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QUESTCOR PHARMACEUTICALS 10-Q 2013
QCOR-2013.6.30-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 ______________________________________________________
FORM 10-Q
______________________________________________________ 
(MARK ONE)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2013
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM              TO             
COMMISSION FILE NUMBER: 001-14758
_________________________________________________________ 
QUESTCOR PHARMACEUTICALS, INC.
(Exact name of Registrant as specified in its charter)
__________________________________________________________ 
CALIFORNIA
 
33-0476164
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer of
Identification No.)
1300 North Kellogg Drive, Suite D
Anaheim, CA 92807
(Address of Principal Executive Offices)

(714) 786-4200
(Registrant's Telephone Number, Including Area Code)
___________________________________________________________ 
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 (or for such shorter prior that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): 
Large accelerated filer
 
x
  
Accelerated filer
 
o
 
 
 
 
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
o
Indicate by check mark whether Registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  o    No  x
As of June 30, 2013 there were 59,993,867 shares of the Registrant’s common stock, no par value per share, outstanding.



TABLE OF CONTENTS

 
 
Page
 
PART I. FINANCIAL INFORMATION
 
Item 1
Condensed Consolidated Financial Statements and Notes (Unaudited)
 
Condensed Consolidated Balance Sheets — June 30, 2013 and December 31, 2012
 
Condensed Consolidated Statements of Income and Comprehensive Income — for the three and six months ended June 30, 2013 and 2012
 
Condensed Consolidated Statements of Cash Flows — for the six months ended June 30, 2013 and 2012
 
Condensed Consolidated Statements of Shareholders' Equity - for the six months ended June 30, 2013
 
Notes to Condensed Consolidated Financial Statements
Item 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3
Quantitative and Qualitative Disclosures about Market Risk
Item 4
Controls and Procedures
 
PART II. OTHER INFORMATION
 
Item 1
Legal Proceedings
Item 1A
Risk Factors
Item 2
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3
Defaults Upon Senior Securities
Item 4
Mine Safety Disclosure
Item 5
Other Information
Item 6
Exhibits
 
Signatures

2


PART I. FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS

3


QUESTCOR PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share information)
(unaudited)
 
 
June 30,
2013
 
December 31,
2012
 
 
 
 
 
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
81,765

 
$
80,608

Short-term investments
 
10,221

 
74,705

Total cash, cash equivalents and short-term investments
 
91,986

 
155,313

Accounts receivable, net of allowances for doubtful accounts of $345 and $0 at June 30, 2013 and December 31, 2012, respectively
 
70,659

 
61,417

Inventories, net of allowances of $1,040 and $52 at June 30, 2013 and December 31, 2012, respectively
 
16,828

 
9,909

Current portion of restricted cash
 
25,000

 

Prepaid expenses and other current assets
 
5,082

 
4,900

Deferred tax assets
 
4,908

 
5,737

Total current assets
 
214,463

 
237,276

Property and equipment, net
 
33,704

 
2,073

Purchased technology, net
 

 
1,493

Goodwill
 
20,811

 

Other Intangibles, net
 
32,130

 

In process R&D asset, net
 
175,777

 

Restricted cash, less current portion
 
50,000

 

Deposits and other assets
 
1,324

 
70

Deferred tax assets
 
11,519

 
11,519

Total assets
 
$
539,728

 
$
252,431

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
12,365

 
$
13,069

Accrued compensation
 
10,520

 
21,300

Sales-related reserves
 
35,590

 
37,376

Dividend payable
 
15,000

 

Accrued royalties
 
16,862

 
9,802

Current portion of contingent consideration in conjunction with acquisition of BioVectra
 
4,364

 

Current portion of in process R&D liability in conjunction with acquisition of Synacthen
 
25,000

 

Income taxes payable
 
4,277

 
7,360

Current portion of long-term debt
 
1,662

 

Other accrued liabilities
 
4,776

 
1,492

Total current liabilities
 
130,416

 
90,399

Long-term debt, less current portion
 
15,125

 

Contingent consideration in conjunction with acquisition of BioVectra
 
25,399

 

In process R&D liability in conjunction with acquisition of Synacthen
 
91,046

 

Non current deferred tax liability
 
11,351

 

Other non current liabilities
 
4,143

 
203

Total liabilities
 
277,480

 
90,602

Shareholders’ equity:
 
 
 
 
Preferred stock, no par value, 5,334,285 shares authorized; none outstanding
 

 

Common stock, no par value, 105,000,000 shares authorized, 59,993,867 and 58,544,206 shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively
 
40,733

 
15,938

Retained earnings
 
224,149

 
145,851

Accumulated other comprehensive (loss) income
 
(2,634
)
 
40

Total shareholders’ equity
 
262,248

 
161,829

Total liabilities and shareholders’ equity
 
$
539,728

 
$
252,431

See accompanying notes.

4


QUESTCOR PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(In thousands, except net income per share data)
(unaudited)
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013
 
2012
Revenue
 
 
 
 
 
 
 
 
Pharmaceutical net sales
 
$
177,045

 
$
112,452

 
$
303,817

 
$
208,421

Contract manufacturing net sales
 
7,528

 

 
15,885

 

Total net sales
 
184,573

 
112,452

 
319,702

 
208,421

Cost of sales (exclusive of amortization of purchased technology and IPR&D asset)
 
17,221

 
6,379

 
33,410

 
11,900

Gross profit
 
167,352

 
106,073

 
286,292

 
196,521

Operating expenses:
 
 
 
 
 
 
 
 
Selling and marketing
 
37,900

 
27,609

 
73,362

 
49,324

General and administrative
 
13,126

 
8,647

 
25,675

 
14,089

Research and development
 
12,240

 
8,485

 
23,033

 
14,150

Depreciation and amortization
 
1,014

 
321

 
2,084

 
612

Impairment of purchased technology
 

 

 
719

 

Total operating expenses
 
64,280

 
45,062

 
124,873

 
78,175

Income from operations
 
103,072

 
61,011

 
161,419

 
118,346

Interest and other (expense) income, net
 
20

 
218

 
(322
)
 
434

Foreign currency transaction loss
 

 

 
(488
)
 

Income before income taxes
 
103,092

 
61,229

 
160,609

 
118,780

Income tax expense
 
33,969

 
19,724

 
52,424

 
38,732

Net income
 
$
69,123

 
$
41,505

 
$
108,185

 
$
80,048

Change in unrealized gains or losses on available-for-sale securities, net of related tax effects and changes in foreign currency translation adjustments.
 
(1,480
)
 
(14
)
 
(2,674
)
 
77

Comprehensive income
 
$
67,643

 
$
41,491

 
$
105,511

 
$
80,125

 
 
 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
 
 
Basic
 
$
1.17

 
$
0.68

 
$
1.86

 
$
1.28

Diluted
 
$
1.12

 
$
0.65

 
$
1.79

 
$
1.23

Shares used in computing net income per share:
 
 
 
 
 
 
 
 
Basic
 
58,938

 
61,112

 
58,075

 
62,308

Diluted
 
61,498

 
64,113

 
60,581

 
65,305

 
 
 
 
 
 
 
 
 
Dividends declared per share of common stock
 
$
0.25

 
$

 
$
0.50

 
$

See accompanying notes.

5


QUESTCOR PHARMACEUTICALS, INC.
CONDENSDED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
 
 
 
Six Months Ended
 
 
June 30,
 
 
2013
 
2012
OPERATING ACTIVITIES
 
 
 
 
Net income
 
$
108,185

 
$
80,048

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Share-based compensation expense
 
12,679

 
6,014

Deferred income taxes
 
962

 
234

Amortization of investments
 
245

 
928

Depreciation and amortization
 
4,645

 
612

Impairment of purchased technology and goodwill
 
719

 

Loss on disposal of property and equipment
 
95

 
10

Changes in operating assets and liabilities, net of business acquisition:
 
 
 
 
Accounts receivable
 
(2,883
)
 
(18,873
)
Inventories
 
4,270

 
(1,191
)
Prepaid income taxes
 

 
2,948

Prepaid expenses and other current assets
 
1,175

 
381

Accounts payable
 
(2,569
)
 
6,780

Accrued compensation
 
(10,780
)
 
(106
)
Accrued royalties
 
7,060

 
1,015

Sales-related reserves
 
(1,786
)
 
4,605

Income taxes payable
 
(2,684
)
 

Contingent consideration
 
1,082

 

Other accrued liabilities
 
2,555

 
920

Other non-current liabilities
 
21

 
(221
)
Net cash flows provided by operating activities
 
122,991

 
84,104

INVESTING ACTIVITIES
 
 
 
 
Purchase of property and equipment
 
(1,138
)
 
(548
)
Purchase of short-term investments
 
(52,001
)
 
(96,631
)
Proceeds from maturities of short-term investments
 
116,206

 
139,438

Restricted cash
 
(75,000
)
 

Acquisition of BioVectra, net of cash acquired
 
(46,692
)
 

Acquisition of Synacthen
 
(60,000
)
 

Proceeds from sale of Doral
 
700

 

Deposits and other assets
 

 
(1
)
Net cash flows (used in) / provided by investing activities
 
(117,925
)
 
42,258

FINANCING ACTIVITIES
 
 
 
 
Repayment of funded long-term debt
 
(613
)
 

Repayment of other long-term debt
 
(212
)
 

Income tax benefit realized from share-based compensation plans
 
5,173

 
4,261

Dividends paid
 
(14,887
)
 

Issuance of common stock, net
 
6,943

 
2,663

Repurchase of common stock
 

 
(185,093
)
Net cash flows used in financing activities
 
(3,596
)
 
(178,169
)
Effect of cash on changes in exchange rates
 
(313
)
 

Increase (decrease) in cash and cash equivalents
 
1,157

 
(51,807
)

6


Cash and cash equivalents at beginning of period
 
80,608

 
88,469

Cash and cash equivalents at end of period
 
$
81,765

 
$
36,662

Supplemental Disclosures of Cash Flow Information:
 
 
 
 
Cash paid for interest
 
$
380

 
$
12

Cash paid for income taxes
 
$
49,234

 
$
31,285

Supplemental Disclosures of Investing and Financing Activities:
 
 
 
 
Dividend payable
 
$
15,000

 
$

In conjunction with the acquisition of BioVectra at January 18, 2013:
 
 
 
 
Incremental fair value of assets acquired, net
 
$
80,698

 
 
Less: fair value of contingent consideration
 
(30,383
)
 
 
 
 
50,315

 
 
Loss on foreign exchange rate
 
488

 
 
Total cash paid for acquisition of BioVectra
 
$
50,803

 
 
See accompanying notes.

7


QUESTCOR PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
 
(in thousands, except per share data)
 
Common Stock
 
Retained
Earnings

 
Accumulated
Other
Comprehensive
Gain (Loss)
 
Total
Shareholders’
Equity
 
 
Shares
 
Amount
 
Balances at December 31, 2012
 
58,544,206

 
$
15,938

 
$
145,851

 
$
40

 
$
161,829

Stock compensation for equity incentives and restricted common stock granted to employees
 
699,858

 
12,679

 
 
 
 
 
12,679

Issuance of common stock pursuant to employee stock purchase plan
 
83,559

 
2,050

 
 
 
 
 
2,050

Dividends declared on shares of common stock
 
 
 
 
 
(29,887
)
 
 
 
(29,887
)
Issuance of common stock upon exercise of stock options
 
671,967

 
5,042

 
 
 
 
 
5,042

Repurchase of common stock
 

 

 

 

 

Cancellation of shares related to tax liability
 
(5,723
)
 
(149
)
 
 
 
 
 
(149
)
Income tax benefit realized from share-based compensation plans
 
 
 
5,173

 
 
 
 
 
5,173

Comprehensive income (loss):
 
 
 
 
 
 
 
 
 


Net unrealized gain on investments
 
 
 
 
 
 
 
(34
)
 
(34
)
Foreign currency translation adjustments
 
 
 
 
 
 
 
(2,640
)
 
(2,640
)
Net income
 
 
 
 
 
108,185

 
 
 
108,185

Total comprehensive income
 

 

 

 

 
105,511

Balances at June 30, 2013
 
59,993,867

 
$
40,733

 
$
224,149

 
$
(2,634
)
 
$
262,248



 See accompanying notes.



8


QUESTCOR PHARMACEUTICALS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. The Company
Questcor Pharmaceuticals, Inc. ("we", "our", "us", or the "Company") is a biopharmaceutical company primarily focused on the treatment of patients with serious, difficult-to-treat autoimmune and inflammatory disorders. We also supply specialty contract manufacturing services to the global pharmaceutical and biotechnology industry through our wholly-owned subsidiary, BioVectra Inc. We also have agreed to acquire certain international rights for Synacthen® (tetracosactide) and Synacthen Depot®, and have licensed the right to develop and seek approval by the U.S. Food and Drug Administration, or FDA, for these products in the United States. Our primary product is H.P. Acthar® Gel (repository corticotropin injection), or Acthar, an injectable drug that is approved by the FDA for the treatment of 19 indications. Of the 19 FDA approved indications, we currently generate substantially all of our pharmaceutical net sales from the use of Acthar in connection with the following indications:
Nephrotic Syndrome (NS): Acthar is indicated “to induce a diuresis or a remission of proteinuria in the nephrotic syndrome without uremia of the idiopathic type or that due to lupus erythematosus.” According to the National Kidney Foundation, nephrotic syndrome can result from several idiopathic type kidney disorders, including idiopathic membranous nephropathy, focal segmental glomerulosclerosis, IgA nephropathy and minimal change disease. Nephrotic syndrome can also occur due to lupus erythematosus. In this Form 10-Q, the terms “nephrotic syndrome” and “NS” refer only to the proteinuria in nephrotic syndrome conditions that are covered by the Acthar label of approved indications.
Multiple Sclerosis (MS): Acthar is indicated “for the treatment of acute exacerbations of multiple sclerosis in adults. Controlled clinical trials have shown H.P. Acthar Gel to be effective in speeding the resolution of acute exacerbations of multiple sclerosis. However, there is no evidence that it affects the ultimate outcome or natural history of the disease.”
Infantile Spasms (IS): Acthar is indicated “as monotherapy for the treatment of infantile spasms in infants and children under 2 years of age.” We continue to support this vulnerable patient population. We believe that a significant percentage of the $360 million in free drug that we have provided from September 2007 through June 30, 2013, has been used to treat IS. We support the IS community through other initiatives. In February 2012, we were awarded the first-ever Corporate Citizenship Award presented by the Child Neurology Foundation. This award honors our long-term commitment to support the child neurology community as well as our specific efforts to fund education and research related to IS.
Rheumatology Related Conditions: Acthar is approved for the following rheumatology related conditions: (i) Collagen Diseases: Acthar is indicated "during an exacerbation or as maintenance therapy in selected cases of systemic lupus erythematosus, systemic dermatomyositis (polymyositis)" and (ii) Rheumatic Disorders: Acthar is indicated as "adjunctive therapy for short-term administration (to tide the patient over an acute episode or exacerbation) in: Psoriatic arthritis, Rheumatoid arthritis, including juvenile rheumatoid arthritis (selected cases may require low-dose maintenance therapy), and Ankylosing spondylitis."
We continue to explore the possible use of Acthar to provide therapeutic benefit to patients suffering from other serious, difficult-to-treat autoimmune and inflammatory disorders that are included on the Acthar label. For example, we recently announced our intent to initiate a pilot commercialization effort for Acthar for the treatment of respiratory manifestations of symptomatic sarcoidosis, a potentially serious, difficult-to-treat disorder. In addition, we are exploring the possibility of pursuing FDA approval for additional indications not currently on the Acthar label, for other serious, difficult-to-treat autoimmune and inflammatory disorders.
In order to improve outcomes for patients with difficult-to-treat autoimmune and inflammatory disorders, we are expanding our research to better understand the mechanism(s) of action of Acthar as well as the pharmacology of Acthar across and within each indication. We are also conducting studies to expand our understanding of why Acthar acts differently than steroids and potentially other melanocortin peptides.

Acquisition of Synacthen
On June 11, 2013, the Effective Date, we acquired from Novartis AG and Novartis Pharma AG, collectively Novartis, a license to develop, market, manufacture, distribute, sell and commercialize Synacthen and Synacthen Depot for all uses in humans in the U.S. Subject to certain conditions and limitations in the License Agreement, the license is exclusive, perpetual and irrevocable. Synacthen is a synthetic melanocortin agonist approved in various countries outside of the United States for certain autoimmune and inflammatory conditions, but has never been developed or approved for patients in the U.S.

9


Subject to certain closing conditions, we also will acquire from Novartis a license and certain assets to develop, market, manufacture, distribute, sell and commercialize Synacthen and Synacthen Depot in certain countries outside the U.S. for all uses in humans. Subject to certain conditions and limitations, these rights and assets are exclusive, perpetual and irrevocable.
Under the terms of the transaction agreements, we paid Novartis an upfront consideration of $60.0 million. We will also be making annual cash payments of $25 million on each of the first, second and third anniversaries of the Effective Date, a potential additional annual cash payment on each anniversary subsequent to the third anniversary until we obtain the first approval of the FDA related to the products, or the FDA Approval, and a milestone payment upon our receipt of the FDA Approval. If we successfully obtain the FDA Approval, we will pay an annual royalty to Novartis based on a percentage of the net sales of the product in the U.S. market until the maximum payment is met. The first three annual payments aggregating to $75.0 million are secured by a letter of credit and classified as restricted cash on the Condensed Consolidated Balance Sheets. In no event will the total payments related to this transaction exceed $300 million.

Acquisition of BioVectra Inc.
On January 18, 2013, we completed our acquisition of BioVectra Inc. BioVectra is located in Prince Edward Island, Canada, and is a supplier of specialty contract manufacturing services to the global pharmaceutical and biotechnology industry. BioVectra manufactures active pharmaceutical ingredients, or API, chemical intermediates, and bioprocessing reagents. BioVectra has been our manufacturing partner for the API in Acthar since April, 2003. BioVectra's facilities are staffed by 178 employees including chemists, engineers and technicians.

We acquired 100% of the issued and outstanding shares of BioVectra for $50.3 million utilizing cash on hand. The former shareholders of BioVectra could receive additional cash consideration of C$50.0 million based on BioVectra's financial results over the next three years, which consideration is payable annually with a final true-up payment in the third year. Contingent consideration in conjunction with the acquisition of BioVectra of $30.4 million was recorded on our condensed consolidated balance sheet at the acquisition date. Any differences between our estimate and actual payments or subsequent adjustments will be recorded in interest and other (expense) income, net.
As of June 30, 2013, there were no changes in the recognized amount or range of outcomes for the contingent consideration recognized as a result of our acquisition of BioVectra. As of June 30, 2013, the estimated value of the contingent consideration of $29.8 million has been recorded as a liability in our condensed consolidated balance sheets ($4.4 million has been recorded as the current portion of the contingent consideration).

For the six months ended June 30, 2013, we recorded $0.2 million of acquisition-related expenses associated with the BioVectra acquisition within general and administrative expenses in our condensed consolidated statements of income and comprehensive income.

The acquisition was recorded by allocating the estimated value of consideration paid by us for the BioVectra acquisition to the assets acquired including intangible assets, and liabilities assumed, based on their estimated fair values at the acquisition date in accordance with the acquisition method of accounting. We are in the process of finalizing the estimated amounts shown below and such amounts are provisional measurements that are subject to change.

The following table reflects the fair value of consideration transferred at the acquisition date (in thousands):


10


Allocation of Purchase Price:
 
Current assets excluding inventory
$
11,691

Inventory
11,774

Property and equipment
35,221

Other non-current assets
1,708

Current deferred tax asset
141

Intangibles
35,581

Goodwill
21,914

 Current liabilities
(6,451
)
 Non-current liabilities, excluding long-term debt
(1,994
)
 Non-current deferred tax liability
(12,012
)
 Long-term debt
(16,875
)
Total net assets acquired
$
80,698

 
 
Cash consideration paid to BioVectra shareholders
$
50,315

Estimated fair value of contingent consideration
30,383

Total purchase consideration
$
80,698

The following unaudited pro forma financial information for the six months ended June 30, 2013 and 2012 presents the combined results of operations of Questcor and the BioVectra acquisition described above, as if the acquisition had occurred as of January 1 of the year prior to acquisition. The unaudited pro forma financial information is not intended to represent or be indicative of the Company's consolidated results of operations or financial condition that would have been reported had this acquisition been completed as of the beginning of the periods presented and should not be taken as indicative of the Company's future consolidated results of operations or financial condition. Pro forma adjustments are tax-effected at the applicable statutory tax rates.
 
Six Months Ended June 30,
 
2013
2012
Net sales
$
321,561

$
214,112

Net income
$
107,578

$
76,157

The above pro forma results could change if the provisional measurements change.



11


2. Summary of Significant Accounting Policies
Basis of Presentation
The condensed consolidated financial statements include the accounts of the Company and our wholly-owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation. In the opinion of the Company's management, all adjustments (consisting of normal recurring adjustments) considered necessary for the fair presentation of interim financial information have been included.
The financial statements of our subsidiaries with functional currencies other than the U.S. dollar are translated into U.S. dollars using period-end exchange rates for assets and liabilities, historical exchange rates for shareholders' equity and weighted average exchange rates for operating results. Translation gains and losses are included in accumulated other comprehensive income in stockholders' equity. Foreign currency transaction gains and losses are included in the results of operations in our condensed consolidated statements of income and comprehensive income.
Use of Estimates
The preparation of financial statements in conformity with U.S generally accepted accounting principles, or GAAP, requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could materially differ from those estimates. Our significant estimates include our estimates for sales-related reserves, impairment of intangibles, deferred tax assets and tax liabilities and share-based compensation, among others.
Revenue Recognition
We recognize revenue in accordance with Accounting Standards Codification 605, “Revenue Recognition-Products,” or ASC 605. Pursuant to ASC 605, we recognize revenue when we have persuasive evidence that an arrangement, agreement or contract exists, when title for our product and risk of loss have passed to our customer, the price we charge for our product is fixed or is readily determinable, and we are reasonably assured of collecting the amounts owed under the resulting receivable. We do not require collateral from our customers. In order to ensure that patients who need Acthar are able to obtain it regardless of ability to pay, we support the patient assistance programs administered by the National Organization of Rare Disorders, or NORD, and the Chronic Disease Fund, by providing free drug with a commercial value of over $360 million to patients from September 2007 through June 30, 2013. We do not recognize any revenue from the Acthar free drug program.
In the U.S., our exclusive customer for Acthar is CuraScript Specialty Distributor, or CuraScript SD. For our sales to CuraScript SD, a sale of Acthar occurs when CuraScript SD accepts a shipment of Acthar based on its order of Acthar from Integrated Commercial Services, which we have engaged to act as our exclusive agent for commercial shipment of Acthar to CuraScript SD. We sell Acthar at a discount from our list price to CuraScript SD, which then sells Acthar primarily to approximately 12 specialty pharmacy companies, including CuraScript Specialty Pharmacy, or CuraScript SP, and to many hospitals.
International sales of our products are immaterial.
Net Sales
We record net sales after establishing reserves for the following:

Medicaid rebates;

TRICARE retail program rebates;

Medicare Part D Coverage Gap Discount Program rebates;

Chargebacks due to other government programs;

Questcor-sponsored co-pay assistance programs;

Exchanges, which have historically been immaterial; and

Other deductions, such as payment discounts.
We currently provide our products to Medicaid participants under an agreement with the Centers for Medicare & Medicaid Services, or CMS. Under this agreement, states are eligible to receive rebates from us for Medicaid patients in

12


accordance with CMS regulations. For the three and six months ended June 30, 2012, the rebate amount equaled 100% of the Average Manufacturers’ Price, or AMP, which approximates the amount we charge to CuraScript SD. During the three months ended March 31, 2013, the rebate amount in the Medicaid system was reset from 100% of the AMP of Acthar to the basic 23.1% of AMP. States have historically provided us with rebate invoices for their Medicaid Fee for Service reimbursements between 60 and 90 days after the end of the calendar quarter in which our products were provided. Certain states are taking longer to submit complete rebate invoices for the Medicaid Managed Care utilization that became rebate eligible on March 23, 2010, as a result of the enactment of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, or the Health Care Reform Acts.
We estimate the end of period liability and the sales reserve needed for Medicaid rebates, TRICARE retail program rebates, Medicare Part D Coverage Gap Discount Program rebates, or Coverage Gap Discount rebates (commonly referred to as the Medicare Part D “donut hole”), and chargebacks due to other government programs.
Our resulting total sales reserve for the quarter includes the sum of the Medicaid sales reserve, the TRICARE sales reserve, the Coverage Gap Discount reserve, the chargeback sales reserve, co-pay assistance payments, and payment discounts provided.
Significant judgment is inherent in the selection of assumptions and the interpretation of historical experience as well as the identification of external and internal factors affecting the determination of our reserves including those related to rebates and chargebacks such as Medicaid, Medicare, TRICARE, VA, 340B, and product returns. Of these, the largest reserves relate to rebates for participation in the Medicaid program which is governed by a complex set of regulations. We believe that the assumptions used to determine these reserves are reasonable considering known facts and circumstances at the time the estimates are made. However, the eventual incurred and paid rebates and chargebacks could materially differ from our reserve amounts because of, among other factors, unanticipated changes in prescription trends or patterns in the states' submissions of Medicaid claims, adjustments to the amount of product in the distribution channel, estimates of the number of Medicaid patients treated with Acthar, estimates of the number of vials used by such patients, are incorrect. If actual Medicaid rebates, or other government program rebates and chargebacks, or interpretation of the regulations are materially different from our estimates and assumptions, we would account for such differences as a change in estimate in the period in which they become known. If actual future payments for such reserves exceed the estimates we made at the time of sale, our consolidated financial position, results of operations and cash flows may be negatively impacted. Our reserves for rebates and chargebacks can also be affected by interpretations of regulations taken by regulatory agencies with respect to historical periods.  During the three months ended June 30, 2013, we received correspondence from CMS that indicates that Questcor should have maintained the existing baseline AMP as used by the prior owner of Acthar before Questcor acquired the drug in 2001. We have no indication that CMS' assertion is without merit and have, therefore, accrued an estimated liability for 2002 - 2009, the prior years affected by this item. This item does not impact periods following 2009. Specifically, we accrued an estimated liability for rebates totaling $11.5 million because the amount is estimable and it is probable that we will pay such amount. This had the effect of reducing our net sales in the quarter ended June 30, 2013 by $11.5 million.
Total Sales-related Reserves
At June 30, 2013 and December 31, 2012, sales-related reserves included in the accompanying condensed consolidated balance sheets were as follows (in thousands):
 
 
 
June 30,
2013
 
December 31, 2012
Medicaid rebates
 
$
30,542

 
$
33,921

Tricare rebates
 
4,019

 
3,222

Medicare Part D Coverage Gap Discount Program rebates
 
673

 
194

Government chargebacks
 
40

 
38

Other discounts
 
316

 
1

Total
 
$
35,590

 
$
37,376

The following table summarizes the activity in the account for sales-related reserves for Medicaid rebates (in thousands):

13


 
 
2013
 
2012
Balance at January 1
 
$
33,921

 
$
29,874

Actual Medicaid payments for sales made in prior year
 
(21,463
)
 
(16,625
)
Actual Medicaid payments for sales made in current year
 
(6,923
)
 
(8,382
)
Current Medicaid provision for sales made in prior year
 
11,497

 
1,039

Current Medicaid provision for sales made in current year
 
13,510

 
27,802

Balance at June 30
 
$
30,542

 
$
33,708

The following table summarizes the activity in the account for sales-related reserves for TRICARE rebates (in thousands):
 
 
2013
 
2012
Balance at January 1
 
$
3,222

 
$
4,095

Actual TRICARE payments for sales made in prior year
 
(3,380
)
 
(571
)
Actual TRICARE payments for sales made in current year
 
(507
)
 
(1,046
)
Current TRICARE provision for sales made in prior year
 

 

Current TRICARE provision for sales made in current year
 
4,684

 
2,234

Balance at June 30
 
$
4,019

 
$
4,712

Product Exchanges and Returns
Acthar has a shelf life of 18 months from the date of manufacture. We authorize Acthar exchanges for expiring and expired product in accordance with our stated return policy, which allows CuraScript SD to return product within one month of its expiration date and for a period up to three months after such product has reached its expiration date. Product exchanges have been insignificant since we began utilizing the services of CuraScript SD to distribute Acthar.
For our contract manufactured finished goods sold through our BioVectra subsidiary, we warrant that our products conform to the applicable product specifications. Each product is shipped with a Certificate of Analysis stating the conditions and results of product performance tests. Our customers must determine the suitability of our product. We do not accept liability for any incidental, direct or indirect consequential or contingent damages arising out of the use, result of use, or the inability to use our products. Should any of our products fail to meet its described specifications for reasons other than misuse or mishandling, at our option, we will either replace the product free of charge or refund the purchase price. We reserve the right to deny a return when the date of the invoice is greater than 30 days from the return request date, or for any other reason as covered by our warranty.
Concentration of Credit Risk
Financial instruments that subject us to a significant concentration of credit risk principally consist of cash and cash equivalents, short-term investments and accounts receivable. We invest our cash in high credit quality government and corporate debt instruments and believe the financial risks associated with these instruments are minimal.
Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. We have never experienced any losses related to these balances. Beginning January 1, 2013, all of our non-interest bearing cash balances were insured up to $250,000 per depositor at each financial institution. We did not have any non-interest-bearing amounts on deposit in excess of federally insured limits at June 30, 2013.
We extend credit to our customer, CuraScript SD, which accounts for approximately 95% of our gross product sales and 90% of our accounts receivable. We have not experienced material credit losses on our customer accounts.
Inventories
We state inventories, net of allowances, at the lower of cost or market value. For our Acthar product, cost is determined by the first-in, first-out method. For our production materials and supplies, work-in-process and finished goods at our contract manufacturer, cost is determined on an average cost basis.
We review inventory periodically for slow-moving or obsolete status. We adjust our inventory if we do not expect to recover the cost of inventory. We would record a reserve to adjust inventory to its net realizable value when any of the following occur: (i) a product is close to expiration and we do not expect it to be sold, (ii) a product has reached its expiration

14


date or (iii) we do not expect a product to be saleable. In determining the reserves for these products, we consider factors such as the amount of inventory on hand and its remaining shelf life, and current and expected market conditions, including management forecasts and levels of competition. We have evaluated the current level of inventory considering historical trends and other factors, and based on our evaluation, have recorded adjustments to reflect inventory at its net realizable value. These adjustments are estimates, which could vary significantly from actual results if future economic conditions, customer demand, competition or other relevant factors differ from expectations. These estimates require us to assess the future demand for our products in order to categorize the status of such inventory items as slow-moving, obsolete or in excess-of-need. These future estimates are subject to the ongoing accuracy of our forecasts of market conditions, industry trends, competition and other factors. Differences between our estimated reserves and actual inventory adjustments have been immaterial, and we account for such adjustments in the current period as a change in estimate.
The components of inventory are as follows (in thousands):
 
 
 
June 30,
2013
 
December 31,
2012
Raw material
 
$
9,626

 
$
9,271

Work-in-process
 
1,948

 

Intermediates
 
1,848

 

Finished goods
 
4,446

 
690

 
 
17,868

 
9,961

Less: Reserve for obsolescence
 
(1,040
)
 
(52
)
 
 
$
16,828

 
$
9,909

Included in inventories at June 30, 2013 is $9.3 million held at BioVectra, in Canada.
Property, Plant and Equipment
Equipment, building, land and leasehold improvements and related accumulated depreciation and amortization are as follows (in thousands):
 
 
 
June 30,
2013
 
December 31,
2012
Equipment (including manufacturing, laboratory and office)
 
$
24,599

 
$
3,466

Building
 
12,665

 

Land
 
390

 

Leasehold improvements
 
1,446

 
1,349

 
 
39,100

 
4,815

Less accumulated depreciation and amortization
 
(5,396
)
 
(2,742
)
 
 
$
33,704

 
$
2,073


Total depreciation and amortization expense amounted to $2.8 million and $0.6 million for the six months ended June 30, 2013 and 2012 respectively. The increase in depreciation and amortization expense was due to the increase in property, plant and equipment as a result of our acquisition of BioVectra on January 18, 2013. We depreciate our property and equipment and amortize our leasehold improvements using the straight-line method of depreciation. Included in property, plant and equipment at June 30, 2013 is $31.6 million held at BioVectra, in Canada.
Supply Concentration Risks
Acthar is derived from the extraction and purification of porcine pituitary glands through complicated processes, and is difficult to manufacture. Acthar bulk concentrate, the API used in Acthar, is processed at our BioVectra subsidiary, in several stages to produce a highly purified raw material for formulation. We have a supply agreement with Cangene bioPharma, Inc., or Cangene, to manufacture commercial quantities of Acthar finished product. Currently, Cangene is our sole source supplier of Acthar finished product. Additionally, we use a sole source provider for potency testing. The processes used to manufacture and test Acthar are complex and subject to FDA inspection and approval. Acthar finished product has a shelf life of 18 months from the date of manufacture.

15


Cash Equivalents and Short-Term Investments
We consider highly liquid investments with maturities from the date of purchase of three months or less to be cash equivalents. We classify available-for-sale debt instruments with maturities at the date of purchase of greater than three months as short-term investments.
We carry available-for-sale securities at fair value, with the unrealized gains and losses, if any, reported in the Condensed Consolidated Statements of Income and Comprehensive Income. If we deem the decline in value to be other-than-temporary and we intend to sell such securities before their full cost can be recovered, we write down such securities to fair value and we charge the loss to net realized losses on investments. We use significant judgment in the determination of when an other-than-temporary decline in value has occurred. We evaluate our investment securities for other-than-temporary declines based on quantitative and qualitative factors. As of June 30, 2013, none of our investments had an other-than-temporary decline in valuation, and no other-than-temporary losses were recognized during the three and six months ended June 30, 2013 and 2012, respectively. We base the cost of securities sold on the specific identification method. We include realized gains and losses, if any, in the accompanying Condensed Consolidated Statements of Income and Comprehensive Income, in Interest and Other Income.
A summary of cash and cash equivalents and short-term investments, classified as available-for-sale, and carried at fair value is as follows (in thousands):
 
 
 
Amortized
Cost
 
Gross
Unrealized
Gain
 
Gross
Unrealized
(Loss)
 
Estimated
Fair Value
June 30, 2013
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
12,504

 
$

 
$

 
$
12,504

Short-term investments:
 
 
 
 
 
 
 
 
Certificates of deposit
 
$
480

 
$

 
$

 
$
480

Corporate bonds
 
6,632

 
3

 
(2
)
 
6,633

Government-sponsored enterprises
 
1,283

 

 
(2
)
 
1,281

     Municipal bonds
 
1,827

 
1

 
(1
)
 
1,827

 
 
$
10,222

 
$
4

 
$
(5
)
 
$
10,221

December 31, 2012
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
7,740

 
$

 
$

 
$
7,740

Short-term investments:
 
 
 
 
 
 
 
 
Certificates of deposit
 
$
720

 
$
2

 
$

 
$
722

Corporate bonds
 
47,857

 
29

 
(8
)
 
47,878

Government-sponsored enterprises
 
24,699

 
13

 

 
24,712

Municipal bonds
 
1,395

 
1

 
(3
)
 
1,393

 
 
$
74,671

 
$
45

 
$
(11
)
 
$
74,705


The amortized cost and fair value of short-term investment securities at June 30, 2013, by contractual maturity, are as follows (in thousands):
 
 
 
Amortized
Cost
 
Estimated Fair
Value
Due in one year or less
 
$
9,412

 
$
9,413

Due after one through two years
 
810

 
808

Total short-term investments
 
$
10,222

 
$
10,221


As of June 30, 2013, the average contractual maturity of our short-term investments was approximately 12 months months.
As of June 30, 2013, we had the following available-for-sale securities that were in an unrealized loss position but were not deemed to be other-than-temporarily impaired (in thousands):
 

16


 
 
Less Than 12 Months
 
12 Months or Greater
 
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
Corporate bonds
 
$
(1
)
 
$
2,534

 
$
(1
)
 
$
354

Government-sponsored enterprises
 

 

 
(2
)
 
998

Municipal bonds
 

 

 
(1
)
 
204

Total
 
$
(1
)
 
$
2,534

 
$
(4
)
 
$
1,556


The gross unrealized losses reported above for June 30, 2013 were caused by general fluctuations in market interest rates from the respective purchase date of these securities through June 30, 2013. No significant facts or circumstances have occurred to indicate that these unrealized losses are related to any deterioration in the creditworthiness of the issuers of the marketable securities we own. Based on our review of these securities, including our assessment of the duration and severity of the related unrealized losses, we have not recorded any other-than-temporary impairments on these investments. For the three months ended June 30, 2013, we did not realize any gains or losses.
Fair Value of Financial Instruments
Our financial instruments include cash and cash equivalents, short-term investments, accounts receivable, accounts payable, dividends payable and accrued liabilities. We believe that the fair value of these financial instruments approximate the reported carrying amounts.
Fair Value Measurements
We account for fair value measurements under Accounting Standards Codification 820 “Fair Value Measurements and Disclosures,” or ASC 820, which defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

Level 1 – Quoted prices in active markets for identical assets or liabilities.

Level 2 – Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
We have segregated all assets and liabilities measured at fair value on a recurring basis (at least annually) into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date in the table below. As of June 30, 2013, assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):
 

17


 
 
 
Basis of Fair Value Measurements
 
 
 
Balance at
 
 
 
 
 
 
Balance Sheet Classification
 
 
June 30,
2013
 
Level 1
 
Level 2
 
Level 3
Cash and cash equivalents
Cash and cash equivalents
 
$
12,504

 
$
12,504

 
$

 
$

Short-term investments
Certificates of deposit
 
480

 
480

 

 

Short-term investments
Corporate bonds
 
6,633

 
6,633

 

 

Short-term investments
Government-sponsored enterprises
 
1,281

 
1,281

 

 

Short-term investments
Municipal bonds
 
1,827

 
1,827

 

 

 
Total assets
 
$
22,725

 
$
22,725

 
$

 
$

 
 
 
 
 
 
 
 
 
 
Current liabilities
Current portion of contingent consideration in conjunction with acquisition of BioVectra
 
4,364

 

 

 
4,364

Non-current liabilities
Contingent consideration in conjunction with acquisition of BioVectra
 
25,399

 

 

 
25,399

 
Total liabilities
 
$
29,763

 
$

 
$

 
$
29,763


The fair value of contingent consideration in conjunction with the acquisition of BioVectra was determined to be Level 3 under the fair value hierarchy. The following table presents the fair value, valuation technique and related unobservable input for the Level 3 measurements:

 
Fair Value
Valuation Technique
Unobservable Input
Rate
Contingent consideration estimate
$
29,763

Probability weighted
discounted future cash flows
Discount rate
5%
Investment securities are exposed to various risk factors, such as interest rate, market and credit risk. Due to the level of risk associated with certain investment securities and the level of uncertainty related to changes in the value of investment securities, it is possible that changes in these risk factors in the near term could have an adverse material impact on our results of operations or shareholders’ equity.
The following table represents a roll forward of the fair value of Level 3 instruments, comprised solely of the contingent consideration, including the current portion of the contingent consideration:
 
 
June 30, 2013
Balance at beginning of period
 
$

Amounts acquired or issued
 
30,383

Changes in fair value
 
(620
)
Balance at end of period
 
$
29,763

Certain assets and liabilities are measured at fair value on a nonrecurring basis. In other words, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment).
Doral® (quazepam), is indicated for the treatment of insomnia characterized by difficulty in falling asleep, frequent nocturnal awakenings, and/or early morning awakenings. At March 31, 2013, we had determined that a portion of the value of our purchased technology associated with our prior acquisition of Doral was impaired. This determination was based on a signed purchase agreement dated April 30, 2013 for the disposition of Doral. Based on the agreement, we did not recover and therefore wrote off $0.7 million as of March 31, 2013. During the quarter ended June 30, 2013, we sold the asset for $0.7 million, the residual net book value. There were no other assets or liabilities measured at fair value on a nonrecurring basis during the three months ended June 30, 2013 and 2012, respectively.

18


Long-term Debt
Funded long-term debt
Our subsidiary, BioVectra, has a supply agreement with a customer to supply a pharmaceutical product for a period of 10 years. Per the supply agreement, BioVectra financed and constructed a facility for the manufacturing of the pharmaceutical product to be supplied under the agreement. BioVectra entered into a term loan agreement with Prince Edward Island Century 2000 Fund Inc. to finance $14.8 million of the construction costs of the facility. The term loan has an interest rate of 4%, is due in full by February 2022 and is secured by certain of our BioVectra assets. Under the supply agreement, the customer agreed to reimburse BioVectra for the quarterly financing payments of $450,743 during the term of the loan.
 
June 30, 2013
4% Term Loan, due February 2022, payable in quarterly installments of $450,743 including principal and interest
$
12,895

Less: Current Portion
1,216

Funded long-term debt, less current portion
$
11,679

Long-term debt
Our subsidiary, BioVectra, has a 2.85% term loan. The loan is payable monthly and is due April 2016. The loan is secured with BioVectra accounts receivable and inventory.
 
June 30, 2013
2.85% Term Loan, due April 2016, payable in monthly installments of $48,170 including principal and interest
$
3,892

Less: Current Portion
446

Long-term debt, less current portion
$
3,446

Share-based Compensation
We recognize compensation expense for all share-based awards made to employees and directors. The fair value of share-based awards is estimated at grant date using an option pricing model and the portion that is ultimately expected to vest is recognized as compensation expense over either (1) the requisite service period or (2) the performance period.
Since share-based compensation is recognized only for those awards that are ultimately expected to vest, we have applied an estimated forfeiture rate to unvested awards for the purpose of calculating compensation cost. These estimates will be revised, if necessary, in future periods if actual forfeitures differ from estimates. Changes in forfeiture estimates impact compensation cost in the period in which the change in estimate occurs.
We use the Black-Scholes option-pricing model to estimate the fair value of share-based awards. The determination of fair value using the Black-Scholes option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables, including expected stock price volatility, risk-free interest rate, expected dividends and projected employee stock option behaviors. We estimate the expected term based on the contractual term of the awards and employees' exercise and expected post-vesting termination behavior.
We use the intrinsic method to account for restricted stock awards. The restricted stock awards are valued based on the closing stock price on the date of grant and amortized ratably over the life of the award.
Additionally, we are required to disclose in our consolidated statements of cash flows the income tax effects resulting from share-based payment arrangements. We adopted the simplified method to calculate the beginning balance of the additional paid-in capital, or APIC, pool of excess tax benefits, and to determine the subsequent effect on the APIC pool and consolidated statements of cash flows of the tax effects of employee share-based compensation awards.
At June 30, 2013, we had $60.5 million of total unrecognized compensation expense related to unvested stock options and unvested restricted awards, which is expected to be recognized over a remaining weighted average vesting period of approximately 2.3 years.

19


Share-based compensation expense is summarized below (in thousands):
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013
 
2012
Selling and marketing
 
$
2,570

 
$
1,095

 
$
5,024

 
$
1,882

General and administrative
 
2,685

 
1,916

 
5,223

 
2,962

Research and development
 
1,276

 
706

 
2,432

 
1,170

Total
 
$
6,531

 
$
3,717

 
$
12,679

 
$
6,014


Net Income Per Share
Basic net income per share applicable to common shareholders is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of common and common equivalents shares, such as stock options and restricted stock outstanding during the period. Diluted earnings for our common shareholders per common stock considers the impact of potentially dilutive securities and excludes the impact of potential common shares related to our stock options and restricted stock in periods in which the option exercise or conversion price is greater than the average market price of our common stock during the period.
 
The following table presents the amounts used in computing basic and diluted net income per share applicable to common shareholders for the three and six months ended June 30, 2013 and 2012 and the effect of dilutive potential common shares on the number of shares used in computing dilutive net income per share applicable to common shareholders. Diluted potential common shares resulting from the assumed exercise of outstanding stock options and restricted stock are determined based on the treasury stock method (in thousands, except per share amounts).
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013
 
2012
Net income applicable to common shareholders
 
$
69,123

 
$
41,505

 
$
108,185

 
$
80,048

Shares used in computing net income per share applicable to common shareholders:
 
 
 
 
 
 
 
 
Basic
 
58,938

 
61,112

 
58,075

 
62,308

Effect of dilutive potential common shares:
 

 

 

 

Stock options
 
2,238

 
2,971

 
2,276

 
2,971

Restricted stock
 
322

 
30

 
230

 
26

Diluted
 
61,498

 
64,113

 
60,581

 
65,305

Net income per share applicable to common shareholders:
 
 
 
 
 
 
 
 
Basic
 
$
1.17

 
$
0.68

 
$
1.86

 
$
1.28

Diluted
 
$
1.12

 
$
0.65

 
$
1.79

 
$
1.23


The following table presents the amounts excluded from the computation of diluted net income per share applicable to common shareholders for the three and six months ended June 30, 2013 and 2012 as the inclusion of these securities would have been anti-dilutive (in thousands):
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2013
 
2012
 
2013
 
2012
Stock options
 
2,010

 
1,207

 
2,004

 
900

Restricted stock awards
 

 

 

 

Basic and diluted net income per share also takes into consideration the two-class method. Under the two-class method, undistributed net income is allocated to common stock and unvested participating securities based on their respective rights to

20


share in dividends. We have determined that restricted stock awards represent participating securities and, therefore, require the use of the two-class method for the calculation of basic and diluted earnings per share. The following table sets forth the calculation of unallocated undistributed earnings, both basic and diluted, using the two-class method for amounts attributable to our common stock and our restricted stock awards (in thousands):

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2013
2012
 
2013
2012
Net income applicable to common shareholders
$
69,123

$
41,505

 
$
108,185

$
80,048

Less: Dividends declared
15,000


 
29,887


Undistributed earnings
$
54,123

$
41,505

 
$
78,298

$
80,048

 
 
 
 
 
 
Common stock undistributed earnings
53,172

41,451

 
76,648

79,951

Unvested restricted stock award undistributed earnings
951

54

 
1,650

97

Total undistributed earnings
$
54,123

$
41,505

 
$
78,298

$
80,048

Dividend Program
During September 2012, our Board of Directors adopted a policy to pay a regular quarterly dividend in such amounts as the Board of Directors may determine from time to time. The Board of Directors declared an initial quarterly cash dividend of $0.20 per common share to all shareholders of record at the close of business on October 31, 2012. In February 2013, we announced an increase in our quarterly cash dividend from $0.20 per share to $0.25 per share, with such increase occurring with the quarterly cash dividend paid on April 30, 2013. In May 2013, we announced our most recent quarterly cash dividend of $0.25 per share and such dividend was paid on July 30, 2013.
Purchased Technology, Goodwill and Intangibles
Purchased technology consists of the following (in thousands):
 
 
 
June 30,
2013
 
December 31,
2012
Purchased technology
 
$
4,386

 
$
4,386

Less accumulated amortization
 
(4,386
)
 
(2,893
)
Purchased technology, net
 
$

 
$
1,493


Purchased technology at June 30, 2013 and December 31, 2012 consists of our acquisition costs for Doral. At March 31, 2013, we determined that a portion of the value of our purchased technology associated with the acquisition of Doral was impaired. As discussed above, during the quarter ended June 30, 2013 we entered into a purchase agreement to sell Doral. The agreed upon purchase price was $0.7 million. Based on the value established by the purchase agreement, we determined that the asset was impaired and wrote off $0.7 million of the asset value as of March 31, 2013. We subsequently wrote off the remaining asset value during the quarter ended June 30, 2013. During the quarter ended June 30, 2013, we sold the asset for $0.7 million.
Goodwill and intangibles acquired in conjunction with the acquisition of BioVectra, consists of the following (in thousands):
 
 
 
June 30,
2013
 
December 31,
2012
Acquired intangibles
 
$
33,677

 
$

Less accumulated amortization
 
(1,547
)
 

Acquired intangibles, net
 
$
32,130

 
$

Goodwill
 
$
20,811

 
$


The following table summarizes the changes in the carrying amount of goodwill (in thousands):

21


Balance at December 31, 2012
 
$

Goodwill resulting from the acquisition of BioVectra
 
21,914

Currency translation
 
(1,103
)
Balance at June 30, 2013
 
$
20,811


The following table summarizes the changes in the carrying amount of intangibles (in thousands):
Balance at December 31, 2012
 
$

Intangibles resulting from the acquisition of BioVectra
 
35,581

Amortization expense
 
(1,547
)
Currency translation
 
(1,904
)
Balance at June 30, 2013
 
$
32,130

Amortization expense for BioVectra's intangibles totaled $1.5 million for the six months ended June 30, 2013. The estimated annual amortization expense for intangible assets is approximately $1.5 million for the remainder of 2013, $3.3 million in 2014, $3.3 million in 2015, $3.1 million in 2016 and $2.9 million in 2017 and $10.3 million thereafter. Amortizable intangible assets are amortized over 8 to 10 years (9 years average). Customer relationships are amortized on an accelerated basis over their useful lives.
Intangibles acquired in conjunction with the acquisition of Synacthen, consists of the following (in thousands):
 
 
June 30,
2013
 
December 31,
2012
In process R&D asset
 
$
176,046

 
$

Less accumulated amortization
 
(269
)
 

In process R&D asset, net
 
$
175,777

 
$

Amortization expense for the intangible acquired in conjunction with the acquisition of Synacthen totaled $0.3 million for the six months ended June 30, 2013. The estimated annual amortization expense for the intangible asset is approximately $4.4 million in 2013, $8.8 million in 2014, $8.8 million in 2015, $8.8 million in 2016 and $8.8 million in 2017 and $136.2 million thereafter. The in process R&D asset will be amortized over 20 years.
Commitments and Contingencies
BioVectra receives funding from the Atlantic Canada Opportunities Agency (“ACOA”) which is contingently repayable on a royalty basis upon sales of commercialized products resulting from 4 projects. In the event that the products are not commercialized under the program or do not continue to generate revenues, the royalty agreement will be terminated without future obligation to BioVectra. Royalties paid under this agreement in the three and six months ended June 30, 2013 were immaterial.
We operate in a highly regulated industry. We are subject to the regulatory authority of the SEC, the FDA and numerous other federal, state and foreign governmental agencies including state attorney general offices, which have become more active in investigating the business practices of pharmaceutical companies.
As permitted under California law and in accordance with our Amended and Restated Bylaws, we indemnify our officers and directors for certain events or occurrences while the officer or director is or was serving at our request in such capacity. The potential future indemnification limit is to the fullest extent permissible under California law. However, we have a director and officer insurance policy that limits our exposure and may enable us to recover a portion of any future amounts paid. We believe the fair value of these indemnification agreements in excess of applicable insurance coverage is minimal. Accordingly, we have no liabilities recorded for these agreements as of June 30, 2013 and December 31, 2012.
Glenridge Litigation
In June 2011, Glenridge Pharmaceuticals LLC, or Glenridge, filed a lawsuit against us in the Superior Court of California, Santa Clara County, alleging that we had underpaid royalties to Glenridge, in connection with the timing of the impact of various offsets in the calculation of net sales. We are defending this lawsuit vigorously. In October 2012, a Judge of the Superior Court denied Glenridge's motion for summary judgment on its claims. In March 2013, Glenridge amended its complaint and added causes of action for breach of contract and breach of the implied covenant of good faith and fair dealing. In April 2013, we filed our answer to this amended complaint.

22


In August 2012, we filed a separate lawsuit in the Superior Court of California, Orange County, against the three principals of Glenridge, as well as Glenridge, challenging the enforceability of our agreement with Glenridge, and alleging breach of fiduciary duty, as well as aiding and abetting of the breach, by the principals. In November 2012, a Judge of the Superior Court of California, Orange County, transferred this lawsuit to the Superior Court of California, Santa Clara County. In February 2013, a Judge of the Superior Court denied Glenridge's motion to stay this lawsuit in favor of the accounting lawsuit described in the immediately preceding paragraph. In February 2013, we filed a motion for summary judgment on issues related to the fiduciary duty claim. In June 2013, a Judge of the Superior Court granted the motion in part, and denied it in part, and found that Glenridge's main principal owed fiduciary duties to Questcor during the relevant period. On June 18, 2013, we filed an amended complaint to introduce new allegations of concealment against Glenridge. Glenridge's responsive pleading is expected to be filed no later than August 22, 2013.
USAO Investigation
On September 21, 2012, we became aware of an investigation by the United States Attorney's Office for the Eastern District of Pennsylvania (the "USAO") regarding our promotional practices. Following our September 24, 2012 announcement of this investigation, we received a subpoena from the USAO for information relating to our promotional practices. We are cooperating with the USAO with regard to this investigation.
Putative Class Action Securities Litigation
On September 26, 2012, a putative class action lawsuit was filed against us and certain of our officers and directors in the United States District Court for the Central District of California, captioned John K. Norton v. Questcor Pharmaceuticals, et al., No. SACv12-1623 DMG (FMOx). The complaint purports to be brought on behalf of shareholders who purchased our common stock between April 26, 2011 and September 21, 2012. The complaint generally asserts that we and certain of our officers and directors violated sections 10(b) and/or 20(a) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, by making allegedly false and/or misleading statements concerning the clinical evidence to support the use of Acthar for indications other than infantile spasms, the promotion of the sale and use of Acthar in the treatment of MS and nephrotic syndrome, reimbursement for Acthar from third-party insurers, and our outlook and potential market growth for Acthar. The complaint seeks damages in an unspecified amount and equitable relief against the defendants. This lawsuit has been consolidated with four subsequently-filed actions asserting similar claims under the caption: In re Questcor Securities Litigation, No. CV 12-01623 DMG (FMOx). On January 4, 2013, the district court issued an order appointing the West Virginia Investment Management Board and Plumbers & Pipefitters National Pension Fund as Lead Plaintiffs in the consolidated securities action. In March 2013, the Lead Plaintiffs filed a consolidated amended complaint for the consolidated securities action. We filed a motion to dismiss the consolidated amended complaint in May 2013. A hearing on the motion is currently scheduled on September 13, 2013.
Federal Shareholder Derivative Litigation
On October 4, 2012, another alleged shareholder filed a derivative lawsuit in the United States District Court for the Central District of California captioned Gerald Easton v. Don M. Bailey, et al., No. SACV12-01716 DOC (JPRx). The suit asserts claims substantially identical to those asserted in the do Valle derivative action described below against the same defendants. This lawsuit has been consolidated with five subsequently-filed actions asserting similar claims under the caption: In re Questcor Shareholder Derivative Litigation, CV 12-01716 DMG (FMOx). In March 2013, the parties entered into a stipulation to stay the consolidated federal derivative lawsuit, pending resolution of the motion to dismiss the consolidated securities action.
State Shareholder Derivative Litigation
On October 2, 2012, an alleged shareholder filed a derivative lawsuit purportedly on behalf of the Company against certain of our officers and directors in the Superior Court of the State of California, Orange County, captioned Monika do Valle v. Virgil D. Thompson, et al., No. 30-2012-00602258-CU-SL-CXC. The complaint asserts claims for breach of fiduciary duty, abuse of control, mismanagement and waste of corporate assets arising from substantially similar allegations as those contained in the Norton case described above, as well as from allegations relating to sales of our common stock by the defendants and repurchases of our common stock. The complaint seeks an unspecified sum of damages and equitable relief. On October 24, 2012, an other alleged shareholder filed a derivative lawsuit purportedly on behalf of the Company against certain of our officers and directors in the Superior Court of the State of California, Orange County, captioned Jones v. Bailey, et al., Case No. 30-2012-00608001-CU-MC-CXC. The suit asserts claims substantially identical to those asserted in the do Valle derivative action. On February 19, 2013, the court issued an order staying the state derivative actions until the putative federal securities and federal derivative actions are resolved.
Put Options Securities Action

23


In March 2013, individual traders of put options filed a securities complaint in the United States District Court for the Central District of California captioned David Taban, et al. v. Questcor Pharmaceuticals, Inc., No. SACV13-0425. The complaint generally asserts claims against us and certain of our officers and directors for violations of the Exchange Act and for state law fraud and fraudulent concealment based on allegations similar to those asserted in the Norton case described above. The complaint seeks compensatory damages in an amount equal to $5 million and punitive damages of an unspecified amount. Pursuant to a stipulation of the parties, our response to the complaint is due in September 2013.
Segment Reporting
We have historically operated in one business segment. On January 18, 2013, we acquired 100% of the issued and outstanding shares of BioVectra Inc. We now manage our operations through two operating segments which are defined by our separate companies - Questcor Pharmaceuticals, Inc., or Questcor Pharmaceuticals, and BioVectra. Each segment is operated as an independent business under its own management team, and has responsibility for its commercial activities, operations, and research and development activities related to its products. We intend to have BioVectra continue to operate independently under its existing management team for the foreseeable future.
Questcor Pharmaceuticals is headquartered in Anaheim, California, and is a biopharmaceutical company focused on the treatment of patients with serious, difficult-to-treat autoimmune and inflammatory disorders. Questcor Pharmaceuticals' primary product is Acthar. Questcor Pharmaceuticals currently generates substantially all of its net sales from the use of Acthar in connection with the following: the treatment of proteinuria in idiopathic types of nephrotic syndrome, the treatment of acute exacerbations of multiple sclerosis in adults, the treatment of certain rheumatology-related conditions, and the treatment of infantile spasms in infants and children under two years of age.
BioVectra is located in Prince Edward Island, Canada, operating from three facilities. BioVectra is a supplier of contract manufacturing services to the global pharmaceutical and biotechnology industry. BioVectra manufactures active pharmaceutical ingredients (API's), chemical intermediates, and bioprocessing reagents, and is our manufacturing partner for the API in our H.P. Acthar® Gel (repository corticotropin injection). BioVectra is proficient in synthetic organic chemistry, natural extraction of bioactive compounds, PEGylation and conjugation chemistry, and fermentation of chemical and biologic molecules. BioVectra has submitted 10 product filings, including ANDA, DMF, VMF, and CMC section preparations for both the FDA and Health Canada. These filings have been made for both synthetic and biologic molecules, and include a human injectable API, as well as a final drug product.
Segment results for net sales are presented in the same manner as we present our operations internally to make operating decisions and assess performance. Net income, which includes the negative impact of purchase price adjustments related to our January 18, 2013 acquisition of BioVectra, is the primary responsibility of segment operating management and therefore all activities remain in the segment in which incurred for performance assessment by our chief operating decision maker.
For the three and six months ended June 30, 2013 and 2012, information regarding our net sales and net income for our operating segments is as follows (in millions):
 
Questcor Pharmaceuticals
BioVectra
Intersegment Eliminations
Consolidated
Net Sales
 
 
 
 
For the three months ended June 30, 2013
$
177,045

$
7,693

$
(165
)
$
184,573

For the three months ended June 30, 2012
$
112,452

$

$

$
112,452

Net Income
 
 
 
 
For the three months ended June 30, 2013
$
70,125

$
(1,015
)
$
13

$
69,123

For the three months ended June 30, 2012
$
41,505

$

$

$
41,505

 
Questcor Pharmaceuticals
BioVectra
Intersegment Eliminations
Consolidated
Net Sales
 
 
 
 
For the six months ended June 30, 2013
$
303,817

$
16,078

$
(193
)
$
319,702

For the six months ended June 30, 2012
$
208,421

$

$

$
208,421

Net Income
 
 
 
 
For the six months ended June 30, 2013
$
110,948

$
(2,770
)
$
7

$
108,185

For the six months ended June 30, 2012
$