<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
COMMISSION FILE NUMBER 0-20045
------------------------
WATSON PHARMACEUTICALS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
------------------------
<TABLE>
<S> <C>
NEVADA 95-3872914
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
311 BONNIE CIRCLE
CORONA, CA 91720
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
(909) 270-1400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.0033 PAR VALUE
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 period 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
AGGREGATE MARKET VALUE, AS OF MARCH 15, 1996, OF COMMON STOCK HELD BY
NON-AFFILIATES OF THE REGISTRANT: $1,333,452,334 BASED ON THE LAST REPORTED SALE
PRICE ON THE NASDAQ NATIONAL MARKET SYSTEM.
NUMBER OF SHARES OF COMMON STOCK OUTSTANDING ON MARCH 15, 1996: 36,607,903
DOCUMENTS INCORPORATED BY REFERENCE
The registrant filed a definitive Proxy Statement pursuant to Regulation
14A within 120 days of the end of the fiscal year ended December 31, 1995.
Portions of such Proxy Statement are incorporated by reference in Part III of
this report.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
PART I
ITEM 1. BUSINESS
OVERVIEW
Watson Pharmaceuticals, Inc. (the "Company"), incorporated in 1985, is
engaged in the manufacture and sale of off-patent medications and the
development of advanced drug delivery systems primarily designed to enhance the
therapeutic benefits of pharmaceutical compounds. The Company's objective is to
become a fully integrated pharmaceutical company which (i) develops and markets
off-patent pharmaceuticals and (ii) develops proprietary and off-patent products
and markets such products worldwide through pharmaceutical companies, joint
ventures and its own marketing efforts. To achieve this objective, the Company
is pursuing a balanced strategy of generating revenue through its established
off-patent pharmaceutical business and capitalizing on its proven research and
development, manufacturing and regulatory capabilities to support the
development of advanced proprietary products. The Company also regularly reviews
potential opportunities to acquire or invest in technologies, products or
product rights and businesses compatible with its existing business.
Since inception, the Company has derived substantially all of its revenues
from the sale of off-patent pharmaceutical products. The Company currently
manufactures and markets 80 dosage strengths representing 30 pharmaceutical
products under 86 approved Abbreviated New Drug Applications ("ANDAs"). During
1995, the Company received five ANDA approvals representing three pharmaceutical
products which it markets. In the period from January 1, 1996 through March 15,
1996, the Company received one ANDA approval representing one pharmaceutical
product, marketed in three dosage strengths. As of March 15, 1996, the Company
had six ANDAs representing six drugs pending before the FDA and has several
drugs under development. The Company intends to continue to develop off-patent
pharmaceutical products based upon market potential, competition, target
indications and other considerations. The number of products under development
may vary from time to time depending on these factors. The Company also seeks to
develop difficult-to-duplicate formulations of both off-patent drugs and
products which employ its drug delivery systems.
In July 1995, a wholly-owned subsidiary of the Company merged with Circa
Pharmaceuticals, Inc. ("Circa") in a transaction accounted for as a
pooling-of-interests. Accordingly, the Company's financial statements have been
retroactively restated to include the results of Circa for all periods
presented. In addition, disclosures throughout this Form 10-K regarding the
Company refer to the combined operations of both Watson Pharmaceuticals, Inc.
and Circa. Circa, founded in 1960, develops and manufactures off-patent and
proprietary drugs, develops alternative drug-delivery systems and distributes
pharmaceutical products. The merger strengthened and diversified the Company's
revenue base, enhanced its manufacturing capabilities and increased its product
development program, particularly in the area of proprietary products. Following
the merger, Dr. Melvin Sharoky, the president of Circa, became president of the
Company. Dr. Allen Chao, who had been president, became chief executive officer
of the Company.
Circa had historically been engaged in the development, manufacture and
marketing of solid dosage generic pharmaceuticals, including prescription and
over-the-counter ("OTC") products. In February 1990, as a result of an
investigation by the United States Food & Drug Administration ("FDA"), Circa
ceased manufacturing and marketing all pharmaceutical products and was
restricted by the FDA from obtaining scientific review of its applications. In
April 1993, following the completion of a comprehensive three year
rehabilitation program, the FDA notified Circa that all regulatory restrictions
were lifted and that it was in compliance with "current Good Manufacturing
Practices" ("cGMP"). As a result, Circa was once again able to operate under the
standard framework of the FDA. In November 1994, Circa received its first
product approval from the FDA since 1989.
<PAGE> 3
PARTNERSHIP AND JOINT VENTURE ACTIVITIES
In 1989, the Company and Rhone-Poulenc Rorer, Inc. ("RPR") formed a
partnership (the "Partnership") to develop and market Dilacor XR(R), a
pharmaceutical product used in the treatment of hypertension. Dilacor XR(R) was
launched by the Partnership in 1992. At December 31, 1993, a liability was due
to the Partnership of $15.2 million for the Company's share of development and
operating costs. The Partnership agreement was amended in April 1993, such that
after September 1, 1993 the Company earns a royalty from sales of the branded
product, Dilacor XR(R). The amended agreement also provided that all royalties
earned will be used first to offset the Partnership liability. The royalty rate
established for this agreement was 1% in 1994, 20% in 1995 and 1996, 22% from
1997 to 2000 and 3% thereafter. The Partnership liability was repaid during
1995. Royalties earned in excess of the Partnership liability will be remitted
to the Company on a quarterly basis. In a subsequent amendment, effective
January 1, 1995, it was agreed that royalty income would be determined by
prescriptions written, as defined, for Dilacor XR(R).
In the year ended December 31, 1993, the Company recognized a loss of $7.6
million from the Partnership. For the years ended December 31, 1995 and 1994,
the Company earned royalties of $22.2 million and $1.2 million, respectively and
recorded a royalty receivable of $8.2 million at December 31, 1995. Dilacor
XR(R) lost exclusivity in May 1995. The Partnership may develop a generic
version of Dilacor XR(R), to be launched as considered appropriate. Any costs
and profits from the sale of the generic product are to be shared equally by the
partners.
The Company has made substantial investments in pharmaceutical joint
ventures and plans to continue this method of investment in the future. The
Company owns a 50% interest in the outstanding common stock of Somerset
Pharmaceuticals, Inc. ("Somerset"). Somerset manufactures and markets the
product Eldepryl(R), which is used in the treatment of Parkinson's Disease. The
Company recognized equity in the earnings of Somerset of $24.8 million, $25.1
million and $23.8 million for the years ended December 31, 1995, 1994 and 1993,
respectively. Management expects 1996 earnings from Somerset to be somewhat
lower due to increased research and development spending in support of Phase III
clinical trials on a transdermal Eldepryl(R) patch.
In October 1995, the Company increased its investment in Andrx Corporation
("Andrx"), a privately-held corporation involved in the development of
controlled-release drug delivery systems. This $15.6 million investment
increased the Company's total ownership to 19.5% of the Andrx common stock
outstanding. In connection with the increased investment, the Company and Andrx
amended their joint venture agreement and made the parties equal partners in the
ANCIRC joint venture. ANCIRC, formed in July 1994, is conducting research and
development activities in the area of controlled-release technology. In the
future, the Company expects certain controlled-release products to emerge from
ANCIRC that, subject to FDA approval, will contribute to the Company's long-term
growth.
In March 1996, Watson's wholly-owned subsidiary, Watson Pharmaceuticals
(Asia) Ltd. ("Watson (Asia)") entered into an agreement to form two joint
ventures with China-based Changzhou No. 4 Pharmaceutical Factory ("Changzhou").
The first joint venture, Changzhou Watson Pharmaceuticals Co. Ltd. ("Joint
Venture A") will establish a manufacturing facility in China for the production,
marketing and sales of pharmaceuticals and related products. A second joint
venture will be known as Changzhou Siyao Pharmaceuticals Co. Ltd. ("Joint
Venture B"). Joint Venture B will provide the raw materials to Joint Venture A.
Total investment by Watson (Asia) in Joint Ventures A and B will be
approximately $9 million. Joint Venture A will be 87.5% owned by Watson (Asia)
and 12.5% owned by Changzhou, and Joint Venture B will be owned 25% by Watson
(Asia) and 75% by Changzhou. A manufacturing facility for Joint Venture A is
expected to be built and operational by mid-to-late 1997. Management anticipates
revenues from Joint Venture A will begin during 1997, as the Company plans to
export certain products to be sold in China through Joint Venture A.
A portion of the Company's net income is derived from joint ventures and a
royalty arrangement. In addition, efforts in developing controlled-release
technology is also primarily conducted through joint ventures. These
arrangements involve various partners, and the Company does not have control of
the joint ventures or the commercial exploitation of the licensed products.
Further, there can be no assurances that such joint ventures will be profitable.
In certain of these arrangements, products developed by the Company may be
2
<PAGE> 4
competitive with products developed by such joint ventures. Management does not
believe that a competitive situation such as this would have a material adverse
effect on the Company.
RESEARCH RELATED ACTIVITIES
In 1991, the Company expanded its work on the development of advanced drug
delivery systems with the acquisition of Zetachron, Inc., ("Zetachron"), a
research and development organization. Research in the advanced drug delivery
area continues, although these activities have not generated significant
revenues for the Company to date. The drug delivery systems under development
employ various routes of administration, including oral and vaginal. These
systems potentially could control and improve the absorption of selected drugs
in the bloodstream, improve dose reliability, reduce side effects and increase
patient convenience and compliance. Management believes that a significant
market exists for drug delivery systems that will enhance and simplify the
therapeutic benefits to the patient. The Company is developing certain
proprietary drug products that utilize its drug delivery systems, each of which,
if and when developed, will require FDA approval of a New Drug Application
("NDA") prior to marketing. Based on data gathered during clinical studies,
during 1995 the Company focused its efforts on two products that utilize its
proprietary drug delivery systems. These two products were selected from an
original group of seven products under consideration for development. The
Company continues to devote significant resources to the research and
development of off-patent and proprietary products. The Company anticipates that
1996 research and development expenditures will be at approximately the same
level as in 1995.
The Company has progressed in its efforts to develop a gum-delivery
technology and has been working on a number of pharmaceutical products in this
area, including OTC and prescription products. In 1994, an application was filed
with the FDA for a generic version of Nicorette(R), a nicotine gum product
developed and marketed by Smith Kline Beecham ("SKB"). In February 1996, SKB's
Nicorette(R) was approved by the FDA as an OTC product. Exclusivity of
Nicorette(R) has yet to be determined by the FDA. The Company will be pursuing
registration of the generic version of this product in other countries over the
next several years. In addition, three OTC products using gum-delivery
technology are under evaluation. The Company is also considering strategic
partners to help promote this product line. In December 1994, the Company filed
an application to obtain a patent for a process that describes a dissolvable
chewable dosage form, Quick Dissolve Chewables (QDC(TM)). The Company intends to
employ this technology for the delivery of both prescription and OTC products.
In 1993, the Company acquired the rights to manufacture and market a
product under a NDA for a widely-used cardiovascular agent. In November 1994,
the Company filed a NDA seeking approval for this product, which it believes
will fill a need for clinicians working in the cardiovascular field. If
approved, this product is expected to receive three years of exclusivity.
PRODUCT DEVELOPMENT STRATEGY
The Company intends to pursue a balanced strategy of developing off-patent
and proprietary products and off-patent products using various drug delivery
technologies. Over the next few years, patents on a relatively large number of
branded drugs will expire, thereby providing additional off-patent product
opportunities. The Company is developing a wide variety of off-patent products,
including those with small but specialized or growing markets as well as
products whose brand name equivalents have U.S. sales of over $100 million.
The Company is developing proprietary products through a combination of
internal and collaborative programs, including joint ventures. The Company may
internally develop certain proprietary products through all stages of
development, including final manufacturing and commercialization. In addition,
the Company may choose to acquire developed products for marketing and
distribution purposes. The Company may also choose to enter into collaborative
or licensing agreements with various parties at various stages of product
development. If the Company determines to market or distribute proprietary
products on its own, it will have to significantly expand its sales and
marketing capabilities.
OFF-PATENT PHARMACEUTICALS. The Company has invested significantly in
off-patent product development and is developing a wide variety of products,
including therapeutic equivalents of solid, liquid and
3
<PAGE> 5
sustained release products as well as off-patent products employing its
proprietary delivery systems. Each product is chosen based on the patent
expiration date, market size and potential, anticipated competition,
availability of active ingredients and other considerations. The Company seeks
to be among the first companies to offer such products. The Company has also
focused its development efforts on technically difficult-to-duplicate products
or products that require advanced manufacturing technology, and the Company
believes that such products will experience limited competition. Of the 80
dosage strengths currently marketed by the Company, it received the first ANDA
approval for 34 products. As of March 15, 1996, the Company believed it held the
only ANDA approval for 16 of these products.
DRUG DELIVERY SYSTEMS. The Company has established a comprehensive program
for the evaluation of its drug delivery systems with specific application to i)
controlled-release products and ii) injection molding technology in the area of
progesterone vaginal insert and estradiol vaginal insert products.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company cautions readers that the following important factors may
affect the Company's actual results and could cause such results to differ
materially from forward-looking statements made by or on behalf of the Company.
Such factors include, but are not limited to, changing market conditions, the
availability and cost of raw materials, the impact of competitive products and
pricing, the timely development, FDA approval and market acceptance of the
Company's products and other risks detailed herein and from time to time in the
Company's Securities and Exchange Commission filings.
OFF-PATENT PHARMACEUTICAL PRODUCTS
MARKETS
The Company markets a broad range of off-patent prescription drugs. Sales
of off-patent drugs have increased significantly in recent years. The Company
believes that this growth is attributable to a number of factors, including (i)
modification of certain state laws to permit or mandate substitution of
off-patent drugs by pharmacists, (ii) the enactment of abbreviated procedures
for obtaining FDA approval to manufacture off-patent prescription drugs, (iii)
changes in government and third-party payor healthcare reimbursement policies to
encourage cost containment by health care providers and consumers, (iv)
increased acceptance of off-patent drugs by physicians, pharmacists and
consumers, and (v) the increasing number of formerly patented drugs which have
become available to off-patent competition.
PRODUCTS
The following table lists the off-patent products for which the Company
holds approved ANDAs:
<TABLE>
<CAPTION>
NUMBER OF
DOSAGE
PRODUCT NAME(1) STRENGTHS THERAPEUTIC CATEGORY BRAND NAME
----------------------------- --------- -------------------- ----------------------
<S> <C> <C> <C>
CENTRAL NERVOUS SYSTEM
Amoxapine.................. 4 Anti-depressant Asendin(R)
Clorazepate Dipotassium.... 3 Anti-anxiety Tranxene(R)
Lorazepam.................. 3 Anti-anxiety Ativan(R)
Loxapine Succinate......... 4 Anti-psychotic Loxitane(R)
Maprotiline
Hydrochloride........... 3 Anti-depressant Ludiomil(R)
Carbidopa-Levodopa......... 3 Anti-Parkinsons Sinemet(R)
CARDIOVASCULAR
Acebutolol Hydrochloride... 2 Anti-hypertensive Sectral(R)
Furosemide................. 3 Anti-hypertensive Lasix(R)
Gemfibrozil................ 1 Anti-cholesterol Lopid(R)
Guanabenz Acetate.......... 2 Anti-hypertensive Wytensin(R)
Guanfacine Hydrochloride... 2 Anti-hypertensive Tenex(R)
</TABLE>
4
<PAGE> 6
<TABLE>
<CAPTION>
NUMBER OF
DOSAGE
PRODUCT NAME(1) STRENGTHS THERAPEUTIC CATEGORY BRAND NAME
----------------------------- --------- -------------------- ----------------------
<S> <C> <C> <C>
Methyldopa &
Hydrochlorothiazide..... 4 Anti-hypertensive Aldoril(R)
Metoprolol Tartrate........ 2 Anti-hypertensive Lopressor(R)
Propranolol
Hydrochloride........... 6 Anti-hypertensive Inderal(R)
Triamterene &
Hydrochlorothiazide..... 2 Anti-hypertensive Maxzide(R)
Maxzide 25(R)
Verapamil Hydrochloride.... 3 Anti-hypertensive Calan(R)
Isoptin(R)
ORAL CONTRACEPTIVE
Ethynodiol Diacetate &
Ethinyl Estradiol....... 2 Oral contraceptive Demulen(R)
Norethindrone & Ethinyl
Estradiol............... 3 Oral contraceptive Modicon(R)
Brevicon(R)
Ortho-Novum(R)
Norinyl(R)
Norethindrone &
Mestranol............... 1 Oral contraceptive Ortho-Novum(R)
Norinyl(R)
ANALGESIA
Butalbital, Aspirin,
Caffeine and Codeine
Phosphate............... 1 Analgesic Fiorinal(R) with
Codeine
Fenoprofen Calcium......... 3 Anti-inflammatory Nalfon(R)
Hydrocodone Bitartrate &
Acetaminophen........... 6 Analgesic Vicodin(R)
Lortab(R)
Indomethacin............... 2 Anti-inflammatory Indocin(R)
HORMONE/HORMONE REGULATOR
Estradiol.................. 3 Hormone replacement Estrace(R)
Estropipate................ 4 Hormone replacement Ogen(R)
OTHER
Albuterol Sulfate.......... 3 Asthma Proventil(R)
Ventolin(R)
Cyclobenzaprine
Hydrochloride........... 1 Muscle spasm relief Flexeril(R)
Glipizide.................. 2 Anti-diabetic Glucotrol(R)
Metoclopramide
Hydrochloride........... 1 Pro-motility Reglan(R)
Loperamide Hydrochloride... 1 Anti-diarrheal Imodium(R) A-D
</TABLE>
- ---------------
(1) The Company has not launched four of the products for which it holds
approved ANDAs. The Company intends to market and ship certain of these
products when it receives clearance under FDA pre-shipment validation
procedures.
MARKETING AND DISTRIBUTION
The Company markets its off-patent products to drug distributors,
pharmaceutical wholesalers, chain drug stores, hospitals, health maintenance
organizations and other drug companies. A majority of the Company's products are
sold under private labels. The Company also sells its products under the "Watson
Laboratories" brand name and intends to increase the percentage of products sold
under such brand name in the future. During 1995, five products in the
hydrocodone bitartrate/acetaminophen product group sold by the
5
<PAGE> 7
Company accounted for approximately 44% of the Company's total revenues. In
1994, three products in this product group accounted for approximately 52% of
the Company's total revenues. For the same period, the loxapine succinate
product group accounted for approximately 11% of total revenues. In 1993,
loxapine succinate and the three products in the hydrocodone
bitartrate/acetaminophen product groups accounted for approximately 15% and 51%,
respectively, of the Company's total revenues. Due to FDA approval of products
that will compete with the Company's hydrocodone products group, management
anticipates increased price competition with respect to the hydrocodone group
and consequently the Company may experience a reduction in future sales of such
products.
Royalty income from the Partnership with RPR represents a material
percentage of the Company's revenues. Royalties are based on the prescriptions
written, as defined, for the product Dilacor XR(R), which lost exclusivity in
May 1995. The Company's equity in the earnings of Somerset were generated from
the sale of one product, Eldepryl(R). Exclusivity on Eldepryl(R) expires in June
1996. Somerset is developing an Eldepryl(R) transdermal patch and is currently
in Phase III clinical trials on this product. In addition, Somerset is also
committed to the development of other pharmaceutical products. The loss of
exclusivity with respect to these products and/or the introduction by other
companies of additional competitive products, could have a material adverse
effect on the financial condition of the Company.
The Company ships products pursuant to purchase orders and does not have
any supply agreements with its customers. The Company's business does not
experience any significant seasonal variation. No single customer accounted for
more than 10% of the Company's total 1995 product sales revenues.
DRUG DELIVERY SYSTEMS AND DEVELOPMENTAL PRODUCTS
The Company has developed a variety of proprietary polymer-based drug
delivery systems for oral and vaginal routes of administration. The Company
believes that its delivery systems offer distinct advantages over conventional
methods of delivery for selected drugs by improving release kinetics, dose
reliability, side effect profile or patient convenience and compliance.
Moreover, the development of a new product combining an approved drug and a
proprietary drug delivery system generally involves less cost, time, and risk
than discovering and commercializing a new chemical entity. Finally, developing
a new delivery system for a drug product can (i) expand the existing market for
an existing indication for the drug, (ii) differentiate the product from
off-patent and branded competition, and (iii) create a new market through a new
indication.
The Company's drug delivery systems use its proprietary injection molding
process which produces consistent product quality across a wide range of dosage
forms. This injection molding technique relies upon the use of patented
FDA-approved thermoplastic polymers and FDA-approved hydrophobic amphiphiles
which, when mixed with appropriate drugs, permit defined adjustment of release
rates.
The Company is developing certain products utilizing its proprietary drug
delivery systems. The following table summarizes the status of the Company's
product development programs. These product development activities have not
generated significant revenues for the Company, and there can be no assurance
that any proprietary product, if and when fully developed, would contribute
materially to the Company's revenues in the future.
<TABLE>
<CAPTION>
POTENTIAL
DRUG/DOSAGE FORM THERAPEUTIC USE STATUS(1)
- --------------------- -------------------- -------------
<S> <C> <C>
Progesterone/Vaginal Hormone Replacement Phase II/III
Estradiol/Vaginal Hormone Replacement Phase II/III
</TABLE>
- ---------------
(1) The notations, Phase II and III, are used to describe the progress of
clinical studies. See "Business -- Regulation."
OTHER ACTIVITIES
In 1995, the Company entered into a strategic alliance with Creighton
Products Corporation ("Creighton"), a division of Sandoz Pharmaceuticals, Inc.
This co-marketing agreement is expected to
6
<PAGE> 8
expand the Company's distribution channels by providing Creighton with certain
of the Company's off-patent pharmaceutical products for distribution into
Creighton's managed care channels. Creighton will also provide the Company with
products for distribution into the Company's wholesaler and distributor
channels.
SUBSIDIARIES
The Company's wholly-owned subsidiaries include Watson Laboratories, Inc.
("Watson Labs"), Watson (Asia), Corona Pharmaceuticals, Inc. (currently
inactive) and Circa. In 1995, the Company developed a plan to merge its
wholly-owned subsidiary, Zetachron, into Watson Labs. As of December 31, 1995,
all Zetachron assets were either merged into Watson Labs or disposed of for an
immaterial loss.
PATENTS AND PROPRIETARY RIGHTS
The Company believes that protection of its patents, proprietary products,
technologies, processes and know-how is important to its business. The Company
maintains an active patent program to protect its technologies. To date, 15
United States patents have been issued: five covering compositions of matter for
the oral delivery systems (which patents expire in 2003), five covering aspects
of the Company's buccal systems (which expire between 2005 and 2010), two
covering aspects of mucosal tissue drug delivery (which expire in 2007 and
2008), one covering the Company's microencapsulation composition used in its
sustained release oral potassium chloride product (expiring in 2006), one
covering a chlorhexidine compound (expiring in 2007) and one covering cutaneous
therapeutic devices (expiring in 2009). The Company maintains an aggressive
patent program, has three additional United States patents pending and has
several patent applications at different stages of development. Recent changes
to the patent law resulting from passage of the Uruguay Round Agreements Act
("URAA") will lengthen the term of some granted patents. Generally, patents have
terms that are the longer of 17 years from patent grant or 20 years from patent
application. The Company also seeks patent protection in major foreign
pharmaceutical markets, and has numerous foreign patents and patents pending.
There can be no assurance that the Company's patents or those of its competitors
would be held valid by a court of competent jurisdiction. Any litigation or
proceedings with respect to patents or proprietary rights could result in
substantial cost to the Company.
The Company does not know whether any of its developing applications will
result in the issuance of any patents or whether any issued patents will provide
proprietary protection or be circumvented or invalidated. The Company may be
required or may desire to obtain licenses from others to develop, manufacture
and market commercially viable products. There can be no assurance that such
licenses will be obtainable on commercially reasonable terms or that any
licensed patents or proprietary rights will be valid and enforceable.
The Company also relies upon unpatented trade secrets, and no assurance can
be given that others will not independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to the Company's
trade secrets or disclose such technology, or that the Company can meaningfully
protect its right to unpatented trade secrets. It is Company policy to require
its key employees, consultants and other advisors to execute confidentiality
agreements. There can be no assurance, however, that these agreements will
provide meaningful protection or adequate remedies for the Company's trade
secrets in the event of unauthorized use or disclosure of such information.
REGULATION
The research and development, manufacture and marketing of the Company's
products and systems are subject to regulation by the FDA in the United States
and by comparable authorities in other countries. These national authorities and
other federal, state and local entities regulate, among other things, research
and development activities and the testing, manufacture, labeling, storage,
record keeping, advertising and promotion of the Company's products.
The Federal Food, Drug and Cosmetic Act, the Public Health Service Act, the
Controlled Substance Act and other federal statutes and regulations govern or
influence all aspects of the Company's business. Noncompliance with applicable
requirements can result in fines and other judicially imposed sanctions,
including product seizures, injunction actions and criminal prosecutions. In
addition, administrative remedies
7
<PAGE> 9
can involve the forced voluntary recall of products as well as the refusal of
the government to approve pending applications or supplements to approved
applications. The FDA also has the authority to withdraw approval of drugs in
accordance with statutory due process procedures, and has significant additional
authority under the Generic Drug Enforcement Act of 1992, which is discussed
below.
FDA approval is required before any dosage form of any new drug, including
an off-patent equivalent of a previously approved drug, can be marketed. All
applications for FDA approval must contain information relating to product
formulation, stability, manufacturing processes, packaging, labeling and quality
control. To obtain FDA approval for a new drug not previously approved by the
FDA, a prospective manufacturer must also provide substantial evidence of safety
and efficacy of the drug product. Finally, the manufacturer must establish that
the methods, facilities, and controls used in connection with the production,
processing, packaging, and storage of the drug meet FDA requirements embodied in
FDA regulations and guidelines generally referred to as the current good
manufacturing practice ("cGMP") requirements. Compliance with cGMP is required
at all times during the manufacture and processing of drugs. Such compliance
requires considerable Company time and resources in the areas of production and
quality control.
There are generally two types of applications for FDA approval that would
be applicable to the Company's products:
NEW DRUG APPLICATION ("NDA"). Generally, with respect to drugs with active
ingredients and/or with a dosage form, dosage strength or delivery system of an
active ingredient not previously approved by the FDA, a prospective manufacturer
must submit to the FDA complete reports of preclinical, clinical and laboratory
studies performed to establish that the drug will be safe and effective for its
intended uses. Substantially all of the Company's products employing its
proprietary delivery systems are expected to require approval under the NDA
procedures.
The FDA approval process for a previously approved drug having a novel
dosage form or drug delivery system may involve the completion of preclinical
studies. Preclinical studies involve laboratory evaluation of product
characteristics and animal studies to assess the safety and potential efficacy
of the product, and proof that the product delivers sufficient quantities of the
drug to the bloodstream to produce the desired therapeutic result. The results
of these studies are submitted to the FDA as part of an Investigational New Drug
Application ("IND"). The IND requests authorization to initiate studies of the
new drug in humans based on the demonstrated safety and potential efficacy of
the compound in the preclinical studies. Once the IND becomes effective, human
clinical trials may commence.
ABBREVIATED NEW DRUG APPLICATION ("ANDA"). The Drug Price Competition and
Patent Term Restoration Act of 1984 (the "1984 Amendments") established a
statutory procedure for submission of ANDAs to the FDA. Under the ANDA
procedure, the FDA waives the requirement of submitting complete reports of
preclinical and clinical studies of safety and efficacy and instead requires
bioavailability data illustrating that the off-patent drug formulation is
bioequivalent to a previously approved drug. Bioavailability measures the rate
and extent of absorption of a drug's active ingredient and its availability at
the site of drug action, typically measured through blood levels. An off-patent
drug is bioequivalent to the previously approved drug if the rate and extent of
absorption of the off-patent drug are not significantly different from that of
the previously approved drug. All of the Company's off-patent drug products,
except for certain products employing its proprietary drug delivery systems, are
subject to the ANDA approval procedures.
The 1984 Amendments protect certain drugs approved under NDA procedures
from immediate competition from ANDA-approved drugs. First, the effective date
of approval of an ANDA-approved drug will ordinarily be delayed until the
expiration of patents, if any, covering the NDA-approved drug, or, in the event
of a challenge to the validity or infringement of an existing patent, until a
court has determined the patent to be invalid or not infringed by the
ANDA-approved drug. Second, under the 1984 Amendments, existing product or use
patents on NDA-approved drugs may be extended for up to five years to compensate
the patent holder for the reduction of the effective patented marketing life of
the drug due to the federal regulatory review period. Finally, with respect to
NDA-approved drugs not covered by existing patents, the FDA awards periods of
three or five years exclusivity, depending on the nature of the NDA-approved
drug and the type of data submitted in the NDA. During a three-year exclusivity
period, the FDA will accept for
8
<PAGE> 10
evaluation an ANDA that refers to the NDA-approved drug as a basis for approval,
but the FDA will not make effective any approval of such an ANDA before
expiration of the three-year period of exclusivity granted to the NDA-approved
drug. During a five-year exclusivity period, the FDA will not accept for
evaluation an ANDA that refers to such an NDA-approved drug as a basis for
approval before expiration of the five-year period of market exclusivity.
Because FDA review preceding ANDA approval ordinarily requires from one year to
two years, the five-year exclusivity period effectively grants the NDA-approved
drug marketing exclusivity for a period of six or more years.
Human clinical trials are typically conducted in three sequential phases,
but the phases may overlap. Phase I trials consist of testing the product in a
small number of patients, primarily for safety, at one or more dosages. In Phase
II, in addition to safety, the efficacy of the product is evaluated in a patient
population somewhat larger than Phase I trials. Phase III trials typically
involve additional testing for safety and clinical efficacy and an expanded
population at geographically dispersed test sites. A clinical plan, or
"protocol," accompanied by the approval of the institution participating in the
trials, must be submitted to the FDA prior to the commencement of each clinical
trial. All patients involved in the clinical trials must provide informed
consent prior to their participation. The FDA may order the temporary or
permanent discontinuation of a clinical trial at any time. The results of the
clinical trials are submitted to the FDA as part of the NDA to establish the
safety and effectiveness of the drug for its intended indications.
The FDA may not approve an NDA or ANDA if applicable regulatory criteria,
including compliance with cGMP, are not satisfied. The FDA may require
additional clinical testing or other types of testing, or manufacturing or
quality control changes. Even if such data are submitted or such changes are
made, the FDA may ultimately decide that the NDA or ANDA does not satisfy the
criteria for approval. Following approval of an NDA or ANDA, the FDA expects the
applicant to conduct extensive in-process and finished product testing on
consecutive batches made in the initial manufacturing campaign to validate the
reliability of all critical processes during full-scale commercial production.
This is commonly referred to in the industry as the pre-shipment validation
process. Only after all processes have been shown through test data to produce
consistent results within quality specifications will the FDA authorize
commercial distribution. Accordingly, following the approval of an ANDA, several
weeks or months ordinarily are required to complete testing and the FDA
pre-shipment validation process. Product approvals may be withdrawn by the FDA
if compliance with regulatory standards is not maintained or if new evidence
demonstrating that the drug is unsafe or lacks efficacy for its intended uses
becomes known after the product reaches the market. The FDA may require testing
and surveillance programs to monitor the effect of proprietary drug delivery
systems which have been commercialized, and has the power to prevent or limit
further marketing of the product based on the results of these post-marketing
programs.
In recent years, the FDA's approval process of ANDA off-patent products has
become more rigorous, time consuming and costly, and the Company cannot predict
the extent to which it may be affected by legislative and regulatory
developments concerning its products, operations or the healthcare field
generally. The URAA, which became effective June 8, 1994, lengthens the term of
existing and future patents by changing the patent term from 17 years, based on
the date of patent grant, to 20 years, based on the date of patent application.
These URAA changes could postpone approval eligibility of some ANDAs. Regulatory
compliance issues or regulatory changes affecting the Company's operations or
the approval or shipment of products could have a material adverse effect upon
the Company's business.
Each domestic drug product manufacturing establishment must be registered
with, and achieve a satisfactory inspection from, the FDA. Drug product
manufacturing establishments located in California and New York also must be
licensed by each of these states. Establishments handling controlled substances
must be licensed by the United States Drug Enforcement Administration ("DEA").
Domestic manufacturing establishments are routinely subject to inspection by the
FDA prior to the approval of an NDA or ANDA and to biennial inspections by the
FDA for cGMP compliance after an NDA or ANDA has been approved. The Prescription
Drug User Fee Act of 1992, enacted to expedite drug approval by providing the
FDA with resources to hire additional medical reviewers, imposes three kinds of
user fees on manufacturers of NDA-approved prescription drugs. Applicants
submitting only ANDAs and most other off-patent drug manufacturers, including
the Company, are not currently subject to any of the three user fees. If the
Company
9
<PAGE> 11
submits NDAs for products employing its proprietary drug delivery systems, the
Company will be subject to user fees.
The Generic Drug Enforcement Act of 1992 establishes penalties for
wrongdoing in connection with the development or submission of an ANDA by
authorizing the FDA to permanently or temporarily debar companies or individuals
from submitting or assisting in the submission of an ANDA, and to temporarily
deny approval and suspend applications to market off-patent drugs. The FDA must
debar companies or individuals convicted of a federal felony for conduct
relating to the development or approval of an ANDA, and may debar persons
convicted of other misconduct. In addition to debarment, the FDA may refuse to
approve an ANDA (for up to 18 months) if the applicant is under active federal
criminal investigation for (i) bribery or (ii) making material false statements
in connection with any ANDA, and if a significant question has been raised
regarding the integrity of the approval process or the reliability of the data
in the ANDA. The FDA may also suspend the distribution of all drugs approved or
developed in connection with certain wrongful conduct. The FDA also has
authority to withdraw approval of an ANDA under certain circumstances and seek
civil penalties. The FDA can also significantly delay the approval of any
pending NDA or ANDA under the "Fraud, Untrue Statements of Material Facts,
Bribery, and Illegal Gratuities Policy."
The methods of reimbursement and fixing of reimbursement levels under
Medicare, Medicaid and other reimbursement programs are under active review by
federal, state and local government entities as well as by private third-party
reimbursers. In addition, Medicaid legislation requires that all pharmaceutical
manufacturers rebate to individual states a percentage of their revenues arising
from Medicaid-reimbursed drug sales. The required rebate for off-patent drug
manufacturers is currently 11%. In addition, political pressure to contain
health care costs at the federal and state levels is increasing.
Political, economic and regulatory influences are subjecting the health
care industry in the United States to fundamental change. The Clinton
Administration previously proposed comprehensive programs to reform the health
care system and has expressed its commitment to increase access to health care
for the presently uninsured, control the continued escalation of health care
expenditures and use health care reimbursement policy to help control the
federal deficit. All potential approaches are under consideration, including
mandated basic health care benefits, controls on health care spending through
limitation on the growth of private health insurance premiums and Medicare and
Medicaid spending, price discounts from drug manufacturers and the creation of
large insurance purchasing groups. In addition, some of the states in which the
Company operates are considering various health care reform proposals. The
Company anticipates that Congress and state legislatures will continue to review
and assess alternative health care delivery systems and payment methodologies
and public debate of these issues will continue in the future. Due to
uncertainties regarding the ultimate features of reform initiatives and their
enactment and implementation, the Company cannot predict which, if any, of such
reform proposals will be adopted, when they may be adopted or what impact they
may have on the Company.
Sales of pharmaceutical products outside the United States are subject to
regulatory requirements governing human clinical trials, post-approval
inspection and marketing approval for drugs and drug delivery systems. These
requirements vary widely from country to country. The Company is also subject to
regulation under federal, state and local regulations regarding work place
safety, environmental protection and hazardous substance controls, among others.
The Company believes that it is in substantial compliance with all such laws.
With respect to any product currently being developed by the Company or its
subsidiaries internally or with joint venture partners, or any product for which
an NDA, ANDA, IND or patent application has been filed, there can be no
assurance that such applications will be approved, or if approved, that any such
product will contribute materially to the Company's future operating results.
SUPPLIERS AND MATERIALS
The principal components used in the Company's business are active and
inactive pharmaceutical ingredients and certain packaging materials. Some of
these components are available only from sole source suppliers. In addition,
sources for materials for the Company's products must be approved by the FDA,
and in
10
<PAGE> 12
many instances only one source has been approved for certain materials in the
Company's products. Development and approval of the Company's pharmaceuticals
are dependent upon the Company's ability to procure active ingredients and
certain packaging materials from FDA-approved sources. The FDA approval of a new
supplier would be required if, for example, active ingredients or such packaging
materials were no longer available from the initially approved supplier. The
qualification of a new supplier would delay the manufacture of the drug
involved. Arrangements with foreign suppliers are subject to certain additional
risks, including the availability of governmental clearances, export duties,
political instability, currency fluctuations and restrictions on the transfer of
funds.
Although to date no significant difficulty has been encountered in
obtaining materials required for products and sources of supply are considered
adequate, there can be no assurance that the Company will continue to be able to
obtain materials as required.
COMPETITION
The Company competes with off-patent drug manufacturers, brand-name
pharmaceutical companies that manufacture or market off-patent drugs, the
original manufacturers of brand-name drugs that continue to produce such drugs
after patent expirations or introduce generic versions of their branded
products, and manufacturers of new drugs that may compete with the Company's
off-patent drugs. The Company's proprietary drug delivery systems will compete
with products developed by numerous pharmaceutical and biotechnology companies.
Many competitors have been in business for a longer period of time than the
Company, have a greater number of products on the market and have greater
financial and other resources.
The principal competitive factors in the off-patent pharmaceutical market
are the ability to be among the first to introduce products after a patent
expires, price, quality, methods of distribution, reputation, customer service
(including maintenance of inventories for timely delivery) and breadth of
product line. Approvals for new products may have a synergistic effect on a
company's entire product line since orders for new products are frequently
accompanied by, or bring about, orders for other products available from such
company. The Company believes that price is a significant competitive factor,
particularly as the number of off-patent manufacturers which produce a
particular product increases. As competition from other manufacturers
intensifies, selling prices typically decline. The Company pursues the
development of products which occupy market niches and should therefore be less
subject to competitive price erosion.
Products utilizing the Company's proprietary drug delivery systems are
expected to compete with other products for specified indications, including
drugs marketed in conventional and alternative dosage forms. New drugs or
further developments in alternative drug delivery methods may provide greater
therapeutic benefits for a specific drug or indication, or may offer comparable
performance at lower cost than those offered by the Company's drug delivery
systems. The Company expects proprietary products approved for sale to compete
primarily on the basis of product efficacy, safety, patient convenience,
reliability, availability, price and patent position. There can be no assurance
that product introductions or developments by others will not render the
Company's products or technologies noncompetitive or obsolete.
PERSONNEL
As of December 31, 1995, the Company had 554 full-time employees, including
14 employees who hold Ph.D.s or M.D.s. Of the Company's employees, 83 are
engaged in research and development (including 10 with Ph.D.s), 268 in
manufacturing, 143 in quality assurance and quality control (including 2 with
Ph.D.s) and 60 in administration, marketing, finance and human resources
(including 1 Ph.D. and 1 M.D.). No employee is represented by a union, and the
Company has never experienced a work stoppage.
ITEM 2. PROPERTIES
The Company's manufacturing facilities and quality control laboratories
(excluding oral contraceptives) are located in an approximately 165,000 square
foot building located at 132 Business Center Drive in Corona, California. The
production and packaging of oral contraceptives and certain other products are
located in a 30,000 square foot building at 100 Business Center Drive in Corona,
California, which is leased by the
11
<PAGE> 13
Company pursuant to long-term leases from an entity controlled by affiliates of
the Company. The Company leases from an independent lessor approximately 26,000
square feet for a warehouse facility in a third building at 341 Bonnie Circle,
Corona, California. The Company also owns an approximately 100,000 square foot
building at 311 Bonnie Circle, Corona, California which is used as the Company's
research and development facility, a warehouse/distribution facility and as its
principal executive offices. The Company's manufacturing facilities comply with
cGMP standards. The Company has received licenses from the California Department
of Health and Human Services and the DEA for the manufacture of drug products.
The Company leases, from an affiliate, a research and development facility
in an 11,000 square foot building in State College, Pennsylvania. In November,
1995, the Company sold an adjacent 8,650 square foot research and development
facility.
The Company also owns manufacturing, warehouse and office facilities
occupying approximately 162,000 square feet in Copiague, New York. The Company
has a 60% interest in a company that owns a 26,000 square foot
microencapsulation facility which is located outside of Dayton, Ohio.
The Company maintains current permits and licenses with various regulatory
bodies for the operation of these facilities.
ITEM 3. LEGAL PROCEEDINGS
SETTLED LITIGATION
In March 1995, six purported class actions, Robbins v. Circa
Pharmaceuticals, Inc. et al., Zimmerman v. Circa Pharmaceuticals, Inc. et al.,
Ballas v. Melvin Sharoky, et al., Schrank v. Circa Pharmaceuticals, Inc. et al.,
Artel Foam Corp. Pension Trust v. Circa Pharmaceuticals, Inc., et al., and Pivan
v. Circa Pharmaceuticals, Inc., et al. were commenced in the Supreme Court of
the State of New York, in the Counties of Suffolk, Suffolk, King, Suffolk,
Suffolk and Suffolk, respectively. Each of the complaints alleged, among other
things, that actions of the individual defendants in connection with the Merger
Agreement between Watson and Circa constituted a breach of their fiduciary
duties, and the Robbins, Zimmerman and Schrank complaints alleged that Watson
aided and abetted the individual defendants in those alleged breaches. In
December 1995 and January 1996, all plaintiffs voluntarily dismissed all actions
against all defendants without prejudice. All of such actions were dismissed
with no payment of any kind made by the Company to the plaintiffs.
PENDING LITIGATION
In January 1995, Circa received a Complaint naming it as a defendant in an
action captioned Lela Reeves V. Circa Pharmaceuticals, Inc., No. 94-436678
(Circuit Court, Wayne County, Michigan). This action is brought as a putative
class action pursuant to Michigan State law. Plaintiff alleges that she was a
consumer of a generic version of Hydergine manufactured by Circa under the
generic name Ergoloid Mesylates, and that between 1987 and 1991 she was induced
to purchase Ergoloid Mesylates tablets that were not validly approved by the FDA
and/or not manufactured in accordance with FDA approvals, and which were neither
safe nor effective. Predicated on these allegations, plaintiff seeks recovery
for herself and on behalf of a purported class consisting of all persons who
purchased Ergoloid Mesylates, by asserting causes of action for common-law
fraud, breach of contract, illegality of contract, constructive trust, and
exemplary damages. Plaintiff seeks damages in the form of (i) reimbursement for
prescription expenses incurred in purchasing Ergoloid Mesylates, (ii) an
accounting of all profits, (iii) other, unspecified economic damages, and (iv)
exemplary damages. Plaintiff's original complaint was served in January 1995. In
March 1995 Circa filed a motion to dismiss all counts of the original complaint.
Circa's motion was granted in part and denied in part pursuant to a decision and
order dated August 14, 1995. In September 1995 plaintiff served and filed an
amended complaint. Circa answered the amended complaint on October 13, 1995. On
September 12, 1995 plaintiff filed a motion to certify the purported class in
this case. After extensive briefing, plaintiff's motion for class certification
was argued before the court on January 3, 1996. The court has not yet rendered a
decision with respect to this motion. Discovery is in the preliminary stages.
12
<PAGE> 14
In October 1995, a putative class action complaint captioned Jimmy Jackson
v. Circa Pharmaceuticals, Inc., et al., was filed against Circa, Lawrence
Raisfeld and Robert Shulman, former presidents of Circa, and Roger Jordan,
president of Vitarine Pharmaceuticals ("Vitarine") in the Circuit Court of
Tallapoosa County, Alabama. The action was filed individually and on behalf of a
class comprised of all residents of the State of Alabama who (a) purchased
Dyazide that was manufactured by Circa or Vitarine during the period 1988 to
1989; (b) purchased Dyazide from a vendor other than Circa or Vitarine; and (c)
purchased the Dyazide for resale purposes only. The action alleges that the
defendants conspired and combined to fix the price of Dyazide during 1988 and
1989. Circa intends to vigorously defend this action, and has filed a motion
objecting to class certification. A hearing on all pending motions is scheduled
for April 10, 1996.
SETTLEMENT OF UNITED STATES DEPARTMENT OF JUSTICE INQUIRY
In July 1995, Circa initiated discussions with the United States Department
of Justice as to possible resolution of a longstanding open inquiry with regard
to possible violations of the False Claims Act in respect of drugs sold prior to
cessation of these product sales in 1990. Through these discussions, the parties
entered into a settlement agreement in March 1996. Under the terms of this
agreement, in March 1996 the Company paid $2.7 million in settlement of all
outstanding claims. The Company had established a reserve at December 31, 1995
for the full amount of the settlement.
Based on the information currently available and through consultation with
outside counsel, the Company does not believe that the resolution of the pending
litigation will have a material adverse effect on the Company's future
operations or consolidated financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the Company's fiscal year ended December 31, 1995.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION AND POSITION
NAME AGE AND OFFICE WITH REGISTRANT
- ----------------------------------- --- --------------------------------------------------
<S> <C> <C>
Alec D. Keith, Ph.D. .............. 63 Chairman of the Board of Directors since October
1991, is a co-founder of Zetachron and held senior
executive positions at Zetachron from 1983
through 1995.
Allen Chao, Ph.D. ................. 50 Chief Executive Officer of the Company since 1983,
is a co-founder of the Company.
Melvin Sharoky, M.D. .............. 45 President of the Company since July, 1995 and
Chief Executive Officer and President of Circa
since 1993.
David C. Hsia, Ph.D. .............. 51 A co-founder of the Company, is Senior Vice
President of Scientific Affairs and has served as
a Vice President of the Company since 1984.
</TABLE>
The executive officers of the registrant are elected annually by the Board
of Directors, hold office until their successors are chosen and qualify, and may
be removed at any time by the affirmative vote of a majority of the Board. The
Company has employment agreements with each of the executive officers. David C.
Hsia is the brother-in-law of Allen Chao. There are no other family
relationships between any director or executive officer of the Company.
13
<PAGE> 15
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock trades on the NASDAQ National Market tier of the
NASDAQ Stock Market under the symbol "WATS." The following table sets forth the
range of quarterly high and low price information for the periods indicated for
the years ended December 31, 1995 and 1994:
<TABLE>
<CAPTION>
FISCAL 1995 HIGH LOW
------------------------------------------------------------------- ------ ------
<S> <C> <C>
First.............................................................. $33.25 $20.00
Second............................................................. 40.25 28.50
Third.............................................................. 44.50 32.38
Fourth............................................................. 50.50 39.50
</TABLE>
<TABLE>
<CAPTION>
FISCAL 1994 HIGH LOW
------------------------------------------------------------------- ------ ------
<S> <C> <C>
First.............................................................. $28.00 $15.25
Second............................................................. 19.25 13.00
Third.............................................................. 25.38 16.25
Fourth............................................................. 28.75 23.50
</TABLE>
As of March 15, 1996, there were 1,720 stockholders of record.
A wholly-owned subsidiary of the Company paid a cash dividend in 1990. The
Company has not paid cash dividends on its common stock since that date and does
not anticipate paying dividends in the foreseeable future. The declaration and
payment of dividends and the amount paid, if any, will be subject to the
discretion of the Company's Board of Directors and will necessarily be dependent
on the earnings and financial condition of the Company and any other factors the
Board of Directors may consider relevant.
14
<PAGE> 16
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA(1)
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------
1995 1994 1993 1992 1991
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Product sales............................. $130,688 $ 93,649 $ 70,838 $ 34,773 $ 30,802
Royalty income............................ 22,247 1,209
-------- -------- -------- -------- --------
Total revenues......................... 152,935 94,858 70,838 34,773 30,802
-------- -------- -------- -------- --------
Cost of revenues.......................... 64,996 48,972 39,207 23,291 21,506
Research and development.................. 18,573 18,980 15,085 8,217 9,556
Selling, general and administrative....... 17,030 13,342 15,682 14,944 17,206
-------- -------- -------- -------- --------
Total operating expenses............... 100,599 81,294 69,974 46,452 48,268
-------- -------- -------- -------- --------
Operating income (loss)................ 52,336 13,564 864 (11,679) (17,466)
Equity in earnings of joint ventures...... 22,766 24,968 24,688 20,712 18,392
Investment and other income(2)............ 11,594 6,542 16,879 2,871 9,657
Merger expenses(3)........................ (13,939)
Gain from (provision for) legal
settlements(4)......................... 2,299 (6,297) (73,383)
Partnership loss(5)....................... (7,644) (15,598)
-------- -------- -------- -------- --------
20,421 33,809 27,626 7,985 (45,334)
-------- -------- -------- -------- --------
Income (loss) before provision
(benefit) for income taxes........... 72,757 47,373 28,490 (3,694) (62,800)
Provision (benefit) for income taxes...... 24,867 10,828 (21,927) 2,396 (7,596)
-------- -------- -------- -------- --------
Net income (loss)...................... $ 47,890 $ 36,545 $ 50,417 $ (6,090) $(55,204)
======== ======== ======== ======== ========
PER SHARE DATA:
Earnings per common and common equivalent
share(6)............................... $ 1.29 $ 1.00 $ 1.42 $ (0.18) $ (1.72)
======== ======== ======== ======== ========
Weighted average number of common and common
equivalent shares outstanding(6).......... 37,143 36,515 35,504 32,938 32,036
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------
1995 1994 1993 1992 1991
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Current assets.............................. $197,634 $172,912 $155,025 $ 57,118 $ 40,987
Working capital............................. 168,812 154,661 131,943 31,534 23,618
Total assets................................ 322,121 262,316 235,672 130,516 122,238
Long-term debt and capitalized lease
obligations............................... 3,577 5,058 2,143 3,991 2,736
Deferred partnership liability.............. 14,033 15,242 7,598
Total stockholders' equity.................. 289,035 223,370 185,081 77,872 81,426
</TABLE>
- ---------------
(1) The Company merged with Zetachron in October 1991 and Circa in July 1995.
The transactions were accounted for as poolings-of-interests, and
accordingly, the consolidated financial data presented includes the accounts
of Zetachron and Circa for all periods presented.
(2) Included in investment and other income for the years ended December 31,
1995, 1994, 1993, 1992 and 1991 were gains from the sales of the common
stock of Marsam Pharmaceuticals of $6.2 million, $3.2 million, $14.5
million, $1.1 million and $1.9 million, respectively. The Company disposed
of its investment in Marsam during 1995.
15
<PAGE> 17
(3) The costs associated with merger of the Company and Circa resulted in a
one-time charge of $13.9 million during 1995.
(4) The gain from and (provision for) legal settlements resulted from the
settlements of and reserve for various lawsuits that the Company was a
defendant in. The majority of these lawsuits were initiated during 1990 and
1991. Management believes that the ultimate resolution of such litigation
will not have a material adverse effect on the Company's future operations
or consolidated financial position.
(5) See Note 6 of the Notes to Consolidated Financial Statements in Item 14(a)
of this Form 10-K.
(6) The merger between Watson and Circa resulted in the exchange of 0.86 of a
share of Watson common stock for each share of Circa common stock. The
computation of earnings (loss) per share is based on the weighted average
number of common shares outstanding, including the dilutive effect of the
assumed exercise of all outstanding stock options and warrants. The weighted
average number of common Circa shares outstanding were adjusted to reflect
the merger exchange ratio. Fully diluted earnings per share is not
materially different from primary earnings per share.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company has historically derived a substantial portion of its revenues
from the manufacture and sale of off-patent pharmaceutical products. While this
continues to be the primary revenue source, certain developments have occurred
which have augmented the Company's revenue mix in 1995.
In 1995, sales of off-patent products accounted for approximately 85.5% of
total revenues; royalty income accounted for 14.5% of total revenues. In 1994,
off-patent product sales accounted for approximately 99% of total revenues;
royalty income accounted for the remaining 1%. In 1993, product sales of
off-patent medications accounted for approximately 100% of total revenues.
In 1991, the Company expanded its work on the development of advanced drug
delivery systems with the acquisition of Zetachron, Inc., a research and
development organization. In 1995, the Company merged Zetachron into its
wholly-owned subsidiary, Watson Laboratories. Research in the advanced drug
delivery area continues, although these activities have not generated
significant revenues for the Company to date. The drug delivery systems under
development employ various routes of administration, including oral and vaginal.
These systems potentially could control and improve the absorption of selected
drugs in the blood stream, improve dose reliability, reduce side effects and
increase patient convenience and compliance. Management believes that a
significant market exists for drug delivery systems that will enhance and
simplify the therapeutic benefits to the patient.
In July 1995, the Company strengthened and diversified its revenue base
through a merger with Circa Pharmaceuticals, Inc. ("Circa"). The merger,
accounted for as a pooling-of-interests, enhanced the Company's manufacturing
capabilities and increased its product development program, particularly in the
area of proprietary products. The Company owns a 50% equity interest in Somerset
Pharmaceuticals, Inc. ("Somerset"), which primarily markets Eldepryl(R) for the
treatment of Parkinson's disease. The Company recorded equity in earnings of
this joint venture of $24.8 million in 1995. Exclusivity expires for Eldepryl(R)
in June 1996. The Company expects earnings from Somerset in 1996 will decrease
somewhat as research and development expenditures will be increased in support
of the Phase III clinical trials on a transdermal Eldepryl(R) patch.
Circa and Rhone-Poulenc Rorer, Inc. ("RPR") were partners in the
development of Dilacor XR(R). Dilacor XR(R) is used for the treatment of
hypertension and angina. Through an amended partnership agreement with RPR, the
Company earns royalties on sales of Dilacor XR(R) by RPR. Royalty income is
determined based upon the market demand for the product, as evidenced by
prescriptions written, as defined. Revenues under this royalty agreement were
$22.2 million in 1995 and $1.2 million in 1994. Dilacor XR(R) lost exclusivity
in May 1995. The Company and RPR intend to launch a generic Dilacor XR(R)
product, following FDA approval, as considered appropriate. The costs and
profits from the generic product are to be shared equally by the Company and
RPR.
16
<PAGE> 18
The Company continues to expand its research and development efforts in the
area of proprietary product development through joint ventures, product
acquisitions and strategic alliances. The Company also continues to seek
opportunities to broaden its technology platform and to invest in new products,
technologies or businesses that are consistent with its strategy to focus on
niche or technically difficult to duplicate products. This strategy was
evidenced by the Company's increased investment in Andrx Corporation ("Andrx"),
a company engaged in the development of advanced controlled-release delivery
systems for certain orally-administered drugs. In October 1995, the Company
purchased additional Andrx common stock for approximately $15.6 million,
increasing its ownership to 19.5% of the total outstanding common stock of
Andrx.
The Company's future results of operations will depend to a significant
extent upon its ability to introduce new off-patent and proprietary
pharmaceutical products. Future operating results may vary significantly on an
annual or quarterly basis depending on the timing of, and the Company's ability
to obtain, FDA approvals of ANDAs and NDAs for such products and FDA approvals
for shipment of such products. Newly introduced off-patent products with limited
or no off-patent competition are typically sold at higher prices, often
resulting in increased gross profit margins. As competition from other
manufacturers intensifies, selling prices typically decline. The Company's
future operating results may also be affected by a variety of additional
factors, including customer purchasing practices and changes in the degree of
competition affecting the Company's products. The loss of exclusivity with
respect to Eldepryl(R) and Dilacor XR(R) and/or the introduction by other
companies of additional competitive products, could have a material adverse
effect on the financial condition of the Company.
QUARTERLY FLUCTUATIONS
The Company's results of operations on a quarterly basis have fluctuated in
the past, and may continue to fluctuate. The Company believes such fluctuations
are primarily due to new product introductions and to a variety of additional
factors including, without limitation, purchasing practices of the Company's
customers and changes in the degree of competition regarding the Company's
products.
To the extent that any of the Company's comments stated herein could be
deemed to be forward-looking statements, please see PART I, ITEM I of this Form
10-K for the year ended December 31, 1995, which contains certain statements to
the effect that the Company is subject to certain risks and uncertainties,
including changing market conditions, the availability and cost of raw
materials, the impact of competitive products and pricing, and the timely
development, FDA approval and market acceptance of the Company's products.
17
<PAGE> 19
RESULTS OF OPERATIONS
The following table represents selected components of the Company's results
of operations, in thousands of dollars and as percentages of revenues. The table
reflects the Company's merger with Circa for all periods presented.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------
1995 1994 1993
------------------ ----------------- ------------------
$ % $ % $ %
-------- ----- ------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Product sales.................... $130,688 85.5% $93,649 98.7% $ 70,838 100.0%
Royalty income................... 22,247 14.5 1,209 1.3
-------- ----- ------- ----- ------- -----
152,935 100.0 94,858 100.0 70,838 100.0
-------- ----- ------- ----- ------- -----
Operating expenses:
Cost of revenues................. 64,996 42.6 48,972 51.6 39,207 55.4
Research & development........... 18,573 12.1 18,980 20.0 15,085 21.3
Selling, general &
administrative................ 17,030 11.1 13,342 14.1 15,682 22.1
-------- ----- ------- ----- ------- -----
100,599 65.8 81,294 85.7 69,974 98.8
-------- ----- ------- ----- ------- -----
Operating income.............. 52,336 34.2 13,564 14.3 864 1.2
Other income (expense):
Equity in earnings from joint
ventures...................... 22,766 14.9 24,968 26.3 24,688 34.9
Merger expenses.................. (13,939) (9.1)
Investment and other income,
net........................... 11,594 7.6 8,841 9.3 2,938 4.1
-------- ----- ------- ----- ------- -----
20,421 13.4 33,809 35.6 27,626 39.0
-------- ----- ------- ----- ------- -----
Income before provision (benefit)
for income taxes.............. 72,757 47.6 47,373 49.9 28,490 40.2
Provision (benefit) for income
taxes............................ 24,867 16.3 10,828 11.4 (21,927) (31.0)
-------- ----- ------- ----- ------- -----
Net income............... $ 47,890 31.3% $36,545 38.5% $ 50,417 71.2%
======== ===== ======= ===== ======= =====
</TABLE>
YEARS ENDED DECEMBER 31, 1995 AND 1994
Revenues for the year ended December 31, 1995 were $152.9 million compared
to $94.9 million for the year ended December 31, 1994, an increase of $58.0
million or 61.2%. The increase in revenues was composed of a $37.0 million
increase in product sales and a $21.0 million increase in royalty income. The
increase in product sales was due primarily to increased sales of the Company's
core products, defined as products available in the marketplace for one year or
longer. In addition, the Company introduced eight products during 1995 which
accounted for $12.9 million in sales, or 9.9% of total 1995 product sales.
The increase in royalty income was attributable to an increase in market
demand for Dilacor XR(R) and to the increase in the royalty percentage on
prescriptions written for Dilacor XR(R) from 1% in 1994 to 20% in 1995. The
royalty percentage on Dilacor XR(R) will increase to 22% for prescriptions
written in the years ending December 31, 1997 through 2000 and then decline to
3% thereafter.
Cost of revenues increased $16.0 million to $65.0 million for the year
ended December 31, 1995 (an increase of 32.7%). Cost of revenues were 49.7% of
product sales in 1995 compared to 52.3% in 1994. This favorable decrease was due
to higher than average gross margins earned on certain core products and new
products introduced during 1995.
Research and development expenses were consistent with the prior year,
decreasing slightly from $19 million in 1994 to $18.6 million in 1995, despite
increasing research and development efforts in the area of proprietary
pharmaceuticals. Following the merger with Circa, the Company integrated the two
research and
18
<PAGE> 20
development departments into one, eliminating duplication and focusing efforts.
The Company expects that 1996 research and development expenses will be
consistent with 1995 research and development expenses.
Selling, general and administrative expenses increased 27.6% to $17.0
million for 1995 from $13.3 million in 1994. The increase in such expenses is
largely attributable to increased marketing and selling expenses associated with
new product introductions and an increase in administrative support due to the
overall growth of the Company. As a percentage of revenues, these costs
decreased from 14.1% to 11.1% from 1994 to 1995, which reflected management's
efforts to control costs. In addition, the Company's growth in revenues out
paced the growth in selling, general and administrative expenses.
Equity in earnings from joint ventures decreased 8.8% (or $2.2 million) to
$22.8 million in 1995 compared to $25.0 million in 1994. The two most
significant ventures included in this earnings amount are Somerset and ANCIRC, a
joint venture with Andrx. Equity in earnings from Somerset decreased slightly
from $25.1 million in 1994 to $24.8 million in 1995. The Company's portion of
ANCIRC's losses increased from $220,000 in 1994 to $1.7 million in 1995. In
October 1995, the Company amended its joint venture agreement with Andrx and
became equal partners in ANCIRC. Previously, the Company recognized 40% of the
costs and profits from ANCIRC.
In connection with the merger with Circa, the Company recorded a one-time
$13.9 million charge for costs incurred related to the merger. These costs
included investment banking fees and other costs related to the consolidation of
operations between the two companies. Included in investment and other income in
1995 was a $6.2 million gain from the sale of Marsam Pharmaceuticals, Inc.
("Marsam") common stock, a stock held for investment purposes, as compared to a
$3.2 million gain in 1994. During 1995, the Company disposed of its remaining
investment in Marsam common stock. In addition, during 1994, the Company
recognized a one-time gain from legal settlements of $2.3 million. The balance
of the increase in investment and other income in 1995 as compared to 1994, was
due to higher short-term interest rates on a larger base of invested cash.
The provision for income taxes increased to $24.9 million in 1995, compared
to $10.8 million in 1994. The effective income tax rates for the years ended
December 31, 1995 and 1994 were 34% and 23%, respectively. This increase was
primarily attributable to increased taxable income and the non-deductibility of
a significant portion of merger expenses recognized in 1995.
Net income increased to $47.9 million in 1995 from $36.5 million in 1994.
As a percentage of revenues, net income decreased to 31.3% in 1995 from 38.5%
principally due to the one-time merger expenses related to the merger with Circa
and the higher effective income tax rate in 1995. Exclusive of non-recurring
merger expenses of $13.9 million, a third quarter gain of $6.2 million from the
gain on sale of Marsam common stock and the income tax effect of such items, net
income for 1995 would have been $57.0 million or $1.54 per share.
YEARS ENDED DECEMBER 31, 1994 AND 1993
Revenues for the year ended December 31, 1994 were $94.9 million compared
to $70.8 million for the year ended December 31, 1993, an increase of $24.1
million or 34.0%. The increase in revenues was composed of a $22.8 million
increase in product sales and a $1.2 million increase in royalty income. The
increase in product sales was due primarily to the introduction of five new
products in 1994. The remaining portion of the increase stemmed from the sales
of core products. The increase in royalty income resulted from royalties on
sales of Dilacor XR(R) by RPR during 1994. The 1% royalty rate in 1994 generated
$1.2 million of royalty income.
Cost of revenues increased $9.8 million to $49.0 million for the year ended
December 31, 1994 (an increase of 25.0%). Cost of revenues were 52.3% of product
sales in 1994 compared to 55.4% in 1993. This favorable decrease was due to
higher than average gross margins earned on new products introduced in 1994 and
certain core products.
Research and development expenses increased 25.8% to $19.0 million for 1994
from $15.1 million for 1993. The increase was primarily due to the addition of
research personnel and increased usage of test chemicals for validation batches
as required by the FDA.
19
<PAGE> 21
Selling, general and administrative expenses decreased 14.9% to $13.3
million in 1994 from $15.7 million in 1993. The $2.4 million decrease in such
expenses was largely attributable to a reduction in the Company's 1994 legal
expenses due to the resolution of certain litigation matters.
Equity in earnings from joint ventures in 1994 increased slightly to $25.0
million from $24.7 million due primarily to earnings from Somerset. In 1993, the
Company recognized a loss from its partnership with RPR of $7.6 million. In
September 1993, the partnership agreement was amended to provide that the
Company would no longer share in profits and losses of the partnership and,
instead, earns royalties from the sales of Dilacor XR(R). The royalties earned
were used to offset the partnership liability, which was $14.0 million and $15.2
million at December 31, 1994 and 1993, respectively. Royalties earned in excess
of this liability will be remitted to the Company.
Investment and other income in 1994 was $6.5 million, a decrease of $10.3
million from the 1993 amount. This decrease was primarily attributable to the
fewer number of Marsam common shares sold in 1994, offset by increased interest
income on the invested proceeds from the Company's public offerings in 1993. The
1994 gain on sales of Marsam common stock was $3.2 million compared to $14.5
million in 1993. In addition, the Company recognized a one-time gain from legal
settlements of $2.3 million in 1994 as compared to a provision for legal
settlements of $6.3 million in 1993.
Income tax expense was $10.8 million, compared to an income tax benefit of
$21.9 million in 1993. The effective income tax rate in 1994 was 23%, compared
with an income tax benefit rate of 77% in 1993. As a result of the merger, the
1993 statement of income reflected the reduction in the valuation allowance
relating to Circa's net deferred tax asset balance at December 31, 1993. In
determining that the deferred tax asset was fully realizable by the combined
company, management considered the prior operating results of each company and
the future plans and expectations for the combined company.
Net income as a percentage of revenues decreased to 38.5% for 1994 from
71.2%, principally from the income tax benefit recorded in 1993, as discussed
above.
LIQUIDITY AND CAPITAL RESOURCES
As the Company has grown during the last three years, its overall liquidity
requirements have increased. The significant increase in accounts receivable,
inventories, and investment in property and equipment have been financed
primarily by cash flows from operating activities and from the Company's public
offerings in 1993. The net proceeds from these offerings were used primarily for
working capital and purchases of property and equipment. The balance was
invested in short-term investments during 1993, 1994 and 1995.
The Company's working capital increased from $154.7 million at December 31,
1994 to $168.8 million at December 31, 1995. This $14.1 million increase was
primarily due to increased cash flow from operations. Net cash provided by all
sources in 1995 was $21.0 million compared to $26.1 million in 1994. The
decrease was primarily attributable to the Company's $15.6 million additional
investment in Andrx, the reduction of the $14.0 million deferred partnership
liability and net changes in certain assets and liabilities. During 1994,
activities were financed primarily with $13.4 million provided by operations,
$8.0 million from the sale of the Company's interest in a joint venture and $5.0
million from bank borrowings.
During 1995, the Company spent $22.6 million on property and equipment
additions and has budgeted approximately $14.0 million for such capital
expenditures in 1996. The Company anticipates that its cash resources and
operating cash flows will be sufficient to fund its current working capital
needs.
At December 31, 1995, the Company had a note payable outstanding of
approximately $4.2 million. This is composed of a single, unsecured term loan
with interest at a fixed rate of 8.1% and payments due monthly through September
2001. In addition, a credit facility of $26.0 million is currently available to
the Company, composed of (i) a $10 million revolving, unsecured working capital
line of credit, (ii) a $6 million revolving, unsecured equipment loan and (iii)
a $10 million non-revolving, unsecured building improvement loan. The Company
has made no borrowings against this credit facility.
20
<PAGE> 22
Primarily as a result of funds from the 1993 public offerings and continued
cash flows from operations, the Company has cash and marketable securities of
$118.3 million at December 31, 1995. The Company regularly reviews potential
opportunities to acquire or invest in technologies, products or product rights.
The Company also regularly reviews potential acquisitions, investments or
combinations involving businesses compatible with its existing business. The
Company could use sources other than cash, such as issuance of debt or equity
securities, to finance any such acquisition or investment. If such an
acquisition or investment was completed, the Company's operating results and
financial condition could change materially in future periods.
Management believes inflation does not have, and has not had, a significant
impact on the Company's revenues or operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is contained in the financial
statements set forth in Item 14(a) under the caption "Consolidated Financial
Statements" as a part of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on
accounting or financial disclosure matters during the Company's fiscal years
ended December 31, 1995 and 1994.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The information concerning directors of the Company required under this
Item is incorporated herein by reference to the Company's definitive proxy
statement pursuant to Regulation 14A, filed with the Commission not later than
120 days after the close of the Company's fiscal year ended December 31, 1995.
EXECUTIVE OFFICERS
The information concerning executive officers of the Company required under
this Item is provided under Item 4 A.
ITEM 11. EXECUTIVE COMPENSATION
The information required under this Item is incorporated herein by
reference to the Company's definitive proxy statement pursuant to Regulation
14A, filed with the Commission not later than 120 days after the close of the
Company's fiscal year ended December 31, 1995.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this Item is incorporated herein by
reference to the Company's definitive proxy statement pursuant to Regulation
14A, filed with the Commission not later than 120 days after the close of the
Company's fiscal year ended December 31, 1995.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this Item is incorporated herein by
reference to the Company's definitive proxy statement pursuant to Regulation
14A, filed with the Commission not later than 120 days after the close of the
Company's fiscal year ended December 31, 1995.
21
<PAGE> 23
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) 1. CONSOLIDATED FINANCIAL STATEMENTS
The following are included herein under Item 8:
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1995 and 1994
Consolidated Statements of Income for the three years ended December 31,
1995.
Consolidated Statements of Stockholders' Equity for the three years ended
December 31, 1995.
Consolidated Statements of Cash Flows for the three years ended December
31, 1995.
Notes to Consolidated Financial Statements
(A) 2. FINANCIAL STATEMENT SCHEDULES:
II. Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the
required information is included in the Consolidated Financial Statements or
notes thereto.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- --------------------------------------------------------------------------------
<C> <C> <S>
2.1 -- Agreement and Plan of Merger among the Registrant, Gum Acquisition Corp. and
Circa Pharmaceuticals, Inc., filed as Exhibit 2.1 to the Company's Registration
Statement on Form S-4 Reg. No. 33-60211 ("33- 60211") and hereby incorporated by
reference.
3.1 -- Articles of Incorporation of the Company and all amendments thereto, filed as
Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1995 and hereby incorporated by reference.
3.2 -- Bylaws of the Company, as amended as of July 18, 1995, filed as Exhibit 3.2 to
the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995
and hereby incorporated by reference.
4.1 -- Amendment to loan agreement between the Company, its subsidiaries and Bank of
America NT & SA dated February 26, 1996.
4.2 -- Loan Agreement between the Company, its subsidiaries and Bank of America NT & SA
dated August 19, 1994 filed as Exhibit 4.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1994 and hereby incorporated by
reference.
10.1 -- Lease between Westgate Associates and the Company dated October 1991 and
addendums thereto, filed as Exhibit 10.5 to the Company's Registration Statement
on Form S-1 Reg. No. 33-46229 ("33-46229") and hereby incorporated by reference.
10.2 -- Industrial Real Estate Lease, as amended, dated August 8, 1995, between
Hsi-Hsiung Hsu Hwa Chao (Chao Family) Trust I and the Company, filed as Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1995 and hereby incorporated by reference.
10.3 -- Amended Lease Agreement between Zetachron, Incorporated and Research Property
Associates dated February 1, 1983, filed as Exhibit 10.7 to 33-46229 and hereby
incorporated by reference.
10.4 -- Grant of Option to Purchase Real Estate by and between Dr. Alec Keith, Mr.
Wallace C. Snipes and Zetachron, Incorporated dated July 1, 1987, filed as
Exhibit 10.8 to 33-46229 and hereby incorporated by reference.
*10.5 -- The Company's 1985 Stock Incentive Plan, filed as Exhibit 10.11 to 33-46229 and
hereby incorporated by reference.
</TABLE>
22
<PAGE> 24
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- --------------------------------------------------------------------------------
<C> <C> <S>
*10.6 -- 1991 Stock Option Plan of the Company as revised, filed as Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995 and
hereby incorporated by reference.
*10.7 -- 1995 Non-Employee Directors' Stock Option Plan, as amended, filed as Exhibit
10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June
30, 1995 and hereby incorporated by reference.
10.8 -- Form of the Company's Employee Invention, Confidential Information Agreement,
filed as Exhibit 10.22 to 33-46229 and hereby incorporated by reference.
10.9 -- Purchase Agreement relating to the Company's purchase of 132 Business Center
Drive property, filed as Exhibit 10.15 to the Company's 1993 Annual Report on
Form 10-K and hereby incorporated by reference.
10.10 -- Purchase and Sale Agreement between the Company, its subsidiaries and AETNA Real
Estate Associates dated October 18, 1994 regarding the acquisition of 311 Bonnie
Circle, Corona, California, filed as Exhibit 10.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1994 and hereby
incorporated by reference.
10.11 -- Senior Executive Employment Agreement dated as of May 29, 1995 between the
Company and Allen Chao, filed as Exhibit 10.1 to 33-60211 and hereby
incorporated by reference.
10.12 -- Form of Senior Executive Employment Agreement dated as of May 29, 1995 between
the Company and David C. Hsia, filed as Exhibit 10.2 to 33-60211 and hereby
incorporated by reference.
10.13 -- Form of Senior Executive Employment Agreement, dated as of May 29, 1995 between
the Company and Alec D. Keith, filed as Exhibit 10.3 to 33-60211 and hereby
incorporated by reference.
10.14 -- Employment Agreement with Dr. Melvin Sharoky dated April 26, 1991 as amended
January 19, 1993 and July 17, 1995, filed as Exhibit 10.3 to the Company's
Quarter Report on Form 10-Q for the quarter ended June 30, 1995 and hereby
incorporated by reference.
11.1 -- Statement of computation of per share earnings.
21.1 -- Subsidiaries of the Company.
23.1 -- Consent of Price Waterhouse LLP.
23.2 -- Consent of Deloitte & Touche LLP.
27.1 -- Financial Data Schedule (EDGAR version only).
99.1 -- Consolidated Financial Statements of Somerset Pharmaceuticals, Inc. and
Subsidiaries for the years ended December 31, 1995, 1994 and 1993.
</TABLE>
- ---------------
* Compensation Plan or Agreement
23
<PAGE> 25
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
WATSON PHARMACEUTICALS, INC.
(Registrant)
By: /s/ ALLEN CHAO, PH.D.
------------------------------------
Allen Chao, Ph.D.
Chief Executive Officer and Director
(Principal Executive and Financial
Officer)
By: /s/ CHATO ABAD
------------------------------------
Chato Abad
Vice President -- Corporate
Controller
(Principal Accounting Officer)
Date: March 28, 1996
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------- ---------------------------------- ---------------
<C> <S> <C>
/s/ Chairman of the Board and Director March 28, 1996
ALEC D. KEITH, PH.D.
- -------------------------------------
Alec D. Keith, Ph.D.
/s/ Chief Executive Officer and March 28, 1996
ALLEN CHAO, PH.D. Director
- -------------------------------------
Allen Chao, Ph.D.
/s/ President and Director March 28, 1996
MELVIN SHAROKY, M.D.
- -------------------------------------
Melvin Sharoky, M.D.
/s/ Secretary and Director March 28, 1996
MICHEL J. FELDMAN
- -------------------------------------
Michel J. Feldman
Director March 28, 1996
- -------------------------------------
Michael Fedida
/s/ Director March 28, 1996
ALBERT F. HUMMEL
- -------------------------------------
Albert F. Hummel
/s/ Director March 28, 1996
RONALD R. TAYLOR
- -------------------------------------
Ronald R. Taylor
</TABLE>
24
<PAGE> 26
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants..................................................... F-2
Consolidated Balance Sheets as of December 31, 1995 and 1994.......................... F-3
Consolidated Statements of Income for each of the three years in the period ended
December 31, 1995................................................................... F-4
Consolidated Statements of Stockholders' Equity for each of the three years in the
period ended December 31, 1995...................................................... F-5
Consolidated Statements of Cash Flows for each of the three years in the period ended
December 31, 1995................................................................... F-6
Notes to Consolidated Financial Statements............................................ F-8
Financial Statement Schedule:
II Valuation and Qualifying Accounts............................................... F-20
</TABLE>
All other schedules are omitted because they are not applicable or the
required information is included in the Consolidated Financial Statements or
notes thereto.
F-1
<PAGE> 27
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Watson Pharmaceuticals, Inc.
In our opinion, based upon our audits and the reports of other auditors,
the consolidated financial statements in the accompanying index on page F-1
present fairly, in all material respects, the financial position of Watson
Pharmaceuticals, Inc. and its subsidiaries at December 31, 1995 and 1994, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1995, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We did not audit the financial
statements of Somerset Pharmaceuticals, Inc. (Somerset), an entity which is 50%
owned by the Company. The Company's investment in Somerset aggregated
$25,741,000 and $22,554,000 at December 31, 1995 and 1994, respectively, and its
equity in the earnings of Somerset totaled $24,800,000, $25,100,000 and
$23,800,000 for the years ended December 31, 1995, 1994 and 1993, respectively.
In addition, we did not audit the financial statements of Circa Pharmaceuticals,
Inc. (Circa), a wholly owned subsidiary, as of December 31, 1994 and for the
each of the two years in the period ended December 31, 1994, which statements
reflect total assets of $103,857,000 (includes $22,554,000 of investment in
Somerset) and net income of $17,259,000 and $8,395,000 (includes equity in the
earnings of Somerset of $25,100,000 and $23,800,000, respectively) for the years
ended December 31, 1994 and 1993, respectively. Those financial statements were
audited by other auditors whose reports thereon have been furnished to us, and
our opinion expressed herein, insofar as it relates to the amounts included for
Somerset and Circa, is based solely on the reports of each of the respective
other auditors. We conducted our audits of the consolidated financial statements
of Watson Pharmaceuticals, Inc. in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits and the respective reports of other auditors provide a reasonable basis
for the opinion expressed above.
PRICE WATERHOUSE LLP
February 5, 1996, except as to Note 11,
which is as of March 4, 1996
F-2
<PAGE> 28
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1994
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents (Note 1)......................... $ 92,214 $ 71,165
Marketable securities (Note 1)............................. 26,038 35,531
Accounts receivable, net of allowances for doubtful
accounts of $1,320 and $903 (Note 1).................... 25,081 16,128
Royalty receivable (Note 6)................................ 8,205
Inventories (Note 3)....................................... 22,637 16,361
Prepaid expenses and other current assets.................. 2,344 2,732
Current deferred tax assets (Note 7)....................... 21,115 30,995
------------ ------------
Total current assets............................... 197,634 172,912
Property and equipment, net (Note 3)......................... 69,999 54,115
Investments in joint ventures and other long-term investments
(Note 4)................................................... 49,355 31,824
Other assets................................................. 5,133 3,465
------------ ------------
Total assets....................................... $322,121 $262,316
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses (Note 3)............. $ 25,215 $ 17,610
Income taxes payable (Note 7).............................. 2,985
Current portion of long-term debt (Note 5)................. 622 641
------------ ------------
Total current liabilities.......................... 28,822 18,251
Long-term debt (Note 5)...................................... 3,577 5,058
Deferred partnership liability (Note 6)...................... 14,033
Other liabilities............................................ 687 1,604
------------ ------------
Total liabilities.................................. 33,086 38,946
------------ ------------
Commitments and contingencies (Note 10)
Stockholders' equity:
Preferred stock; no par; 2,500,000 shares authorized; none
outstanding (Note 8)....................................
Common stock; par value of $.0033; 100,000,000 shares
authorized; 36,368,725 and 35,782,704 shares issued and
outstanding, respectively (Note 8)...................... 120 118
Additional paid-in capital................................. 146,439 132,115
Retained earnings.......................................... 142,711 94,821
Unrealized holding gain (loss) on marketable securities.... 621 (870)
Unearned compensation-stock awards (Note 1)................ (856) (2,814)
------------ ------------
Total stockholders' equity......................... 289,035 223,370
------------ ------------
Total liabilities and stockholders' equity......... $322,121 $262,316
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
F-3
<PAGE> 29
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
1995 1994 1993
-------- ------- --------
<S> <C> <C> <C>
Revenues:
Product sales............................................. $130,688 $93,649 $ 70,838
Royalty income (Note 6)................................... 22,247 1,209
------- ------- --------
Total revenues.................................... 152,935 94,858 70,838
------- ------- --------
Operating expenses:
Cost of revenues (Note 9)................................. 64,996 48,972 39,207
Research and development (Note 9)......................... 18,573 18,980 15,085
Selling, general and administrative (Note 9).............. 17,030 13,342 15,682
------- ------- --------
Total operating expenses.......................... 100,599 81,294 69,974
------- ------- --------
Operating income............................................ 52,336 13,564 864
Other income (expense):
Equity in earnings of joint ventures (Note 4)............. 22,766 24,968 24,688
Investment and other income............................... 11,594 6,542 16,879
Merger expenses (Note 2).................................. (13,939)
Gain from (provision for) legal settlements............... 2,299 (6,297)
Partnership loss.......................................... (7,644)
------- ------- --------
Total other income, net........................... 20,421 33,809 27,626
------- ------- --------
Income before provision (benefit) for income taxes.......... 72,757 47,373 28,490
Provision (benefit) for income taxes (Note 7)............... 24,867 10,828 (21,927)
------- ------- --------
Net income.................................................. $ 47,890 $36,545 $ 50,417
======= ======= ========
Per share data:
Earnings per share (Note 1)................................. $ 1.29 $ 1.00 $ 1.42
======= ======= ========
Weighted average number of common and common equivalent
shares outstanding (Note 1)............................... 37,143 36,515 35,504
======= ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 30
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
NOTES UNREALIZED HOLDING
COMMON STOCK ADDITIONAL RECEIVABLE GAIN (LOSS) UNEARNED TOTAL
--------------- PAID-IN RETAINED FROM ON MARKETABLE COMPENSATION STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS STOCKHOLDERS SECURITIES STOCK AWARDS EQUITY
------ ------ ---------- --------- ------------ ------------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER
31, 1992.......... 31,699 $105 $ 71,629 $ 7,859 $(42) $ (4,850) $ 74,701
Net proceeds from
initial public
offering........ 2,443 8 25,975 25,983
Net proceeds from
second public
offering........ 1,065 3 28,921 28,924
Exercise of
options/warrants... 410 1 2,093 2,094
Net collections of
notes receivable
from
stockholders.... 2 2
Tax benefit
related to stock
option plan..... 2,285 2,285
Common stock
issued to
employees....... 344 1 2,862 (2,863) 0
Cancellation of
common stock
issued to
employees....... (411 ) (1) (2,960) 2,163 (798)
Amortization of
unearned
compensation.... 1,471 1,471
Net income........ 50,417 50,417
------ ---- -------- -------- ---- ----- ------- --------
BALANCE AT DECEMBER
31, 1993.......... 35,550 117 130,805 58,276 (40) (4,079) 185,079
Exercise of
options/warrants... 213 1 425 426
Collections of
notes receivable
from
stockholders.... 40 40
Tax benefit
related to stock
option plan..... 659 659
Common stock
issued to
employees....... 26 326 326
Cancellation of
common stock
issued to
employees....... (6 ) (100) 80 (20)
Amortization of
unearned
compensation.... 1,185 1,185
Adjustment for
unrealized
holding loss on
investment...... $ (870) (870)
Net income........ 36,545 36,545
------ ---- -------- -------- ---- ----- ------- --------
BALANCE AT DECEMBER
31, 1994.......... 35,783 118 132,115 94,821 (870) (2,814) 223,370
Exercise of
options......... 586 2 7,516 7,518
Tax benefit
related to stock
option plan..... 6,808 6,808
Amortization of
unearned
compensation.... 1,958 1,958
Adjustment for
unrealized
holding gain on
investment...... 1,491 1,491
Net income........ 47,890 47,890
------ ---- -------- -------- ---- ----- ------- --------
BALANCE AT DECEMBER
31, 1995.......... 36,369 $120 $146,439 $142,711 $ $ 621 $ (856) $ 289,035
====== ==== ======== ======== ==== ===== ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 31
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
1995 1994 1993
--------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.............................................. $ 47,890 $ 36,545 $ 50,417
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization........................ 5,243 4,447 3,666
Amortization of unearned compensation-stock awards... 1,958 1,491 1,471
Amortization of deferred income and bond premium..... (917) (146) (917)
Decrease in deferred partnership liability........... (14,033) (1,209)
Dividends received from Somerset..................... 18,000 18,000 17,688
Equity in earnings of joint ventures................. (19,067) (20,945) (13,152)
Gain on sale of Marsam stock......................... (6,243) (3,180) (14,491)
Gain on settlements with former officers............. (2,299) (3,416)
Provision for doubtful accounts...................... 417 119 257
Tax benefit related to stock option plan............. 6,808 659 2,285
Changes in assets and liabilities:
Increase in accounts receivable...................... (9,371) (7,262) (2,089)
Increase in royalty receivable....................... (8,205)
Increase in inventories.............................. (6,276) (3,715) (4,829)
Decrease in prepaid expenses and other current
assets............................................. 24 420 845
(Increase) decrease in deferred tax assets........... 8,215 (597) (29,632)
(Increase) decrease in other assets.................. 82 49 (157)
Increase in accounts payable and accrued expenses.... 7,605 1,931 7,798
Increase (decrease) in income taxes payable.......... 3,263 (360)
Decrease in accrual for legal settlements............ (10,881) (5,256)
--------- -------- --------
Total adjustments............................... (12,497) (23,118) (40,289)
--------- -------- --------
Net cash provided by operating activities....... 35,393 13,427 10,128
--------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment..................... (22,588) (21,484) (13,380)
Disposals of property and equipment..................... 1,463 104 4
Purchases of marketable securities...................... (386,502) (19,164) (18,173)
Proceeds from sale of marketable securities............. 396,725 45,324
Proceeds from sale of Marsam stock...................... 7,005 3,869 16,428
Proceeds from sale of a joint venture................... 7,992
Investment in Andrx..................................... (15,645) (6,000)
Investment (increase) decrease in other joint
ventures............................................. (818) (1,518) 676
Payment to partnership.................................. (8,000)
--------- -------- --------
Net cash provided by (used in) investing
activities.................................... $ (20,360) $ 9,123 $(22,445)
--------- -------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 32
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
1995 1994 1993
--------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from initial public offering............... $ 25,983
Net proceeds from second public offering................ 28,924
Proceeds from issuance of long-term debt................ $ 5,000
Principal payments on long-term debt.................... $ (1,502) (1,938) (2,665)
Purchase and retirement of stock........................ (825)
Proceeds from exercise of stock options................. 7,518 426 2,094
Net collections of notes receivable from stockholders... 40 2
--------- -------- --------
Net cash provided by financing activities....... 6,016 3,528 53,513
--------- -------- --------
Net increase in cash and cash equivalents................. 21,049 26,078 41,196
Cash and cash equivalents at beginning of year............ 71,165 45,087 3,891
--------- -------- --------
Cash and cash equivalents at end of year.................. $ 92,214 $ 71,165 $ 45,087
========= ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest............................................. $ 446 $ 901 $ 778
Income taxes......................................... $ 6,765 $ 10,082 $ 6,387
ADDITIONAL DISCLOSURES OF NON-CASH ITEMS:
Stock issued in exchange for note receivable............ $ 20
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE> 33
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of business and principles of consolidation
Watson Pharmaceuticals, Inc. (the "Company") is engaged in the production,
marketing and distribution of off-patent pharmaceutical products and the
research and development of proprietary pharmaceutical products and drug
delivery systems. The consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries, including Circa Pharmaceuticals,
Inc. ("Circa") that merged with the Company on July 17, 1995 (Note 2). All
intercompany accounts and transactions have been eliminated.
The Company's wholly-owned subsidiaries include Watson Laboratories, Inc.
("Watson Labs"), Watson Pharmaceuticals (Asia) Ltd. (Note 11), Corona
Pharmaceuticals, Inc. (currently inactive) and Circa. In 1995, the Company
developed a plan to merge its wholly-owned subsidiary, Zetachron, Inc.
("Zetachron") into Watson Labs. At December 31, 1995, all Zetachron assets were
either merged into Watson Labs or disposed of for an immaterial loss.
Cash and cash equivalents
Cash and cash equivalents include time deposits and readily marketable
securities with original maturities of three months or less.
Fair Value of Financial Instruments
The Company values financial instruments as required by Statement of
Financial Accounting Standards No. 107, "Disclosures about Fair Values of
Financial Instruments" ("SFAS 107"). The carrying amounts of cash and cash
equivalents, marketable securities, accounts and other receivables, inventories,
accounts payable, accrued expenses and debt approximate fair value. For certain
long-term investments for which there are no market prices, a reasonable
estimate of fair value could not be made without incurring excessive costs. It
was not practicable to estimate the fair value of an investment representing
19.5% of the issued common stock of Andrx Corporation, a privately-held company.
Accordingly, the investment in Andrx was carried at its original cost of $21.6
million at December 31, 1995.
Marketable securities
The Company's investment portfolio consists of fixed income securities,
equity securities and money market funds, all of which are included in the
Company's cash and cash equivalents or marketable securities. In 1994, the
Company adopted SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities". Under SFAS 115, all of the Company's investments are classified as
"available-for-sale" securities and are reported at fair market value. Any
unrealized holding gains or losses are reported as a separate component of
stockholders' equity. Realized gains and losses are determined on the specific
identification method and are reported in income. Maturity dates on fixed income
securities ranged from 1996 to 2023.
F-8
<PAGE> 34
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and fair market values of all marketable securities are
summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1995
----------------------------------------------------
GROSS GROSS FAIR
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUES
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Fixed income securities:
U.S. Treasury securities.............. $ 36,741 $463 $ (54) $ 37,150
State-issued securities............... 4,400 4,400
Corporate bonds....................... 9,444 232 9,676
Commercial paper...................... 46,197 (48) 46,149
Equity securities....................... 6,624 28 6,652
Money market funds...................... 14,225 14,225
-------- ---- ----- --------
$117,631 $723 $(102) $118,252
======== ==== ===== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1994
----------------------------------------------------
GROSS GROSS FAIR
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUES
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Fixed income securities:
U.S. Treasury securities.............. $ 51,526 $ $(2,610) $ 48,916
State-issued securities............... 8,961 (62) 8,899
Commercial paper...................... 16,699 16,699
Equity securities....................... 4,648 (771) 3,877
Marsam common stock..................... 763 2,573 3,336
Money market funds...................... 24,969 24,969
-------- ------ ------- --------
$107,566 $2,573 $(3,443) $106,696
======== ====== ======= ========
</TABLE>
Realized gains from the sales of Marsam common stock were $6.2 million,
$3.2 million and $14.5 million for the years ended December 31, 1995, 1994 and
1993, respectively. Realized gains and losses from the sales of other marketable
securities were not material for the three years in the period ended December
31, 1995.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or
market.
Property and equipment
Property and equipment are stated at cost. Major renewals and improvements
are capitalized, while normal maintenance and repairs are expensed as incurred.
At the time properties are retired from service, the cost and accumulated
depreciation are removed from the respective accounts and gains or losses are
reflected in income.
Depreciation expense is computed principally on a straight-line basis over
the estimated useful lives of two to ten years for furniture, fixtures and
equipment and thirty years for buildings and building improvements. Leasehold
improvements and assets recorded under capital leases are amortized on a
straight-line basis over the terms of the respective leases.
F-9
<PAGE> 35
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Unearned compensation
Prior to its merger with the Company (Note 2), Circa maintained stock award
plans (the "stock awards") for key employees and officers. The stock awards
contained certain vesting provisions which required unearned compensation to be
recorded for the fair market value of the shares issued. Concurrent with the
merger, the stock awards were converted to equivalent common shares in the
Company pursuant to the merger exchange ratio in the merger agreement.
Compensation expense was charged on a straight-line basis to selling, general
and administrative expense over the related vesting periods. At December 31,
1995, unearned compensation related to the stock awards totalled $856,000 and
will be amortized through January 1997.
Revenue recognition
Revenues from product sales are recognized upon shipment and are net of
returns. Royalty income is recognized as earned pursuant to the terms of the
Company's amended agreement with Rhone-Poulenc Rorer, Inc. (Note 6).
Product sales to major customers
In 1993, two customers accounted for 28% of product sales, 15% and 13%
individually. In 1994, two customers accounted for 25% of product sales, 13% and
12% individually. In 1995, no individual customers accounted for more than 10%
of the Company's product sales.
Research and development activities
The costs associated with the development, testing and approval of
pharmaceutical products and drug delivery systems are expensed as incurred.
Income taxes
The Company accounts for income taxes in accordance with SFAS 109,
"Accounting for Income Taxes". Under the liability method specified by SFAS 109,
the deferred tax assets and liabilities are measured each year based on the
difference between the financial statement and income tax bases of assets and
liabilities at the applicable enacted income tax rates. The deferred tax
provision is the result of changes in the deferred tax assets and liabilities.
Earnings per share
The computation of earnings per share is based on the weighted average
number of common shares outstanding. The weighted average number of shares
includes the dilutive effect of the assumed exercise of all outstanding stock
options and warrants described in Note 8.
Use of Estimates by Management
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make certain
estimates and assumptions. These estimates and assumptions are reflected in the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at December 31, 1995 and 1994. Management's estimates and
assumptions are also reflected in the revenues and expenses for the three years
ended December 31, 1995.
Concentration of credit risk
The Company is potentially subject to a concentration of credit risk with
respect to its trade receivable balance, all of which is due from service
providers, distributors, wholesalers and chain drug stores in the health
F-10
<PAGE> 36
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
care and pharmaceutical industries. The Company performs ongoing credit
evaluations of its customers and maintains reserves for potential uncollectible
accounts. Actual losses from uncollectible accounts have been within
management's expectations.
Reclassifications
Certain amounts in the 1993 and 1994 financial statements have been
reclassified to conform with the 1995 presentation. These reclassifications had
no effect on net income or retained earnings.
2. MERGER WITH CIRCA
On July 17, 1995, the stockholders of the Company and Circa approved the
merger which resulted in Circa becoming a wholly-owned subsidiary of the
Company. Circa, founded in 1960, develops and manufactures off-patent and
proprietary drugs, develops alternative drug delivery systems and distributes
pharmaceutical products. Under the terms of the merger agreement, Circa
stockholders received 0.86 of a share of the Company's common stock for each
Circa share. Accordingly, the Company issued approximately 18.7 million shares
of its common stock for all of the outstanding common shares of Circa.
The merger qualifies as a tax-free reorganization and was accounted for as
a pooling-of-interests. The Company's financial statements have been
retroactively restated to include the results of Circa for all periods
presented.
Combined and separate results of Watson and Circa during the periods
preceding the merger are summarized as follows (in thousands):
<TABLE>
<CAPTION>
WATSON CIRCA ADJUSTMENT COMBINED
------- ------- ---------- --------
<S> <C> <C> <C> <C>
Six months ended June 30, 1995 (Unaudited)
Total revenues................................ $53,142 $ 7,483 $60,625
Equity in earnings of joint ventures.......... $10,204 $10,204
Net income.................................... $12,257 $13,447 $25,704
Year ended December 31, 1994
Total revenues................................ $87,057 $ 7,801 $94,858
Equity in earnings of joint ventures.......... $24,968 $24,968
Net income.................................... $18,686 $17,259 $ 600 $36,545
Year ended December 31, 1993
Total revenues................................ $67,547 $ 3,291 $70,838
Equity in earnings of joint ventures.......... $24,688 $24,688
Net income.................................... $12,222 $ 8,395 $ 29,800 $50,417
</TABLE>
The combined financial results of the Company and Circa presented above
include adjustments and reclassifications made to conform accounting policies
and financial statement presentation of the two companies. The adjustments that
affected net income resulted from the reduction in the valuation allowance
related to certain net deferred tax assets. Previously, these net deferred tax
assets were fully reserved by Circa. In determining that the deferred tax assets
were fully realizable by the combined company, management considered the prior
operating results of each company and the future plans and expectations for the
combined company. Intercompany transactions between the two companies for the
periods presented were not material.
In connection with the merger, the Company recorded a one-time charge of
$13.9 million for merger-related expenses during the quarter ended September 30,
1995. These expenses included investment banking fees and other costs related to
the consolidation of operations between the two companies.
F-11
<PAGE> 37
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. BALANCE SHEET COMPONENTS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1995 1994
-------- --------
(IN THOUSANDS)
<S> <C> <C>
INVENTORIES:
Raw materials................................................ $ 11,483 $ 7,969
Work-in-process.............................................. 5,112 3,264
Finished goods............................................... 6,042 5,128
-------- --------
$ 22,637 $ 16,361
======== ========
PROPERTY AND EQUIPMENT:
Buildings and improvements................................... $ 22,457 $ 23,392
Leasehold improvements....................................... 7,396 7,339
Land and land improvements................................... 4,937 5,058
Machinery and equipment...................................... 41,403 31,421
Research and laboratory equipment............................ 9,020 7,753
Furniture and fixtures....................................... 2,667 2,372
-------- --------
87,880 77,335
Less accumulated depreciation and amortization............... (32,647) (28,307)
-------- --------
55,233 49,028
Construction in progress..................................... 14,766 5,087
-------- --------
$ 69,999 $ 54,115
======== ========
ACCOUNTS PAYABLE AND ACCRUED EXPENSES:
Trade accounts payable....................................... $ 16,824 $ 10,140
Reserve for litigation settlement............................ 2,839 3,119
Accrued payroll and benefits................................. 2,716 1,890
Reserve for sales coupons.................................... 1,783
Other accrued expenses....................................... 1,053 2,461
-------- --------
$ 25,215 $ 17,610
======== ========
</TABLE>
4. INVESTMENTS IN JOINT VENTURES AND OTHER LONG-TERM INVESTMENTS
Joint Ventures
Somerset Pharmaceuticals, Inc. ("Somerset")
The Company maintains a 50% interest in the outstanding common stock of
Somerset and utilizes the equity method to account for this investment. Somerset
markets the product Eldepryl(R), which is used in the treatment of Parkinson's
disease. Income recognized from Somerset was approximately $24.8 million, $25.1
million and $23.8 million for the years ended December 31, 1995, 1994 and 1993,
respectively. Income includes 50% of Somerset's earnings, ongoing management
fees and amortization of deferred income, offset by amortization of goodwill.
The excess cost of this investment over the Company's proportionate share of
Somerset's net assets was $8.4 million and $9.4 million at December 31, 1995 and
1994 respectively, and is being amortized on a straight-line basis over 15
years.
F-12
<PAGE> 38
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Condensed income statements and balance sheets of Somerset are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1995 1994 1993
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Net revenues....................................... $107,365 $124,566 $118,998
Costs and expenses................................. 42,812 59,557 55,825
Income taxes....................................... 20,200 20,900 21,408
-------- -------- --------
Net income............................... $ 44,353 $ 44,109 $ 41,765
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1995 1994
------- -------
(IN THOUSANDS)
<S> <C> <C>
Current assets................................................... $43,993 $48,770
Other assets..................................................... 7,127 6,380
------- -------
Total assets........................................... $51,120 $55,150
======= =======
Current liabilities.............................................. $17,057 $29,211
Other liabilities................................................ 63 292
Stockholders' equity............................................. 34,000 25,647
------- -------
Total liabilities and stockholders' equity............. $51,120 $55,150
======= =======
</TABLE>
ANCIRC
In July 1994, the Company and Andrx Corporation ("Andrx") formed a joint
venture, ANCIRC, to develop off-patent pharmaceutical products utilizing Andrx's
controlled-release technology. During 1995, the terms of the ANCIRC joint
venture agreement were amended whereby the Company and Andrx became equal
partners in the sharing of costs and profits in the ANCIRC joint venture.
Previously, the Company was responsible for 40% of the costs and profits of
ANCIRC. The Company utilizes the equity method to account for this joint venture
and recognized losses from ANCIRC of approximately $1.7 million and $220,000 for
the years ended December 31, 1995 and 1994, respectively.
Combined Results for Unconsolidated Investments in Joint Ventures
The following aggregate financial information is provided for
unconsolidated investments in joint ventures accounted for using the equity
method:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1995 1994 1993
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Net revenues....................................... $107,365 $126,726 $121,202
======== ======== ========
Gross profit....................................... $ 93,748 $109,979 $107,158
======== ======== ========
Net income......................................... $ 41,099 $ 44,409 $ 43,567
======== ======== ========
</TABLE>
F-13
<PAGE> 39
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1995 1994
------- -------
(IN THOUSANDS)
<S> <C> <C>
Current assets................................................... $44,078 $49,473
Other assets..................................................... 7,127 6,516
------- -------
Total assets........................................... $51,205 $55,989
======= =======
Current liabilities.............................................. $18,422 $30,201
Other liabilities................................................ 63 292
Stockholders' equity............................................. 32,720 25,496
------- -------
Total liabilities and stockholders' equity............. $51,205 $55,989
======= =======
</TABLE>
Other Long-Term Investments
Andrx Corporation
Andrx develops advanced controlled-release drug delivery systems and
distributes certain off-patent pharmaceutical products manufactured by others.
On October 30, 1995, the Company invested an additional $15.6 million in Andrx,
bringing its ownership to 19.5% of Andrx's total outstanding common shares. The
Company utilizes the cost method to account for its investment in Andrx.
5. DEBT
In 1994, the Company entered into an agreement with a bank (the "financing
agreement") that provided for several financing facilities. Under the terms of a
facility in this agreement, $5.0 million was borrowed in 1994. A seven-year note
payable was established, with monthly payments due through September 2001.
At December 31, 1995, the facilities available to the Company under the
financing agreement are composed of (i) a $10 million revolving, unsecured
working capital line of credit, (ii) a $6 million revolving, unsecured equipment
loan and (iii) a $10 million non-revolving, unsecured building improvement loan.
The financing agreement provides for a variable interest rate, which would
initially range from the bank's prime rate (8.50% at December 31, 1995) minus
one-eighth of a percent to the bank's prime rate. The Company may elect a fixed
interest rate, which would be based on the bank's short-term base rate plus a
maximum of one and one-eighth percent. The Company must maintain specified
financial ratios and must comply with certain restrictive covenants. At December
31, 1995, the Company was in compliance with all of the ratios and covenants.
The financing agreement expires on June 1, 1996. Except for the note payable
outstanding at December 31, 1995, no borrowings have been made under this
financing agreement.
Long-term debt is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1995 1994
------ ------
(IN THOUSANDS)
<S> <C> <C>
Note payable to bank, unsecured, at a fixed rate of 8.105%, payable
in monthly installments of $78, including interest, due September
2001............................................................. $4,199 $4,770
Mortgage due to bank, repaid on November 30, 1995.................. 562
Mortgage due to Pennsylvania Industrial Development Authority,
repaid
on November 30, 1995............................................. 367
------ ------
4,199 5,699
Less current portion............................................. (622) (641)
------ ------
Long-term debt........................................... $3,577 $5,058
====== ======
</TABLE>
F-14
<PAGE> 40
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1995, annual maturities of long-term debt consist of the
following:
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31, (IN THOUSANDS)
--------------------------------------------------------------------
<S> <C>
1996................................................................ $ 622
1997................................................................ 673
1998................................................................ 730
1999................................................................ 791
2000................................................................ 858
Thereafter.......................................................... 525
------
$4,199
======
</TABLE>
6. PARTNERSHIP WITH RHONE-POULENC RORER, INC. ("RPR")
In 1989, the Company and RPR formed a partnership (the "Partnership") to
develop and market Dilacor XR(R), a pharmaceutical product used in the treatment
of hypertension. Dilacor XR(R) was launched by the Partnership in 1992. At
December 31, 1993, a liability was due to the Partnership of $15.2 million for
the Company's share of development and operating costs. The Partnership
agreement was amended in April 1993, such that after September 1, 1993 the
Company earns a royalty from sales of the branded product, Dilacor XR(R). The
amended agreement also provided that all royalties earned will be used first to
offset the Partnership liability. The royalty rate established for this
agreement was 1% in 1994, 20% in 1995 and 1996, 22% from 1997 to 2000 and 3%
thereafter. Royalties earned in excess of the Partnership liability will be
remitted to the Company on a quarterly basis. In a subsequent amendment,
effective January 1, 1995, it was agreed that royalty income would be determined
by prescriptions written, as defined, for Dilacor XR(R).
For the year ended December 31, 1993, the Company recognized a loss of $7.6
million from the Partnership. For the years ended December 31, 1995 and 1994,
the Company earned royalties of $22.2 million and $1.2 million, respectively and
recorded a royalty receivable of $8.2 million at December 31, 1995.
7. INCOME TAXES
The provision for income taxes is summarized as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1995 1994 1993
------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Taxes currently payable:
Federal............................................ $ 6,623 $ 8,400 $ 4,635
State.............................................. 3,336 2,372 1,010
------- ------- --------
9,959 10,772 5,645
Deferred provision (benefit):
Federal............................................ 7,622 (592) (25,421)
State.............................................. 478 (11) (4,436)
------- ------- --------
8,100 (603) (29,857)
Exercise of stock options not treated as a reduction
of income tax expense.............................. 6,808 659 2,285
------- ------- --------
$24,867 $10,828 $(21,927)
======= ======= ========
</TABLE>
F-15
<PAGE> 41
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The exercise of stock options represents a tax benefit reflected as a
reduction of taxes currently payable, however, it is not treated as a reduction
of income tax expense for financial reporting purposes. Income taxes have been
provided for the possible distribution of approximately $17.0 million of
undistributed earnings related to the Company's investments in joint ventures.
The income tax provision differs from the amount computed by applying the
federal income tax rate to income as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
Expected tax at federal statutory rate...................... 35% 35% 35%
State income tax, net of federal benefit.................... 5 6 6
Research tax credits........................................ (1) (2) (3)
Dividends received deduction................................ (7) (11) (17)
Non-deductible merger expenses.............................. 3
Other....................................................... (1) (4)
Reduction of valuation allowance related to deferred tax
assets.................................................... -- (1) (98)
-- --- ---
34% 23% (77)%
== === ===
</TABLE>
Deferred tax assets and liabilities are measured based on the difference
between the financial statement and tax bases of assets and liabilities at the
applicable enacted tax rates. Deferred tax assets and liabilities are the
results of the following temporary differences:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1995 1994
------- -------
(IN THOUSANDS)
<S> <C> <C>
Benefits from net operating loss carryforwards................. $18,122 $26,562
Difference in accounting for inventory and receivables......... 4,019 2,045
Benefits from tax credits and carryforward credits............. 2,965 3,023
Difference in depreciation for book and tax purposes........... (4,998) (3,394)
Difference in investment basis for book and tax................ (116) 502
Other items.................................................... 2,788 2,257
------- -------
Net deferred tax assets.............................. $22,780 $30,995
======= =======
</TABLE>
The Company had net operating loss ("NOL") carryforwards at December 31,
1995 of approximately $51.0 million for federal and New York state income tax
purposes. During 1995, the Company utilized NOL carryforwards of approximately
$26.3 million and $9.0 million to offset federal and New York state income,
respectively. The utilization of the New York NOL carryforward is generally
limited to the federal NOL carryforward amount. Due to certain income tax
regulations related to the Company's ownership change, the amount of the federal
NOL carryforward available to offset future taxable income is subject to an
annual limitation of approximately $40.0 million. The annual NOL limitation may
be further limited if additional changes in ownership occur. The Company's NOL
carryforwards will begin to expire in 2006. The Company has approximately $1.9
million in federal qualified research credits which expire beginning in 2001 and
approximately $1.7 million in federal alternative minimum tax credits which have
no expiration date. These credits are available to directly offset future
federal income taxes.
F-16
<PAGE> 42
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. STOCKHOLDERS' EQUITY
Preferred stock
In 1992, the Company authorized 2,500,000 shares of no par preferred stock.
The Board of Directors has the authority to fix the rights, preferences,
privileges and restrictions, including dividend rates, conversion and voting
rights, terms and prices of redemptions and liquidation preferences without vote
or action by the stockholders. At December 31, 1995, no preferred stock was
issued.
Warrants
In 1987, the Company issued warrants to purchase shares of the Company's
common stock at $8.48 per share. All of the warrants were exercised prior to
their expiration in September 1994, which resulted in the issuance of 101,203
shares of the Company's common stock.
Stock option plans
The Company has adopted several stock option plans that authorize the
granting of options to employees, directors and/or consultants to purchase the
Company's common stock subject to certain conditions. The options are generally
granted at the fair market value of the shares underlying the options at the
date of the grant, become exercisable over a five year period and expire in ten
years. In conjunction with the merger with Circa, certain stock option plans
were assumed (the "assumed options") by the Company. The assumed options were
adjusted by the exchange ratio as specified in the merger agreement. No
additional options will be granted under any of the assumed options plans.
Activity under the stock option plans during the years ended December 31,
1995, 1994 and 1993 is summarized as follows:
<TABLE>
<CAPTION>
NUMBER OPTION PRICE
OF SHARES PER SHARE
--------- ---------------
<S> <C> <C>
Outstanding at December 31, 1992......................... 1,673,059 $ 0.30 - $30.52
Granted................................................ 204,547 $ 6.69 - $25.00
Exercised.............................................. (357,976) $ 0.30 - $11.05
Canceled............................................... (84,029) $ 5.38 - $30.52
--------- ---------------
Outstanding at December 31, 1993......................... 1,435,601 $ 2.00 - $30.52
Granted................................................ 741,470 $12.65 - $33.00
Exercised.............................................. (30,512) $ 3.67 - $16.50
Canceled............................................... (170,441) $ 6.69 - $30.52
--------- ---------------
Outstanding at December 31, 1994......................... 1,976,118 $ 2.00 - $33.00
Granted................................................ 1,572,698 $18.75 - $47.00
Exercised.............................................. (567,107) $ 2.00 - $49.05
Canceled............................................... (70,524) $14.39 - $37.25
--------- ---------------
Outstanding at December 31, 1995......................... 2,911,185 $ 3.67 - $47.00
========= ===============
Exercisable at December 31, 1995......................... 1,115,664 $ 3.67 - $36.63
========= ===============
</TABLE>
In 1991, the Company issued 330,125 non-statutory options at an exercise
price of $3.67 per share. Through December 31, 1995, 103,299 of these options
were exercised. The remaining 226,826 options are exercisable in 1996.
F-17
<PAGE> 43
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. RELATED PARTIES
The Company leases a portion of its facilities from related parties. The
rent expense is charged to cost of revenues, research and development and
selling, general and administrative expenses. These leases are summarized below:
In 1985, the Company entered into leases for a manufacturing facility and
leasehold improvements with a family trust in which the Chief Executive Officer
and certain family members are beneficiaries for an original term of ten years,
commencing January 1, 1986. The agreement for the leasehold improvements has
expired and the obligation was paid in full at December 31, 1995. The lease for
the manufacturing facility was extended through December 31, 2000, requires
monthly payments of approximately $25,000 and includes a 5% per year escalation
factor.
In 1989, the Company assigned its purchase rights under a lease for office
and manufacturing facilities to a partnership in which the Chief Executive
Officer and certain family members are the general partners. The partnership
purchased the facilities and assumed the lease with the Company. In April 1994,
the Company acquired the manufacturing and office facilities from the family
partnership for a purchase price of $3.6 million which approximated the fair
market value at the time of sale.
The Company's research and development facility in Pennsylvania is leased
from a partnership in which the Chairman of the Board is a partner. The 15 year
lease was entered into on March 1, 1984. Lease payments of approximately
$130,000 were made to the partnership in each of the three years ended December
31, 1995. The Company has the option, at any time during the lease period, to
purchase the building from the partnership for the partnership's cost ($1.2
million) plus the cost of any partnership improvements to the building. The
Company guarantees the partnership's mortgage on the building.
Rent paid to related parties is summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER
31,
----------------------
1995 1994 1993
---- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Cost of revenues..................................... $247 $323 $548
Research and development expenses.................... 154 133 225
Selling, general and administrative expenses......... 31 94 122
---- ---- ----
$432 $550 $895
==== ==== ====
</TABLE>
10. COMMITMENTS AND CONTINGENCIES
Facility and equipment leases
The Company has entered into operating leases for certain of its facilities
and equipment. The terms of the operating leases for the Company's facilities
require the Company to pay property taxes, normal maintenance expenses and
maintain minimum insurance coverage. Total rental expense for operating leases
were approximately $631,000, $1.1 million and $1.3 million for the years ended
December 31, 1995, 1994 and 1993, respectively.
F-18
<PAGE> 44
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1995, future minimum lease payments under all noncancelable
operating leases consist of the following:
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31, (IN THOUSANDS)
--------------------------------------------------------------------
<S> <C>
1996................................................................ $ 642
1997................................................................ 629
1998................................................................ 507
1999................................................................ 320
2000................................................................ 297
------
Total minimum lease payments........................................ $2,395
======
</TABLE>
Employee retirement plan
The Company maintains a 401(k) retirement plan covering substantially all
employees. Monthly contributions are made by the Company based upon the employee
contributions to the plan. The Company contributed approximately $190,000,
$161,000 and $67,000 to the retirement plan for the years ended December 31,
1995, 1994 and 1993, respectively.
Legal matters
The Company is involved in various disputes and litigation matters which
arise in the ordinary course of business. The litigation process is inherently
uncertain and it is possible that the resolution of these disputes and lawsuits
may adversely effect the Company. Management believes, however, that the
ultimate resolution of such matters will not have a material adverse impact on
the Company's financial position or results of operations.
11. SUBSEQUENT EVENT
In March 1996, the Company's wholly-owned subsidiary, Watson
Pharmaceuticals (Asia) Ltd. ("Watson (Asia)") entered into an agreement to form
two joint ventures with China-based Changzhou No. 4 Pharmaceutical Factory
("Changzhou"). The first joint venture, Changzhou Watson Pharmaceuticals Co.
Ltd. ("Joint Venture A") will establish a manufacturing facility in China for
the production, marketing and sales of pharmaceuticals and related products. A
second joint venture will be known as Changzhou Siyao Pharmaceuticals Co. Ltd.
("Joint Venture B"). Joint Venture B will provide the raw materials to Joint
Venture A. The total investment by Watson (Asia) in Joint Ventures A and B is
anticipated to be approximately $9.0 million. Joint Venture A will be 87.5%
owned by Watson (Asia) and 12.5% owned by Changzhou. Joint Venture B will be
owned 25% by Watson (Asia) and 75% by Changzhou.
F-19
<PAGE> 45
WATSON PHARMACEUTICALS, INC.
SCHEDULE II -- VALUATION & QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT CHARGE TO BALANCE AT
BEGINNING COSTS AND DEDUCTIONS/ END OF
OF PERIOD EXPENSES OTHER PERIOD
------------ --------- ----------- ----------
<S> <C> <C> <C> <C>
YEAR END 1995:
Allowance for doubtful accounts............. $ 903 $ 417 $ $1,320
YEAR END 1994:
Allowance for doubtful accounts............. $ 574 $ 579 $ (250) $ 903
YEAR END 1993:
Allowance for doubtful accounts............. $ 121 $ 453 $ $ 574
</TABLE>
F-20
<PAGE> 46
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIALLY
NUMBERED
EXHIBIT NO. DESCRIPTION PAGE
- ----------- ---------------------------------------------------------------------- ------------
<C> <C> <S> <C>
2.1 -- Agreement and Plan of Merger among the Registrant, Gum Acquisition
Corp. and Circa Pharmaceuticals, Inc., filed as Exhibit 2.1 to the
Company's Registration Statement on Form S-4 Reg. No. 33-60211 ("33-
60211") and hereby incorporated by reference.
3.1 -- Articles of Incorporation of the Company and all amendments thereto,
filed as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1995 and hereby incorporated by
reference.
3.2 -- Bylaws of the Company, as amended as of July 18, 1995, filed as
Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1995 and hereby incorporated by reference.
4.1 -- Amendment to loan agreement between the Company, its subsidiaries and
Bank of America NT & SA dated February 26, 1996.
4.2 -- Loan Agreement between the Company, its subsidiaries and Bank of
America NT & SA dated August 19, 1994 filed as Exhibit 4.1 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1994 and hereby incorporated by reference.
10.1 -- Lease between Westgate Associates and the Company dated October 1991
and addendums thereto, filed as Exhibit 10.5 to the Company's
Registration Statement on Form S-1 Reg. No. 33-46229 ("33-46229") and
hereby incorporated by reference.
10.2 -- Industrial Real Estate Lease, as amended, dated August 8, 1995,
between Hsi-Hsiung Hsu Hwa Chao (Chao Family) Trust I and the Company,
filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1995 and hereby incorporated by
reference.
10.3 -- Amended Lease Agreement between Zetachron, Incorporated and Research
Property Associates dated February 1, 1983, filed as Exhibit 10.7 to
33-46229 and hereby incorporated by reference.
10.4 -- Grant of Option to Purchase Real Estate by and between Dr. Alec Keith,
Mr. Wallace C. Snipes and Zetachron, Incorporated dated July 1, 1987,
filed as Exhibit 10.8 to 33-46229 and hereby incorporated by
reference.
*10.5 -- The Company's 1985 Stock Incentive Plan, filed as Exhibit 10.11 to
33-46229 and hereby incorporated by reference.
*10.6 -- 1991 Stock Option Plan of the Company as revised, filed as Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1995 and hereby incorporated by reference.
*10.7 -- 1995 Non-Employee Directors' Stock Option Plan, as amended, filed as
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1995 and hereby incorporated by reference.
10.8 -- Form of the Company's Employee Invention, Confidential Information
Agreement, filed as Exhibit 10.22 to 33-46229 and hereby incorporated
by reference.
10.9 -- Purchase Agreement relating to the Company's purchase of 132 Business
Center Drive property, filed as Exhibit 10.15 to the Company's 1993
Annual Report on Form 10-K and hereby incorporated by reference.
</TABLE>
<PAGE> 47
<TABLE>
<CAPTION>
SEQUENTIALLY
NUMBERED
EXHIBIT NO. DESCRIPTION PAGE
- ----------- ---------------------------------------------------------------------- ------------
<C> <C> <S> <C>
10.10 -- Purchase and Sale Agreement between the Company, its subsidiaries and
AETNA Real Estate Associates dated October 18, 1994 regarding the
acquisition of 311 Bonnie Circle, Corona, California, filed as Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1994 and hereby incorporated by reference.
*10.11 -- Senior Executive Employment Agreement dated as of May 29, 1995 between
the Company and Allen Chao, filed as Exhibit 10.1 to 33-60211 and
hereby incorporated by reference.
*10.12 -- Form of Senior Executive Employment Agreement dated as of May 29, 1995
between the Company and David C. Hsia, filed as Exhibit 10.2 to
33-60211 and hereby incorporated by reference.
*10.13 -- Form of Senior Executive Employment Agreement, dated as of May 29,
1995 between the Company and Alec D. Keith, filed as Exhibit 10.3 to
33-60211 and hereby incorporated by reference.
*10.14 -- Employment Agreement with Dr. Melvin Sharoky dated April 26, 1991 as
amended January 19, 1993 and July 17, 1995, filed as Exhibit 10.3 to
the Company's Quarter Report on Form 10-Q for the quarter ended June
30, 1995 and hereby incorporated by reference.
11.1 -- Statement of computation of per share earnings.
21.1 -- Subsidiaries of the Company.
23.1 -- Consent of Price Waterhouse LLP.
23.2 -- Consent of Deloitte & Touche LLP.
27.1 -- Financial Data Schedule (EDGAR version only)
99.1 -- Consolidated Financial Statements of Somerset Pharmaceuticals, Inc.
and Subsidiaries for the years ended December 31, 1995, 1994 and 1993.
</TABLE>
- ---------------
* Compensation Plan or Agreement
<PAGE> 1
EXHIBIT 4.1
===============================================================================
[BANK OF AMERICA LOGO] AMENDMENT TO DOCUMENTS
- -------------------------------------------------------------------------------
AMENDMENT NO. 3 TO BUSINESS LOAN AGREEMENT
AND
ASSUMPTION AGREEMENT
This Amendment No. 3 to Business Loan Agreement and Assumption
Agreement is entered into as of February 26, 1996, between BANK OF AMERICA
NATIONAL TRUST AND SAVINGS ASSOCIATION ("Bank") and Watson Pharmaceuticals,
Inc., ("WPI"), Watson Laboratories, Inc., ("WLI") ("Initial Borrowers") AND
Circa Pharmaceuticals, Inc. ("CPI") (New "Borrower").
RECITALS
A. WHEREAS, Bank and Initial Borrowers entered into that certain
Business Loan Agreement dated as of June 30, 1994, as previously amended (the
"Agreement"); and
B. WHEREAS, Initial Borrowers, New Borrower and Bank desire to further
amend certain terms and provisions of said Agreement as more specifically
hereinafter set forth; and
C. WHEREAS, New Borrower desires to be a party to and to assume the
obligations under the Agreement jointly and severally with Initial Borrowers
(now, collectively, "Borrowers").
AGREEMENT
NOW, THEREFORE, in consideration of the foregoing recitals, Bank and
Borrowers mutually agree to amend said Agreement as follows:
1. Circa Pharmaceuticals, Inc. unconditionally, jointly and severally
assumes each and every obligation under the Agreement and by its signature
hereto becomes a party to the Agreement.
2. In Paragraph 2.2 of the Agreement, the date "June 1, 1996" is
substituted for the date "June 1, 1995".
3. Paragraph 2.6 (b) of the Agreement is amended to read in its
entirety as follows:
"(b) The Borrowers will repay the principal amount outstanding on
the Facility No. 2 Expiration Date in sixty (60) successive
monthly installments starting July 1, 1996. On June 1, 2002,
the Borrowers will repay the remaining principal balance plus
any interest then due."
4. In Paragraph 4A.2 of the Agreement, the date "June 1, 1996" is
substituted for the date "June 1, 1995".
5. Paragraph 4A.4(b) of the Agreement is amended to read in its
entirety as follows:
"(b) The borrowers will repay each principal amount advanced in
eighty-four (84) successive equal monthly installments
starting on the first day of the month following each advance,
provided, however, that if and to the extent any portion of
outstanding principal should become subject to an interest
rate protection agreement, including an interest rate swap,
the Borrowers will repay such portion in quarterly
installments. On May 1, 2003, the Borrowers will repay the
remaining principal balance plus any interest then due."
- -------------------------------------------------------------------------------
AmendL (10/92) -1- 002947-10036
<PAGE> 2
6. A new subparagraph (h) is added to Paragraph 9.2 of the Agreement,
which reads in its entirety as follows:
"(h) Within 45 days of the period's end, CPI's quarterly financial
statements. These financial statements may be company
prepared."
7. In Paragraph 9.4 of the Agreement, the amount "One Hundred Eighty
Million Dollars ($180,000,000)" is substituted for the amount "Ninety Five
Million Dollars ($95,000,000)".
8. In Paragraph 9.8(e) of the Agreement, the amount "Five Million
Dollars ($5,000,000)" is substituted for the amount "One Million Five Hundred
Thousand Dollars ($1,500,000)".
9. Paragraph 9.10 of the Agreement is amended to read in its entirety
as follows:
"9.10 CAPITAL EXPENDITURES. With respect to all Borrowers on an
aggregate basis, not to spend or incur obligations (including the
total amount of any capital leases) for more than Twenty Six Million
Dollars ($26,000,000) in any single fiscal year to acquire fixed or
capital assets."
10. Paragraph 9.20(c) of the Agreement is amended to read in its
entirety as follows:
"(c) enter into any consolidation, merger, pool, joint venture,
syndicate, or other combination, or acquire or purchase a
business or its assets, except for such transactions not
exceeding an aggregate for all Borrowers of Ten Million
Dollars ($10,000,000) in any one line-year."
11. Paragraph 9.20(f) of the Agreement is amended to read in its
entirety as follows:
"(f) make any loans or advances to or investments in any person or
entity in excess of an aggregate amount at any time exceeding
ten percent (10%) of the Borrowers' tangible net worth at
such time, subject to Borrowers being in compliance with all
other terms and conditions."
Except as provided in this Amendment, all of the terms and
provisions of the Agreement shall remain in full force and effect.
This Amendment shall be effective between the parties as of the
date hereof. The Agreement, as amended hereby, shall hereinafter constitute the
Agreement between the parties
________________________________________________________________________________
AmendL (10/92) -2- 002947-10036
<PAGE> 3
IN WITNESS WHEREOF, this Amendment has been executed by the parties
hereto as of the date first written above.
Bank of America
National Trust and Savings Association Watson Pharmaceuticals, Inc.
x /s/ Curt L. McCombs x /s/ Allen Chao
--------------------------------- ---------------------------------
By: Curt L. McCombs, Vice President By: Allen Chao, Chief
Executive Officer
x /s/ Michel J. Feldman
---------------------------------
By: Michel J. Feldman, Secretary
Watson Laboratories, Inc.
x /s/ Allen Chao
---------------------------------
By: Allen Chao, President
x /s/ Chato Abad
---------------------------------
By: Chato Abad, Vice President of
Finance
Circa Pharmaceuticals, Inc.
x /s/ Melvin Sharoky
---------------------------------
By: Melvin Sharoky, President
x /s/ Michel J. Feldman
---------------------------------
By: Michel J. Feldman, Secretary
- -------------------------------------------------------------------------------
AmendL (10/92) -3- 002947-10036
<PAGE> 4
===============================================================================
[BANK OF AMERICA LOGO] CORPORATE RESOLUTIONS TO OBTAIN CREDIT
- -------------------------------------------------------------------------------
RESOLVED, that this corporation, Circa Pharmaceuticals, Inc., may:
1. borrow money from BANK OF AMERICA NATIONAL TRUST AND SAVINGS
ASSOCIATION ("Bank");
2. obtain for the account of this corporation commercial and standby
letters of credit issued by Bank;
3. obtain for the account of this corporation Bank's acceptance of
drafts and other instruments; and
4. discount with or sell to Bank notes, acceptances, drafts,
receivables and other evidences of indebtedness, and assign or
otherwise transfer to Bank any security interest or lien for such
obligations;
from time to time, in such amount or amounts as in the judgement of the
Authorized Officers (as hereinafter defined) this corporation may require (the
credit facilities described in the first part of this resolution are
collectively referred to herein as the "Credit Facilities"); provided, however,
that the aggregate principal amount outstanding at any one time under the
Credit Facilities authorized by this resolution shall not exceed the sum of
Thirty Four Million Dollars ($34,000,000), which sum shall be in addition to
such other amount or amounts as otherwise may be authorized.
RESOLVED FURTHER, that the Authorized Officers are hereby authorized
and directed, as security for any obligation or obligations of this corporation
to Bank, whether arising pursuant to these Resolutions or otherwise, to grant
in favor of Bank a security interest in or lien on any real or personal
property belonging to or under the control of this corporation.
RESOLVED FURTHER, that
1. If only one signature is obtained, any one of the following:
a.
b.
c.
d.
e.
f.
2. If two signatures are obtained, any one of the following:
a. Melvin Sharoky, President
b. Michel J. Feldman, Secretary
c.
d.
e.
f.
together with any one of the following:
g. Allen Chao, Chairman of the Board
h.
i.
j.
k.
l.
of this corporation, acting individually or in any combination as may be set
forth above (the "Authorized Officers"), are hereby authorized and directed, in
the name of this corporation, to execute and deliver to Bank, and Bank is
requested to accept:
a. the notes, credit agreements, advance account agreements,
acceptance agreements, letter of credit applications and agreements, purchase
agreements or other instruments, agreements and documents which evidence the
obligations of this corporation under the Credit Facilities obtained or to be
obtained pursuant to these resolutions;
b. any and all security agreements, deeds of trust, mortgages,
financing statements, fixture filings or other instruments, agreements and
documents with respect to any security interest or lien authorized to be given
pursuant to these resolutions; and
c. any other instruments, agreements and documents as Bank may require
and the Authorized Officers may approve.
- -------------------------------------------------------------------------------
N-243 11-87 (Reprint 12-87) -1- 002946-10057
<PAGE> 5
- --------------------------------------------------------------------------------
RESOLVED FURTHER, that the Authorized Officers are hereby authorized
and directed, in the name of this corporation, to endorse, assign to Bank, and
deliver to Bank, any and all notes, acceptances, drafts, receivables and other
evidences of indebtedness discounted with or sold to Bank, together with any
security interest or lien for such obligations, and to guarantee the payment of
the same to Bank.
RESOLVED FURTHER, that any and all of the instruments, agreements and
documents referred to above may contain such recitals, covenants, agreements
and other provisions as Bank may require and the Authorized Officers may
approve, and the execution of such instruments, agreements and documents by the
Authorized Officers shall be conclusive evidence of such approval, and that the
Authorized Officers are authorized from time to time to execute renewals or
extensions of any and all such instruments, agreements and documents.
RESOLVED FURTHER, that Bank is authorized to act upon the foregoing
resolutions until written notice of revocation is received by Bank, and that
the authority hereby granted shall apply with equal force and effect to the
successors in office of the Authorized Officers.
CORPORATE SECRETARY'S CERTIFICATE
I, Michel J. Feldman, Secretary of Circa Pharmaceuticals, Inc., a
corporation organized and existing under the laws of the State of New York (the
"Corporation"), hereby certify that the foregoing is a full, true and correct
copy of resolutions of the Board of Directors of the Corporation, duly and
regularly adopted by the Board of Directors of the Corporation in all respects
as required by law and the by-laws of the Corporation on February 26, by the
unanimous consent in writing of all members of the Board of Directors of the
Corporation to the adoption of said resolutions.
I further certify that said resolutions are still in full force and
effect and have not been amended or revoked, and that the specimen signatures
appearing below are the signatures of the officers authorized to sign for the
Corporation by virtue of such resolutions.
IN WITNESS WHEREOF, I have hereunto set my hand as Secretary of the
Corporation, and affixed the corporate seal of the Corporation, on February 26,
1996.
AUTHORIZED SIGNATURES:
x /s/ Melvin Sharoky x /s/ Michel J. Feldman
- --------------------------------- --------------------------------
Melvin Sharoky, President Michel J. Feldman, Secretary of
Circa Pharmaceuticals, Inc.
x /s/ Michel J. Feldman New York Corporation
- ---------------------------------
Michel J. Feldman, Secretary
x /s/ Allen Chao Affix Corporate Seal Here.
- ---------------------------------
Allen Chao, Chairman of the Board
x
- ---------------------------------
x
- ---------------------------------
x
- ---------------------------------
- --------------------------------------------------------------------------------
N-243 11-87 (Reprint 12-87) -2- 002946-10057
<PAGE> 1
Exhibit 11.1
Watson Pharmaceuticals, Inc.
Statement of Computation of Per Share Earnings
(in thousands)
<TABLE>
<CAPTION>
1995 1994 1993
------- ------- -------
<S> <C> <C> <C>
Net income $47,890 $36,545 $50,417
======= ======= =======
Common stock:
Shares outstanding from
beginning of period 35,783 35,549 32,016
Pro rata shares:
Sales of stock 2,274
Exercise of stock
options & warrants 261 109 141
Assumed exercise of stock
options using treasury
stock method 1,099 851 1,168
Shares issued to employees 12 288
Cancellation of shares
issued to employees (6) (383)
------- ------- -------
Weighted average number of
common and common
equivalent shares
outstanding 37,143 36,515 35,504
======= ======= =======
Earnings per share $ 1.29 $ 1.00 $ 1.42
======= ======= =======
</TABLE>
<PAGE> 1
Exhibit 21.1
Watson Pharmaceuticals, Inc.
Subsidiaries of the Company
<TABLE>
<S> <C>
Name Country or State of Incorporation
- ---- ---------------------------------
Watson Laboratories, Inc. Nevada
Watson Pharmaceuticals (Asia) Ltd. British Virgin Islands
Corona Pharmaceuticals, Inc. Nevada
Circa Pharmaceuticals, Inc. New York
</TABLE>
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (No. 33-70878 and No. 33-94350) of Watson
Pharmaceuticals, Inc. of our report dated February 5, 1996, except as to Note
11, which is as of March 4, 1996, appearing on page F-2 of the Annual Report
on Form 10-K for the year ended December 31, 1995.
PRICE WATERHOUSE LLP
Costa Mesa, California
March 27, 1996
<PAGE> 1
Exhibit 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
33-70878 and No. 33-94350 of Watson Pharmaceuticals, Inc. on Form S-8 of our
report dated February 2, 1996 (relating to the consolidated financial
statements of Somerset Pharmaceuticals, Inc. and Subsidiaries) appearing in
this Annual Report on Form 10-K of Watson Pharmaceuticals, Inc. for the year
ended December 31, 1995.
Deloitte & Touche LLP
Pittsburgh Pennsylvania
March 25, 1996
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> DEC-31-1995
<CASH> 92,214
<SECURITIES> 26,038
<RECEIVABLES> 33,286
<ALLOWANCES> 1,320
<INVENTORY> 22,637
<CURRENT-ASSETS> 197,634
<PP&E> 102,646
<DEPRECIATION> 32,647
<TOTAL-ASSETS> 322,121
<CURRENT-LIABILITIES> 28,822
<BONDS> 0
0
0
<COMMON> 120
<OTHER-SE> 288,915
<TOTAL-LIABILITY-AND-EQUITY> 322,121
<SALES> 130,688
<TOTAL-REVENUES> 152,935
<CGS> 64,996
<TOTAL-COSTS> 100,599
<OTHER-EXPENSES> (20,421)
<LOSS-PROVISION> 417
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 72,757
<INCOME-TAX> 24,867
<INCOME-CONTINUING> 47,890
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 47,890
<EPS-PRIMARY> 1.29
<EPS-DILUTED> 1.29
</TABLE>
<PAGE> 1
EXHIBIT 99.1
[DELOITTE & TOUCHE LLP LOGO]
________________________________________________________________________________
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS FOR THE
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993, AND
INDEPENDENT AUDITORS' REPORT
________________________________________________________________________________
[DELOITTE TOUCHE
TOHMATSU
INTERNATIONAL
LOGO]
<PAGE> 2
[DELOITTE & TOUCHE LLP LOGO & LETTERHEAD]
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Somerset Pharmaceuticals, Inc.:
We have audited the accompanying consolidated balance sheets of Somerset
Pharmaceuticals, Inc. and subsidiaries as of December 31, 1995 and 1994, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Somerset Pharmaceuticals, Inc. and
subsidiaries as of December 31, 1995 and 1994, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
- -----------------------------
February 2, 1996
[DELOITTE TOUCHE
TOHMATSU
INTERNATIONAL
LOGO]
<PAGE> 3
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1995 AND 1994
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1995 1994
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $21,315,000 $17,529,000
Investment securities 180,000 3,338,000
Accounts receivable (net of allowance
for doubtful accounts of $100,000) 13,875,000 20,653,000
Inventories 6,551,000 5,293,000
Prepaid expenses and other current assets 2,072,000 1,957,000
----------- -----------
Total current assets 43,993,000 48,770,000
PROPERTY AND EQUIPMENT - Net 5,496,000 4,266,000
INTANGIBLE ASSETS - Net 1,451,000 1,644,000
OTHER ASSETS 180,000 470,000
----------- -----------
$51,120,000 $55,150,000
=========== ===========
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY 1995 1994
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable $ 1,512,000 $ 292,000
Accrued marketing costs - 11,000,000
Royalty payable 4,676,000 5,850,000
Medicaid payable 1,004,000 837,000
Other accrued expenses 1,479,000 1,996,000
Accrued research and development 1,921,000 1,901,000
Income taxes payable 4,390,000 5,017,000
Amounts due to related parties 2,075,000 2,318,000
----------- -----------
Total current liabilities 17,057,000 29,211,000
DEFERRED REVENUE 63,000 292,000
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 13,719
shares authorized, 11,297 shares issued - -
Retained earnings 34,452,000 26,099,000
Less treasury stock, 644 shares at cost (452,000) (452,000)
----------- -----------
Total stockholders' equity 34,000,000 25,647,000
----------- -----------
$51,120,000 $55,150,000
=========== ===========
</TABLE>
See notes to consolidated financial statements.
-2-
<PAGE> 4
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1995 1994 1993
<S> <C> <C> <C>
NET SALES $107,365,000 $124,566,000 $118,998,000
------------ ------------ ------------
COSTS AND EXPENSES:
Cost of sales 13,617,000 16,399,000 13,991,000
Marketing 4,862,000 23,457,000 25,826,000
Research and development 17,904,000 10,424,000 9,134,000
Administrative 8,601,000 9,845,000 8,005,000
------------ ------------ ------------
44,984,000 60,125,000 56,956,000
------------ ------------ ------------
62,381,000 64,441,000 62,042,000
OTHER INCOME 2,172,000 568,000 1,131,000
------------ ------------ ------------
INCOME BEFORE INCOME TAXES 64,553,000 65,009,000 63,173,000
PROVISION FOR INCOME TAXES 20,200,000 20,900,000 21,408,000
------------ ------------ ------------
NET INCOME $ 44,353,000 $ 44,109,000 $ 41,765,000
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
-3-
<PAGE> 5
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON STOCK TREASURY STOCK RETAINED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT EARNINGS EQUITY
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1992 11,297 $ -- 644 $(452,000) $ 2,640,000 $ 2,188,000
Accretion of the carrying value of the
redeemable preferred stock -- -- -- -- (15,000) (15,000)
Net income -- -- -- -- 41,765,000 41,765,000
Dividends -- -- -- -- (26,400,000) (26,400,000)
------ ----- --- --------- ------------ ------------
BALANCE, DECEMBER 31, 1993 11,297 -- 644 (452,000) 17,990,000 17,538,000
Net income -- -- -- -- 44,109,000 44,109,000
Dividends -- -- -- -- (36,000,000) (36,000,000)
------ ----- --- --------- ------------ ------------
BALANCE, DECEMBER 31, 1994 11,297 -- 644 (452,000) 26,099,000 25,647,000
Net income -- -- -- -- 44,353,000 44,353,000
Dividends -- -- -- -- (36,000,000) (36,000,000)
------ ----- --- --------- ------------ ------------
BALANCE, DECEMBER 31, 1995 11,297 $ -- 644 $(452,000) $ 34,452,000 $ 34,000,000
====== ===== === ========= ============ ============
</TABLE>
See notes to consolidated financial statements.
-4-
<PAGE> 6
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1995 1994 1993
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 44,353,000 $ 44,109,000 $ 41,765,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 847,000 587,000 285,000
Deferred tax expense (benefit) 283,000 862,000 (800,000)
Deferred revenue (229,000) (166,000) (167,000)
Changes in operating assets and liabilities:
Accounts receivable 6,778,000 (4,558,000) (1,872,000)
Inventories (1,258,000) (1,473,000) (1,578,000)
Prepaid expenses and other current assets (398,000) (375,000) 352,000
Accounts payable 1,220,000 87,000 (227,000)
Royalty payable (1,174,000) 1,070,000 190,000
Accrued marketing costs (11,000,000) 1,900,000 1,386,000
Accrued research and development 20,000 (145,000) 981,000
Other accrued expenses (350,000) 763,000 201,000
Income taxes payable (627,000) 2,117,000 570,000
Amounts due to related parties (243,000) 255,000 278,000
------------ ------------ ------------
Net cash provided by operating activities 38,222,000 45,033,000 41,364,000
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease in investment securities 3,158,000 132,000 2,006,000
Purchase of property and equipment (1,884,000) (1,898,000) (2,690,000)
Decrease (increase) in other assets 290,000 234,000 (268,000)
------------ ------------ ------------
Net cash provided by (used in) investing activities 1,564,000 (1,532,000) (952,000)
------------ ------------ ------------
</TABLE>
(Continued)
-5-
<PAGE> 7
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1995 1994 1993
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Redemption of preferred stock $ -- $ -- $ (1,149,000)
Dividends paid on preferred stock -- -- (176,000)
Dividends paid on common stock (36,000,000) (36,000,000) (35,200,000)
Net (decrease) increase in note payable -- (253,000) 253,000
------------ ------------ ------------
Net cash used in financing activities (36,000,000) (36,253,000) (36,272,000)
------------ ------------ ------------
NET INCREASE IN CASH AND CASH
EQUIVALENTS 3,786,000 7,248,000 4,140,000
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 17,529,000 10,281,000 6,141,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 21,315,000 $ 17,529,000 $ 10,281,000
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ -- $ 7,000 $ 5,000
============ ============ ============
Income taxes $ 22,074,000 $ 17,683,000 $ 21,259,000
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
-6-
<PAGE> 8
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
- --------------------------------------------------------------------------------
1. PRINCIPLES OF CONSOLIDATION AND OPERATIONS
The consolidated financial statements include the accounts of Somerset
Pharmaceuticals, Inc. (the "Company") and its wholly owned subsidiaries,
Somerset Pharmaceuticals Holding Company and Somerset Caribe, Inc. The
Company is jointly owned by Mylan Laboratories, Inc. and Watson
Pharmaceuticals, Inc., with each owning 50% of the outstanding common
stock of the Company. All significant intercompany accounts and
transactions have been eliminated in consolidation. The Company,
incorporated in February 1986, is engaged in the development, testing
and marketing of drugs to be used in the treatment of various human
disorders. Currently, the Company manufactures (at its plant in Puerto
Rico), markets and sells Eldepryl, which is used as a treatment for
Parkinson's Disease. The Company has exclusivity relating to the
chemical compound Eldepryl, for use as a treatment for late stage
Parkinson's Disease through June of 1996.
The Company is party to an exclusive 14-year agreement (through November
22, 2003) with Chinoin Pharmaceutical Company ("Chinoin") of Budapest,
Hungary under which Eldepryl and other new potential drugs resulting
from Chinoin research are made available for licensing by the Company.
The license agreement requires the Company to pay royalties equal to 7%
of net sales of Eldepryl including sub-license revenues. The Company
incurred royalty expense of approximately $8,473,000, $9,983,000 and
$8,383,000 for the years ended December 31, 1995, 1994 and 1993,
respectively.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Cash and Cash Equivalents - The Company generally considers debt
instruments purchased with a maturity of three months or less and
investments in money market accounts to be cash equivalents.
b. Investment Securities - Effective January 1, 1994, the Company
adopted Statement of Financial Accounting Standards ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity
Securities." The effect of adopting SFAS No. 115 on the Company's
financial statements was not material. Gross proceeds from sales
and maturities of investments approximated $4,898,000 and $70,000
in 1995, and $797,000 and $750,000 in 1994, respectively, and
realized gains or losses were not material. At December 31, 1995
and 1994, the investment securities were available-for-sale, and
there were no material unrealized gains or losses.
c. Inventories - Inventories are stated at the lower-of-cost or
market, with cost determined on a first-in, first-out basis.
d. Property and Equipment - Property and equipment are stated at
cost. Depreciation is provided over the estimated useful lives of
the assets by the straight-line method. Estimated useful lives
are five to seven years for machinery and equipment and furniture
and fixtures and 35 years for the building.
e. Intangible Assets - Intangible assets are amortized on a
straight-line basis over 14 years.
-7-
<PAGE> 9
f. Research and Development - Research and development costs are
expensed as incurred.
g. Concentration of Credit Risk - The Company's product is sold
throughout the United States. The Company performs ongoing credit
evaluation of its customers financial condition and generally
requires no collateral from its customers.
h. Use of Estimates in the Preparation of Financial Statements - The
preparation of financial statements in conformity with generally
accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets
and liabilities at the date of the financial statements, as well
as the reported amounts of income and expenses during the
reporting period.
3. INVENTORY
Inventory consists of the following at December 31, 1995 and 1994:
<TABLE>
<CAPTION>
1995 1994
<S> <C> <C>
Raw material $ 5,091,000 $ 4,686,000
Work in process 163,000 375,000
Finished goods 1,297,000 232,000
------------- -------------
Total $ 6,551,000 $ 5,293,000
============= =============
</TABLE>
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31, 1995 and
1994:
<TABLE>
<CAPTION>
1995 1994
<S> <C> <C>
Land $ 300,000 $ 300,000
Building 2,255,000 2,067,000
Machinery and equipment 4,048,000 2,410,000
Furniture and fixtures 146,000 87,000
------------- -------------
6,749,000 4,864,000
Less accumulated depreciation 1,253,000 598,000
------------- -------------
Property and equipment - net $ 5,496,000 $ 4,266,000
============= =============
</TABLE>
5. SUB-LICENSE OF RIGHTS
On February 9, 1988, the Company granted a sub-license to its exclusive
right and license to use its technology to Draxis Health Inc. (formerly
Deprenyl Research Limited) to commercialize certain drugs in Canada for
15 years. The Company receives a royalty of 11% of Draxis Health Inc.'s
net sales over the license period.
-8-
<PAGE> 10
Royalty income, less related royalty expense to Chinoin, included in
other income for the years ended December 31, 1995, 1994 and 1993 was
approximately $197,000, $199,000 and $357,000, respectively.
6. INTANGIBLE ASSETS
Intangible assets primarily represent the cost of a modification to the
terms of the Chinoin Agreement, less accumulated amortization of
$1,254,000 and $1,061,000 at December 31, 1995 and 1994, respectively.
7. CO-PROMOTIONAL AGREEMENT
Effective October 1, 1990, the Company entered into an agreement with
Sandoz Pharmaceuticals Corporation ("Sandoz") to co-promote the product
Eldepryl. Under the terms of the agreement, the Company is required to
make certain payments to Sandoz in the event sales of Eldepryl exceed
certain predefined minimums. The agreement requires Sandoz, among other
things, to expend, at a minimum, a predetermined amount for advertising
during each year of the agreement. Once the predetermined levels of
sales are exceeded, the Company is required to pay Sandoz for
advertising expenditures made on behalf of the Company. After Sandoz's
advertising expenses are reimbursed, any additional amounts are shared
by Sandoz and the Company based upon the terms of the agreement.
In December 1994, the Company amended its co-promotional agreement with
Sandoz. The amended agreement eliminated certain residual period
payments to Sandoz, shortened the term to March 31, 1996, eliminated
certain sales force detail requirements and requires certain payments to
be made to the Company if a predetermined level of sales is not
achieved.
During 1995 the Company entered into an agreement with CoCensys, Inc.
for the promotion of Elderpryl. The agreement is effective January 1,
1996 and has an initial term of two years and is renewable annually
thereafter. Under the terms of the agreement, the Company will
compensate CoCensys, Inc. based on a predetermined formula that
considers both the number of new prescriptions written and the net sales
dollars in each quarter.
During 1995, 1994 and 1993, the Company expensed $5,304,000, $22,360,000
and $24,260,000, respectively, pursuant to the agreement. Additionally,
certain co-promotional fees paid by Sandoz at the commencement of the
agreement are being recognized ratably by the Company during the term of
the agreement (six years, expiring on March 31, 1996), and certain costs
associated with the procurement, negotiation and execution of the
agreement by the owners of the Company are being incurred by the Company
in approximately the same amount.
-9-
<PAGE> 11
8. INCOME TAXES
The income tax provision consists of the following for the years ended
December 31, 1995, 1994 and 1993:
<TABLE>
<CAPTION>
1995 1994 1993
<S> <C> <C> <C>
Current tax expense:
Federal $ 15,625,000 $ 15,025,000 $ 17,938,000
State 4,177,000 4,899,000 4,124,000
Foreign 115,000 114,000 146,000
------------- ------------- -------------
19,917,000 20,038,000 22,208,000
------------- ------------- -------------
Deferred tax expense (benefit):
Federal 256,000 754,000 (700,000)
State 27,000 108,000 (100,000)
------------- ------------- -------------
283,000 862,000 (800,000)
------------- ------------- -------------
Total provision for income taxes $ 20,200,000 $ 20,900,000 $ 21,408,000
============= ============= =============
</TABLE>
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes. The tax effects of significant items comprising the Company's
deferred taxes (which are included in "Other Assets" in the balance
sheet) as of December 31, 1995 and 1994 are as follows:
<TABLE>
<CAPTION>
1995 1994
<S> <C> <C>
Deferred tax assets:
Deferred revenue $ 23,000 $ 110,000
Deferred compensation 122,000 228,000
Chargeback allowance 148,000 152,000
Other 37,000 42,000
------------- -------------
330,000 532,000
Deferred tax liabilities - excess of tax amortization
over reporting amortization 246,000 165,000
------------- -------------
Net deferred tax assets $ 84,000 $ 367,000
============= =============
</TABLE>
-10-
<PAGE> 12
The statutory federal income tax rate is reconciled to the effective tax
rate as follows for the years ended December 31, 1995, 1994 and 1993:
<TABLE>
<CAPTION>
1995 1994 1993
<S> <C> <C> <C>
Tax at statutory rate 35.0% 35.0% 35.0%
State income tax (net of federal benefit) 2.8 3.5 4.1
Tax credits (9.4) (9.9) (7.2)
Tollgate tax 3.9 3.9 2.0
Other (1.0) (.4) --
---- ---- ----
Effective tax rate 31.3% 32.1% 33.9%
==== ==== ====
</TABLE>
Tax credits result principally from operations in Puerto Rico.
9. RELATED PARTY TRANSACTIONS
The Company incurs expenses for ongoing management services and over a
six year period for specific services related to the procurement,
negotiation and execution of the original co-promotion agreement by the
owners of the Company. The Company also incurs other expenses from one
or both of its owners as detailed below for the years ended December 31,
1995, 1994 and 1993:
<TABLE>
<CAPTION>
1995 1994 1993
<S> <C> <C> <C>
Management fees $5,370,000 $6,228,000 $5,950,000
Research and development -- 1,020,000 835,000
Inventory handling and distribution fees 415,000 650,000 750,000
Rent - equipment and facilities 1,416,000 1,065,000 647,000
Product liability insurance -- 618,000 675,000
Purchase of raw materials 450,000 -- --
</TABLE>
10. SIGNIFICANT CUSTOMERS
The Company had sales to certain customers which individually exceeded
10% of sales. In 1995 sales to four major customers were $23,986,000,
$23,467,000, $15,733,000 and $13,111,000, respectively. In 1994 sales to
three major customers were of $30,090,000, $23,479,000 and $17,991,000,
respectively. In 1993 sales to three customers were $28,993,000,
$27,181,000 and $16,974,000, respectively.
11. EMPLOYEE BENEFIT PLANS
The Company has a defined contribution profit sharing plan covering
substantially all employees. Contributions are made at the discretion of
the Board of Directors. Additionally, during 1994, the Company initiated
a deferred compensation plan for certain key employees. Contributions
are based on profitability levels for the year. During 1995, 1994 and
1993, the Company recorded expense of $83,000, $755,000 and $100,000 for
these plans, respectively.
* * * * * *
-11-
