Questcor Thrives On High Margins, Pricey Drug Acthar

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Questcor Pharmaceuticals derives nearly all its revenue from a single drug -- Acthar -- that has no patent protection. In its filings with the Securities and Exchange Commission, Questcor concedes that there is "limited clinical evidence" for the drug's effectiveness for its on-label indications, relative to newer treatments, and that more studies could take years.

Meanwhile, Questcor is under investigation by the Justice Department for its promotional practices.

So how is it that Questcor last year more than doubled its revenue? How is it that earnings per share last quarter -- at $1.35 -- were roughly double levels of a year ago? How is it that Questcor keeps adding major clusters of new patients for Acthar? And how is it that Questcor stock, which ended May around $34, has soared to near $66?

"It's a unique company," said Jim Molloy, analyst with Janney Montgomery and Scott.

Acthar -- Questcor's meal ticket -- is derived from the pituitary glands of pigs. The drug is marketed to patients with rare and serious conditions, many of whom are unresponsive to other treatments. Key conditions treated are flare-ups of multiple sclerosis, infantile spasms and nephrotic syndrome, a kidney disorder.

In targeting patients with serious conditions and few therapeutic alternatives, Questcor has enviable pricing power. A vial of Acthar currently costs about $29,000. One course of treatment can take a single vial in some cases of MS flare-ups or perhaps seven or eight on average for nephrotic syndrome, the drug's top revenue generator.

Targeted Conditions

When Don Bailey took over as Questcor CEO in 2007, the price for a vial of Acthar was $1,650. Almost immediately, Questcor raised the price to $23,000. Suddenly, a company that was struggling to stay afloat had found a pricing elixir.

In 2010, the FDA reviewed Acthar's old label, which allowed it to market for dozens of different medical conditions. The drug was originally approved by the FDA in 1952, when testing was less thorough. After review, the FDA reduced the number of on-label indications to 19.

Questcor got down to work finding patients within those 19 indications who could most benefit from the drug.

"Acthar seems to be an option for patients who don't respond well to steroids or other treatments. We also look for difficult-to-treat disorders where there can be a devastating outcome," Bailey said. "It's not curative. But patients feel better. It usually means relief of symptoms."

Last year, patients with nephrotic syndrome -- a condition that can lead to kidney loss -- contributed $243 million to Questcor sales. Multiple sclerosis patients suffering acute flare-ups accounted for $207 million. Revenue from treating young children suffering from infantile spasms was nearly $43 million.

Acthar treated just 7,000 patients. This year, says Bailey, that number should grow to 10,000.

Expanded Use For Acthar

Across its indications, the drug is used in patients with serious, difficult-to-treat autoimmune and inflammatory disorders. The recent excitement around Questcor revolves around its success with a new disease category: rheumatology conditions that include lupus and rheumatoid arthritis. Sales growth has been impressive.

"They're on track to sell $100 million in the first nine months of 2013 for rheumatology, which they weren't even treating until the second quarter of 2012," said analyst Molloy. That's just a start. Rheumatology sales can grow to $500 million by 2016, Molloy estimates.

Questcor typically markets to a narrow cohort of high-need patients. In rheumatoid arthritis, for example, Questcor targets patients with severe symptoms who don't respond to other treatments. That's a group of 65,000 out of 1.3 million rheumatoid arthritis sufferers, Bailey estimates.

Bailey continues to look for new patients within the 19 FDA-sanctioned treatment conditions. He indicates there may be dermatology and ophthalmology marketing thrusts ahead.

What About Rivals?

As Questcor grows, its revenue honeypot gets ever more enticing to potential rivals. So why hasn't there been any generic competition?

Oppenheimer & Co. analyst Akiva Felt reasons that rivals may be deterred by "the complexity of the manufacturing process." That process, noted CEO Bailey, is "protected by trade secrets." Bailey contends that trade secrets can offer stronger protection than patents.

Still, investors should be aware that generic competition could appear suddenly and unannounced for the off-patent Acthar. The FDA would not need to give Questcor notice of a filing for new generics.

And there are other risks. Analyst Felt says that with Questcor "there's always been a fear" that insurers would change policies and decline reimbursement.

However, this hasn't happened widely. "The reimbursement environment is favorable for us and has been stable for years," said Bailey. He emphasizes that insurers weigh cases individually. And in cases in which Acthar is the treatment of last resort, they have been disinclined to deny coverage.

Due in part to premium pricing, Questcor's margins are high. Its pre-tax operating margin was 61% in 2012, then dipped to 48% in the first quarter of this year and bounced to 62% in the second quarter.Does this make Questcor a takeout target? Or does it make Acthar a prime target for generics manufacturers? Those could be the key questions for investors.

Potential acquirers, notes Felt, could be dissuaded by Questcor's lack of patent protection .

"Acquirers would have to get comfortable with the unique intellectual property situation," Felt said.

In SEC filings, Questcor reports receiving a subpoena last September from the U.S. Attorney's Office for the Eastern District of Pennsylvania "requesting documents pertaining to an investigation of our promotional practices."

Asked which specific "promotional practices" were under investigation, Questcor executives declined comment.

Bailey did say the investigation could run for some time. "They typically run for years and years," he noted. A spokeswoman for the U.S. Attorney's Office said it was that office's policy to neither confirm nor deny whether investigations were ongoing.

Analysts note that such inquiries -- if there are negative findings -- can result in hefty fines. Asked if a $200 million fine was possible, as another analyst had indicated might be possible, Molloy replied that "a couple of hundred million would make sense."

The impact of any such fine would shrink with time. Molloy, for example, estimates that Questcor revenue could approach or exceed $1.4 billion by 2016. At Questcor's current high margins, any such fine would look manageable.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



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