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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 MARCH 31, 2004OR[  ]
    
    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: 0-20772 QUESTCOR PHARMACEUTICALS, INC. (Exact name of Registrant as specified in its charter)
 CALIFORNIA
(State or other jurisdiction
of incorporation or organization)
    
    33-0476164
(I.R.S. Employer
Identification No.)
 3260 Whipple Road
Union City, CA 94587-1217
(Address of Principal Executive Offices) REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 400-0700 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 [  ] Indicate by check mark whether Registrant is an accelerated filer (as
defined in Rule 12B-2 of the Act). Yes [  ] No [x] At
May 7, 2004 there were 51,060,220 shares of the Registrants common
stock, no par value per share, outstanding.




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##### Table of Contents



QUESTCOR PHARMACEUTICALS, INC. FORM 10-Q TABLE OF CONTENTS PagePART I. FINANCIAL INFORMATIONItem 1
    
    Financial Statements and Notes (Unaudited)Condensed Consolidated Balance SheetsMarch 31, 2004 and December 31, 2003
    
    
    3Condensed Consolidated Statements of Operationsfor the three months ended March 31, 2004 and 2003
    
    
    4Condensed Consolidated Statements of Cash Flowsfor the three months ended March 31, 2004 and 2003
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    19Item 4
    
    Controls and Procedures
    
    
    19PART II. OTHER INFORMATIONItem 1
    
    Legal Proceedings
    
    
    19Item 2
    
    Changes in Securities and Use of Proceeds
    
    
    19Item 3
    
    Defaults Upon Senior Securities
    
    
    19Item 4
    
    Submission of Matters to a Vote of Security Holders
    
    
    19Item 5
    
    Other Information
    
    
    19Item 6
    
    Exhibits and Reports on Form 8-K
    
    
    19Signatures
    
    
    
    
    21EXHIBIT 31EXHIBIT 32
 2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS
 QUESTCOR PHARMACEUTICALS, INC. 
 CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
 March 31,
    
    December 31,2004
    
    2003(Unaudited)
    
    (Note 1)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    6,173
    
    
    $
    3,220Accounts receivable, net of allowances of $60 at March 31, 2004 and
December 31, 2003, respectively
    
    
    1,976
    
    
    
    2,161Inventories, net
    
    
    1,017
    
    
    
    1,050Prepaid expenses and other current assets
    
    
    956
    
    
    
    873Total current assets
    
    
    10,122
    
    
    
    7,304Property and equipment, net
    
    
    720
    
    
    
    609Purchased technology, net
    
    
    13,473
    
    
    
    13,709Goodwill and other indefinite lived intangible assets
    
    
    479
    
    
    
    479Deposits and other assets
    
    
    820
    
    
    
    828Total assets
    
    $
    25,614
    
    
    $
    22,929LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,456
    
    
    $
    1,402Accrued compensation
    
    
    312
    
    
    
    358Other accrued liabilities
    
    
    1,028
    
    
    
    1,052Short-term debt
    
    
    168
    
    
    
    140Convertible debentures, (face amount of $4,000), net of
deemed discount of $474 at March 31, 2004, current portion
    
    
    3,526
    
    
    
    Total current liabilities
    
    
    6,490
    
    
    
    2,952Convertible debentures, (face amount of $4,000), net of
deemed discount of $598 at December 31, 2003
    
    
    
    
    
    
    3,402Other non-current liabilities
    
    
    926
    
    
    
    916Commitments and contingenciesPreferred stock, no par value, 7,500,000 shares authorized;
2,155,715 Series A shares issued and outstanding at
March 31, 2004 and December 31, 2003 (aggregate
liquidation preference of $10,000 at March 31, 2004 and
December 31, 2003)
    
    
    5,081
    
    
    
    5,081Stockholders equity:Preferred stock, no par value, 8,400 and 9,100 Series B shares
issued and
outstanding at March 31, 2004 and December
31, 2003, respectively,
net of issuance costs (aggregate liquidation preference of $8,400
and $9,100 at March 31, 2004 and December 31, 2003, respectively)
    
    
    7,578
    
    
    
    8,278Common stock, no par value, 105,000,000 shares authorized;
51,060,220 and 45,387,802 shares issued and outstanding at March
31, 2004 and December 31, 2003, respectively
    
    
    88,377
    
    
    
    85,232Deferred compensation
    
    
    (21
    )
    
    
    (17
    )Accumulated deficit
    
    
    (82,817
    )
    
    
    (82,915
    )Total stockholders equity
    
    
    13,117
    
    
    
    10,578Total liabilities and stockholders equity
    
    $
    25,614
    
    
    $
    22,929
 See accompanying notes. 3




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QUESTCOR PHARMACEUTICALS, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 (UNAUDITED)
 Three Months EndedMarch 31,2004
    
    2003Revenues:Net product sales
    
    $
    5,148
    
    
    $
    2,362Technology, contract research, grant and royalty revenue
    
    
    
    
    
    
    259Total revenues
    
    
    5,148
    
    
    
    2,621Operating costs and expenses:Cost of product sales
    
    
    856
    
    
    
    675Selling, general and administrative
    
    
    3,028
    
    
    
    2,803Research and development
    
    
    578
    
    
    
    611Depreciation and amortization
    
    
    298
    
    
    
    169Total operating costs and expenses
    
    
    4,760
    
    
    
    4,258Income (loss) from operations
    
    
    388
    
    
    
    (1,637
    )Non-cash amortization of deemed discount on
convertible debentures
    
    
    (131
    )
    
    
    (131
    )Interest income (expense), net
    
    
    (72
    )
    
    
    4Other income (expense), net
    
    
    3
    
    
    
    (77
    )Rental income, net
    
    
    82
    
    
    
    71Net income (loss)
    
    
    270
    
    
    
    (1,770
    )Non-cash deemed dividend related to beneficial
conversion feature of Series B Preferred Stock
    
    
    
    
    
    
    1,301Dividends on Series B Preferred Stock
    
    
    172
    
    
    
    167Net income (loss) applicable to common stockholders
    
    $
    98
    
    
    $
    (3,238
    )Basic and diluted net income (loss) per share
applicable to common stockholders
    
    $
    0.00
    
    
    $
    (0.08
    )Shares used in computing basic and diluted net income (loss)
per share applicable to common stockholders
    
    
    50,032
    
    
    
    38,677
 See accompanying notes. 4




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QUESTCOR PHARMACEUTICALS, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
 (UNAUDITED)
 Three Months EndedMarch 31,2004
    
    2003OPERATING ACTIVITIESNet income (loss)
    
    $
    270
    
    
    $
    (1,770
    )Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:Stock-based compensation expense
    
    
    10
    
    
    
    8Amortization of deemed discount on convertible debentures
    
    
    131
    
    
    
    131Amortization of deferred compensation
    
    
    2
    
    
    
    7Depreciation and amortization
    
    
    298
    
    
    
    169Other-than-temporary loss on investment
    
    
    
    
    
    
    51Deferred rent expense
    
    
    10
    
    
    
    (11
    )Loss on the sale of investments
    
    
    
    
    
    
    13Loss on the sale of equipment, net
    
    
    
    
    
    
    13Changes in operating assets and liabilities:Accounts receivable
    
    
    185
    
    
    
    29Inventories
    
    
    33
    
    
    
    (672
    )Prepaid expenses and other current assets
    
    
    (67
    )
    
    
    59Accounts payable
    
    
    54
    
    
    
    881Accrued compensation
    
    
    (46
    )
    
    
    (366
    )Other accrued liabilities
    
    
    (24
    )
    
    
    (327
    )Net cash flows provided by (used in) operating activities
    
    
    856
    
    
    
    (1,785
    )INVESTING ACTIVITIESPurchase of property and equipment
    
    
    (173
    )
    
    
    (194
    )Purchase of short-term investments
    
    
    
    
    
    
    (2,048
    )Proceeds from maturities and sales of short-term investments
    
    
    
    
    
    
    263Proceeds from sale of property and equipment
    
    
    
    
    
    
    15Decrease in other assets
    
    
    1
    
    
    
    Net cash flows used in investing activities
    
    
    (172
    )
    
    
    (1,964
    )FINANCING ACTIVITIESIssuance of common stock, net of issuance costs
    
    
    2,409
    
    
    
    Issuance of Series B preferred stock and warrants, net of
issuance costs
    
    
    
    
    
    
    9,404Short-term borrowings
    
    
    211
    
    
    
    288Repayment of short-term and long-term debt
    
    
    (183
    )
    
    
    (276
    )Payment of Series B preferred stock dividends
    
    
    (168
    )
    
    
    Repayments of capital lease obligations
    
    
    
    
    
    
    (1
    )Net cash flows provided by financing
activities
    
    
    2,269
    
    
    
    9,415Increase in cash and cash equivalents
    
    
    2,953
    
    
    
    5,666Cash and cash equivalents at beginning of period
    
    
    3,220
    
    
    
    6,156Cash and cash equivalents at end of period
    
    $
    6,173
    
    
    $
    11,822SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:Cash paid for interest
    
    $
    83
    
    
    $
    87NON-CASH INVESTING AND FINANCING ACTIVITIES:Common stock
issued upon conversion of Series B preferred stock and accrued dividends
for Series B preferred stock
    
    $
    704
    
    
    $
    
 See accompanying notes. 5




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QUESTCOR PHARMACEUTICALS, INC. 
 NOTES TO CONDENSED CONSOLIDATED MARCH 31, 2004 FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION Questcor Pharmaceuticals, Inc. (the Company) is a specialty
pharmaceutical company that acquires, markets and sells brand name prescription
drugs through a U.S. direct sales force and international distributors. The Company focuses on the treatment of central nervous system
(CNS) diseases and gastroenterological disorders which are served by a
limited group of physicians such as neurologists,
gastroenterologists, and bariatric surgeons.
The Companys strategy is to acquire pharmaceutical products that it believes
have sales growth potential, are promotionally responsive to a focused and
targeted sales and marketing effort and complement the Companys existing
products, and can be acquired at a reasonable valuation relative to
our cost of capital. The Company currently markets five products in the U.S.: HP Acthar®
Gel (Acthar), an injectable drug that is approved for the treatment of
certain CNS disorders with an inflammatory component, including the treatment
of flares associated with multiple sclerosis (MS) and is also commonly used
in treating patients with infantile spasm; Nascobal®, the only prescription
nasal gel used for the treatment of various Vitamin B-12 deficiencies;
Ethamolin®, an injectable drug used to treat enlarged weakened blood vessels at
the entrance to the stomach that have recently bled, known as esophageal
varices; Glofil®-125, an injectable agent that assesses how well the kidney is
working by measuring glomerular filtration rate, or kidney function; and
VSL#3®, a patented probiotic marketed as a dietary supplement to promote normal
gastrointestinal function. Probiotics are living organisms in food and dietary
supplements, which, upon ingestion in certain numbers, improve the health of
the host beyond their inherent basic nutrition. The Company acquired Nascobal,
a nasal gel formulation of Cyanocobalamin USP (Vitamin B-12), from Nastech
Pharmaceutical Company, Inc. in June 2003 and began distributing Nascobal in
July 2003. The Company markets Nascobal for patients with Crohns Disease and
MS, or who have undergone gastric bypass surgery, since these patients are at high risk of developing severe deficiencies of
Vitamin B-12 due to a compromised ability to absorb Vitamin B-12 through the
gastrointestinal system. The accompanying unaudited consolidated financial statements of the
Company have been prepared in accordance with accounting principles generally
accepted in the United States and applicable Securities and Exchange Commission
regulations for interim financial information. These financial statements do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. The unaudited financial statements should be read in conjunction
with the audited financial statements and related footnotes included in the
Companys Annual Report on Form 10-K for the year ended December 31, 2003, as
filed on March 30, 2004 with the Securities and Exchange Commission. The
accompanying balance sheet at December 31, 2003 has been derived from the
audited financial statements at that date. 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. Operating results for the interim periods presented are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2004. The consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated. 2. STOCK-BASED COMPENSATION The Company generally grants stock options to its employees for a fixed
number of shares with an exercise price equal to the fair market value of the
shares on the date of grant. As allowed under Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), the
Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees and related interpretations in
accounting for stock awards to employees. Accordingly, no compensation expense
is recognized in the Companys financial statements in connection with stock
options granted to employees with exercise prices not less than fair market
value. Deferred compensation for options granted to employees is determined as
the difference between the fair market value of the Companys common stock on
the date options were granted and the exercise price. For purposes of
disclosures pursuant to SFAS 123, as amended by Statement of Financial
Accounting Standards No. 148, Accounting for Stock-Based Compensation 
Transition and Disclosure, the estimated fair value of options is amortized to
expense over the options vesting periods. The following table illustrates the effect on net income (loss) per share
applicable to common stockholders if the Company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee compensation (in
thousands, except per share amounts): 6




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Three months endedMarch 31,2004
    
    2003Net income (loss) applicable to common
stockholders as reported
    
    $
    98
    
    
    $
    (3,238
    )Add: Stock-based employee
compensation expense included
in reported net loss
    
    
    5
    
    
    
    7Deduct: Total stock-based
employee compensation
expense determined
under fair value
method for all awards
    
    
    (145
    )
    
    
    (356
    )Net loss applicable to common
stockholders, pro forma
    
    $
    (42
    )
    
    $
    (3,587
    )Basic and diluted net income (loss)
per share applicable to common
stockholders:As reported
    
    $
    0.00
    
    
    $
    (0.08
    )Pro forma
    
    $
    (0.00
    )
    
    $
    (0.09
    )
 Compensation expense for options granted to non-employees has been
determined in accordance with SFAS 123 and EITF 96-18, Accounting for Equity
Instruments that are Issued to Other than Employees for Acquiring, or in
conjunction with Selling Goods or Services, as the fair value of the
consideration received or the fair value of the equity instruments issued,
whichever is more reliably measured. Compensation expense for options granted
to non-employees is periodically re-measured as the underlying options vest. 3. REVENUE RECOGNITION Revenues from product sales of Acthar, Nascobal, Ethamolin, Glofil-125,
Inulin and VSL#3 are recognized based upon shipping terms, net of estimated
reserves for government chargebacks, Medicaid rebates, and payment discounts.
Revenue is recognized upon shipment of product, provided the title to the
products has been transferred at the point of shipment. If title of product
transfers at point of receipt by the customer, revenue is recognized upon
customer receipt of the shipment. The Company records estimated sales
allowances against product revenues for government chargebacks, Medicaid
rebates and payment discounts based on historical chargebacks and discounts, as
required. The Companys return policy allows customers to return expired
product for exchange within six months beyond the expiration date. Returns are
exchanged for replacement product, and estimated costs for such exchanges,
which include actual product material costs and related shipping charges, are
included in Cost of Product Sales. Returns are subject to quality assurance
reviews prior to acceptance. The Company records returns allowances for
expected returns based upon historical returns, analysis of return merchandise
authorizations and other factors such as shelf life. The Company routinely
assesses the historical returns and other experience including customers
compliance with return goods policy and adjusts its allowances as appropriate.
Allowances for Medicaid rebates, government chargebacks and product returns are
$589,000 and $582,000 at March 31, 2004 and December 31, 2003, respectively,
and are included in Other Accrued Liabilities. The Company sells product to
wholesalers, who in turn sell its products to pharmacies and hospitals. In the
case of VSL#3, the Company sells directly to consumers. The Company does not
require collateral from its customers. The Company has received government grants that support the Companys
research efforts in specific research projects. These grants provide for
reimbursement of approved costs incurred as defined in the various awards. The Company has received payments in exchange for proprietary licenses
related to technology and patents. The Company classifies these payments as
Technology Revenue. These payments are recognized as revenues upon receipt of
cash and the transfer of intellectual property, data and other rights licensed,
assuming no continuing material obligations exist. 4. CASH AND CASH EQUIVALENTS The Company considers highly liquid investments with maturities from the
date of purchase of three months or less to be cash equivalents. The Company
had cash and cash equivalents of $6,173,000 and $3,220,000 at March 31, 2004
and December 31, 2003, respectively, all in money market funds. The fair value
of the funds approximated cost. 7




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During the quarter ended March 31, 2003, the Company recognized an
other-than-temporary loss of $51,000 and a realized loss of $13,000 related to
its equity investment in Rigel Pharmaceuticals, Inc. (Rigel). These amounts
are included in Other Income (Expense) on the accompanying Consolidated
Statement of Operations. The Company liquidated its investment in Rigel common
stock in the second quarter of fiscal year 2003. 5. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out method)
or market and consist of the following (in thousands): March 31,
    
    December 31,2004
    
    2003Raw materials
    
    $
    575
    
    
    $
    534Work in process
    
    
    
    
    
    
    197Finished goods
    
    
    795
    
    
    
    660Less allowance for excess and obsolete inventories
    
    
    (353
    )
    
    
    (341
    )$
    1,017
    
    
    $
    1,050
 6. PURCHASED TECHNOLOGY AND INTANGIBLE ASSETS Goodwill and assembled workforce no longer subject to amortization
amounted to $479,000 at March 31, 2004 and December 31, 2003. The Company
performed an impairment test of goodwill and assembled workforce as of December
31, 2003, which did not result in an impairment charge. The Company will
continue to monitor the carrying value of goodwill and assembled workforce
through the annual impairment tests or more frequently if indicators of
potential impairment exist. As of March 31, 2004, no indicators of potential
impairment existed. No such impairment losses have been recorded to date. Purchased technology at March 31, 2004 includes $14.2 million related to
the Nascobal acquisition. The Nascobal purchased technology is being amortized
over its estimated life of 15 years. Accumulated amortization for the Nascobal
purchased technology is $751,000 as of March 31, 2004. 7. COMMITMENTS, INDEMNIFICATIONS AND CONTINGENCIES The Company, as permitted under California law and in accordance with its
Bylaws, indemnifies its officers and directors for certain events or
occurrences while the officer or director is or was serving at the Companys
request in such capacity. The potential future indemnification limit is to the
fullest extent permissible under California law; however, the Company has a
director and officer insurance policy that limits its exposure and may enable
it to recover a portion of any future amounts paid. The Company believes the
fair value of these indemnification agreements is minimal. Accordingly, the
Company has no liabilities recorded for these agreements as of March 31, 2004. From time to time, the Company may become involved in claims and other
legal matters arising in the ordinary course of business. Management is not
currently aware of any such matters that will have a material adverse affect on the
financial position, results of operations or cash flows of the Company. 8. NET INCOME (LOSS) PER SHARE APPLICABLE TO COMMON STOCKHOLDERS Basic and diluted net income (loss) per share applicable to common
stockholders is based on net income (loss) applicable to common stockholders
for the relevant period, divided by the weighted average number of common
shares outstanding during the period. Diluted earnings per share applicable to
common stockholders gives effect to all potentially dilutive common shares
outstanding during the period such as options, warrants, convertible preferred
stock, and contingently issuable shares. Diluted net income per share
applicable to common stockholders has not been presented separately for the
period ended March 31, 2004 as basic net income per share is $0.00. Diluted
net loss per share applicable to common stockholders has not been presented
separately for the period ended March 31, 2003 since, due to the Companys net
loss position, it is anti-dilutive. If the Companys net income per share
applicable to common stockholders had been $0.01 or greater for the period
ended March 31, 2004, then shares used in calculating diluted earnings per
share applicable to common stockholders would have included, if dilutive, the
effect of the outstanding 9,447,104 stock options to purchase common shares,
11,080,492 convertible preferred shares, 2,531,644 common shares issuable upon
conversion of debentures, placement unit options for 127,678 common shares and
4,559,407 warrants to purchase common shares. 8




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9. EQUITY TRANSACTIONS In
January 2004 the Company entered into agreements with some of its existing
investors and issued 4,878,201 shares of common stock in exchange for
$2,399,050 in cash and the surrender of outstanding warrants to purchase
3,878,201 shares of common stock. The warrants retired represented
approximately 46% of the Companys warrants outstanding as of December 31,
2003. The warrants surrendered were included as consideration at their
aggregate fair value of $743,000 which was determined using a Black-Scholes
valuation method. The purchase price of the common stock, which was payable in
cash and surrender of outstanding warrants, was $0.644 per share, which was the
volume weighted average price of the Companys common stock for the five
trading days prior to the agreement to the terms of the transaction.
Sigma Tau participated in the transaction, purchasing 759,493 shares of common stock for aggregate consideration of
$489,000 in cash and the surrender of 759,493 warrants to purchase common
stock. In January 2004, shares of the Companys Series B Preferred Stock with a
stated value of $600,000 plus accrued dividends of $2,000 were converted into
640,147 shares of common stock. In March 2004, shares of the Companys Series B Preferred Stock with a
stated value of $100,000 plus accrued dividends of $1,600 were converted into
107,995 shares of common stock. 10. 2004 DIRECTORS STOCK OPTION PLAN In February 2004, the Board of Directors adopted the 2004 Non-Employee
Directors Equity Incentive Plan (the 2004 Plan). The adoption of the 2004
Plan is subject to shareholder approval at the Companys 2004 Annual Meeting of
Shareholders. Under the terms of the 2004 Plan, 1,250,000 shares of the
Companys common stock would be authorized for grants of non-qualified stock
options to non-employee directors of the Company. The 2004 Plan provides for
the granting of 25,000 options to purchase common stock upon appointment as a
non-employee director and an additional 15,000 options each January thereafter
upon reappointment. Such option grants will vest over four years and the
exercise price of the options is 85% of the fair market value on the date of
grant. Additionally, the 2004 Plan provides for the annual granting of 10,000
options to members of committees of the Board of Directors and an additional
7,500 options to chairmen of committees. Such option grants will have an
exercise price equal to 100% of the fair market value of the Companys common
stock on the date of the grant and will become fully vested at the time of
grant. The maximum term of the options granted under the 2004 Plan is ten
years. 11. SERIES B CONVERTIBLE PREFERRED STOCK In January 2003, the Company completed a private placement of Series B
Convertible Preferred Stock and warrants to purchase common stock to various
investors. Gross proceeds to the Company from the private placement were $10
million. Net of issuance costs, the proceeds to the Company were
$9.4 million. Of the original $10 million stated value, Series B
Convertible Preferred Stock having a stated value of $1.6 million has
been converted into common stock through March 31, 2004. The holders of the Series B Convertible Preferred Stock have the right,
upon the occurrence of certain designated optional redemption events, to
require the Company to redeem the Series B Preferred Stock at 100% of stated
value, together with all accrued and unpaid dividends and interest. The
redemption events are all within the control of the Company. Therefore, in
accordance with EITF Topic D-98, the Company has classified the Series B
Preferred Stock in permanent equity. In addition, the Company initially
recorded the Series B Preferred Stock at its fair value on the date of
issuance. The Company has elected not to adjust the carrying value of the
Series B Preferred Stock to the redemption value of such shares, since it is
uncertain whether or when the redemption events will occur. Subsequent
adjustments to increase the carrying value to the redemption value will be made
when it becomes probable that such redemption will occur. As of March 31, 2004,
the redemption value of the Series B Preferred Stock was $8.4 million. The purchasers of the Series B Preferred Stock also received for no
additional consideration warrants exercisable for an aggregate of 3,399,911
shares of Common Stock at an exercise price of $1.0824 per share, subject to
certain anti-dilution adjustments. The warrants expire in January 2007. The
warrants issued to the Series B holders were assigned a value of $1,527,000
which decreased the carrying value of the preferred stock. The warrants were
valued using the Black-Scholes method with the following assumptions: a risk
free interest rate of 3%; an expiration date of January 15, 2007; volatility of
82% and a dividend yield of 0%. In connection with the issuance of the Series B
Preferred Stock and warrants, the Company recorded $1,301,000 related to the
beneficial conversion feature on the Series B Preferred Stock as a deemed
dividend, which increased the carrying value of the preferred stock. A
beneficial conversion feature is present because the effective conversion price
of the Series B Preferred Stock was less than the fair value of the Common
Stock on the commitment date. For the quarter ended March 31, 2003, the deemed
dividend increased the loss applicable to common stockholders in the
calculation of basic and diluted net loss per common share. 9




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12. RELATED PARTY TRANSACTIONS In December 2001, the Company entered into a promotion agreement with VSL
Pharmaceuticals Inc. (VSL), a private company owned in part by the major
shareholders of Sigma Tau. Sigma Tau beneficially owned approximately 28% of
the Companys outstanding stock as of March 31, 2004. In June 2002, the Company
signed an amendment to the promotion agreement. Effective January 1, 2004, the
promotion agreement and all amendments were assigned by VSL to Sigma Tau
Pharmaceuticals, Inc. Under these agreements, the Company has agreed to
purchase VSL#3 from VSL at a stated price, and has also agreed to promote,
sell, warehouse and distribute the VSL#3 product direct to customers at its
cost and expense, subject to certain expense reimbursements. Revenues from
sales of VSL#3 are recognized when product is shipped to the customer. The
Company does not accept returns of VSL#3. VSL#3 revenue for the quarter ending
March 31, 2004 was $336,000 and is included in Net Product Sales. Included in
Accounts Payable is $114,000 for amounts owed to VSL at March 31, 2004. An
access fee to VSL is calculated quarterly, which varies based upon sales and
costs incurred by the Company subject to reimbursement under certain
circumstances. For the quarter ended March 31, 2004, the amount of the access
fee was $67,000 and is included in Selling, General and Administrative expense
in the accompanying Consolidated Statement of Operations. During the quarter
ended March 31, 2004 the Company paid $240,000 to VSL for the purchase of VSL#3
product and access fees. In January 2002, the Company entered into a royalty agreement with
Glenridge Pharmaceuticals LLC (Glenridge). Kenneth R. Greathouse, the
Companys former Vice President of Commercial Operations, is a part owner of
Glenridge. Effective September 30, 2003, Mr. Greathouse ceased
to be an officer of
Questcor. The agreement calls for the payment of royalties on a quarterly
basis on the net sales of Acthar. The Company paid Glenridge $69,000 and
$95,000 in the quarters ended March 31, 2004 and 2003, respectively, related to
royalties on Acthar sales. The Company has accrued $56,000 for royalties earned
in the quarter ended March 31, 2004, which is included in Other Accrued
Liabilities in the accompanying Consolidated Balance Sheet. 13. COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) is comprised of net income (loss) and the
change in unrealized holding gains and losses on available-for-sale securities. Three Months EndedMarch 31,2004
    
    2003Net income (loss)
    
    $
    270
    
    
    $
    (1,770
    )Change in unrealized gains(losses) on
available-for-sale securities
    
    
    
    
    
    
    41Comprehensive income (loss)
    
    $
    270
    
    
    $
    (1,729
    )
 10




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties, including statements regarding the period of time during which
our existing capital resources and income from various sources will be adequate
to satisfy our capital requirements. Our actual results could differ materially
from those discussed herein. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in this section,
as well as those discussed in our annual report on Form 10-K for the fiscal
year ended December 31, 2003, including Item 1 Business of Questcor Risk
Factors, as well as factors discussed in any documents incorporated by
reference herein or therein. Whenever used in this Quarterly Report, the terms
Questcor, Company, we, our, ours, and us refer to Questcor
Pharmaceuticals, Inc. and its consolidated subsidiaries. Overview We are a specialty pharmaceutical company that acquires, markets and sells
brand name prescription drugs through our U.S. direct sales force and
international distributors. We focus on the treatment of central
nervous system (CNS) diseases and gastroenterological disorders which are
served by a limited group of physicians such as neurologists,
gastroenterologists and bariatric surgeons. Our strategy is to acquire pharmaceutical products that we
believe have sales growth potential, are promotionally responsive to a focused
and targeted sales and marketing effort and complement our existing
products, and can be acquired at a reasonable valuation relative to
our cost of capital.
We currently market five products in the United States:  
    
    HP Acthar® Gel (Acthar), an injectable drug that is approved for
the treatment of certain CNS disorders with an inflammatory component
including the treatment of flares associated with multiple sclerosis
(MS) and is also commonly used in treating patients with infantile
spasm;
    
    Nascobal®, the only prescription nasal gel used for the treatment of
various Vitamin B-12 deficiencies including Vitamin B-12 deficiencies
associated with Crohns disease, gastric bypass surgery and MS;
    
    Ethamolin®, an injectable drug used to treat enlarged weakened blood
vessels at the entrance to the stomach that have recently bled, known as
esophageal varices;
    
    Glofil®-125, an injectable agent that assesses how well the kidney is
working by measuring glomerular filtration rate, or kidney function; and
    
    VSL#3®, a patented probiotic marketed as a dietary supplement to
promote normal gastrointestinal function. Probiotics are living
organisms in food and dietary supplements, which, upon ingestion in
certain numbers, improve the health of the host beyond their inherent
basic nutrition. In June 2003, we acquired Nascobal, an FDA approved nasal gel formulation
of Cyanocobalamin USP (Vitamin B-12), from Nastech Pharmaceutical Company, Inc.
(Nastech) for $14.2 million.
We also agreed to acquire the rights to Nascobal spray, an improved
dosage form, for which there will be two contingent payments to
Nastech of $2 million each. Upon approval by the FDA of an NDA filed
by Nastech for Nascobal spray, Nastech is obligated to transfer the NDA
to us, and we are obligated to pay $2 million to Nastech.  Upon
subsequent issuance of a patent for the nasal spray, we are obligated
to pay an additional $2 million to Nastech.
 We began distributing Nascobal in July 2003. We
are marketing Nascobal for patients with Crohns Disease and MS, and patients
who are at high risk of developing severe deficiencies of Vitamin B-12 due to a
compromised ability to absorb Vitamin B-12 through the gastrointestinal system.
We are also marketing Nascobal for patients who have undergone gastric bypass
surgery, have inflammatory bowel disease, or other conditions that lead to a
malabsorbtive state. Consistent with our focus on sales and marketing, our spending on research
and development activities is minimal. Expenses incurred for the Acthar
manufacturing site transfer and medical and regulatory affairs are classified
as Research and Development Expenses in the accompanying Consolidated
Statements of Operations. We have entered into agreements with pharmaceutical
and biotechnology companies to further the development of certain acquired
technology. In June 2002, we signed a definitive License Agreement with Fabre
Kramer Pharmaceuticals, Inc. (Fabre Kramer), whereby we granted Fabre Kramer
exclusive worldwide rights to develop and commercialize HypnostatTM (intranasal
triazolam for the treatment of insomnia) and PanistatTM (intranasal alprazolam
for the treatment of panic disorders). We have granted rights to Rigel
Pharmaceuticals, Inc. (Rigel) of South San Francisco, California for our
antiviral drug discovery program, and granted rights to Dainippon Pharmaceuticals
Co., Ltd. (Dainippon) of Osaka, Japan for our antibacterial program. 11




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We have incurred an accumulated deficit of $82.8 million at March 31,
2004. At March 31, 2004, we had $6.2 million in cash and cash equivalents.
Results of operations may vary significantly from quarter to quarter depending
on, among other factors, the results of our sales efforts, timing of expiration
of our products and the resulting shipment of replacement product under our
exchange policy, the availability of finished goods from our sole-source
manufacturers, the timing of certain expenses including the Acthar site
transfer costs and various market research and marketing planning expenses, the
seasonality of sales of Ethamolin, the acquisition of marketed products, the
establishment of strategic alliances and corporate partnering arrangements and
the receipt of milestone payments. Critical Accounting Policies Our managements discussion and analysis of our financial condition and
results of operations is based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosures. On an
on-going basis, we evaluate our estimates, including those related to product
returns, sales allowances, bad debts, inventories, investments and intangible
assets. We base our estimates on historical experience and on various other
assumptions that we believe are reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions. We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements. Product Returns, Rebates and Sales Allowances We have estimated allowances for product returns from wholesalers and
pharmacies, government chargebacks for goods purchased by certain Federal
government organizations including the Veterans Administration, Medicaid
rebates to all states for goods purchased by patients covered by Medicaid,
and cash discounts for prompt payment. We estimate our allowances by utilizing
historical information for existing products and data obtained from external
sources. For new products, we estimate our allowances for product returns,
government chargebacks and rebates on specific terms for product returns,
chargebacks and rebates, and our experience with similar products. We have an exchange policy in which we exchange replacement product for
product returns. The estimated costs for such potential exchanges, which
include actual product costs and related shipping charges, are included in Cost
of Product Sales. In estimating returns for each product, we analyze (i)
historical returns and sales patterns, (ii) current inventory on hand at
wholesalers and in the distribution channel, and the remaining shelf life of
that inventory (ranging from 18 months to 3 years for all products except
Glofil), and (iii) changes in demand measured by prescriptions as provided by
an independent third party source and our internal estimates. For Glofil, we
accept no returns for expired product. We routinely assess our historical
experience including customers compliance with our exchange policy, and we
adjust our allowances as appropriate. In December 2002, we noted that certain customers were not complying with
our exchange policy. These customers were deducting from amounts owed to us the
full price of expired Acthar they planned to return to us. We reached an
agreement with these customers to reverse these short-remittances and to accept
replacement product. Certain customers received an administration fee from us.
It remains our customers standard practice to deduct from payments to us the
amount of the sales value of expired product, or returns receivable, that they
have requested authorization to return. The returns receivable is $408,000 at
March 31, 2004, primarily due to the return materials authorization requests
for expired product from batches of Acthar that expired in November 2002, May
2003 and January 2004 and Ethamolin that expired in October 2003, January 2004
and February 2004. Customers have indicated that they will reimburse us for
these deductions upon the replacement of expired units in accordance with our
exchange policy, however, our experience has been the timing of such
reimbursements is slower than the collection of our normal trade receivables.
As of March 31, 2004, replacement units have been shipped with respect to
approximately one third of the amounts owing to us and we are seeking
reimbursement from these customers. As long as our customers standard practice
is to deduct amounts related to the return of expired product, a returns
receivable will arise. Should our customers not comply with our exchange
policy, the amounts deducted by them for returns may not be collectible, and we
would increase our allowance for bad debts. Our exchange policy is not commonplace in the pharmaceutical industry. The
standard policy in the industry is to issue credit memoranda in exchange for
expired product that is returned. Our customers have expressed dissatisfaction
with our exchange policy, and, although they have complied to date, our ability
to enforce this policy in the future on customers whose influence and resources
are far greater than ours may be minimal. If our customers do not comply with
our exchange policy, our options may be limited. We 12




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could either not sell our products to them or we could be forced to change
our exchange policy to allow for the issuance of credit memoranda in exchange
for returned expired products. Under such a policy, we would no longer issue
replacement product. The issuance of credit memoranda would negatively impact
cash flow in the short-term but may increase future sales as shipment of
replacement product at no cost would no longer occur. Should we be forced to change to a returns policy in which credit
memoranda are issued in exchange for expired product, an allowance for returns
(credit memoranda) would be necessary and would be recorded with an offset to
net product sales at the time of the policy change. The allowance would be
based on an estimate of the future credit memoranda to be issued based upon
historical return rates by product, applied to the quantity of product sold
that has not yet expired. Further, if such a policy change were made the
currently recorded allowance for product exchanges would be eliminated
resulting in a reduction of cost of product sales. With respect to Acthar, the
historical return rate has been approximately 18% to 20% due to the short shelf
life of Acthar and the nature of the disease for which it is prescribed. A
change in our business policy to a return for credit memoranda basis would have
a significant negative financial impact at the time of the change. If we
adopted a policy of issuing credit memoranda for expired product in the future,
we may need allowances of up to $2 million to $3 million based on historical
return rates for each product. A change in our exchange policy to issuing
credit memoranda for expired product would be considered a change in accounting
estimate and would be accounted for on a prospective basis. The impact of such
a change would be to reduce net product sales by the amount of the estimated
future credit memoranda to be issued offset by a reduction in cost of product
sales for the elimination of the allowance for product replacement. In March 2004, one of our three largest customers communicated to us that
they do not want to continue complying with our exchange policy and would like
to be issued credit memoranda for expired product. We have met with this
customer and they have agreed to continue to adhere to our exchange policy for
the time being. However, we offered, and are awaiting a response to, a proposal
to the customer to transition in the future to a policy of issuing credit
memoranda for returned product. Under the proposal, we would change to a credit
memorandum policy for this customer commencing with shipments from the next lot
of each product to be released. The next lot of Acthar would be released in
June 2004, Nascobal would be released later in 2004 and Ethamolin in 2006. We
would continue with the exchange policy through the return period (six months
after expiration) for all lots of each product that have been shipped to date
or that are currently being shipped for each product. In effect, under the
transition plan the exchange policy would continue until all the currently
released unexpired lots have passed their six month return period. Under the
proposal for Acthar the current exchange policy would continue until June 2005,
Ethamolin continues until October 2006 and Nascobal continues until May 2006,
which is six months after the expiration of the lots already sold or currently
being sold. Upon release of the new lot of each product, shipments thereafter
would be subject to a credit memo policy for returns. Should our customer
accept our proposal to transition to a policy in which credit memoranda are
issued in exchange for expired product, an allowance for returns (credit
memoranda) on future shipments would be necessary and would be recorded with
an offset to net product sales as shipments from the new lots are released. The
allowance would be based on an estimate of the future credit memoranda to be
issued based upon historical return rates by product, applied to the quantity
of product sold under the credit memo policy that has not yet expired. We are
awaiting a response from the customer to our proposal. We do not know if this
policy will be accepted in full by the customer. In April 2004, another of our three largest customers verbally
communicated their intention to implement new procedures which may impact our
exchange policy. Preliminary discussion indicates that the customers new
procedures may require us to change some of the administrative processes for
handling returns. We are awaiting specifics as to their new procedures and the
administrative changes that they request and at this time we are unable to
assess the impact on the exchange policy or Questcors financial
results. In estimating Medicaid rebates, we match the actual rebates to the
quantity of product sold by pharmacies on a product-by-product basis to arrive
at an actual rebate percentage. This historical percentage is used to estimate
a rebate percentage that is applied to the sales to which the rebates apply to
arrive at the rebate expense (allowance) for the period. In particular, we
consider allowable prices by Medicaid. In estimating government chargeback
allowances, we analyze actual chargeback amounts by product and apply
historical chargeback rates to sales to which chargebacks apply, typically
sales to the Veterans Administration and other U.S. government organizations.
We routinely assess our experience with Medicaid rebates and government
chargebacks and adjust the allowances accordingly. For
qualified customers, we grant payment terms of 2%, net 30 days.
Allowances for cash discounts are estimated based upon historical experience
and the amount of trade accounts receivable subject to the cash discounts. If actual product returns, government chargebacks, Medicaid rebates and
cash discounts are greater than our estimates, or if our customers fail to
adhere to our exchange policy, additional allowances may be required. To date,
the actual amounts have approximated our estimates. 13




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Inventories We maintain inventory reserves primarily for obsolescence (due to the
expiration of shelf life of a product). In estimating inventory obsolescence
reserves, we analyze on a product-by-product basis (i) the expiration date,
(ii) our sales forecasts, and (iii) historical demand. Judgment is required in
determining whether the forecasted sales information is sufficiently reliable
to enable us to reasonably estimate inventory obsolescence. If actual future
usage and demand for our products are less favorable than those projected by
our management, additional inventory write-offs may be required in the future. Intangible Assets We have intangible assets related to purchased technology, goodwill and
other acquired intangibles. The determination of related estimated useful lives
and whether or not these assets are impaired involves significant judgment.
Changes in strategy and/or market conditions could significantly impact these
judgments and require adjustments to recorded asset balances. In accordance
with SFAS 144, we review intangible assets, as well as other long-lived assets,
for impairment whenever events or circumstances indicate that the carrying
amount may not be fully recoverable. In accordance with SFAS 142, we review
goodwill and other intangible assets with no definitive lives for impairment on
an annual basis. Our fair value is compared to the carrying value of
our net assets, including the intangible assets. If the fair value is
greater than the carrying amount, then no impairment is indicated. To date, no impairment has been
indicated. Results of Operations Three months ended March 31, 2004 compared to the three months ended March 31,
2003: Total Revenues Three Months EndedMarch 31,Increase/
    
    %2004
    
    2003
    
    (Decrease)
    
    Change(in $000s)Net product sales
    
    $
    5,148
    
    
    $
    2,362
    
    
    $
    2,786
    
    
    
    118
    %Technology, contract research, grant and royalty revenue
    
    
    
    
    
    
    259
    
    
    
    (259
    )
    
    
    Total revenues
    
    $
    5,148
    
    
    $
    2,621
    
    
    $
    2,527
    
    
    
    96
    %
 Total revenues for the quarter ended March 31, 2004 increased $2,527,000,
or 96%, from the quarter ended March 31, 2003 due to increases in net product
sales. Net product sales for the quarter ended March 31, 2004 increased by
$2,786,000, or 118%, from the quarter ended March 31, 2003. The increase in net
product sales is primarily the result of revenue from sales of Nascobal, which
was introduced in July 2003, and also reflects higher net product sales of
Acthar and Ethamolin in the period. Net product sales for the first quarter of
2004 were positively affected by seasonal demand for Ethamolin. We believe that
Ethamolin sales will be significantly reduced in the remaining quarters of
2004. In addition, net product sales for the first quarter of 2004 include
$325,000 of shipments to wholesalers at the beginning of the quarter for orders
received in December 2003. We expect quarterly fluctuations in the net sales
of all of our products due to the timing of shipments, seasonality of demand
and the reallocation of promotional efforts for each product. The lower net product sales of Acthar in the first quarter of 2003 on a
comparative basis reflects the negative effect of our decision in the first
quarter of 2003 to briefly discontinue normal wholesaler shipments of Acthar
and to limit shipments to critical care and emergency care situations only, due
to the relatively short dating of Acthar in our inventory and at the wholesale
level. The increase in net product sales of Ethamolin in the first quarter of
2004 over the first quarter of 2003 was partially the result of lower shipments
in the first quarter of 2003 resulting from the impact of the advanced buying
by wholesalers of Ethamolin in mid-2002, after we pre-announced a price
increase. Pursuant to our exchange policy for expired product, during the quarter
ended March 31, 2004, we replaced vials of Acthar at no cost for certain
returned product from Acthar batches that expired in November 2002 and May 2003
and Ethamolin that expired in October 2003. Subsequent to March 31, 2004, we
will continue to replace Acthar and Ethamolin returned from these expired lots,
as 14




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well as from the Acthar batch that expired in January 2004 and the
Ethamolin batches that expired in January and February 2004. The replacement of
product subsequent to March 31, 2004 for product that has expired and future
expiring product may displace future quarter sales. The full extent of this
displacement is not ascertainable at this time. However, in the quarter ended
March 31, 2004, we replaced vials of expired Acthar with a sales value of
approximately $134,000, and we also replaced units of expired Ethamolin at no
cost with a sales value of approximately $23,000. The costs related to
replacement products are reserved for and are included as a component of Cost
of Product Sales. Under our exchange policy, as of March 31, 2004 customers
have requested the replacement of expired Acthar and Ethamolin with a sales
value of greater than $720,000. We intend to replace this expired product in
the second and third quarter of 2004. These replacements will likely displace
future sales. We review the amount of inventory at the wholesale level in order to help
assess the demand for Acthar, Ethamolin and Nascobal. Quarterly revenues will
fluctuate based on buying patterns of the wholesalers, expiration dates of
product sold and timing of shipment of replacement product under our exchange
policy. We did not recognize any technology revenue for the quarter ended March
31, 2004. We recognized $250,000 in technology revenue for the quarter ended
March 31, 2003 from our License Agreement with Fabre-Kramer. We did not recognize any contract research, grant and royalty revenue for
the quarter ended March 31, 2004, as compared to the $9,000 we recognized in
the first quarter of 2003 from reimbursements under our Small Business
Innovation Research grant related to our GERI compound research projects. The
grant was terminated in July 2003. Cost of Product Sales Cost of product sales for the quarter ended March 31, 2004 increased
$181,000, or 27%, to $856,000 from $675,000 for the quarter ended March 31,
2003. Cost of product sales includes material cost, packaging, warehousing and
distribution, product liability insurance, royalties, quality control, quality
assurance and write-offs of excess inventory. The increased dollars are
primarily due to increased material costs related to higher product sales and
increases in costs of product stability testing. We expect per unit material
costs for Acthar to increase moderately in the future due to higher contract manufacturing
and laboratory costs. Cost of product sales as a percentage of net product
sales decreased to 17% for the quarter ended March 31, 2004 from 29% for the
quarter ended March 31, 2003. The decrease in the percentage of cost of product
sales as compared to net product sales is the result of changes in the mix of
products sold and cost efficiencies due to volume increases. In April 2003, we
decided to outsource certain functions previously performed in our Carlsbad,
California distribution center, including, but not limited to, warehousing,
shipping and quality control studies. Selling, General and Administrative Three Months EndedMarch 31,%2004
    
    2003
    
    Increase
    
    Change(in $000s)Selling, general and administrative expense
    
    $
    3,028
    
    
    $
    2,803
    
    
    $
    225
    
    
    
    8
    %Percentage of total revenue
    
    
    59
    %
    
    
    107
    %
 Selling, general and administrative expenses for the quarter ended March
31, 2004 increased $225,000, or 8%, from the quarter ended March 31, 2003. As a
percentage of revenue, selling, general and administrative expenses decreased
to 59% for the quarter ended March 31, 2004 compared to 107% for the quarter
ended March 31, 2003, largely due to the increase in total revenues. The
increase in dollars is primarily due to increased spending on sales and
marketing, including certain non-recurring market research and marketing
planning studies that are nearing completion, offset by lower legal expenses,
investor relations expenses, and bonuses. Research and Development Research and development expenses for the quarter ended March 31, 2004
were $578,000 as compared to $611,000 for the quarter ended March 31, 2003. The
costs included in research and development relate primarily to our
manufacturing site transfers and medical and regulatory affairs compliance
activities. The decrease is primarily due to lower Acthar site transfer costs
and a reduction 15




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in royalty expense and patent fees, offset in part by increased regulatory
fees related to Nascobal. Research and development expenses for the quarter ended March 31, 2004
include approximately $200,000 related to the manufacturing site transfer of
Acthar, as compared to approximately $235,000 for the quarter ended March 31,
2003. This amount includes costs for the testing necessary to transfer a
potency assay to a new contract laboratory. In fiscal year 2003, a third party
contract laboratory performed tests to attempt to validate the transfer of the
potency assay. As of September 30, 2003, this laboratory had been unsuccessful
in validating the assay in order to complete the transfer. Based in part on the
results of these tests, we were not able to complete the transfer of the assay
to a new contract laboratory during 2003. In the fourth quarter of fiscal year
2003, we temporarily suspended the testing and instead completed a review of
the results achieved to date. We performed an analysis of the variables
involved that may have affected the validation of the assay. Beginning in the
first quarter of 2004, we have resumed the testing necessary to transfer the
potency assay to a new contract laboratory and have made additional progress in
the assay transfer. If this laboratory is unable to validate this specific
assay, we may be forced to find a new contractor to complete this work, which
in turn could increase our costs substantially. On January 22, 2004 we received final approval from the FDA for the
finished goods site transfer of Acthar to Chesapeake Biological Laboratories. Depreciation and Amortization Depreciation and amortization expense for the quarter ended March 31, 2004
increased to $298,000, or 76%, from $169,000 for the quarter ended March 31, 2003.
This increase was due primarily to the amortization of the purchased technology
related to the Nascobal product acquisition (for $14.2 million) in June 2003.
The Nascobal purchased technology will be amortized over 15 years. Other Income and Expense Items Three Months EndedMarch 31,
    
    Increase/
    
    %2004
    
    2003
    
    (Decrease)
    
    Change(in $000's)Non-cash amortization of deemed discount on convertible debentures
    
    $
    (131
    )
    
    $
    (131
    )
    
    $
    
    
    
    
    Interest income
    
    
    11
    
    
    
    90
    
    
    
    (79
    )
    
    
    (88
    )%Interest expense
    
    
    (83
    )
    
    
    (86
    )
    
    
    (3
    )
    
    
    (3
    )%Other income
    
    
    3
    
    
    
    
    
    
    
    3
    
    
    
    Other expense
    
    
    
    
    
    
    (77
    )
    
    
    (77
    )
    
    
    Rental income, net
    
    
    82
    
    
    
    71
    
    
    
    11
    
    
    
    15
    %
 Non-cash amortization of deemed discount on convertible debentures for the
quarter ended March 31, 2004 was $131,000, consistent with the quarter ended
March 31, 2003. The convertible debentures were issued in March 2002. Interest income for the quarter ended March 31, 2004 decreased by $79,000
from the quarter ended March 31, 2003. The decrease was primarily due to lower
cash balances during the first quarter of 2004 and interest earned in the first
quarter of 2003 on a financing lease of equipment. Interest expense for the
quarter ended March 31, 2004, which consists primarily of interest on the
convertible debentures, was consistent with the quarter ended March 31, 2003. Other expense for the quarter ended March 31, 2004 decreased $77,000 from
the quarter ended March 31, 2003. The expense in the first quarter of fiscal
year 2003 was primarily due to the other-than-temporary loss of $51,000 and
realized losses of $13,000 related to our investment in the common stock of
Rigel Pharmaceuticals. We liquidated our investment in Rigel common stock in
the second quarter of fiscal year 2003. Rental income, net, for the quarter ended March 31, 2004 increased 15%
from the quarter ended March 31, 2003. Rental income, net, primarily arises
from the lease and sublease of our former headquarters facility in Hayward,
California. Although the current rental income from the sublessee exceeds the
current rental expense on the Hayward facility, there can be no assurance our
sublessee will not default on the sublease agreement, and if they were to do
so, we would still be obligated to pay rent on this property. 16




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Series B Preferred Stock Dividends Preferred Stock dividends of $172,000 and $167,000 for the quarters ended
March 31, 2004 and 2003, respectively, represent the 8% cash dividends paid to
our Series B Preferred Stockholders. These dividends are required to be paid in
cash quarterly. The Series B Preferred Stock was issued in January 2003. Non-cash deemed dividends of $1,301,000 at March 31, 2003 are related to
the beneficial conversion feature in connection with the Series B Preferred
Stock and warrants issued in January 2003. A beneficial conversion feature was
recorded because the effective conversion price of the Series B Preferred Stock
was less than the fair value of our common stock on the commitment date. Net Income (Loss)
Applicable to Common Stockholders For the quarter ended March 31, 2004, we generated net income applicable
to common stockholders of $98,000, or $0.00 net income per share applicable to
common stockholders, as compared to a net loss applicable to common
stockholders of $(3,238,000), or $(0.08) net loss per share applicable to
common stockholders for the quarter ended March 31, 2003. In the first quarter
of fiscal year 2004 dividends on Series B Preferred Stock of $172,000 were
recorded in arriving at the net income applicable to common stockholders. In
the first quarter of fiscal year 2003 dividends on Series B Preferred Stock of
$167,000 and non-cash deemed dividends related to the beneficial conversion
feature of Series B Preferred Stock of $1,301,000 were recorded in arriving at
the net loss applicable to common stockholders. Liquidity and Capital Resources We have funded our activities to date principally through various
issuances of equity securities. Through March 31, 2004, we have raised total
net proceeds of $63.0 million. We have also funded our activities to date to a
lesser extent through product sales. At March 31, 2004, we had cash and cash equivalents of $6,173,000 compared
to $3,220,000 at December 31, 2003. At March 31, 2004, our working capital was
$3,632,000 compared to $4,352,000 at December 31, 2003. The decrease in our
working capital was principally due to the reclassification of $3.5 million of
convertible debentures to current liabilities at March 31, 2004, partially
offset by net proceeds of $2.4 million received in our private placement in
January 2004 and funds provided by operations. The convertible debentures,
with a face value of $4 million, are due in March 2005. Prior to March 31, 2005 we may have to make cash payments totaling $6 million, which include $2 million payable at maturity
on our convertible debenture, and $4 million in contingent payments to Nastech relating to our agreement to acquire rights to the new
Nascobal nasal spray, an improved dosage form of Nascobal. The $4 million total of 8% convertible debentures were issued in March 2002, $2 million to an institutional investor, and
$2 million to a wholly-owned subsidiary of Sigma Tau, Defiante Farmaceutica Unipessoal L.D.A. (Defiante). At
maturity on March 15, 2005, we may redeem the institutional
investors debentures for stock, subject to certain limitations.
We may redeem Defiantes debenture for stock at maturity, provided the market price of our common stock at the time of
redemption is greater than $1.50 per share (representing the five day average closing sale price of our common stock
immediately prior to March 15, 2002). If the price of our common stock is not greater than $1.50 per share on March 15, 2005,
we would expect to pay $2 million in cash to Defiante to redeem the convertible debenture. In connection with our acquisition of Nascobal, we also agreed to
acquire the rights to Nascobal spray, an improved dosage form,
for which there will be two contingent payments to Nastech of $2
million each. Upon approval by the FDA of an NDA filed by
Nastech for Nascobal spray, Nastech is obligated to transfer the NDA
to us, and we are obligated to pay $2 million to Nastech.
Upon subsequent issuance of a patent for the nasal spray, we are obligated to pay an additional $2 million to Nastech.
An NDA was filed by Nastech with the FDA in December 2003. We understand that the FDAs target for review and action on NDA applications
is ten months from the date of submission. Hence the NDA could be approved as early as the fourth quarter of 2004; however, the
final approval may not occur until the first half of fiscal year
2005. The final patent application for Nascobal nasal spray has been filed. We may have substantial cash outlays for the Acthar site transfer. The
site transfer process is not complete and may require substantial cash outlays
for the work performed, capital expenditures and inventory, prior to the
transfer being complete. We incurred approximately $200,000 of expenses during
the quarter ended March 31, 2004 related to the Acthar site transfer, and
expect that expenses in future quarters may exceed this amount. It is currently our customers standard practice to deduct from payments
to us the amount of the sales value of expired product, or returns receivable, that they have requested
for return. The returns receivable amounted to $408,000
at March 31, 2004. Customers have indicated that they will reimburse us for
these deductions upon the replacement of units in accordance with our exchange
policy, however, our experience has been the timing of such reimbursements is
slower than the collection of our normal trade receivables. As of March 31,
2004, replacement units have been shipped, relating to approximately one-third
of amounts owing to us and we are seeking reimbursement from these customers.
As long as our customers standard practice is to deduct amounts related to the
return of expired product, a returns receivable will arise. Should our
customers not comply with our exchange policy, the amounts deducted by them for
returns may not be collectible. In January 2004, we entered into agreements with existing shareholders and
issued 4,878,201 shares of common stock in exchange for $2,399,050 in cash and
the surrender of outstanding warrants to purchase 3,878,201 shares of common
stock. The warrants retired 17




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represented approximately 46% of our warrants outstanding as of December
31, 2003. The warrants surrendered were included as consideration at their
aggregate fair value of $743,000, which was determined using a Black-Scholes
valuation method. The purchase price of the common stock, which was payable in
cash and surrender of outstanding warrants, was $0.644 per share, which was the
volume weighted average price of our common stock for the five trading days
prior to reaching agreement on the terms of the transaction. Sigma
Tau participated in the transaction, purchasing 759,493 shares of common stock for aggregate consideration of
$489,000 in cash and the surrender of 759,493 warrants to purchase common
stock. In January 2003, we completed a private placement of Series B Convertible
Preferred Stock and warrants to purchase common stock to various healthcare
investors. Our gross proceeds from the private placement were $10 million. Net
of issuance costs, our proceeds were $9.4 million. The Series B Preferred Stock
had an aggregate stated value at the time of issuance of $10 million and is entitled to a quarterly
dividend at an initial rate of 8% per year, which rate will increase to 10% per
year on and after January 1, 2006, and to 12% on and after January 1, 2008. The
dividends are paid in cash on a quarterly basis. In addition, on the occurrence
of designated events the dividend rate will increase by an additional 6% per
year. The Series B Preferred Stock is entitled to a liquidation preference over
our common stock and Series A Preferred Stock upon a liquidation, dissolution
or winding up of Questcor. The Series B Preferred Stock is convertible at the
option of the holder into our common stock at a conversion price of $0.9412 per
share, subject to certain anti-dilution adjustments. To date, Series B
Preferred Stock having a stated value of $1,600,000 and accrued and unpaid
dividends of $17,000 has been converted into 1,724,912 shares of common stock.
We have the right commencing on January 1, 2006 (assuming specified conditions
are met) to redeem the Series B Preferred Stock at a price of 110% of stated
value, together with all accrued and unpaid dividends and arrearage interest.
In addition, upon the occurrence of designated Optional Redemption Events, the
holders have the right to require us to redeem the Series B Preferred Stock at
100% of stated value, together with all accrued and unpaid dividends and
accrued interest. The terms of the Series B Preferred Stock contain a variety
of affirmative and restrictive covenants, including limitations on indebtedness
and liens. Each share of Series B Preferred Stock is generally entitled to a
number of votes equal to 0.875 times the number of shares of common stock
issuable upon conversion of such share of Series B Preferred Stock. The
purchasers of the Series B Preferred Stock also received for no additional
consideration warrants exercisable for an aggregate of 3,399,911 shares of our
common stock at an exercise price of $1.0824 per share, subject to certain
anti-dilution adjustments. The warrants expire in January 2007. In June 2003,
the exercise price of the warrants was adjusted to $0.9412 per share. In
January 2004 warrants to purchase 373,990 shares of common stock were
surrendered as consideration, along with cash, for the issuance of 373,990
shares of common stock. Based on our internal forecasts and projections, we believe that our cash
on hand at March 31, 2004, and the net cash flows generated from operations,
will be sufficient to fund operations through at least December 31, 2004,
unless a substantial portion of our cash is used for product acquisition or our
2004 revenues are less than we expect. Our future funding requirements will depend on many factors, including:
the timing and extent of product sales; returns of expired product; the
acquisition and licensing of products, technologies or compounds, if any; our
ability to manage growth; timing of payments to Nastech relating to the nasal
spray formulation of Nascobal; competing technological and market developments;
costs involved in filing, prosecuting, defending and enforcing patent and
intellectual property claims; the receipt of licensing or milestone fees from
current or future collaborative and license agreements, if established; the
timing of regulatory approvals; the timing and successful completion of the
Acthar site transfer; payment of dividends and compliance to prevent additional
dividend events; any expansion or acceleration of our development programs or
optional redemption events, and other factors. If our revenues do not grow and provide cash flow from operations in an
amount sufficient to meet our obligations, or if we do not have sufficient
funds to redeem the convertible debentures, which have a face value of $4
million, for cash, or a combination of cash and stock, upon maturity in March 2005, or if we are unable to maintain
compliance with certain covenants and thus avoid the payment of additional
dividends of 6% to the holders of our Series B Convertible Preferred Stock, or
we do not have sufficient funds to make the contingent payments, if, and when
due to Nastech for the new nasal spray form of Nascobal, or if we have
insufficient funds to acquire additional products or expand our operations, we
will seek to raise additional capital through public or private equity
financing or from other sources. However, traditional asset based debt financing
has not been available on acceptable terms. Additionally, we may seek to
raise additional capital whenever conditions in the financial markets are
favorable, even if we do not have an immediate need for additional cash at that
time. There can be no assurance that we will be able to obtain additional funds
on desirable terms or at all. 18




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our exposure to market risk at March 31, 2004 has not changed materially
from December 31, 2003, and reference is made to the more detailed disclosures
of market risk included in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2003 as filed with the Securities and Exchange Commission on
March 30, 2004. 
 ITEM 4. CONTROLS AND PROCEDURES We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commissions rules and forms and that such
information is accumulated and communicated to our management, including our
Chief Executive Officer and Chief Financial Officer, as appropriate, to allow
for timely decisions regarding required disclosure. In designing and evaluating
the disclosure controls and procedures, management recognizes that any controls
and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management is required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures. As required by SEC Rule 13a(b), we carried out an evaluation, under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures as of the end of
the quarter covered by this report. Based on the foregoing, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and
procedures were effective at the reasonable assurance level. There has been no change in our internal controls over financial reporting
during our most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal controls over financial
reporting. 
 PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS Not applicable 
 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable 
 ITEM 5. OTHER INFORMATION Not applicable 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K  (a)
    
    Exhibits31
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32
    
    Certification pursuant to Section 906 of the Public Company Accounting
Reform and Investor Act of 2002. 19




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(b)
    
    Reports on Form 8-K On January 14, 2004, we reported on Form 8-K, under Item 5, that the
Companys Board of Directors had created the designation of Lead Director and
had appointed Brian C. Cunningham, a current member of the Board, to serve as
Lead Director until the Companys next annual meeting of shareholders. On March 3, 2004, we furnished on Form 8-K, under Item 12, our press
release of our results for the quarter and year ended December 31, 2003. 20




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized. QUESTCOR PHARMACEUTICALS, INC.Date:
May 13, 2004
    
    By:
    
    /s/ CHARLES J. CASAMENTOCharles J. CasamentoChairman, President & CEODate:
May 13, 2004
    
    By:
    
    /s/ TIMOTHY E. MORRISTimothy E. MorrisSenior Vice President, Finance & Administration andChief Financial Officer (Principal Financial andAccounting Officer)
 21




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Exhibit Index  31
    
    Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.  32
    
    Certification pursuant to Section 906 of the Public Company Accounting
Reform and Investor Act of 2002.