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Questcor Pharmaceuticals, Inc. (NASDAQ:QCOR)

Bank of America Merrill Lynch 2013 Health Care Conference Call

May 14, 2013 7:20 PM ET

Executives

Don Bailey - President and CEO

Analysts

Steve Byrne - Bank of America Merrill Lynch

Steve Byrne - Bank of America Merrill Lynch

Steve Byrne, I cover Biotech stocks of BofA Merrill. It's a pleasure for me to introduce Don Bailey, CEO of Questcor. Don's had a very diversified professional experience in a variety of management roles. He's been at the helm of Questcor since the middle part of this last decade.. It's been a wild ride these last couple of years, and I look forward to Don's remarks.

Don Bailey

All right. Good afternoon. Is this the last meeting today or is there one more.

Steve Byrne - Bank of America Merrill Lynch

One more.

Don Bailey

All right. So, to know exactly how much is left. So, thanks for attending the Questcor presentation. We will try to give you an update here and leave some time for questions. I am not going to read this, but this is our Safe Harbor statement. We certainly encourage all investors to read carefully about our risks, and they are laid out in all of our filings, I think as you know they usually boil down to potential issues with respect to competitors and regulators.

Questcor is focused principally on a drug called Acthar. Acthar is a drug that helps patients with serious autoimmune and inflammatory condition, and this has been a drug that's had some very good success here in the last half dozen years, and it's been the focus of the company, and as a result, we have become more intrigued by the immune system and have some plans for longer-term activity with respect to the immune system and possibly other drugs that would be helpful with these types of conditions.

So, Acthar is our flagship product. Our key therapeutic areas are nephrotic syndrome, MS relapses, infantile spasms, and most recently rheumatology and some various indications in rheumatology. All of these are on label, and all of them have significant unmet need, patients who have devastating medical conditions and are in need of some additional therapies. And our strategy is very straightforward, it is just to expand to awareness of the appropriate use of Acthar in these conditions, and we are calling on key specialties, rheumatologists, nephrologists, and neurologists in doing so.

And currently, the latest focus is on adding rheumatology into the mix. We started this about three to six months ago, and the early take on this is that it looks good so far. The company is profitable, debt free, cash-flow positive. We have a strong balance sheet and we have had a practice of returning our cash flow, free cash flow to shareholders in the main.

Now, this pie chart here gives you just a very rough idea of how our business spreads out. These are very rough numbers, I think plus or minus 5% or maybe even a little bit more. And the reason we can't tell the business any closer than this is because of the impact of inventory. There's timing issues with respect to exactly how much business we have at any given time in these areas. But roughly speaking, nephrology -- nephrotic syndrome represents about half of our business. MS is the next biggest piece, infantile spasms has been steady in the 10% area, and what’s been shrinking actually because the business is steady and everything else has been growing.

And then rheumatology was just started recently. It's already almost as big as infantile spasms. And then there is the all-important other. And the reason other is important is that this drug does get used for many other autoimmune indications, some of which are on label, some of which aren't, but there is always substantial to look at those and the uses of Acthar in those to see possible new therapeutic areas that we might want to explore and potentially get added to the label.

So, nephrotic syndrome is a condition that impacts the kidney. It's characterized by excessive spilling of protein from the kidney into the urine. This is called proteinuria, and in the case of nephrotic syndrome, when that protein level in the urine reaches an extreme amount, which is typically 3.5 grams in a 24-hour period, then a patient is deemed to have nephrotic syndrome. And the numbers can move non abnormal as a very low number much like one, one-hundredth of that, and patients with severe nephrotic syndrome, the numbers run all the way up above 10, 20, even to 30. I think it stops measuring at about 30.

And it's caused by a number of underlying kidney conditions. I have listed some of them here, idiopathic membranous nephropathy is one that's sort of clogging of the filtration system, FSGS which is a scaring of the tubes and some of the other filtration elements that are in the kidney; IgA nephropathy, and lupus nephritis is another one. All of these conditions, that no matter which of the underlying diseases that you have can result in end-stage renal disease, which of course is very bad because that means you are going to have to go on dialysis or get a transplant. Dialysis is not a good outcome, not a good place to be because typically that is life limiting, and of course transplants are very hard to come by.

There is a significant unmet need, there are few treatment options. There's very little approved in this area. There is no standard of care in the United States particularly, and Acthar, we've provided the exact wording from our label. It's a little bit convoluted there, but it's basically says it's -- Acthar is indicated to try to reduce the level of proteinuria in these types of situations.

For MS, Acthar is approved to treat relapses, also called exacerbations or flares. This is a -- MS is neurodegenerative disease. It occurs in about 400,000 patients in the U.S. There is an extensive number of these patients that have relapses every year. Relapses can range from mild to severe, and patients have a sudden worsening of their MS conditions which can show up in the loss of vision, inability to walk, difficulty just conducting normal daily activities, and they need help, and so far as for the treatment of MS relapses, the only approved drug are steroids and Acthar, and it's pretty well known that relapses, if untreated, can cause the patient to have a worsened level of ability or greater level of disability going forward. So, it's important to treat these relapses.

Infantile spasms is an unfortunate condition that affects babies. The good news here is it doesn't affect very many, the bad news that unsuccessfully treated patients, babies will have a permanent -- can have permanent developmental disability. They can have -- end up needing hospice care. And the good news is that in many cases with appropriate treatment, the baby can lead an absolutely normal life. Acthar has developed, has been developed -- by the physicians that treat this as the gold standard, was approved in 2010, but it has been used for over 40 years, 50 years actually to treat infantile spasms, and is currently probably used to treat about half of the IS patients in the U.S.

Rheumatology area is really a basket of indications on the Acthar label including dermatomyositis, polymyositis, which is neuromuscular condition; lupus, which I think people have heard of in most part; rheumatoid arthritis, and psoriatic arthritis. Each of these can pose a serious health risk, if not controlled, and many cases are difficult to manage. Acthar is approved treatment for all of these, and we've had some initial uptake. We just entered this market in the third quarter of last year, and we ramped up our sales force from an initial 12 because they were successful to 55, and those people just hit the field during fourth quarter and actually all the way into February.

Let me run through – (inaudible) focus a little bit of rheumatology, because that's kind of the new thing. And you can see here in this pie chart that it looks to us based on our analysis and market research study we did that there's about 20,000 patients in the poly and dermatomyositis area that could benefit from treatment with Acthar. The typical treatment here is five vials of Acthar which translates into about a $140,000 worth of sales. So, this is a pretty good sized market for Questcor and for Acthar.

There is a lot drugs that are commonly used, but other than steroids none of these drugs are approved for treating myositis, for poly or dermatomyositis. And so we view this as a pretty good market. And this is the first market we are targeting in rheumatology. So about half of our prescriptions are coming from poly and dermatomyositis, because that's where our sales force is, it has their principal initial focus.

Lupus, Acthar has an approval here for both treating the underlying lupus condition as well as lupus flares. It differs from the indication we have in MS, where Acthar is just approved to treat flares. There is a drug approved for treating Lupus which is Benlysta, but other than steroids there is nothing approved for treating flares. And again here it looks like a pretty good sized market, 60,000 patients by our estimate. And so that looks like a pretty sizeable market. We are not sure how much drug will be used here so I can't really give you a revenue numbers. But it certainly will be significant.

Rheumatoid arthritis is another indication and while on this picture that sliver is very small, looks very small the actual number of patients there is just as big as the other indication. There's 65,000 and that's because there is almost 1.3 million patients with rheumatoid arthritis. And there are quite a few drugs approved for rheumatoid arthritis but our research shows that there is a decent number of patients who do get relief from all the current -- from any of the current drugs on the market and we have seen some fair number of rheumatoid arthritis prescriptions here in the first six months even without any focus on it by our sales force, just being out there talking to the doctors about myositis, the doctors see this on the label.

The last one that I am going to talk about in rheumatology is psoriatic arthritis. Again a good sized patient population, similar to rheumatoid arthritis. We are seeing a little bit of an uptick here, maybe not as much as rheumatoid arthritis but again it's on the label. The actual wording from the label is here, I am not going to go through this, but you can see this at your leisure and it's on our label, it's on our website.

So how does Acthar work? Acthar seems to treat a variety of these auto-immune and inflammatory conditions. So why is that? It appears from our research that Acthar modulates the immune system basically through binding to what are called melanocortin receptors. These receptors are located throughout the body. There's five types of receptors. One and three are located in immune cells for example and melanocortin receptor two is located on the kidney. And there is typically a (result) also production which then causes production, so along with other adrenal chemicals.

So Acthar seems to have a binding affinity to all five of these receptors and we believe that, that's one of the reasons it's been helpful here therapeutically. All the Acthar components have yet to be characterized but ACTH is believed to be the primary component but there are other melanocortin peptides and possibly other peptides from the pituitary that are in Acthar which comes from forcing pituitary.

We have a great deal of scientific effort underway. We have been increasing our spending in R&D, doubling it last year over the prior year and our goal was to double it again this year. We have approximately 70 projects underway half of which are in the company sponsored area and half of which are in physician sponsored trials where we are funding the trial.

We have four clinical studies underway which I will talk about briefly and we are -- the goal of all this is to gain an understanding of what's going on with Acthar in the body and the biological processes, and to gradually increase the body of evidence surrounding Acthar and its use. We are also exploring new indications in diabetic nephropathy, ALS and migraine just are some examples.

So in the ongoing research in our proved indications in membranous nephropathy we have a phase IV trial underway, looking at refractory non-responsive patients or patients who have relapsed persistently active workers. We have a Phase IV trial that just initiated last well in Q4. And it's administration of Acthar over a six month period. So this would be in maintenance, the first use of Acthar really in a maintenance role. In lupus exacerbations there is a physician sponsored study that's just finishing up and should read out in the summer. And in DM and PM the poly Polymyositis/Dermatomyositis we have a patient registry that has been initiated and there's that data been collected there.

In addition to the on label indications we have a label enhancement strategy. We have a trial that's been underway in diabetic nephropathy. It's approximately 40% enrolled. It's a phase II study and it's of course easily the most common cause of end stage renal disease, because there are so many patients with diabetic nephropathy. We just announced that we will be starting this study in ALS, Lou Gehrig's disease. This is a typically fatal neurological disease and in this study we are going to be looking at a Phase II study in about 160 patients. And we have requested orphan designation for Acthar in ALS. And we can use the study to decide whether Acthar has any usefulness in ALS as a potential new indication.

We get asked a lot about how is Acthar's competitive structure set up. And Acthar is biologic product that comes from porcine pituitaries as I mentioned through a trade secretive manufacturing process. So we believe the trade secrets surrounding Acthar would make it very difficult for somebody to duplicate this process and the nature of the drug with (relatively) will be -- make it very difficult to reverse engineer it and hence we think we have pretty good protection. There are other drugs out there that are similar primarily and there is one, (Botoxes) and other that have similar types of IP.

It is possible for a synthetic -- of any of the families of ACTH or any of the other melanocortin peptides to be created. But they would have to look at a single indication. They have to run clinical trials, they'd have a challenging IP landscape. So we think the business case isn't the best in that pathway.

Let me move on to the financial results. In Q1 sales were up 40% or so there as you can see. Earnings were up a little bit and cash flow from operations remain strong. You can see a big reduction in the share count which is a result of a share buyback we had in place for a number of years.

Our strategy has been to definitely to focus on shareholders. We are focused on Acthar. We haven't really wandered outside of Acthar so far and we want to find new indications and of course further pursue the existing indications. In the long term we put a much heavier emphasis on science as well as the commercial effort and we have done a little bit of reversification but it's been really on point. We acquired our manufacturer. So vertical integration here recently. And we would be interested in any assets that are directly within this whole melanocortin area.

We, so far our strategy with our cash, the free cash flow we have generated which is about I think 450 million of free cash we have generated in the last several years. We have returned 80% of that to shareholders. These are through share repurchases. We have repurchased 20 million shares and we have 60 million outstanding. So pretty significant number. We have recently initiated a dividend program and already stepped that up once. So we still have plenty of room left under our share repurchase.

So in a kind of summary slide here, Acthar we believe has an unusual and unique therapeutic role. And has sustainable competitive advantages through the nature of the trade secret. Acthar is approved for 19 indications. So it's got a good label. And many of these markets are sizeable and have significant unmet needs. Two principal markets have -- we have done really well there, sales are up over 200 million in each of those markets. And yet the penetration remains modest. In rheumatology which --certainly the market size that we are looking at is much bigger than the others, is off to a good start. We have increased our emphasis on science in the last three years and we will continue that for the foreseeable future. And the company's financial profile was quite good.

So with that, Steve I'll…

Question-and-Answer Session

Steve Byrne - Bank of America Merrill Lynch

Any questions here? May we have the mic here.

Unidentified Analyst

Don, at the 1Q update, you had said that the MS category had been weak in the first quarter but that April trends were looking more positive. Do you have any update on how the rest of the month looks, especially for MS? And then secondly, how is the new reimbursement center, has that come up and is that fully operational?

Don Bailey

So yeah, so we noticed on our -- that MS started to soften in Q4 a little bit versus Q3. It's been kind of on a steady pace upwards, and we noted on our earnings call in the fourth quarter that Q4 was a little weaker than Q3, it was softer than Q3, I think it was the phrase we used and that it was continuing into Q1. And indeed during February and January, January and February we did see a fewer prescriptions being written for Acthar in the treatment of MS flares, and hence fewer prescriptions making it through the reimbursement process.

And then in March, we saw that trend reverse. And that uptrend -- downtrend turned into an uptrend in March and continued into April, and April was now looking -- April's over, but April looked a lot like the months where it was fairly strong back in the third quarter. So, of course, we have been asked over and over again as to why this has occurred, because this is a reduction in the number of prescriptions being written, so this doesn't have anything to do with reimbursement or anything else.

And frankly, we really can't tell you for sure, there are some theories out there that MS flares are seasonal, and so that certainly would be a reason for this. But other than that, we don't really have any great insight. We have looked at a bunch of other theories, but they just don't really make sense.

As far as the reimbursement center, we have two groups helping us with reimbursement, and we have been trying to optimize our reimbursement process. We have had very good success with reimbursement. We are working with a new vendor in addition to our old vendor, and that process -- that changeover has had some learning curve issues. So we mentioned this on the quarterly call only because we had these other issues with respect to inventory in MS softness, otherwise we probably wouldn't have brought it up. But the effect was probably impacted in the first quarter about 5% of sales, so it wasn't critical. We would expect that to sort itself out during the second and third quarters.

Unidentified Analyst

You have acquired one of your two key manufacturers of the value chain providers, and there's still another one, and I am curious between those two companies, which one do you feel holds more important, (inaudible). What I am getting at, I guess is, why wouldn't you continue the vertical integration or why not?

Don Bailey

Okay, so that's a good question. The key step in the process really is the production of API, the active pharmaceutical ingredient, and so that's starting with the raw materials and creating really the part of the product that causes the bulk of the therapeutic action, and that was being made by the group that we acquired, and we felt that that's where the bulk of the trade secrets were, and so that is why we were focused on that step. The other step is -- the critical step is the final sale and developing, taking the API and turning it into a final product. And we believe that that is not as much of a trade secret and is a little bit easier to move if we needed to. So, we probably aren't going to go there, it is a little bit bigger company. The company requires something within our doability range, the other ones are a little too big.

Unidentified Analyst

Is there any update you can share with us regarding the investigation over selling practices?

Don Bailey

Well, we are like a lot of companies under DoJ investigation, and our lawyers tell me I can't really talk about it. And that even if I did, the information I would give you wouldn't be that useful to you because these things change, and lasts years and years, and we are only just a little bit into this. These things can last for many, many years, so we are being highly co-operative with the government in this thing, I will tell you that much.

Unidentified Analyst

Glad to hear that. Pricing you had pretty healthy price increases if you can kind of think three to five years out what kind of policies or thoughts do you have that might guide the future?

Don Bailey

Well the main thing we do is watch what other companies are doing and other companies are taking especially in the MS space seem to continue to taking price increases roughly of 15% annualized rate. So we noticed that. We haven't taken a price increase for a while. We announced and after fact in our filings, so you see from our filing, our last price increase we took was May of 2012 and we have taken it about every six months up to that or so. Not sure what we will do, it's art, not science it's not like you can exactly pinpoint what you'll do for three to five years ahead. And I have no way to answer that second part of your question although I would love to know the answer myself.

Unidentified Analyst

Thank you.

Unidentified Analyst

And just on rheumatologists generally start off in one of the indications and try Acthar in another one

Don Bailey

Well I think not surprisingly a rheumatologist is probably going to think of the most difficult patient and want to go there first. We found on that in nephrology that was kind of the sequence, seems like every doctor has a patient they just aren't really concerned about and have not been able to find something to work and so that tends to be their initial focus. And so it might myositis but it could be in one way other conditions as well. But we we're little surprised to see that we thought we're going to get some traction in myositis and in the first quarter about half of the prescriptions that were filled were poly and dermatomyositis and half were in the other conditions.

Unidentified Analyst

And what's your outlook for the rheumatology basket of indications in terms of revenue driver longer term relative to nephrology?

Don Bailey

Well Steve Cartt and myself, Steve our Chief Operating Officer he is the person closest to (inaudible) we both believe that this has the potential to be our best indication. It feels to us like we are reliving the process we went through with nephrology, where we had early uptake, and of course the major thing we had to wait on is will the practicing doctor embrace this, i.e. does it work with their patients and do -- does word of mouth help you amongst doctors and that happened in nephrology, and we are starting to see that in rheumatology but I will feel better after I get two more quarter. I think we get two more quarters of uptake and we can start to really do all that math, you can start multiplying all those numbers together and see what you get but certainly looks very promising at this point.

Unidentified Analyst

Do you have any proof of concept data in ALS or anything even at investigator initiated study that led you to move ahead?

Don Bailey

Yeah, that's really good question but we have got center stage was a major researcher came to us, well known ALS preclinical researcher came to us, and ran Acthar through some of his animal models had surprisingly good result. And he was very encouraged by what happened, and encouraged us to move on. And to study it (inaudible) and that's why we went directly to Phase II. We met with FDA and they approved accepted our IND launch approved IND, accepted our IND so we'll get off and join here.

So that's study is a two stage study in the first stage 40 patients will be put through a safety test. We want to make sure the drug is safe in ALS patients it's been safe another types of patients so it should be in NM in second stage. There will be four dosing regiments in the first stage. And we will pick two of those that seemed to be the safest into the second stage and we will run two dosing arms against the placebo arm on in 120 patients over nine months, between two and three.

Unidentified Analyst

Do you have another -- let me just get this one, do you have any other animal data in any other autoimmune inflammatory diseases that would suggest something else to look into?

Don Bailey

We do, I mean we had some very good support animal support data support on nephrotic syndrome, we had some, I want to get this correct, I am not 100% sure whether I am ready to say that but I think we had some in migraine as well.

Unidentified Analyst

Okay.

Steve Byrne - Bank of America Merrill Lynch

But Don you mentioned that you are interested in melanocortin assets, I believe not too long ago you added somebody, what's the title that was in charge of business development, are you - could you talk a little about, are you developing a pipeline of things look at or there a lot of these things around and what your requirements?

Don Bailey

Well, that's a good question. I can't give you any name particular as far as specifics. But he is busy all the time, to tell you that, and there is more out there than one would expect, mostly in the scientific and pre and even pre-clinical, I mean just in the development of how you might get to a melanocortin molecule or compound more quickly. So maybe in the area of analogs melanocortin analogs, or there is not lot out there in terms of actual commercial products, of course but anything in that whole paradigm would be something we will be interested, and of course that's be some we can afford.

Steve Byrne - Bank of America Merrill Lynch

Okay, I think we are out of time. Thank you Don.

Don Bailey

Okay, thank you all.

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