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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (MARK ONE) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005 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
(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  þ  No  o Indicate by check mark whether Registrant is an accelerated filer (as defined in Rule
12B-2 of the Act).   Yes  o  No  þ At May 9, 2005 there were 52,676,234 shares of the Registrants common stock, no par
value per share, outstanding.




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QUESTCOR PHARMACEUTICALS, INC. FORM 10-Q TABLE OF CONTENTS PART I. FINANCIAL INFORMATION
    
    
    3Item 1
    
    Financial Statements and Notes (Unaudited)
    
    
    3Condensed Consolidated Balance Sheets  March 31, 2005 and December 31, 2004
    
    
    3Condensed Consolidated Statements of Operations  for the three months ended March 31, 2005 and 2004
    
    
    4Condensed Consolidated Statements of Cash Flows  for the three months ended March 31, 2005 and 2004
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 3
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    20Item 4
    
    Controls and Procedures
    
    
    20PART II. OTHER INFORMATION
    
    
    20Item 1
    
    Legal Proceedings
    
    
    20Item 2
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    20Item 3
    
    Defaults Upon Senior Securities
    
    
    20Item 4
    
    Submission of Matters to a Vote of Security Holders
    
    
    20Item 5
    
    Other Information
    
    
    20Item 6
    
    Exhibits
    
    
    21Signatures
    
    
    
    
    22EXHIBIT 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 31,2005
    
    
    2004(Unaudited)
    
    
    (Note 1)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    8,231
    
    
    $
    8,729Accounts receivable, net of allowances for doubtful accounts of $88 and $40 at
March 31, 2005 and December 31, 2004, respectively
    
    
    2,217
    
    
    
    2,349Inventories
    
    
    1,641
    
    
    
    1,769Prepaid expenses and other current assets
    
    
    882
    
    
    
    839Total current assets
    
    
    12,971
    
    
    
    13,686Property and equipment, net
    
    
    570
    
    
    
    614Purchased technology, net
    
    
    14,504
    
    
    
    12,758Goodwill and other indefinite-lived intangible assets
    
    
    299
    
    
    
    299Deposits and other assets
    
    
    726
    
    
    
    816Total assets
    
    $
    29,070
    
    
    $
    28,173LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    865
    
    
    $
    1,103Accrued compensation
    
    
    956
    
    
    
    974Sales-related reserves
    
    
    2,357
    
    
    
    1,683Other accrued liabilities
    
    
    944
    
    
    
    598Short-term debt and current portion of long-term debt and capital lease obligation
    
    
    548
    
    
    
    349Convertible debentures (face amount of $4,000), net of deemed discount of $103 at
December 31, 2004
    
    
    4,000
    
    
    
    3,897Total current liabilities
    
    
    9,670
    
    
    
    8,604Long-term debt and long-term portion of capital lease obligation
    
    
    1,854
    
    
    
    2,021Other non-current liabilities
    
    
    863
    
    
    
    886Commitments and contingenciesPreferred stock, no par value, 7,500,000 shares authorized; 2,155,715 Series A
shares issued and outstanding at March 31, 2005 and December 31, 2004 (aggregate
liquidation preference of $10,000 at March 31, 2005 and December 31, 2004)
    
    
    5,081
    
    
    
    5,081Shareholders equity:Preferred stock, no par value, 8,400 Series B shares issued and outstanding at
March 31, 2005 and December 31, 2004, net of issuance costs (aggregate
liquidation preference of $8,400 at March 31, 2005 and December 31, 2004)
    
    
    7,578
    
    
    
    7,578Common stock, no par value, 105,000,000 shares authorized; 51,306,984 and
51,216,488 shares issued and outstanding at March 31, 2005 and December 31, 2004,
respectively
    
    
    88,555
    
    
    
    88,436Deferred compensation
    
    
    (9
    )
    
    
    (10
    )Accumulated deficit
    
    
    (84,522
    )
    
    
    (84,423
    )Total shareholders equity
    
    
    11,602
    
    
    
    11,581Total liabilities and shareholders equity
    
    $
    29,070
    
    
    $
    28,173
 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 31,2005
    
    
    2004Revenues:Net product sales
    
    $
    4,498
    
    
    $
    5,148Operating costs and expenses:Cost of product sales
    
    
    748
    
    
    
    856Selling, general and administrative
    
    
    2,618
    
    
    
    3,028Research and development
    
    
    499
    
    
    
    578Depreciation and amortization
    
    
    311
    
    
    
    298Total operating costs and expenses
    
    
    4,176
    
    
    
    4,760Income from operations
    
    
    322
    
    
    
    388Non-cash amortization of deemed discount on convertible debentures
    
    
    (108
    )
    
    
    (131
    )Interest income
    
    
    35
    
    
    
    11Interest expense
    
    
    (139
    )
    
    
    (83
    )Other income, net
    
    
    
    
    
    
    3Rental income, net
    
    
    43
    
    
    
    82Net income
    
    
    153
    
    
    
    270Non-cash deemed dividend related to beneficial conversion feature of Series B
Preferred Stock
    
    
    84
    
    
    
    Dividends on Series B Preferred Stock
    
    
    168
    
    
    
    172Net income (loss) applicable to common shareholders
    
    $
    (99
    )
    
    $
    98Basic and diluted net income (loss) per share applicable to common shareholders
    
    $
    0.00
    
    
    $
    0.00Shares used in computing basic and diluted net income (loss) per share
applicable to common shareholders
    
    
    51,216
    
    
    
    50,032
 See accompanying notes. 4




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QUESTCOR PHARMACEUTICALS, INC. 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
 (UNAUDITED)
 Three Months EndedMarch 31,2005
    
    
    2004OPERATING ACTIVITIESNet income
    
    $
    153
    
    
    $
    270Adjustments to reconcile net income to net cash provided by operating activities:Stock-based compensation expense
    
    
    
    
    
    
    10Amortization of deemed discount on convertible debentures
    
    
    108
    
    
    
    131Amortization of deferred compensation
    
    
    1
    
    
    
    2Depreciation and amortization
    
    
    311
    
    
    
    298Deferred rent expense
    
    
    (23
    )
    
    
    10Changes in operating assets and liabilities:Accounts receivable
    
    
    132
    
    
    
    185Inventories
    
    
    128
    
    
    
    33Prepaid expenses and other current assets
    
    
    (43
    )
    
    
    (67
    )Accounts payable
    
    
    (238
    )
    
    
    54Accrued compensation
    
    
    (18
    )
    
    
    (46
    )Sales-related reserves
    
    
    674
    
    
    
    7Other accrued liabilities
    
    
    178
    
    
    
    (31
    )Net cash flows provided by operating activities
    
    
    1,363
    
    
    
    856INVESTING ACTIVITIESPurchase of property and equipment
    
    
    (14
    )
    
    
    (173
    )Acquisition of purchased technology
    
    
    (2,000
    )
    
    
    Proceeds from sale of property and equipment
    
    
    1
    
    
    
    Decrease in other assets
    
    
    85
    
    
    
    1Net cash flows used in investing activities
    
    
    (1,928
    )
    
    
    (172
    )FINANCING ACTIVITIESIssuance of common stock, net of issuance costs
    
    
    35
    
    
    
    2,409Short-term borrowings
    
    
    191
    
    
    
    211Repayment of short-term and long-term debt
    
    
    (159
    )
    
    
    (183
    )Payment of Series B preferred stock dividends
    
    
    
    
    
    
    (168
    )Net cash flows provided by financing activities
    
    
    67
    
    
    
    2,269Increase (decrease) in cash and cash equivalents
    
    
    (498
    )
    
    
    2,953Cash and cash equivalents at beginning of period
    
    
    8,729
    
    
    
    3,220Cash and cash equivalents at end of period
    
    $
    8,231
    
    
    $
    6,173SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid for interest
    
    $
    58
    
    
    $
    83NON-CASH INVESTING AND FINANCING ACTIVITIES:Deemed dividend related to beneficial conversion feature of Series B preferred stock
    
    $
    84
    
    
    $
    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, 2005 FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION Questcor Pharmaceuticals, Inc. (the Company)
is a specialty pharmaceutical company that currently focuses on developing and commercializing novel
therapeutics for the treatment of neurological disorders. The
Company focuses on the treatment of diseases and disorders of the central nervous system (CNS)
which are served by a limited group of physicians such as neurologists. 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, complement the Companys
therapeutic focus on neurology and can be acquired at a reasonable valuation relative to the
Companys cost of capital. In addition, through corporate collaborations, the Company intends to
develop new medications focused on its target markets. The Company currently markets four products
in the United States: H.P. 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; and
Glofil®-125, an injectable agent that assesses how well the kidney is working by measuring
glomerular filtration rate, or kidney function. The Companys agreement to promote and sell
VSL#3®, a patented probiotic marketed as a dietary supplement to promote normal gastrointestinal
function, expired in January 2005. 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,
2004, as filed on March 31, 2005 with the Securities and Exchange Commission. The accompanying
balance sheet at December 31, 2004 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, 2005. 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 No. 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 No. 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. 6




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The following table illustrates the effect on net income (loss) per share applicable to common
shareholders if the Company had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation (in thousands, except per share amounts): Three months endedMarch 31,2005
    
    
    2004Net income (loss) applicable to common shareholders as reported
    
    $
    (99
    )
    
    $
    98Add: Stock-based employee compensation expense included in reported net income
(loss)
    
    
    1
    
    
    
    5Deduct: Total stock-based employee compensation expense determined under fair
value method for all awards
    
    
    (121
    )
    
    
    (145
    )Net loss applicable to common shareholders, pro forma
    
    $
    (219
    )
    
    $
    (42
    )Basic and diluted net income (loss) per share applicable to common shareholders:As reported
    
    $
    0.00
    
    
    $
    0.00Pro forma
    
    $
    0.00
    
    
    $
    0.00
 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. In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R,
Share-Based Payment, a revision to SFAS No. 123, Accounting for Stock-Based Compensation. SFAS
No. 123R eliminates the Companys ability to use the intrinsic value method of accounting under APB
Opinion 25, Accounting for Stock Issued to Employees, and generally requires a public entity to
reflect on its income statement, instead of pro forma disclosures in its financial footnotes, the
cost of employee services received in exchange for an award of equity instruments based on the
grant-date fair value of the award. The grant-date fair value will be estimated using
option-pricing models adjusted for the unique characteristics of those equity instruments. SFAS No.
123R is effective generally for public companies as of the beginning of the first interim or annual
reporting period that begins after December 15, 2005. SFAS No. 123R applies to all awards granted
after the required effective date, to awards that are unvested as of the effective date, and to
awards modified, repurchased, or cancelled after that date. As of the required effective date, all
public entities that used the fair-value-based method for either recognition or disclosure under
the original SFAS No. 123 will apply this revised statement. Under SFAS No. 123R, the Company must
determine the appropriate fair value model to be used for valuing share-based payments, the
amortization method for compensation cost and the transition method to be used at date of adoption.
The transition methods include modified prospective and modified retrospective adoption options.
Under the modified prospective method, compensation cost is recognized beginning with the effective
date (a) based on the requirements of SFAS No. 123R for all share-based payments granted after the
effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to
employees prior to the effective date of SFAS No. 123R that remain unvested on the effective date.
The modified retrospective method includes the requirements of the modified prospective method
described above, but also permits entities to restate based on the amounts previously recognized
under SFAS No. 123 for purposes of pro forma disclosures, either (a) all prior periods presented or
(b) prior interim periods of the year of adoption. The Company is currently evaluating the
requirements of SFAS No. 123R and will adopt this statement at the effective date. The Company
expects that the adoption of this statement may have a material effect on its financial statements. 3. REVENUE RECOGNITION Revenues from product
sales of Acthar, Nascobal, Ethamolin and Glofil-125 are recognized based
upon shipping terms, net of estimated reserves for government chargebacks, Medicaid rebates,
payment discounts, and returns for credit. Revenue is recognized upon customer receipt of the
shipment, provided the title to the product transfers at the point of receipt by the customer.
If the title to the product transfers at the point of shipment, revenue is recognized upon
shipment of the product. The Company records estimated sales reserves against product revenues for government
chargebacks, Medicaid rebates, payment discounts and product returns for credit memoranda based on
historical chargebacks, rebates, discounts and product returns. The Companys policy of issuing
credit memoranda for expired product, which became effective for product lots released after May
31, 2004, allows customers to return expired product for credit within a six-month period after the
expiration date. Customers who return expired product from production lots released after May 31,
2004 will be issued credit memoranda equal to the sales value of the 7




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product returned, and the estimated amount of such credit memoranda is recorded as a liability
with a corresponding reduction in gross product sales. This reserve will be reduced as future
credit memoranda are issued, with an offset to accounts receivable. The Companys product exchange policy, which applies to product lots released prior to June 1,
2004, allows customers to return expired product for exchange within
a six-month period after the
expiration date. Returns from these product lots 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 inspection prior to
acceptance. The Company records reserves for expected product exchanges and credit memoranda based
upon historical return rates by product, analysis of return merchandise authorizations, returns
received, 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 reserves as appropriate. For Glofil and VSL#3 the Company accepts no returns for expired

product. Reserves for government chargebacks, Medicaid rebates, product exchanges and product returns
for credit memoranda were $2,357,000 and $1,683,000 at March 31, 2005 and December 31, 2004,
respectively, and are classified as Sales-Related Reserves in the Consolidated Balance Sheets. The
reserves at March 31, 2005 include $1,656,000 for estimated product returns for credit memoranda on
product lots of Acthar and Nascobal released and shipped after May 31, 2004. The Company sells product to wholesalers, who in turn sell these products to pharmacies and
hospitals. In the case of VSL#3, the Company sold directly to consumers. The Company does not
require collateral from its customers. 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
$8,231,000 and $8,729,000 at March 31, 2005 and December 31, 2004, respectively. All cash
equivalents are in money market funds and commercial paper. The fair value of the funds
approximated cost. 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 31,2005
    
    
    2004Raw materials
    
    $
    1,254
    
    
    $
    1,239Work in process
    
    
    
    
    
    
    228Finished goods
    
    
    470
    
    
    
    409Less allowance for excess and obsolete inventories
    
    
    (83
    )
    
    
    (107
    )$
    1,641
    
    
    $
    1,769
 6. PURCHASED TECHNOLOGY AND INTANGIBLE ASSETS Goodwill no longer subject to amortization amounted to $299,000 at March 31, 2005 and December
31, 2004. The Company performed an impairment test of goodwill (including assembled workforce)
during the quarter ended December 31, 2004, which resulted in an impairment charge of $180,000
related to the assembled workforce. The Company will continue to monitor the carrying value of the
remaining goodwill through the annual impairment tests or more frequently if indicators of
potential impairment exist. As of March 31, 2005, no indicators of potential impairment existed. Purchased technology at March 31, 2005 includes $14.2 million related to the Nascobal
acquisition and $2.0 million related to the transfer of the New Drug Application (NDA) for the
Nascobal nasal spray from Nastech Pharmaceutical Company Inc. (Nastech). The Nascobal purchased
technology is being amortized over its estimated life of 15 years. Accumulated amortization for the
Nascobal purchased technology is $1,719,000 as of March 31, 2005. As part of the Nascobal acquisition, the Company acquired rights to Nascobal nasal spray, an
improved dosage form, for which an NDA was filed by Nastech with the Food and Drug Administration
(FDA) at the end of 2003. Under the terms of the Agreement, subject to the approval of the NDA
for the new Nascobal nasal spray dosage form by the FDA, the Company was required to make a $2.0
million payment for the transfer of the NDA from Nastech to the Company. In February 2005, the NDA
for Nascobal spray was approved by the FDA, and the Company paid the required $2.0 million to
Nastech. 8




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7. CONVERTIBLE DEBENTURES In March 2002, the Company issued $4.0 million of 8% convertible debentures to SF Capital
Partners Ltd. (SFCP), and Defiante Farmaceutica Lda (Defiante), a wholly-owned subsidiary of
Sigma-Tau Finanziaria SpA (Sigma-Tau), a significant shareholder and affiliate of the Company.
Sigma-Tau beneficially owned approximately 26% of the Companys outstanding common stock as of
March 31, 2005. The Company paid interest on the debentures at a rate of 8% per annum on a
quarterly basis. The debentures were convertible into 2,531,644 shares of the Companys common
stock at a fixed conversion price of $1.58 per share (subject to adjustment for stock splits and
reclassifications). On March 8, 2005, the Company and Defiante entered into an amendment to the Convertible
Debenture issued by the Company in favor of Defiante, extending the maturity date to April 15,
2005. On March 10, 2005, the Company and SFCP entered into an amendment to the Convertible
Debenture issued by the Company in favor of SFCP, extending the maturity date to April 15, 2005 and
amending certain of the terms of the Companys option to repay the SFCP Debenture in shares of
common stock at the maturity date. On April 15, 2005, the Company redeemed both convertible debentures in full in cash totaling
$4.0 million, plus accrued interest to April 15, 2005. 8. SECURED PROMISSORY NOTE In July 2004, the Company issued a $2.2 million secured promissory note to Defiante. The
interest rate on the note is 9.83% per annum. Repayment of the note consists of interest only for
the first twelve months, with monthly principal and interest payments thereafter through August
2008. The note is secured by the Nascobal intellectual property including the NDA for the spray
formulation. The Company purchased the world-wide rights to Nascobal, including the rights to the
spray formulation from Nastech in June 2003. 9. 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,
2005. 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. 10. NET INCOME (LOSS) PER SHARE APPLICABLE TO COMMON SHAREHOLDERS Basic and diluted net income (loss) per share applicable to common shareholders is based on
net income (loss) applicable to common shareholders for the relevant period, divided by the
weighted average number of common shares outstanding during the period. Diluted net income per
share applicable to common shareholders 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 loss per share applicable to common shareholders has not
been presented separately for the period ended March 31, 2005 as, due to the Companys net loss
position, it is anti-dilutive. Had the Company reported net income for the period ended at March
31, 2005, shares used in calculating diluted earnings per share applicable to common shareholders
would have included, if dilutive, the effect of the outstanding options to purchase 6,722,568
common shares, 11,080,492 convertible preferred shares, 2,531,644 common shares issuable upon
conversion of debentures (such debentures have since been redeemed in full), placement unit options
for 127,679 common shares and warrants to purchase 4,539,407 common shares. Diluted net income per
share applicable to common shareholders has not been presented separately for the period ended
March 31, 2004 as basic net income per share is $0.00. 9




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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, resulting in a stated
value of $8.4 million for Series B Convertible Preferred Stock as of March 31, 2005. According to the terms of the private placement agreement, each holder of Series B Convertible
Preferred Stock 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, including the failure to maintain Net Cash, Cash Equivalent and Eligible
Investment Balances, as defined in the Companys Certificate of Determination of Series B Preferred
Stock (the Certificate of Determination), of at least 50% of the aggregate stated value of the
outstanding shares of Series B Preferred Stock, the dividend rate will increase by an additional 6%
per year. 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
$0.9412, as adjusted by agreement dated June 13, 2003, per share, subject to certain anti-dilution
adjustments. The expiration date of the warrants was January 15, 2007. 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. On March 29, 2005, the Company and all of the holders of the outstanding shares of Series B
Preferred Stock of the Company entered into a Series B Preferred Shareholder Agreement and Waiver.
Pursuant to such agreement (i) the holders waived certain rights to receive additional dividends
through March 31, 2006, (ii) the holders, with respect to dividends payable on April 1, 2005, July
1, 2005, October 1, 2005 and January 1, 2006, accepted as full and complete payment of all such
dividend payments the issuance by the Company to them in a private placement of shares of the
Companys common stock having an aggregate value equal to the dividends otherwise payable on those
dates, with the shares of common stock so issued valued at fair market value based upon a ten-day
weighted average trading price formula through March 29, 2005, and (iii) the expiration date of the
warrants to purchase shares of the Companys common stock held by the holders was extended for one
year, until January 15, 2008. As a result of the extension of the warrant expiration date, the Company revalued the warrants
issued to the Series B Preferred Stockholders, resulting in an incremental value of $84,000 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 3.9%; an
expiration date of January 15, 2008; volatility of 59% and a dividend yield of 0%. In connection
with the revaluation, the Company recorded $84,000 related to the beneficial conversion feature on
the Series B Preferred Stock as an additional deemed dividend, which increased the carrying value
of the Series B Preferred Stock. For the three months ended March 31, 2005, the deemed dividend
increased the net loss applicable to common shareholders in the calculation of basic and diluted
net loss per common share. 12. RELATED PARTY TRANSACTIONS In December 2001, the Company entered into a promotion agreement with VSL Pharmaceuticals
Inc., and its successor, Sigma-Tau Pharmaceuticals Inc. (Sigma-Tau Pharmaceuticals), a private
company owned in part by the major shareholders of Sigma-Tau. The promotion agreement expired in
January 2005, in accordance with its terms. Under these agreements, the Company agreed to purchase
VSL#3 from Sigma-Tau Pharmaceuticals at a stated price, and also agreed to promote, sell, warehouse
and distribute the VSL#3 product directly to customers at its cost and expense, subject to certain
expense reimbursements. The Company does not accept returns of VSL#3. VSL#3 revenue for the quarter
ended March 31, 2005 was minimal, as the agreement expired in January 2005, and is included in Net
Product Sales. Included in Accounts Payable is $203,000 for amounts owed to Sigma-Tau
Pharmaceuticals at March 31, 2005. An access fee to Sigma-Tau Pharmaceuticals was calculated
quarterly, which varied based upon sales and costs incurred by the Company subject to reimbursement
under certain circumstances. For the quarter ended March 31, 2005, the amount of the access fee was
$35,000 and is included in selling, general and administrative expense in the accompanying
Condensed Consolidated Statements of Operations. During the three months ended March 31, 2005 and
2004, the Company paid $0 and $240,000, respectively, to Sigma-Tau Pharmaceuticals for the purchase
of VSL#3 product and access fees. Upon the hiring of Reinhard Koenig, MD, PhD, as Vice President, Medical Affairs in February
2004, the Company issued to Dr. Koenig a Promissory Note for $50,000 at an interest rate of prime
plus 1% per annum. The principal and interest was to be forgiven on 10




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February 8, 2005 provided that Dr. Koenig continued as a full-time employee through that date.
In May 2004, Dr. Koenig was appointed an officer of the Company. Dr. Koenig continued as a
full-time employee through the specified date, and the principal and interest were forgiven in
February 2005 in accordance with the terms of the note. For accounting purposes, the loan was
amortized over the one year service period. 13. COMPREHENSIVE INCOME Comprehensive income is comprised of net income and the change in unrealized holding gains and
losses on available-for-sale securities. Three Months EndedMarch 31,2005
    
    
    2004($000s)Net income
    
    $
    153
    
    
    $
    270Change in unrealized gains on available-for-sale securities
    
    
    
    
    
    
    Comprehensive income
    
    $
    153
    
    
    $
    270
 14. SUBSEQUENT EVENTS On April 1, 2005, the Company issued 1,344,000 shares of common stock in a private placement
to holders of its Series B Preferred Stock. The shares were issued in lieu of the quarterly cash
dividends payable on April 1, 2005, July 1, 2005, October 1, 2005 and January 1, 2006, and had an
aggregate value equal to the dividends otherwise payable on those dates, with the shares of common
stock so issued valued at fair market value based upon a ten-day weighted average trading price
formula through March 29, 2005 (See Note 11  Series B Convertible Preferred Stock). On April 15, 2005 the Company redeemed in cash $4.0 million of 8% convertible debentures held
by SF Capital Partners Ltd. and Defiante (See Note 7  Convertible Debentures). 11




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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, 2004, 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 currently focuses on
developing and commercializing novel therapeutics
for the treatment of neurological disorders. We focus on the treatment of diseases and disorders
of the central nervous system (CNS) which are served by a limited group of physicians such as
neurologists. 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,
complement our therapeutic focus on neurology and can be acquired at a reasonable valuation
relative to our cost of capital. We currently market four products in the United States:  
    H.P. 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; and
    Glofil®-125, an injectable agent that assesses how well the kidney is working by
measuring glomerular filtration rate, or kidney function. In January 2005, our agreement to promote and sell VSL#3 expired in accordance with its terms.
The product will be promoted in the future by Sigma-Tau Pharmaceuticals, Inc. Our strategy, which we announced in April 2005, is to focus on developing and commercializing
products that treat CNS diseases and disorders. As part of this strategy, we are initially focusing
our promotional efforts on Acthar. We also intend to pursue the licensing and acquisition of
products that are consistent with our focus on neurology. In addition, we intend to develop new
products that have the potential to address significant unmet medical needs in the CNS field, using
both our own intellectual property and intellectual property licensed from other companies. Consistent with our prior focus on sales and marketing, our spending on research and
development activities to date is modest. Expenses incurred for the Acthar manufacturing site
transfer and medical and regulatory affairs are classified as Research and Development Expenses in
the accompanying unaudited Condensed Consolidated Statements of Operations. We expect our research
and development spending to increase in the future as we implement our new strategy. 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 a development agreement with Rigel Pharmaceuticals, Inc. of South San
Francisco, California for our antiviral drug discovery program, and a development agreement with
Dainippon Pharmaceuticals Co., Ltd. of Osaka, Japan for our antibacterial program. 12




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We have incurred an accumulated deficit of $84.5 million at March 31, 2005. At March 31, 2005,
we had $8.2 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, demand for
our products by patients and consumers, inventory levels of our products at wholesalers, timing of
expiration of our products and the resulting shipment of replacement product under our product
exchange policy, future credit memoranda to be issued under our credit memoranda policy, the
availability of finished goods from our sole-source manufacturers, the timing of certain expenses,
the acquisition of marketed products, and the establishment of strategic alliances and corporate
partnering arrangements. 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 sales reserves, product returns, bad debts, inventories 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 Reserves We have estimated reserves for product returns from wholesalers, hospitals 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 reserves by utilizing
historical information for existing products and data obtained from external sources. For new
products, we estimate our reserves for product returns, government chargebacks and rebates on
specific terms for product returns, chargebacks and rebates, and our experience with similar
products. We have a product exchange policy, effective for product lots released prior to June 1, 2004,
in which we will ship replacement product for expired product returned to us within six months
after expiration. 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 the remaining shelf life of that inventory (ranging from 18 months to 3
years for all products except Glofil, which is not subject to our product return policy), and (iii)
changes in demand measured by prescriptions or other data 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 product
exchange policy, and we adjust our reserves as appropriate. During the second quarter of 2004 we implemented a transition plan for expired product returns
from the product exchange policy to a credit memoranda policy for the return of expired product
within six months after the expiration date. Expired product returned from lots released after May
31, 2004 is subject to a credit memoranda policy in which a credit memoranda will be issued for the
original purchase price of the returned product. A reserve for the sales value of estimated
returns on shipments of Acthar and Nascobal product lots released and shipped after May 31, 2004
has been recorded as a liability in the amount of $1,656,000 as of March 31, 2005 with a
corresponding reduction in gross product sales. This reserve reflects an estimate of future credit
memoranda to be issued for Acthar and Nascobal, applied to the quantity of product shipped from
lots subject to the credit memoranda policy. The reserve will be reduced as future credit memoranda
are issued, with an offset to accounts receivable. In estimating the return rate for expired
product subject to credit memoranda, we analyze (i) historical returns and sales patterns, (ii)
current inventory on hand at wholesalers and the remaining shelf life of that inventory, and (iii)
changes in demand measured by prescriptions and other data as provided by an independent third
party source and our internal estimates. A new lot of Ethamolin is not expected to be released
until late 2005, at which time a reserve for credit memoranda will be estimated and recorded as a
reduction of gross product sales based upon the quantity of product shipped. This will reduce the
future amount recorded as net product sales. 13




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A transition period will extend through 2006 between the existing product exchange policy,
applicable to product lots released prior to June 1, 2004, and the new credit memoranda policy,
applicable to product lots released after May 31, 2004. Return periods (six months after
expiration) for product lots released prior to June 1, 2004 end as follows: Acthar, June 2005;
Nascobal, May 2006; Ethamolin, October 2006. The credit memoranda policy commenced with the actual
release of product lots of Acthar in June 2004 and Nascobal in July 2004, and will apply to the
actual release of an Ethamolin lot currently planned for mid-2005. Planned releases of products are
subject to change. Reserves for the estimated credit memoranda applicable to future returns related
to sales from these product lots will be recorded as shipments occur, and will reduce gross product
sales. Until the transition from our product exchange policy to a credit memoranda policy for
expired product is complete in 2006, both the product exchange policy and the credit memoranda
policy will be in effect at the same time, which will result in lower revenues than historically
experienced due to the additional impact of displacement of future sales from the product exchange
policy and reduction of gross product sales for the reserves under the credit memoranda policy. If we were to issue credit memoranda for all returns currently subject to the product exchange
policy, the reserves for credit memoranda would be significantly increased, with an offset to gross
product sales at the time of the policy change. The reserve 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. If such a policy change occurred, the negative
impact on our revenues, operations and cash position would be substantial in the near term.
Further, if such a policy change were made, the currently recorded reserve for product exchanges
would be eliminated resulting in a reduction of cost of product sales. Certain customers have deducted the full price of expired product which they planned to return
from the amounts owed to us (returns receivable). We reached an agreement with our three largest
wholesalers to accept replacement product and pay the amounts previously deducted in return for an
administration fee, however it remains their standard practice to deduct from payments to us the
sales value of expired product that they have requested authorization to return. As of March 31,
2005, our returns receivable is $759,000, primarily due to return materials authorization requests
for expired product from Acthar lots that expired in January and December 2004, and Ethamolin lots
that expired in January and February 2005. Wholesalers have indicated that they will reimburse us
for these deductions upon the replacement of expired units in accordance with our product exchange
policy; however, in our experience the timing of such reimbursements is slower than the collection
of our normal trade receivables. As of March 31, 2005, replacement units have been shipped with
respect to approximately 18% of the amounts owing to us and we are seeking reimbursement from these
wholesalers. As long as the wholesalers standard practice is to deduct amounts related to the
return of expired product, a returns receivable will arise. Should the wholesalers not comply with
our product exchange policy, the amounts deducted by them for returns may not be collectible, and
we would need to increase our allowance for bad debts. 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 estimated rebate reserve for the period. In particular, we consider
allowable prices by Medicaid. In estimating government chargeback reserves, we analyze actual
chargeback amounts by product and apply historical chargeback rates to sales to which chargebacks
apply. We routinely assess our experience with Medicaid rebates and government chargebacks and
adjust the reserves accordingly. For qualified customers, we grant payment terms of 2%, net 30 days. Allowances for cash
discounts are estimated based upon 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 the wholesalers fail to adhere to our product exchange or credit
memoranda policy, additional reserves may be required. To date, actual amounts have been consistent
with our estimates. Inventories We maintain inventory reserves primarily for excess and obsolete inventory (due to the
expiration of shelf life of a product). In estimating inventory excess and 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 excess and obsolete
inventory. 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. 14




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We intend to control inventory levels of our products purchased by our customers. Customer
inventories will be compared to both internal and external databases to determine adequate
inventory levels. We will monitor our product shipments to customers and compare these shipments
against prescription demand for our individual products. Intangible Assets We have intangible assets related to purchased technology and goodwill. The determination of
related estimated useful lives and whether or not these assets are impaired involves significant
judgment. Changes in strategy 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. As
of March 31, 2005, no impairment has been indicated. Results of Operations Three months ended March 31, 2005 compared to the three months ended March 31, 2004: Total Revenues Three Months EndedMarch 31,
    
    
    
    
    
    
    %2005
    
    
    2004
    
    
    (Decrease)
    
    
    Change(in $000s)Net product sales
    
    $
    4,498
    
    
    $
    5,148
    
    
    $
    (650
    )
    
    
    (13
    )%
 Total revenues for the quarter ended March 31, 2005, which consisted of net product sales
only, decreased $650,000 or 13% from the quarter ended March 31, 2004. The decrease in total net
product sales is primarily the result of reserves recorded under our credit memoranda policy
initiated in the second quarter of 2004 and reserves for Medicaid rebates. Gross product sales were
slightly higher in the quarter ended March 31, 2005 in comparison to the quarter ended March 31,
2004. During the quarter ended March 31, 2005, net product sales of Acthar and Nascobal were
reduced by $603,000 for reserves for credit memoranda under the credit memoranda policy for
returns. Net product sales of Acthar, which represented the largest percentage of our total net
product sales for the quarter ended March 31, 2005, increased significantly as compared to the same
period in 2004. The increase in Acthar net product sales was due to both increased unit sales and
a price increase of 9.5% that went into effect January 3, 2005. The increase in Acthar net sales
was offset by a decrease in Nascobal net product sales, as compared to the first quarter of 2004.
The decrease in Nascobal sales was primarily a result of a reduction during the quarter of
inventories held by our wholesaler customers, and partly a result of lower demand as compared to
the same period in 2004. Net product sales of Ethamolin and Glofil were comparable to first quarter
of 2004 net product sales. VSL#3 net product sales were minimal in the first quarter of 2005, as
our promotion agreement with Sigma-Tau Pharmaceuticals expired in January 2005. First quarter 2005
net product sales do not include approximately $550,000 in orders for Acthar, Nascobal and
Ethamolin which were received in March 2005 and shipped in early April 2005. We have
adopted a practice of periodically evaluating wholesaler inventory balances, and postponing
shipments, in order to minimize product returns, among other reasons. The revenue from these
orders, net of applicable sales reserves, will be included in the second quarter of 2005 net
product sales. Our product exchange policy for expired product remains in effect for lots released prior to
June 1, 2004. Pursuant to our product exchange policy, during the quarter ended March 31, 2005, we
replaced vials of Acthar at no cost for certain returned product from Acthar batches that expired
in January and December 2004, having a gross sales value of approximately $215,000, and Ethamolin
that expired in December 2004, and January and February 2005, having a gross sales value of
approximately $39,000, calculated using the unit prices in effect at March 31, 2005. Subsequent to
March 31, 2005, we will continue to replace Acthar and Ethamolin returned from these expired lots.
The replacement of product subsequent to March 31, 2005 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 as it is subject to market conditions and customer behavior not within
our control. The costs related to replacement products are reserved for and are included as a
component of Cost of Product Sales. Under our product exchange policy, as of March 31, 2005,
customers have requested the replacement of expired Acthar and Ethamolin with a gross sales value
of approximately $1,524,000 which we have not yet replaced. We intend to replace this expired
product in the second and third quarter of 2005. These replacements will likely displace future
sales. 15




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We review the amount of inventory at the wholesale level in order to help assess the demand
for Acthar, Ethamolin and Nascobal. We may choose to defer sales in situations where we believe
inventory levels are already adequate. We expect quarterly fluctuations in the net sales of all of
our products due to the timing of shipments, changes in wholesaler inventory levels, expiration
dates of products sold, the timing of replacement units shipped under our product exchange policy,
the impact of reserves provided for under our credit memoranda policy and the reallocation of
promotional efforts for each product. Cost of Product Sales Cost of product sales for the quarter ended March 31, 2005 decreased $108,000, or 13%, to
$748,000 from $856,000 for the quarter ended March 31, 2004. Cost of product sales includes
material cost, packaging, warehousing and distribution, product liability insurance, royalties,
quality control, quality assurance and write-offs of excess or obsolete inventory. The decrease in
cost of product sales is primarily due to decreases in direct materials costs, the mix of products
sold, and lower obsolescence expense resulting from decreases to the obsolescence allowance
recorded in the first quarter of 2005. The decreases were partially offset by an increase in the
return allowances, increases in royalties on Acthar and higher distribution expense resulting from
fees for distribution services. During the second quarter of 2004, one of our largest wholesalers
began charging a fee for distribution services provided to us. Another major wholesaler implemented
a similar fee for distribution services in the fourth quarter of 2004. Cost of product sales as a
percentage of net product sales was 17% for the quarter ended March 31, 2005 which was consistent
with the quarter ended March 31, 2004. We expect per unit material costs for Acthar to increase in
the future due to higher contract manufacturing and laboratory costs, which we anticipate could
decrease our gross margin on Acthar. Selling, General and Administrative Three Months EndedMarch 31,
    
    
    Increase/
    
    
    %2005
    
    
    2004
    
    
    (Decrease)
    
    
    Change(in $000s)Selling, general
and administrative
expense
    
    $
    2,618
    
    
    $
    3,028
    
    
    $
    (410
    )
    
    
    (14
    )%Percentage of
total revenue
    
    
    58
    %
    
    
    59
    %
 Selling, general and administrative expenses for the quarter ended March 31, 2005 decreased
$410,000 from the quarter ended March 31, 2004, primarily due to decreased spending on sales and
marketing, including market research and marketing programs, and lower salaries and related
expenses resulting from executive personnel changes. The decreases were partially offset by
severance expenses associated with the resignation of our former Vice President of Sales and
Marketing and the realignment of the sales force in 2005. Selling, general and
administrative expenses were 58% of revenue for the quarter ended March 31, 2005, which was
consistent with the quarter ended March 31, 2004. Research and Development Research and development expenses for the quarter ended March 31, 2005 were $499,000, a
decrease of $79,000 as compared to $578,000 for the quarter ended March 31, 2004. The costs
included in research and development relate primarily to our manufacturing site transfers and
medical and regulatory affairs compliance activities. The decrease as compared to the same period
in 2004 was due primarily to decreased Acthar site transfer costs, offset by increased regulatory
fees and patent-related legal fees. Research and development expenses for the quarter ended March 31, 2005 include approximately
$6,000 related to the manufacturing site transfer of Acthar, as compared to approximately $181,000
for the quarter ended March 31, 2004. These amounts include costs associated with the Acthar bulk
manufacturing site transfer and the transfer of the potency assay to a new contract laboratory. In
2003, we transferred the Acthar final fill and packaging process to our contract manufacturer,
Chesapeake Biological Laboratories Inc. (CBL), and produced our first lot of Acthar finished
vials. In 2004, we transferred the Acthar API manufacturing process to our contract manufacturer,
BioVectra dcl (BioVectra), and produced the first BioVectra API lot. We also selected a new
contract laboratory to perform three bioassays associated with the release of API and finished
vials. Two of these bioassays have been successfully transferred to the contract laboratory, and we
are awaiting FDA approval of these two transfers. We have experienced delays and cost overruns in
the validation of the third assay, potency. In 2004, we conducted additional studies aimed at
identifying critical differences in the way the potency assay is performed at the contract
laboratory as compared with the previous laboratory. Some differences were identified and
corrected, however results were still not acceptable. Work on this assay transfer is planned to
restart by mid-2005. In the remainder of fiscal year 2005, the costs which we plan to incur related
to the API manufacturing site transfer and the bioassay transfers are expected to be less than the
costs incurred in 2004. 16




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Depreciation and Amortization Depreciation and amortization expense for the quarter ended March 31, 2005 increased to
$311,000 from $298,000 for the quarter ended March 31, 2004. This increase was due primarily to the
payment of $2.0 million to Nastech in February of 2005 upon the approval of the NDA for Nascobal
nasal spray. The Nascobal purchased technology is being amortized over 15 years. Other Income and Expense Items Three Months EndedMarch 31,
    
    
    Increase/
    
    
    %2005
    
    
    2004
    
    
    (Decrease)
    
    
    Change(in $000s)Non-cash
amortization of
deemed discount on
convertible
debentures
    
    $
    (108
    )
    
    $
    (131
    )
    
    $
    (23
    )
    
    
    (18
    )%Interest income
    
    
    35
    
    
    
    11
    
    
    
    24
    
    
    
    218
    %Interest expense
    
    
    (139
    )
    
    
    (83
    )
    
    
    56
    
    
    
    67
    %Other income
    
    
    
    
    
    
    3
    
    
    
    (3
    )
    
    
    (100
    )%Rental income, net
    
    
    43
    
    
    
    82
    
    
    
    (39
    )
    
    
    (48
    )%
 Non-cash amortization of deemed discount on convertible debentures for the quarter ended March
31, 2005 decreased by $23,000 from the quarter ended March 31, 2004. The decrease was due to the
deemed discount being fully amortized as of March 15, 2005 when the convertible debentures were
scheduled to mature. The convertible debentures were issued in March 2002. In March 2005, the
maturity date of the convertible debentures was extended to April 15, 2005, on which date we
redeemed such convertible debentures in full in cash. Interest income for the quarter ended March 31, 2005 increased by $24,000 from the quarter
ended March 31, 2004. The increase was primarily due to higher cash balances during the first
quarter of 2005. Interest expense for the quarter ended March 31, 2005 increased by $56,000 from
the quarter ended March 31, 2004. Interest expense consists primarily of interest on our
convertible debentures and on the $2.2 million promissory note we issued to a wholly-owned
subsidiary of Sigma-Tau, Defiante Farmaceutica Lda (Defiante) in July 2004. The increase in the
first quarter of 2005 was primarily due to interest on the $2.2 million promissory note. Rental income, net, for the quarter ended March 31, 2005 decreased by $39,000 from the quarter
ended March 31, 2004. Rental income, net, arises primarily 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 through November 2012. Series B Preferred Stock Dividends Preferred Stock dividends of $168,000 and $172,000 for the quarters ended March 31, 2005 and
2004, respectively, represent the 8% dividends paid quarterly to our Series B Preferred
Stockholders. The dividend for the quarters ended March 31, 2005 and March 31, 2004 were paid in
common stock and cash, respectively. In March 2005, we reached agreement with all of the holders
of the outstanding shares of our Series B Preferred Stock to accept a private placement of shares
of our common stock having an aggregate value equal to the dividends payable on April 1, 2005, July
1, 2005, October 1, 2005 and January 1, 2006. Liquidity and Capital Resources We have funded our activities to date principally through various issuances of equity
securities and debt. Through March 31, 2005, we have raised total net proceeds of $63.2 million. We
have also funded our activities to date to a lesser extent through product sales. At March 31, 2005, we had cash and cash equivalents of $8,231,000 compared to $8,729,000 at
December 31, 2004. At March 31, 2005, our working capital was $3,301,000 compared to $5,082,000 at
December 31, 2004. The decrease in our working capital was principally due to the $2 million
payment made to Nastech upon approval of the NDA for the Nascobal spray in February 2005. 17




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As of March 31, 2005, we had 8% convertible debentures with a face value of $4 million
outstanding, $2 million issued to Defiante, and $2 million issued to SF Capital Partners Ltd.
(SFCP), an institutional investor. Under the original terms of the debentures, we could redeem
SFCPs debenture at maturity for stock, subject to certain limitations, and we could redeem
Defiantes debenture for stock at maturity, provided the market price of our common stock at the
time of redemption was 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
was not greater than $1.50 per share on March 15, 2005, we would
have been required to pay $2 million in
cash to Defiante to redeem the convertible debenture. The original maturity date of the debentures was March 15, 2005. On March 8, 2005, we entered
into an amendment to the debenture with Defiante, extending the maturity date to April 15, 2005.
On March 10, 2005, we entered into an amendment to the debenture with SFCP, extending the maturity
date to April 15, 2005 and amending certain of the terms of our option to repay the SFCP debenture
in shares of common stock at the maturity date. On April 15, 2005, we redeemed both convertible
debentures in cash totaling $4 million, plus accrued interest. In connection with our acquisition of Nascobal, we also agreed to acquire the rights to
Nascobal nasal spray, an alternative dosage form of Vitamin B-12, for which there are two
contingent payments to Nastech of $2 million each. In February 2005, upon approval by the FDA of an
NDA filed by Nastech in December 2003 for Nascobal nasal spray, Nastech was obligated to transfer
the NDA to us, and we were obligated to pay $2 million to Nastech. We made the $2 million payment
to Nastech in February 2005. Upon subsequent issuance of a United States patent including claims
for a nasal spray that treats any indication in the approved NDA, we are obligated to pay an
additional $2 million to Nastech. The United States patent applications for the Nascobal nasal
spray have been filed by Nastech. In July 2004, we issued a $2.2 million secured promissory note to Defiante. The note is secured by the Nascobal intellectual
property including the NDA for the spray formulation. The note, bearing interest at 9.83% per
annum, requires interest only payments for the first twelve months, with monthly principal and
interest payments thereafter through August 2008. It is currently our customers standard practice to deduct from payments to us the amount of
the purchase price of expired product, or returns receivable, that they have requested to return.
The returns receivable amounted to $759,000 at March 31, 2005. Customers have indicated that they
will reimburse us for these deductions upon the replacement of units in accordance with our product
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, 2005, replacement units have been
shipped relating to approximately 18% 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 product exchange policy, the amounts deducted by them for returns may not be collectible. In August 2004, Mr. Charles J. Casamento resigned as Chairman, President and CEO of the
Company. Under the separation agreement entered into by us and Mr. Casamento, and consistent with
certain terms of his employment agreement, we (i) will continue to pay Mr. Casamento his regular
monthly base salary of $38,208 for 18 months, (ii) paid the prorated portion of his 2004 annual
bonus potential in the amount of $136,294 in August 2004, and (iii) extended the exercise period
for 18 months of 129,251 stock options with an exercise price of $1.25 per share. All other stock
options held by Mr. Casamento expired on November 3, 2004. Although certain payments are being paid
on a monthly basis over the 18 months, Mr. Casamento will not be performing further services for
us, other than part-time consulting services, if requested by the Company. In June 2004, we implemented a transition plan for expired product returns from a product
exchange policy to a credit memoranda policy. Under the credit memoranda policy, a credit
memorandum will be issued for the original purchase price of the returned product, for expired
product returned from lots released after May 31, 2004. We expect that cash flow will be negatively
impacted when future credit memoranda are issued for expired product returned from lots subject to
our credit memoranda policy. 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. 18




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On March 29, 2005, we entered into a Series B Preferred Shareholder Agreement and Waiver with
all of the holders of the outstanding shares of our Series B Preferred Stock. Pursuant to such
agreement (i) the holders waived certain rights to receive additional dividends through March 31,
2006, (ii) the holders, with respect to dividends payable on April 1, 2005, July 1, 2005, October
1, 2005 and January 1, 2006, accepted as full and complete payment of all such dividend payments
the issuance by us to them in a private placement of shares of our common stock having an aggregate
value equal to the dividends otherwise payable on those dates, with the shares of common stock so
issued valued at fair market value based upon a ten-day weighted average trading price formula
through March 29, 2005, and (iii) the expiration date of the warrants to purchase shares of our
common stock held by the holders were extended for one year, until January 15, 2008. Accordingly,
on April 1, 2005, we issued 1,344,000 shares of common stock in a private placement to holders of
our Series B Convertible Preferred Stock. 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 $1.6 million 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 its stated value ($8.4 million at
March 31, 2005), 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. In June 2003, the exercise price of the warrants was adjusted to $0.9412
per share. In March 2005, the expiration date of the warrants was extended from January 2007 to
January 2008. 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,
2005, and the net cash flows generated from operations will be sufficient to fund operations
through at least March 31, 2006, unless a substantial portion of our cash is used for product
acquisition or our revenues are significantly 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; the repositioning of our product portfolio; our ability to
manage growth; timing of the payment to Nastech relating to the patent approvals for 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 provide cash flows from operations in an amount sufficient to meet our
obligations, or if we are unable to maintain compliance with certain covenants when applicable 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 payment, if, and when
due to Nastech for the patent approvals of 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. 19




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our exposure to market risk at March 31, 2005 has not changed materially from December 31,
2004, 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, 2004 as filed with the Securities and
Exchange Commission on March 31, 2005. 
 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 Principal Accounting 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-15(b), we carried out an evaluation, under the supervision and
with the participation of our management, including our Chief Executive Officer and Principal
Accounting 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 Principal Accounting 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. UNREGISTERED SALES OF EQUITY 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 20




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Not applicable 
 ITEM 6. EXHIBITS Exhibit No.
    
    Description31
    
    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.
   *
    These certifications are being furnished solely to accompany this quarterly report pursuant
to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the
Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of
Questcor Pharmaceuticals, Inc., whether made before or after the date hereof, regardless of
any general incorporation language in such filing.   21




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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 16, 2005
    By:
    /s/ JAMES L. FARESJames L. FaresPresident and Chief Executive Officer By:
    /s/ BARBARA J. MCKEEBarbara J. McKeePrincipal Accounting Officer  22




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Exhibit Index Exhibit No.
    
    Description31
    
    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.
   *
    These certifications are being furnished solely to accompany this quarterly report pursuant
to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the
Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of
Questcor Pharmaceuticals, Inc., whether made before or after the date hereof, regardless of
any general incorporation language in such filing.