaving patients unable to work or function normally at home, with some relapses requiring costly hospitalizations. There is also published evidence that relapses can worsen the progression of MS-related disability. Based on feedback provided to us by prescribing neurologists and prescription data that we can see, MS patients, on average, receive 1.5 vials of Acthar per prescription.

Turning now to our newest market, rheumatology, during the fourth quarter, which was only the second quarter of our pilot commercial effort, rheumatology had estimated sales of between $5 million and $8 million, or about 5% of total Acthar sales.

Our team has been exploring this new market and educating a select group of rheumatologists about Acthar and its appropriate role in treating dermatomyositis and polymyositis as well as certain other indications for which Acthar is FDA approved. As seen by the sales growth over the first six months of promotion, with a very small number of reps, we are off to an encouraging early start in rheumatology.

As a reminder, the focus of our initial promotional effort has been on the rare neuromuscular disorders, dermatomyositis and polymyositis, which I’ll refer to as DM/PM. These conditions can very often be difficult to treat. Patients can become highly debilitated and in more advanced cases DM/PM can even be life threatening.

As we’ve discussed before, there are about 65,000 to 70,000 DM/PM patients in the U.S. and about 25,000 to 30,000 of these patients are not well controlled on traditional treatments. These patients are in need of another FDA approved treatment approach, and Acthar is now being selected by some rheumatologists as that next treatment alternative in the management of such patients.

What we are seeing out in the field in terms of Acthar usage in the treatment of DM/PM patients is roughly 5 vials over a period of 12 weeks. Rheumatologists are employing Acthar typically as a short term treatment in patients who have had a worsening of disease symptoms. The goal with Acthar is to get those symptoms back under control and back to baseline so that the patient, in most cases, can continue on their chronic medications.

It is still early, and it is possible that we may see the use of Acthar by rheumatologists evolve over time as they gain more experience with it in their practices. Seeing early and encouraging success in rheumatology in the fourth quarter, we initiated expansion of our rheumatology sales force from 12 to 55 reps, and earlier this month we completed the expansion with virtually all of these new rheumatology reps now hired, trained, and out in the field making appointments and beginning to meet with physicians.

Because of its broad immune-modulating mechanism of action, Acthar has the potential to help patients suffering from any of the serious rheumatology related disorders addressed by the FDA approved indications specified on the Acthar label. These include rheumatoid arthritis, systemic lupus erythematosus, psoriatic arthritis, juvenile RA, and ankylosing spondylitis.

Within most of the rheumatology related disorders listed on the Acthar label lies a significant population where Acthar could be an appropriate treatment option for patients needing an FDA approved alternative therapy.

With the expansion of the rheumatology field force, we can now reach far more physicians that may have patients with rheumatological diseases that have not been well controlled on traditional therapies. So we have been moving quickly, and we will expect to begin seeing the early impact of this recent rheumatology expansion as we move into the second quarter.

Lastly, I’ll comment briefly on infantile spasms. We had estimated Acthar net sales of between $15 million and $18 million in IS in the fourth quarter of 2012, or roughly 10% of sales. While IS prescriptions tend to vary a bit quarter to quarter, annual Acthar usage in IS has been pretty consistent over the past couple of years, and we expect this to continue. As a reminder, a typical course of therapy for IS is roughly 3.5 to 4.5 vials over the course of two to four weeks.

On the reimbursement front, our team speaks with both large and small insurers multiple times daily, and we believe that the overall reimbursement environment for Acthar remains favorable. As you know, Acthar prescriptions are generally handled on a case by case basis, with each case undergoing significant review by the payer for appropriateness. This has been the case over the last several years, and continues to be the case.

I have made some brief qualitative comments regarding MS and NS prescription activities so far in Q1. I’ll also comment on a couple of key factors that may impact the first quarter. At the end of the fourth quarter, following about 9 months of planning, we established a new reimbursement center, which we believe will be able to effectively grow with our business long term and better support Acthar’s intensive reimbursement process with a customer service approach that is unmatched in the specialty pharmaceuticals arena.

During Q1, this new operation has been ramping up, and has already made significant progress toward becoming fully productive. With any new startup operation of this kind, we expect there to be a multi-month period of transition.

In addition, we made distribution channel changes in the first quarter associated with establishing a lower Medicaid rebate for Acthar. These two operational items, which we believe will provide significant benefits to the company in the long term, may cause some disruption during this transition period.

In summary, 2012 was a very good year for Questcor, as we more than doubled net sales over 2011 and finished with a very strong record fourth quarter. This growth reflects both increased recognition by physicians of Acthar’s unique properties, and its role in treating what are often some of their toughest to treat patients, as well as our expanded reach resulting from multiple sales force expansions.

As a company, our focus remains squarely on helping patients with serious, difficult to treat, autoimmune and inflammatory conditions. This support includes not only generous copay assistance programs but also continued support of our very active patient assistance program. Since August 2007, this program has provided $262 million of Acthar free of charge to uninsured and underinsured patients.

In addition to providing patients with both copay assistance and free drug when they are needed, we are also rapidly ramping up our investments in research and development in order to gain a much more complete understanding of exactly how Acthar works and the range of disease states in which it may play a beneficial therapeutic role.

I’ll now turn the call over to Dr. David Young, our chief scientific officer, who will bring you up to date on our scientific efforts and company sponsored clinical programs. David?

David Young

Thanks, Steve. Good afternoon everybody. I am pleased to provide you with an update on our R&D efforts. Overall, our scientific efforts and investments have greatly expanded in 2012. Before discussing company sponsored research programs we have underway, I would like to acknowledge the significant contributions that investigator initiated studies have had on the development of Acthar.

As a reminder, we provide product and/or funding for these studies, but don’t have direct involvement in study design or the study itself. These studies are often very small, and usually not controlled, but over the years they have provided us with valuable clinical experience supporting Acthar’s efficacy and safety. It is important to note that these studies also provided some of the initial data demonstrating that Acthar’s mechanism of action was much more than that of a steroid.

I will focus my comments today on the larger company sponsored research programs that are underway, many of which originated as investigator initiated studies. We have clinical programs underway in nephrology and lupus, and we are initiating new efforts in ALS and other indications. All are areas of research focused on conditions which have autoimmune and inflammatory components, as well as a significant unmet medical need.

Also, in order to better understand how Acthar works, we continue to put a significant amount of effort and resources into non-clinical pharmacology and translational research. This work has included investigating how Acthar’s biological activity differs from that of corticosteroids such as methylprednisolone and prednisone and how Acthar differs from synthetic melanocortin peptides such as the peptide that is in synacthen.

Much of the work that has gone into R&D efforts is beginning to bear fruit. A more complete understanding of the biological activity of Acthar is only now emerging. Let me begin with the nonclinical work, and then move into the clinical studies.

The nonclinical research continues to add to the body of evidence of Acthar’s uniqueness. Here are some of the key themes emerging from this work. First, these studies continue to support our belief that Acthar is more than just ACTH1-39.

Second, the study’s contradict a now-outdated view of Acthar as being merely a stimulator of [adrenocortical] production. The data that supports these findings come both cell and animal based research. We are still in the process of confirming this, but so far the preliminary results look very, very good.

Third, we are seeing the broad mechanism of action of Acthar in a number of disease animal models, which show that Acthar works differently than steroids for synthetic melanocortin peptides. We are seeing it in MS, lupus, and nephrology animal models.

For example, at the American Society of Nephrology meeting last fall, an abstract was presented highlighting Acthar’s immunomodulation properties in a systemic lupus and systemic lupus nephritis animal model. This study showed that Acthar significantly affected immunomodulatory cells and renal function, more than prednisone itself.

Understanding Acthar’s mechanism of action is also playing an important role in our continued investigation on Acthar’s potential utility in other inflammatory and immunomodulatory disease states. Disease states such as idiopathic membranous nephropathy, systemic lupus, and diabetic nephropathy have clinical programs underway.

Our [unintelligible] nephropathy phase II proof of concept randomized placebo-controlled trial is actively screening and enrolling patients. We anticipate that enrollment will be complete in the first half of 2014. Acthar has the potential to address this very large unmet medical need.

As you may recall, we are also screening and enrolling patients in our idiopathic membranous nephropathy phase IV study. Patients enrolled in this study are refractory, which we define in the study as either nonresponsive to current standard therapies or as having relapsed after partial remission on the standard therapy.

The availability of a prescription of Acthar and the strict enrollment criteria has made enrollment challenging. For example, we often have patients and physicians preferring to simply prescribe the drug versus choosing to enroll and potentially receive a placebo. We currently have 10 patients enrolled in the study.

We have recently initiated a phase IV randomized placebo-controlled trial looking at persistently active lupus. Lupus is a serious systemic disease which, left untreated or inadequately treated, may have a substantial effect on the morbidity and mortality of individuals who are afflicted.

Conventional treatments include corticosteroids and immunosuppressive medications. However, there is a need for alternative therapeutic options, particularly in SOE patients who may not be adequately controlled with, or who are intolerant to, traditional therapies. We have just started this multi-site dose ranging study that will treat patients for six months.

We are also evaluating the potential for Acthar in other indications not currently on the Acthar label, including ALS, or Lou Gehrig’s disease. Neuroinflammation has now been established as an important factor in the pathogenesis of ALS. Based on our nonclinical research, we have found that some of the centrally located and peripheral cells that may be responsible for this neuroinflammation in ALS are directly affected by Acthar.

We have had very good interaction with FDA on the protocol, and hope to have an agreement with the FDA on a proof of concept IND trial in the next few months. We anticipate getting this trial underway in the first half of this year, with treatment duration being over a 9-month period.

There are also other potential INDs that we are discussing with FDA for 2013. To date, the nonclinical and clinical data lead us to strongly believe that Acthar is not only a unique product with anti-inflammatory and immunomodulation properties, but it is a product that can help many types of patients with many types of conditions who have an unmet medical need.

We will continue to provide you with updates on our R&D efforts as our research progresses further. Now, Mike Mulroy, our CFO, will discuss our financial highlights. Mike?

Mike Mulroy

Thanks, David, and good afternoon everyone. Net sales for the fourth quarter were $160.5 million, up from $75.5 million in the fourth quarter of 2011, with the increase driven primarily by increased physician acceptance of Acthar to treat serious, difficult to treat medical conditions.

In the fourth quarter of 2012, our government sales reserve rate, which primarily relates to Medicaid, was 9.5% of our gross revenues of $180.1 million, or $17.1 million. This percentage has declined, as infantile spasms, which has a higher Medicaid incidence rate, has accounted for a smaller percentage of our overall business mix.

During 2012, we did not generate any net sales on Medicaid sales due to our historic rebate percentage. Effective in the first quarter of 2013, our rebate to Medicaid was reset. The first quarter will experience a blend of the old and new rebate percentages. Our historical 10-Q and 10-K filings provide more details on the net sales calculation as it relates to the Medicaid rebate.

Our operating expenses grew significantly throughout 2012, due to the growth of our commercial operations and our research and development program, as well as an expanded infrastructure to support a larger company. For example, in 2012, we invested in a new outsourced reimbursement hub that has taken the place of our previous vendor.

This Questcor dedicated solution should provide patients who receive prescriptions for Acthar across multiple disease states with greater resources to process their insurance claims. The growth in opex was more than offset by the growth in net sales, net income, and EPS. This resulted in an operating margin of 59% in the fourth quarter of 2012, compared to 57% in the year ago period.

We expect operating expenses to increase again in 2013, due in part to continued investment in R&D, which we expect to approximately double again over 2012 levels. Our current estimate is that a 2013 opex will increase in the range of 40-50% over 2012.

Turning to the bottom line, earnings per share for the quarter were $1.03 diluted, based on $60.3 million diluted shares outstanding, up from $0.48 in the year ago period. As we have discussed on previous earnings calls, ordering patterns by our distributor can have a significant impact on our financial results.

Fourth quarter 2012 results were positively impacted by two orders that were shipped and received in late December, representing 360 of our total 6,330 vials shipped in the fourth quarter. These orders could have just as easily landed in the first quarter of 2013.

Since these orders were received and filled in December, they had the effect of increasing channel inventory as we headed into Q1, which, together with the operational items that Steve mentioned earlier in the call, could impact Q1 results. As we have discussed in previous disclosures, Questcor believes that investors should consider the company’s results over several quarters when analyzing its performance.

Operating cash flow during the fourth quarter was $83.6 million, driven primarily by net income of $61.9 million in the quarter. Return on equity was 174% for the fourth quarter. We repurchased approximately 750,000 shares in the fourth quarter, and remain committed to returning cash to shareholders, both through the share repurchase program and our regular dividend.

Through our repurchase program and dividend, we have returned over $364 million to our shareholders since the beginning of 2008, representing approximately 82% of our operating cash flow over that same period.

Now I’ll turn the call back to Don for a summary and some comments on our outlook for 2013. Don?

Don Bailey

Thanks, Mike. So, to summarize, 2012 was another year of growth for Questcor. Our focus on helping more patients with unmet medical needs led to record financial performance for both the fourth quarter and the full year.

In 2012, we significantly expanded all three sales forces and our sales and marketing infrastructure, roughly doubled our investment in R&D, negotiated the BioVectra transaction, which closed in January, initiated a dividend, and repurchased $6.8 million of our outstanding shares.

Our goal for 2013 is to optimize all that we’ve done in 2012 and continue the strong execution trends. With the exception of IS, which we treat as a steady, mature market, we currently anticipate continued revenue growth in 2013 in all areas where we focus our efforts, neurology, specifically MS relapses, nephrology, and rheumatology.

As we look ahead to 2013 and beyond, we believe we can sustainably grow our business due to four key factors. First, we believe that Acthar provides a real and substantial benefits to many patients who would otherwise continue to suffer the effects of serious, difficult to treat disorders, where other therapies have not provided the intended treatment outcomes.

Second, our market penetration in MS, nephrotic syndrome, and rheumatology, while growing, remains relatively modest. Third, we continue to assemble an excellent, experienced team to pursue our growth plans. And fourth, we will continue to invest aggressively in R&D by roughly doubling our research and development investment again in 2013.

The growing amount of research on Acthar, including studies of the mechanisms of action in animal models, a steadily increasing number of multicenter clinical trials, research conducted by independent investigators, and incoming case reports and other anecdotal information from practicing physicians continue to build the body of evidence for physicians and payers that Acthar is unique and may be able to help and benefit many more patients with inflammatory and autoimmune disorders.

Operator, we’ll now open up the call for questions.

Question-and-Answer Session

Operator

[Operator instructions.] Our final question comes from Steven Byrne of Bank of America. Your line is open.

Steve Byrne – Bank of America

Steve, I have a couple for you. Based on the sales split between the various indications, would you say that the allocation of reps to those indications, with roughly half neurology and then a quarter in each of nephrology and rheumatology, does that make sense to you? Or do you think it might be appropriate to rearrange that a bit?

Steve Cartt

I think it makes sense given our markets and the characteristics of each market. If you look at nephrology, for example, there’s much less competition for the time of the nephrologists than there is in neurology, where there are multiple MS sales forces and other sales forces really hotly competing for their time. So that’s a big driver of this.

In rheumatology, we’re just getting going. So it’s hard to tell exactly how many we’ll need. We have multiple indications there, so that’s going to be something that develops over time for sure, given how early it is.

But nephrology feels about right. It’s in the range of other nephrology sales forces. We’re also looking at the number of doctors in each specialty, which is an important factor. So you kind of have to blend all these things in together. It’s not just looking at the sales in each individual category, it’s looking at what do we need to drive revenues going forward and where is most profitable.

Steve Byrne - Bank of America

And then in nephrology, it looks like you really had a little more traction with the sales force expansion that you implemented a couple of quarters ago. Does that make sense to you, that it has just taken a little more time for that new tranche of reps to get contraction with the nephrologists?

Steve Cartt

Yeah, it makes perfect sense. In the past, we’ve had examples where we’ve had certain reps we brought in, and they’ve been up to speed and very productive early, but that’s not always the case. It’s hard to have very rapid productivity with new hires. So I think this is sort of a pattern. It looks perfectly reasonable, and we’re starting to see the benefit now from that expansion we did in the middle of last year. It just really takes time for new reps, who may be experienced selling new drugs in nephrology, it takes them some time to get used to Acthar, what our positioning is, getting comfortable with the whole reimbursement process, etc.

Operator

Our next question comes from Mario Corso of Mizuho USA. Your line is open.

Mario Corso - Mizuho USA

I wondered if you could talk a little bit about the new reimbursement center and how it’s maybe logistically, financially, and operationally different from what you had in place before. Also wondering kind of what you’re seeing in the rheumatology area at this point that led you to expand the sales force. And then thirdly, on the corporate development side, is there a goal to get something done this year on a transactional basis?

Don Bailey

So you had three questions, reimbursement center, why are we doing this, and rheumatology and what the decisions were there, and corporate development. So we’ll take these in order. We’ve been working on this reimbursement center for a while. I let Steve give a little bit more color. But we noticed that the old group that was performing this function seemed to be getting a little distracted, probably because they were in the middle of a merger, or post-merger. So earlier last year we started to put together a change. I’ll let Steve walk through why we think that’s an improvement going forward.

Steve Cartt

We had been thinking for a long time that we would ultimately need a fully dedicated Acthar reimbursement center that was customized just for this product. There’s so many aspects, and [unintelligible] were so different, and the reimbursement process is more intensive, probably, than most products that are available.

And our growth, we knew that eventually it was going to outstrip the capabilities of our former center. It just happened a little bit faster than we expected given our tremendous growth rate last year. But we had been planning for quite a while to do so.

Really the basic gist of it is that with the old center, with any kind of cookie cutter reimbursement center, with Acthar we’re sort of trying to fit a square peg in a round hole. But with this new reimbursement center, we’ve really been working to design this from the ground up, specifically based on Acthar’s needs, the various therapeutic areas we’re in, the different indications, obviously the premium pricing that we have, our positioning in the market, all the support services that go around servicing these markets with a product like this.

So this is really an investment. It’s almost, to some extent, a short term pain for long term gain. It’s investment for the future. Cracking the $500 million mark this last year, it probably just happened faster than we expected for sure. But this is an investment for the long term for this product, as we continue to grow it.

Don Bailey

So then your next question had to do with rheumatology and so in rheumatology our initial focus is in polymyositis and dermatomyositis, which for those who aren’t familiar with that disease is a very difficult disease to treat. It can have a devastating impact, and there’s a fairly significant fatality rate from that disease. And Steve, maybe you can answer the question as to what did we see there early on and why did we expand it so quickly.

Steve Cartt

That’s a good question. We’ve gone through this model a couple of times. We did it with MS where we had a small number of reps and began to generate revenues, and we did it again with nephrotic syndrome, with a pilot effort of five a couple of years back. And that’s been very successful so far with a couple of expansions under our belt now.

In rheumatology, we decided to bring on 12 pilot reps in the third quarter, and they quickly proved themselves to be profitable, and we’ve found that there really truly is a niche there for us. There’s a high unmet need in DM/PM for additional medications.

We actually began seeing some spillover driving into refractory types of RA patients and lupus as well. And this is a bit of a surprise to us. We expected to see some eventually, but it was a quick job for the doctors. They began treating patients with DM/PM and seeing positive results. And they started looking at our label and asking our rep about indications.

And for some of the doctors they began initiating trial with some patients where they basically had run out of treatment options. So I think those two things combined, fairly rapid uptick in prescriptions and then spillover into these other indications, by a number of doctors. And then the positive feedback we’re getting back as well.

So positive feedback, high unmet need, and the fact that this small pilot force was very profitable quickly. And if you look at Q4, we estimate rheumatology’s net sales are in the $5 million to $8 million range. If you annualize that, that easily pays for 12 sales people. And we’re just getting great feedback from the field as well.

Don Bailey

The last question that Mario asked was about corporate development, and so first let me remind everybody that we did close an acquisition in early January of BioVectra, and we’re happy to report that business is already off to a good start. Since the acquisition, some of their customers have had positive events which should cause BioVectra’s business to grow substantially. They’re a little smaller than Questcor. Their growth has been very impressive. And we look forward to that business continuing to grow.

We are focused particularly as far as corporate development and anything that relates to the melanocortin technology. Acthar appears to impact the melanocortin system and the melanocortin receptors, so that’s our principal focus, is anything that can help us better understand and accelerate any of our development efforts with respect to Acthar.

That’s really our focus as opposed to trying to buy something, but of course we’ll be opportunistic as we always have been. Operator?

Operator

Our next question comes from David Amsellem of Piper Jaffray. Your line is open.

Rebecca Forest - Piper Jaffray

Hi, this is Rebecca Forest for David. I just had a clarifying question about the Medicaid rebate. You mentioned there would be a blended rate in the first quarter, and I was wondering if you could give some clarity on that. And then going forward, after the first quarter, will it be 23%?

Don Bailey

I’ll ask Mike to answer those two questions. Blended rate and post-Q2.

Mike Mulroy

Right. Without getting into too much detail on it, we’ll have a blended rate in Q1 really based on channel inventory. So it will have some inventory that’s been in the channel under the old rebate rate, and as we replenish that with new inventory, it will be under the new rebate rate. So Q1 will be a transition quarter.

And then in terms of the rate going forward, we’d expect it to be at that standard basic rate that drugs typically start with, the 23.1% rate, at least initially.

Rebecca Forest - Piper Jaffray

And then just one more. You briefly discussed business development stuff in the previous question, but I was wondering if you could maybe give some more color on products or types of products you would be looking at to acquire.

Don Bailey

Well, it’s not so much products as it is technology, so we would be looking for scientific efforts or licenses around anything that would be associated with the melanocortin system or [CTH]. So that would probably be more our focus, although we’re open to anything that’s pituitary, adrenal related if it’s going to help us grow our business overall. We’re not just trying to add on sales, or tack on acquisitions. That wouldn’t really our focus. So it would be more of a strategic focus.

Operator

Our next question is from Christina [Sabor] of Lazard Capital Markets. Your line is open.

Christina [Sabor] - Lazard Capital Markets

I think you’ve pretty much answered my question. I’m asking on behalf of Josh Schimmer. So basically, just on the reimbursement rate for Medicaid. And so the projected timing of when you will officially announce it, will it be in the next earnings quarter?

Don Bailey

We can’t predict exactly what it is. we have pretty well implemented the changes we need to undertake. And it’s just the process of working through inventory. And we just don’t know what inventory’s out there. So there’s no way for us to predict what the outcome in Q1 is so we know we’ve gone from a high rebate to a low rebate, and eventually we should even out.

And then subsequent changes could always make our rate be higher than the statutory rate, but there’s other things that impact that. It’s quite a complicated calculation. But for now, in Q1, it’s going to be somewhere between [unintelligible] and what we think the statutory rate would be. Sorry we can’t give you an exact number. We just have no way to know.

Operator

Our next question comes from James Molloy of Janney. Your line is open.

James Molloy - Janney Capital Markets

I had a couple of quick questions on the R&D. The doubling the R&D in 2013. It seems like a pretty big jump. Can you walk through what we’ll see in there that should drive that?

Don Bailey

That’s an excellent question, and our R&D includes all the work that David Young was talking about. So we have a number of trials that are moving into more robust phases. We have the lupus trial that’s just been started. We want to get going with the ALS trial, or proof of concept study. So all of those will certainly add to our R&D expense.

Year over year, we’ve about doubled the number of studies we were looking at. I think we’ve gone from 30 to 60 studies roughly. We certainly would like to get more studies going [unintelligible]. And these studies include both the company sponsored studies and the investigator research studies, which are roughly split in half, numbers wise.

We have greatly expanded our medical affairs group, in order to support our commercial efforts, because they need to answer questions that doctors have that are medically oriented, that only they can answer. So we’ve expanded that group pretty significantly to support the increasing number of questions we’re getting from physicians. So I think that’s a [unintelligible] of like 30 people or so. A year ago it was only about 10 people.

So that’s where all the expense is for next year.

James Molloy - Janney Capital Markets

And then a follow up. I know that you’re increasing the reimbursement group. I think I understand it was about 30 people before. It’s still 30 people? Is that going up? And can you walk through the timeline for when a script comes in from a doc for the first time and how long it takes to kind of get an NS, or really any script, reimbursed with your group working with the doctor’s office.

Don Bailey

I’ll ask Steve to answer that question in a second, but just for starters, the size of the group stayed roughly the same. But we think that the caliber of the people that we have involved in the process has increased significantly. And the processes that we’re employing, we believe will be much more fruitful in the long term.

Steve, you want to add any color there on the lifecycle of a typical script?

Steve Cartt

Sure. As Don mentioned, we look at this as an overall upgrade on the center, obviously an investment in our long term business. But as far as turnaround times, on average, you tend to see longer turnaround times with nephrotic syndrome and more recently with the rheumatology prescriptions.

So that’s really a function of in rheumatology there’s not as much of an urgent need for drug. It’s more of a situation where they’re on chronic meds and they’re adding Acthar into the mix. In nephrology, that’s, again, a long term development of kidney disease, so it’s not an urgent care situation. So there’s not as much urgency either on the physician’s part, the office’s part, or with the payers.

Also, there’s larger dollars involved in the rheumatology prescriptions and nephrology prescriptions versus, say, MS. So MS is urgent care, smaller dollar amount. They tend to have quicker turnarounds overall. In nephrology, typical is about two to three weeks to get those prescriptions cleared. And from what we can tell, the physicians in most cases are perfectly fine with that given the lack of urgency, and in rheumatology, it’s similar.

I guess the other factor in rheumatology is that for the plans, they’ve seen very few of these prescriptions overall, and so it’s kind of a new situation for them. Some of them, you have to educate them about dermatomyositis and polymyositis for example, and why Acthar would be used in those types of patients than what they’re currently using.

So a bit of an educational curve we need to take them up. But everything seems to be going well. It looks very similar to the way nephrotic syndrome looked early on.

Operator

Our next question comes from Juan Sanchez of Ladenburg. Your line is open.

Juan Sanchez - Ladenburg Thalmann

A couple of questions. The first one is how much of your research and development efforts driven by feedback from payers or insurance companies vis-à-vis your own initiatives or [unintelligible] positioning of the drug? And the second one is why is investing in understanding the drug’s effect in the melanocortin system a good one, a good investment? Is this more like a regulatory IP strategy? Or is it more to try to understand the implication in future indications?

Don Bailey

Our R&D programs are designed around - really both the questions are almost involving the same thing. We really need to start with Acthar. And the history of the drug, as I think all of you know, is one where Big Pharma kind of kicked this drug to the curb, and abandoned the drug, and never really did any R&D for it for the first 50-55 years of its life. There was clinical trials run in order to get approvals, but there really wasn’t much in the way of R&D spent on the basics of what’s in the drug and what else could it be used for.

We continue to see cases where Acthar is used in a very, very wide range of autoimmune conditions, and we get encouragement from various researchers to look into those diseases and the possible use of Acthar in those diseases.

So that’s really where - between the case reports that we hear about and the physician input, academic physician input - we get the ideas for what to pursue and how to pursue it. And as we learn more and more about the drug itself, we need to do that, the pharmacology of the drug, so that we can determine which of these medical conditions may have the most potential for Acthar to be beneficial. So that really drives our entire R&D effort, certainly all the studies and the clinical work.

And the reason that we want to look more into, for example, the melanocortin system is because the way that whole immune system works is still an evolving science, and it’s clear that there are a number of different [effectors] and active cells that are involved in that process, and we need to better understand those processes.

I think you know, a lot of companies are looking at the immune system to find drugs that impact the immune system in a positive way. So it all fits together. It’s not driven by people other than really those that are out there practicing medicine.

Operator

Our next question comes from Yale Jen of ROTH Capital. Your line is open.

Yale Jen – ROTH Capital

The first one is for the multiple sclerosis script, will have sort of weakness over the last quarter, maybe [unintelligible] this quarter so far. Could you see any future direction might be, what kind of seasonality things there is? A little bit of outlook on that?

Don Bailey

I’ll let Steve give some color and I’ll give my two cents’ worth here. We’ve had almost five years of continued growth in MS. It’s not surprising that we might start to see a little tipping over in that curve. It’s pretty common in technology adoption to see a flattening, and then maybe as you move up the adoption curve and find new adopters you can reaccelerate and find some new information that allows additional groups of people to adopt your technology.

And probably one of the factors that’s going on in MS, we never know exactly what all the factors are, there’s no way to know, could be seasonality. We don’t see any reason why we shouldn’t be able to grow MS in the future. There certainly are more patients who believe can be helped by Acthar. It’s just a matter of continuing the commercial programs that we have underway.

Steve, you want to add to that?

Steve Cartt

Sure. It’s a good question. We do hear pretty routinely in winter months from prescribers and even nonprescribers that they just don’t tend to see as many relapses during cold weather. We don’t have any data of our own to fully confirm that, but that’s what we’re told by the doctors that are treating patients with MS in many cases. So there could be a seasonality element.

As Don mentioned, we’ve come off multiple years of tremendously rapid growth in MS. And maybe we’re entering a period where it’s a little bit more moderate. You know, we had year over year in the fourth quarter of 40%, which is nothing to sneeze at, but it’s not 100% or 150%, in MS, and it’s been that in previous time periods. So maybe entering into a more moderate period, where it’s more susceptible to a little bit of seasonality now and then. We just don’t know for sure, but we do expect to grow it over time.

Yale Jen – ROTH Capital

Great, and second question is a little bit of housekeeping, maybe for Mike. The acquisition, in terms of their revenue going forward, would that be a separate line in the P&L and top line to reveal how those things will be reported? In terms of of cost of goods and how that will be working out in reporting.

Mike Mulroy

We’re still finalizing. I think the face of our financials will be consolidated, but depend in the footnotes you’ll see segment reporting. So you will see a breakout of that back in the notes.

Operator

Our final question comes from Tim Chiang of GRT Capital. Your line is open.

Tim Chiang - GRT Capital

I just had a question on the new reimbursement center. Have you already upgraded the staff there? Or is that still an ongoing process?

Don Bailey

We started the implementation very, very late in 2012, so they’re up and running. The work’s all been transitioned to the new group. And as Steve said, they’re gaining competency every day, and we would expect, by sometime in Q2, for them to be close to fully capable.

Tim Chiang - GRT Capital

And then just one follow up, just in regards to the infantile spasms, how big were the sales in the fourth quarter from that segment?

Don Bailey

Approximately $15 million.

Steve Cartt

I think I said $15-18 million range.

Tim Chiang - GRT Capital

And because of lower rebates that you guys expect in 2013, that number should increase substantially, is that right?

Don Bailey

Yeah, that number should go up. About half of the Medicaid activity is in IS and half is in the adult diseases. So yes.

Steve Cartt

Keep in mind too that there does seem to be some variability month to month and quarter to quarter in IS. It bounces around a little bit due to the low volumes. But yeah, for the Medicaid files gone out, as Don said, we’ll definitely see some benefit there.

Tim Chiang - GRT Capital

And then Mike, I know you gave some guidance for operating expense increases, 40-50% increases over 2012 for 2013. Does that reflect additional sales force hires in 2013?

Mike Mulroy

I don’t think we’ll be expanding our sales forces in 2013. At least that’s not our current plan. We did a lot of expansion. We more than doubled our number of employees during 2012. So Steve used the word optimize, is what we’re planning on doing with the investments we’ve already made.

Operator

I’ll now hand the call back to management for closing remarks.

Don Bailey

Thanks everybody for calling in, and we look forward to speaking to you in due course, and we’ll talk to you again all together at the end of the first quarter. Take care.

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