<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 13, 1997.
REGISTRATION NO. 333-20029
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
PRE-EFFECTIVE AMENDMENT
NO. 4 TO
FORM S-4
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
---------------------
WATSON PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
NEVADA 2834 95-3872914
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code) Identification No.)
</TABLE>
311 BONNIE CIRCLE
CORONA, CALIFORNIA 91720
(909) 270-1400
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)
---------------------
ALLEN CHAO, PH.D.
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
311 BONNIE CIRCLE
CORONA, CALIFORNIA 91720
(909) 270-1400
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
COPIES TO:
<TABLE>
<C> <C>
MICHEL J. FELDMAN, ESQ. PHILIP B. SCHWARTZ, ESQ.
ARTHUR DON, ESQ. AKERMAN, SENTERFITT & EIDSON, P.A.
D'ANCONA & PFLAUM ONE S.E. THIRD AVENUE
30 NORTH LASALLE STREET 28TH FLOOR
CHICAGO, IL 60602 MIAMI, FL 33131
</TABLE>
---------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon
as practicable after the effective date of this Registration Statement and the
effective time of the proposed merger (the "Merger") of Royce Laboratories, Inc.
("Royce") with a subsidiary of the registrant, as described in the Agreement and
Plan of Merger, dated as of December 24, 1996, as amended effective as of March
4, 1997, attached as Annex A to the Proxy Statement/Prospectus forming a part of
this Registration Statement.
If any of the securities being registered on this Form are to be offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. [ ]
---------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
ROYCE LABORATORIES, INC.
5350 N.W. 165TH STREET
MIAMI, FLORIDA 33014
(305) 624-1500
March 17, 1997
Dear Fellow Shareholders:
You are cordially invited to attend a Special Meeting of the Shareholders
of Royce Laboratories, Inc. ("Royce" or the "Company") to be held on the 16th
day of April, 1997 at 11:00 a.m. Miami time at Don Shula's Hotel & Golf Club,
Miami Lakes Drive, Miami Lakes, Florida.
At the Special Meeting, holders of the Company's outstanding common stock,
$.005 par value per share (the "Royce Common Stock"), will be asked to consider
and vote upon a proposal to approve an Agreement and Plan of Merger, as amended
effective as of March 4, 1997 (the "Merger Agreement"), among Watson
Pharmaceuticals, Inc., ("Watson"), Dolphins Acquisition Corp., a wholly-owned
subsidiary of Watson, and the Company, with respect to the merger of Dolphins
Acquisition Corp. with and into the Company, as provided for in the Merger
Agreement (the "Merger"), and to approve the Merger.
Under the terms of the Merger Agreement, Watson will issue at the closing
of the Merger to the holders of each share of Royce Common Stock, the number of
shares of Watson common stock, $.0033 par value per share ("Watson Common
Stock"), equal to $7.25 divided by the average closing price (the "Average
Closing Price") of a share of Watson Common Stock for the ten consecutive
trading days ending on the trading day immediately preceding the effective date
of the Merger (the "Effective Date"), subject to a $38.00 and $47.00 collar (the
"Exchange Ratio"), all as more particularly described in the accompanying Notice
of Special Meeting of Shareholders and Proxy Statement/Prospectus. Based upon
the maximum Average Closing Price of $47.00 and the minimum Average Closing
Price of $38.00, and the number of shares of Royce Common Stock and options and
warrants to purchase shares of Royce Common Stock outstanding on February 27,
1997, (a) the maximum and minimum number of shares of Watson Common Stock which
can be issued in connection with the Merger is 2,580,738 and 2,086,439,
respectively, which excludes between 392,964 and 317,698 shares of Watson Common
Stock, respectively, which will be issued upon the exercise of outstanding
options and warrants to purchase shares of Royce Common Stock, and (b) the
Exchange Ratio may be as high as 0.191 or as low as 0.154. Based on 13,525,879
shares of Royce Common Stock issued and outstanding on February 27, 1997,
options and warrants to purchase 2,059,558 shares of Royce Common Stock
outstanding on February 27, 1997 and assuming that the Average Closing Price is
$43.50 (the last closing price of Watson Common Stock on February 27, 1997),
Watson will issue 0.167 of a share of Watson Common Stock for each share of
Royce Common Stock, or an aggregate of 2,254,313 shares of Watson Common Stock
to the holders of all outstanding shares of Royce Common Stock upon the closing
of the Merger, which excludes 343,260 shares of Watson Common Stock to be issued
upon the exercise of the outstanding options and warrants to purchase shares of
Royce Common Stock. Cash will be issued in lieu of fractional shares of Watson
Common Stock.
Gruntal & Co. Incorporated ("Gruntal"), Royce's financial advisor, has
rendered an opinion that the terms of the Merger are fair, from a financial
point of view, to the holders of Royce Common Stock. A copy of such opinion,
which includes certain assumptions made and limitations on the review undertaken
by Gruntal, appears as Annex B to the Proxy Statement/Prospectus.
You should read carefully the accompanying Notice of Special Meeting of
Shareholders and the Proxy Statement/Prospectus for details of the Merger and
for additional related information.
THE BOARD OF DIRECTORS OF ROYCE HAS UNANIMOUSLY ADOPTED THE MERGER
AGREEMENT, DETERMINED THAT THE MERGER IS IN THE BEST INTERESTS OF ROYCE AND ITS
SHAREHOLDERS, AND RECOMMENDS THAT THE SHAREHOLDERS OF ROYCE VOTE FOR THE
APPROVAL OF THE MERGER AGREEMENT.
<PAGE> 3
The affirmative vote of the holders of a majority of the outstanding Royce
Common Stock is necessary to approve the Merger Agreement.
I look forward to meeting with those shareholders who are able to be
present at the Special Meeting; however, whether or not you plan to attend the
Special Meeting, please complete, sign and date the enclosed proxy card and
return it promptly in the enclosed postage-paid envelope. If you attend the
Special Meeting, you may vote in person if you wish, even though you have
previously returned your proxy card. Your prompt cooperation will be greatly
appreciated.
Please do not send your stock certificates with your proxy card. If the
Merger Agreement is approved by the Company's shareholders and the Merger is
consummated, you will receive a transmittal form and instructions for the
surrender and exchange of your shares.
Thank you for your cooperation.
Sincerely,
Patrick J. McEnany
Chairman, President and Chief
Executive Officer
PLEASE COMPLETE, SIGN, DATE AND RETURN THE ENCLOSED PROXY CARD.
2
<PAGE> 4
ROYCE LABORATORIES, INC.
5350 N.W. 165TH STREET
MIAMI, FLORIDA 33014
(305) 624-1500
---------------------
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
APRIL 16, 1997
---------------------
TO THE SHAREHOLDERS OF ROYCE LABORATORIES, INC.:
NOTICE IS HEREBY GIVEN that a Special Meeting of the shareholders (the
"Meeting") of Royce Laboratories, Inc., a Florida corporation (the "Company"),
will be held on April 16, 1997, at 11:00 a.m., Miami time, at Don Shula's Hotel
& Golf Club, Miami Lakes Drive, Miami Lakes, Florida for the following purposes:
1. To consider and vote upon a proposal to approve and adopt an
Agreement and Plan of Merger, dated as of December 24, 1996, as amended
effective as of March 4, 1997, among Watson Pharmaceuticals, Inc., a Nevada
corporation ("Watson"), Dolphins Acquisition Corp., a Florida corporation
and a wholly-owned subsidiary of Watson established for purposes of the
Merger (the "Sub"), and the Company, and the Plan of Merger annexed thereto
(collectively, the "Merger Agreement") and to approve the Merger, as
described more completely in the accompanying Proxy Statement/Prospectus
and in the Merger Agreement which is annexed thereto as Annex A.
2. To transact such other business as may properly come before the
Special Meeting or at any adjournments or postponements thereof.
Pursuant to the Company's Bylaws, the Board of Directors has fixed the
close of business on February 27, 1997, as the record date for the determination
of shareholders entitled to notice of and to vote at the Meeting and at any
adjournments or postponements thereof.
The affirmative vote of the holders of a majority of the outstanding shares
of the Company's common stock, $.005 par value per share ("Royce Common Stock"),
is necessary to approve and adopt the Merger Agreement and approve the Merger.
Holders of the Royce Common Stock will not be entitled to dissenters'
rights as a result of the Merger. Under Florida law, dissenters' rights are
unavailable to the holders of the Royce Common Stock because, on the Record
Date, there were more than 2,000 holders of record of the Royce Common Stock.
IT IS IMPORTANT THAT PROXIES BE RETURNED PROMPTLY. THEREFORE, WHETHER OR
NOT YOU PLAN TO BE PRESENT AT THE MEETING, PLEASE SIGN AND DATE THE ENCLOSED
PROXY AND RETURN IT IN THE ENCLOSED ENVELOPE, WHICH DOES NOT REQUIRE POSTAGE IF
MAILED IN THE UNITED STATES. YOUR PROXY MAY BE REVOKED AT ANY TIME BEFORE IT IS
VOTED BY SIGNING AND RETURNING A LATER DATED PROXY WITH RESPECT TO THE SAME
SHARES, BY FILING WITH THE SECRETARY OF THE COMPANY A WRITTEN REVOCATION BEARING
A LATER DATE OR BY ATTENDING AND VOTING AT THE SPECIAL MEETING.
BY ORDER OF THE BOARD OF DIRECTORS,
Richard W. Gross,
Secretary
Miami, Florida
March 17, 1997
<PAGE> 5
PROXY STATEMENT
ROYCE LABORATORIES, INC.
---------------------
PROSPECTUS
WATSON PHARMACEUTICALS, INC.
This Proxy Statement/Prospectus (the "Proxy Statement/Prospectus") is being
furnished to shareholders of Royce Laboratories, Inc., a Florida corporation
(the "Company" or "Royce"), in connection with the solicitation of proxies
("Proxy" or "Proxies") by the Board of Directors of the Company for use in
connection with the Special Meeting of Shareholders of the Company to be held on
April 16, 1997 and any adjournments or postponements thereof (the "Meeting").
At the Meeting, the Company's shareholders will consider and vote upon a
proposal to approve and adopt an Agreement and Plan of Merger, dated as of
December 24, 1996, as amended effective as of March 4, 1997, by and among Watson
Pharmaceuticals, Inc., a Nevada corporation ("Watson"), Dolphins Acquisition
Corp., a Florida corporation and a wholly-owned subsidiary of Watson established
for purposes of the Merger (the "Sub"), and the Company, and the Plan of Merger
annexed thereto (collectively the "Merger Agreement") and to approve the Merger.
Pursuant to the merger contemplated by the Merger Agreement (the "Merger"), the
Sub is to be merged with and into the Company, and the Company is to become a
wholly-owned subsidiary of Watson. The manner and basis of converting shares of
Royce common stock, $.005 par value per share ("Royce Common Stock"), into
shares of Watson common stock, $.0033 par value per share ("Watson Common
Stock"), are described more fully below and are set forth in the Merger
Agreement which is attached hereto as Annex A.
The Average Closing Price for purposes of calculation of the Exchange Ratio
is subject to a collar (the "Collar"). Based upon the maximum Average Closing
Price (as defined herein) of $47.00 and the minimum Average Closing Price of
$38.00, and the number of shares of Royce Common Stock and options and warrants
to purchase shares of Royce Common Stock outstanding on February 27, 1997, (a)
the maximum and minimum number of shares of Watson Common Stock which can be
issued in connection with the Merger is 2,580,738 and 2,086,439 respectively,
which excludes between 392,964 and 317,698 shares of Watson Common Stock,
respectively, which will be issued upon the exercise of outstanding options and
warrants to purchase shares of Royce Common Stock, and (b) the Exchange Ratio
(as defined herein) may be as high as 0.191 or as low as 0.154. Based on
13,525,879 shares of Royce Common Stock issued and outstanding on February 27,
1997, options and warrants to purchase 2,059,558 shares of Royce Common Stock
outstanding on February 27, 1997 and assuming the Average Closing Price is
$43.50 (the last closing price of the Watson Common Stock on February 27, 1997),
Watson will issue 0.167 of a share of Watson Common Stock for each share of
Royce Common Stock or an aggregate of 2,254,313 shares of Watson Common Stock to
the holders of all outstanding shares of Royce Common Stock upon the closing of
the Merger, which excludes 343,260 shares of Watson Common Stock to be issued
upon the exercise of outstanding options and warrants to purchase shares of
Royce Common Stock. Cash will be issued in lieu of fractional shares of Watson
Common Stock. The Exchange Ratio provides for the conversion of each share of
Royce Common Stock into the right to receive the number of shares of Watson
Common Stock equal to the following: $7.25 divided by the Average Closing Price.
The value of the shares received will depend upon the actual market price of the
Watson Common Stock. The effect of the Collar will be to limit the maximum and
minimum number of shares that will be issuable to Royce shareholders. All
options and warrants to acquire Royce Common Stock at the Effective Time will
remain outstanding after the Effective Time. Each such option or warrant shall
be exercisable upon the same terms and conditions in their respective option or
warrant agreement, except that (x) the unexercised portion of each such option
or warrant will be exercisable into the number of shares of Watson Common Stock
(rounded to the nearest whole share, with 0.5 rounded upward) equal to the
number of shares of Royce Common Stock subject to such unexercised portion
multiplied by the Exchange Ratio; and (y) the exercise price per share of Watson
Common Stock will be equal to the applicable exercise price per share of Royce
Common Stock subject to such option or warrant divided by the Exchange Ratio
(rounded to the nearest full cent, with $0.005 rounded upward). No payment will
be made for fractional interests in such options or warrants.
The number of shares of Watson Common Stock to be received by the holders of
Royce Common Stock will be determined in accordance with the Exchange Ratio. The
Average Closing Price will be calculated immediately prior to the closing of the
Merger. The Closing Date is expected to occur either on the day of the
shareholder vote or on the day following the shareholder vote. Consequently, the
actual consideration to be paid to the Royce shareholders and the Exchange Ratio
will not be determinable at the time of the shareholder vote. Current market
prices for the Watson Common Stock may be obtained free of charge prior to the
Effective Time by calling Royce's Investor Relations at 1-800-432-5682. The
Exchange Ratio and the Average Closing Price are subject to adjustment in the
event of any stock split, reverse stock split, stock dividend, subdivision,
reclassification, split, combination, exchange, recapitalization or other
similar transaction with respect to Watson Common Stock or Royce Common Stock
occurring prior to the Effective Time, so that holders of shares of Royce Common
Stock will receive the consideration that has been contemplated by the terms of
the Merger Agreement. From December 24, 1996 through the date of this Proxy
Statement/Prospectus, no such actions have occurred and none are contemplated.
See "Summary -- Merger Consideration" for a description of the range of shares
to be issued and applicable Exchange Ratio.
SEE "RISK FACTORS" BEGINNING ON PAGE 19 FOR INFORMATION THAT SHOULD BE
CONSIDERED BY SHAREHOLDERS OF THE COMPANY IN VOTING UPON THE MERGER AGREEMENT.
Watson has filed a Registration Statement on Form S-4 (the "Registration
Statement") with the Securities and Exchange Commission (the "Commission") under
the Securities Act of 1933, as amended (the "Securities Act"), with respect to
the shares of Watson Common Stock that will be issued in connection with the
Merger. This Registration Statement also registers the shares of Watson Common
Stock issuable upon the exercise of Royce's outstanding warrants and options
(except options granted under Royce's 1992 and 1995 Stock Option Plans and
options granted outside of any Company stock option plan to employees of the
Company). This Proxy Statement/Prospectus constitutes the Prospectus of Watson
filed as part of the Registration Statement. All information contained in this
Proxy Statement/Prospectus concerning Watson has been provided by Watson. All
information contained in this Proxy Statement/Prospectus concerning the Company
has been provided by the Company.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON
THE ACCURACY OR ADEQUACY OF THIS PROXY
STATEMENT/PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
This Proxy Statement/Prospectus and the accompanying Notice of Special
Meeting of Shareholders and Proxy are first being mailed to the shareholders of
the Company on or about March 17, 1997. A shareholder of the Company who has
given a Proxy may revoke it at any time prior to its exercise by filing with the
Secretary of the Company an instrument of revocation or a duly executed proxy
bearing a later date, or by attending the Special Meeting and voting in person.
Attendance at the Meeting will not, in and of itself, constitute revocation of a
Proxy.
Shareholders of the Company are urged to read and carefully consider the
information contained in this Proxy Statement/ Prospectus and the Annexes
attached hereto.
THE DATE OF THIS PROXY STATEMENT/PROSPECTUS IS MARCH , 1997.
<PAGE> 6
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information....................................... 1
Incorporation of Certain Documents by Reference............. 1
Cautionary Statement........................................ 2
Summary..................................................... 3
Comparative Per Share Data.................................. 17
Comparative Market Data..................................... 18
Risk Factors................................................ 19
The Meeting................................................. 25
The Merger.................................................. 27
Opinion of Royce's Financial Advisor........................ 39
Opinion of Watson's Financial Advisor....................... 45
The Merger Agreement........................................ 51
Comparative Rights of Shareholders.......................... 58
Description of Watson Capital Stock......................... 66
Watson's Business........................................... 69
Watson's Management......................................... 72
Watson's Principal Stockholders............................. 74
Watson's Executive Compensation............................. 76
Watson's Selected Consolidated Financial Information........ 79
Watson's Management's Discussion............................ 81
Watson's Supplementary Consolidated Financial Information... 88
Watson's Supplementary Management's Discussion.............. 90
Watson's Certain Relationships and Related Transactions..... 96
Royce's Business............................................ 97
Royce's Selected Consolidated Financial Information......... 109
Royce's Management's Discussion............................. 110
Royce's Security Ownership of Certain Beneficial Owners and
Management................................................ 114
Dissenters' Rights.......................................... 115
Legal Matters............................................... 115
Experts..................................................... 115
Index to Financial Statements............................... F-1
Royce's Consolidated Financial Statements................... F-2
Watson's Consolidated Financial Statements.................. F-27
Watson's Supplementary Consolidated Financial Statements.... F-50
Watson's Consolidated Financial Statements -- September 30,
1996...................................................... F-75
Watson's Supplementary Consolidated Financial
Statements -- September 30, 1996.......................... F-81
Unaudited Pro Forma Condensed Combined Financial
Statements................................................ F-88
ANNEX
A -- Agreement and Plan of Merger, As Amended............... A-1
B -- Opinion of Gruntal & Co., Incorporated................. B-1
C -- Opinion of Bear, Stearns & Co. Inc..................... C-1
</TABLE>
i
<PAGE> 7
AVAILABLE INFORMATION
Watson and the Company are subject to the informational reporting
requirements of the Securities Exchange Act of 1934 (the "Exchange Act") and, in
accordance therewith, file reports, proxy statements and other information with
the Commission. Such reports, proxy statements and other information are
available for inspection and copying at the public reference facilities
maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549, and at the regional offices of the Commission,
located at Suite 1300, 7 World Trade Center, New York, New York 10048 and Suite
1400, Citicorp Center, 500 West Madison Street, Chicago, Illinois 60661-2511.
Copies of such materials can also be obtained by mail from the Public Reference
Section of the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549 at prescribed rates. Such material can also be inspected
at the offices of the National Association of Securities Dealers, 1935 K Street,
N.W., Washington, D.C. 20006. In addition, electronic copies of the Registration
Statement and all related exhibits and schedules may be accessed on the World
Wide Web via the Commission's EDGAR database at its website
(http://www.sec.gov).
This Proxy Statement/Prospectus does not contain all of the information set
forth in the Registration Statement and the exhibits thereto, certain parts of
which are omitted in accordance with the rules and regulations of the
Commission. Statements contained in this Proxy Statement/Prospectus, or in any
document incorporated in this Proxy Statement/Prospectus by reference, as to the
contents of any contract or other document referred to herein or therein are not
necessarily complete, and in each circumstance reference is made to the copy of
such contract or other document filed as an exhibit to the Registration
Statement or documents incorporated in this Proxy Statement/Prospectus. Each
such statement is qualified in all respects by such reference. The Registration
Statement and any amendments thereto, including exhibits filed as a part
thereof, are available for inspection and copying as set forth above.
No person is authorized to give any information or to make any
representation in connection with the solicitation of Proxies or the offering of
securities made hereby other than those contained in this Proxy
Statement/Prospectus or in the documents incorporated herein by reference and,
if given and made, such information or representation must not be relied upon as
having been authorized by Watson or the Company. This Proxy Statement/Prospectus
does not constitute an offer to sell, or a solicitation of an offer to buy, any
securities, or the solicitation of a proxy, in any jurisdiction, to any person
to whom it is not lawful to make any such offer or solicitation in each
jurisdiction. Neither the delivery of this Proxy Statement/Prospectus nor the
issuance of securities made hereunder shall, under any circumstances, create an
implication that there has been no change in the affairs of Watson or the
Company since the date hereof or that the information in this Proxy
Statement/Prospectus or in any documents incorporated herein by reference is
correct as of any time subsequent to its date.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents filed with the Commission by Watson pursuant to the
Exchange Act are incorporated by reference in this Proxy Statement/Prospectus:
(i) Watson Annual Report on Form 10-K for the year ended December 31, 1995, as
amended; (ii) Watson Current Reports on Form 8-K, dated October 3, 1996 and
January 9, 1997; and (iii) Watson Quarterly Reports on Form 10-Q for the
quarterly periods ended March 31, 1996, June 30, 1996 and September 30, 1996, as
amended and (iv) the description of Watson Common Stock contained in Watson
Registration Statement on Form 8-A, dated April 3, 1992.
In addition, all documents filed by Watson with the Commission pursuant to
Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act after the date and prior
to the date of the Meeting shall be deemed to be incorporated by reference
herein and shall be a part hereof from the date of filing of such documents. Any
statement contained in a document incorporated by reference herein or contained
in this Proxy Statement/ Prospectus shall be deemed to be modified or superseded
for purposes of this Proxy Statement/Prospectus to the extent that a statement
contained herein (or in any other subsequently filed document which also is
incorporated by reference herein) modifies or supersedes such statement. Any
statement so modified or
1
<PAGE> 8
superseded shall not be deemed to constitute a part of this Proxy
Statement/Prospectus, except as so modified or superseded.
CAUTIONARY STATEMENT
This Proxy Statement/Prospectus contains forward-looking statements within
the meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. Actual results could differ materially from those projected in the
forward-looking statements as a result of the risk factors set forth under "Risk
Factors" and elsewhere in this Proxy Statement/Prospectus. The information in
this Proxy Statement/Prospectus should be carefully considered before consenting
to the exchange of Royce Common Stock for Watson Common Stock in the Merger.
THIS PROXY STATEMENT/PROSPECTUS INCORPORATES DOCUMENTS BY REFERENCE WHICH
ARE NOT PRESENTED HEREIN OR DELIVERED HEREWITH. COPIES OF SUCH DOCUMENTS (OTHER
THAN EXHIBITS TO SUCH DOCUMENTS, UNLESS SUCH EXHIBITS ARE SPECIFICALLY
INCORPORATED BY REFERENCE) ARE AVAILABLE, WITHOUT CHARGE, TO ANY PERSON,
INCLUDING ANY BENEFICIAL OWNER TO WHOM THIS PROXY STATEMENT/PROSPECTUS IS
DELIVERED, UPON WRITTEN OR ORAL REQUEST TO WATSON PHARMACEUTICALS, INC., 311
BONNIE CIRCLE, CORONA, CALIFORNIA 91720, TELEPHONE NUMBER (909) 270-1400;
ATTENTION: INVESTOR RELATIONS. IN ORDER TO ENSURE DELIVERY OF THE DOCUMENTS
PRIOR TO THE MEETING, REQUESTS SHOULD BE MADE BY APRIL 7, 1997.
2
<PAGE> 9
SUMMARY
The following is a summary of certain information contained elsewhere or
incorporated by reference in this Proxy Statement/Prospectus. Reference is made
to, and this Summary is qualified in its entirety by, the more detailed
information contained or incorporated by reference in this Proxy
Statement/Prospectus and the Annexes attached hereto. The Company's shareholders
are urged to read and carefully consider this Proxy Statement/Prospectus and the
Annexes attached hereto.
PARTIES TO THE MERGER
WATSON PHARMACEUTICALS, INC.
Watson develops, manufactures and markets a comprehensive array of
off-patent (referred to herein as "off-patent" or "generic") pharmaceuticals,
and develops proprietary pharmaceutical products. Watson pursues a balanced
strategy of generating revenue through its long-established off-patent
pharmaceuticals business, capitalizing on its proven capabilities to support the
development of off-patent and proprietary products, and seeking opportunities to
acquire businesses, technologies and products to broaden its technology
platform. Watson's objective is to become a fully integrated pharmaceutical
company, which (i) develops and markets off-patent pharmaceuticals and (ii)
develops proprietary products and markets such products worldwide through
pharmaceutical companies, joint ventures and its own marketing efforts. To
achieve this objective, Watson 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. Watson targets difficult-to-produce niche pharmaceuticals, thereby
avoiding competition with traditional commodity-oriented off-patent
pharmaceutical companies. Watson also regularly reviews potential opportunities
to acquire or invest in technologies, products or product rights and businesses
compatible with its existing business. See "Watson's Business."
In addition to the Merger, Watson entered into a definitive Agreement and
Plan of Merger ("Oclassen Merger Agreement") with Oclassen Pharmaceuticals, Inc.
("Oclassen") dated as of September 25, 1996, as amended effective November 14,
1996 and as amended effective December 31, 1996, pursuant to which Oclassen
agreed to merge (the "Oclassen Merger") with a subsidiary of Watson created for
the purpose of the Oclassen Merger, with Oclassen surviving the Oclassen Merger
as a wholly-owned subsidiary of Watson. It is intended that the Oclassen Merger
will qualify as a pooling of interests for accounting purposes and a tax free
reorganization for federal income tax purposes. The Oclassen Merger was
consummated on February 27, 1997. See "Watson's Business -- Recent
Developments."
Watson's principal executive offices are located at 311 Bonnie Circle,
Corona, California 91720. Its telephone number is (909) 270-1400. Watson is
currently traded on the Nasdaq National Market System ("Nasdaq NMS") under the
symbol "WATS."
ROYCE LABORATORIES, INC.
Royce develops, manufactures and markets generic prescription drugs in
solid dosage forms (tablets and capsules). At present, Royce manufactures and
markets 20 generic prescription drugs in 42 dosage strengths and has received
approval on an additional drug in 3 dosage strengths which it has not yet
commenced manufacturing and marketing. Additionally, Royce has, at present,
abbreviated new drug applications ("ANDAs") pending with the Food and Drug
Administration ("FDA") for 9 new generic prescription products.
Royce's principal executive offices are located at 5350 N.W. 165th Street,
Miami, Florida 33014. Its telephone number is (305) 624-1500. Royce is currently
traded on the Nasdaq SmallCap Market under the symbol "RLAB."
3
<PAGE> 10
THE MEETING
DATE, TIME AND PLACE OF MEETING
The Meeting will be held on April 16, 1997 at 11:00 a.m., Miami time, at
Don Shula's Hotel & Golf Club, Miami Lakes Drive, Miami Lakes, Florida. At the
Meeting, the Company's shareholders will be asked to approve and adopt the
Merger Agreement and approve the Merger.
RECORD DATE AND OUTSTANDING SHARES ENTITLED TO VOTE
Only holders of record of Royce Common Stock at the close of business on
February 27, 1997 (the "Record Date") are entitled to notice of and to vote at
the Meeting. As of the close of business on the Record Date, there were
13,525,879 shares of Royce Common Stock outstanding and entitled to vote. The
holders of the Royce Common Stock are each entitled to one vote per share on the
matter to be considered at the Meeting. The presence, in person or by proxy, of
the holders of record of a majority of the issued and outstanding shares of
Royce Common Stock on the Record Date is necessary to constitute a quorum for
the transaction of business at the Meeting.
VOTING OF PROXIES
The Proxy accompanying this Proxy Statement/Prospectus is solicited on
behalf of the Company's Board of Directors for use at the Meeting. The Company's
shareholders are requested to complete, date and sign the accompanying Proxy and
promptly return it in the enclosed envelope (which requires no postage if mailed
in the United States) to the Company's transfer agent. The Proxy permits each
Royce shareholder to specify that shares be voted "FOR" or "AGAINST" (or
"ABSTAIN" from) the approval and adoption of the Merger Agreement. An abstention
or broker non-vote has the same effect as a vote against the Merger. If properly
executed and returned, such Proxy will be voted in accordance with the choice
specified. Where a signed Proxy is returned, but no choice specified, the
applicable shares will be voted for the approval and adoption of the Merger
Agreement. A Proxy may be revoked at any time before its exercise by filing with
the Company Secretary, an instrument of revocation or a duly executed proxy
bearing a later date, or by attendance at the Meeting and electing to vote in
person. Attendance at the Meeting will not, in and of itself, constitute
revocation of a Proxy.
VOTES REQUIRED
Approval and adoption of the Merger Agreement requires the affirmative vote
of the holders of a majority of the shares of Royce Common Stock outstanding on
the Record Date. As of the Record Date, Royce's directors and executive officers
as a group owned, of record, 799,952 shares (or 5.9%) of the then outstanding
Royce Common Stock, excluding shares to be issued to them upon the exercise of
outstanding options and warrants. All directors and executive officers of Royce
have indicated that they will vote for the approval and adoption of the Merger
Agreement and approval of the Merger.
SOLICITATION OF PROXIES AND EXPENSES
The Company will bear the cost of the solicitation of Proxies from its
shareholders. In addition to solicitation by mail, the directors, officers and
employees of the Company may solicit Proxies from the Company's shareholders by
telephone, telegram, telecopy, letter or in person. The Company has engaged
Morrow & Co., Inc. a professional proxy solicitation firm, to assist in such
solicitation for an estimated fee of $10,000, including disbursements. The
Company will request brokers, custodians, nominees and other record holders to
forward copies of this Proxy Statement/Prospectus, Proxies and other soliciting
materials to persons for whom they hold shares of Royce Common Stock and to
request authority for the exercise of Proxies. In such cases, the Company, upon
request of the record holders, will reimburse such holders for their reasonable
expenses.
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<PAGE> 11
RISK FACTORS
The decision by a Royce shareholder to approve the Merger Agreement and the
Merger and to become a stockholder of Watson involves a number of risks:
including the risk that the combined company may experience difficulties in
integration of the two businesses; that certain persons might have interests in
the Merger that differ from the interests of a Royce shareholder; that the
shareholders of Royce will effectively relinquish direct control over the
business of Royce; that the rights of Royce shareholders may differ as
stockholders of a Nevada corporation; that there are certain conditions to the
consummation of the Merger; the possibility of future acquisitions and any
problems attendant thereto; Watson's lack of control over joint ventures
pursuant to which it derives substantial revenue; Watson's and Royce's
dependence upon new product introductions; the level of competition in the
combined company's industries; the extent of, and changes in, the level of
government regulation; the dependence of the combined company on certain key
personnel; the potential volatility of the price of Watson Common Stock and the
absence of dividends; the fluctuations in quarterly earnings which Watson has
experienced and may continue to experience; the costs associated with product
development and the uncertainty of returns; risks relating to any difficulty in
obtaining patent or other intellectual property protection or the costs
associated therewith; the dependence of the combined company on certain
products; the uncertainty of royalty and joint venture income; the dependence of
the combined company on certain suppliers; the loss of exclusive rights to
market certain products; the cost and availability of product liability
insurance and the risks associated with any such liability action; the existence
of certain anti-takeover provisions under Nevada law; the dilution the Royce
shareholders will experience as a result of the Merger; the existence of certain
"no-shop" provisions; and the fact that the closing of the Merger is subject to
the satisfaction of certain conditions.
THE MERGER
The following summary is qualified in its entirety by reference to the more
detailed discussion of the Merger which appears under the caption "The Merger"
and to the full text of the Merger Agreement which is attached hereto as Annex A
and is incorporated herein by reference. Capitalized terms not defined herein
are defined in the Merger Agreement.
STRUCTURE OF THE MERGER
Pursuant to the Merger Agreement, (i) the Sub will be merged with and into
the Company, (ii) each issued and outstanding share of Royce Common Stock will
be converted into the right to receive shares of Watson Common Stock, and cash
in lieu of fractional shares, and (iii) each outstanding share of the Sub's
common stock will be converted into one share of Royce Common Stock, as a result
of which the Company, as the surviving corporation of the Merger, will become a
wholly-owned subsidiary of Watson. After the Merger, shareholders of the Company
will no longer have any direct ownership interest in the Company and each
shareholder of the Company will become a Watson stockholder. For a summary of
the principal differences between the rights of holders of Royce Common Stock
and Watson Common Stock, see "--Effects of the Merger on Rights of Shareholders;
Summary of Comparative Rights of Shareholders" and "Comparative Rights of
Shareholders."
MERGER CONSIDERATION
Under the terms of the Merger Agreement, Watson will issue at the closing
of the Merger to each holder of a share of Royce Common Stock a number of shares
of Watson Common Stock equal to the following (the "Exchange Ratio"): $7.25
divided by the average daily closing price (the "Average Closing Price") of a
share of Watson Common Stock as quoted on the Nasdaq NMS and as reported in The
Wall Street Journal for the ten consecutive trading days ending on the trading
day immediately preceding the effective date of the Merger (the "Effective
Date"). If the Average Closing Price (i) exceeds $47.00, the Average Closing
Price will be deemed to be $47.00 for purposes of calculating the Exchange Ratio
and (ii) is less than $38.00, the Average Closing Price shall be deemed to be
$38.00 for purposes of calculating the Exchange Ratio.
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<PAGE> 12
Based upon the maximum Average Closing Price of $47.00 and the minimum
Average Closing Price of $38.00, and the number of shares of Royce Common Stock
and options and warrants to purchase shares of Royce Common Stock outstanding on
February 27, 1997, (a) the maximum and minimum number of shares of Watson Common
Stock which can be issued in connection with the Merger is 2,580,738 and
2,086,439, respectively, which excludes between 392,964 and 317,698 shares of
Watson Common Stock, respectively, to be issued upon the exercise of outstanding
options and warrants to purchase shares of Royce Common Stock, and (b) the
Exchange Ratio may be as high as 0.191 or as low as 0.154.
No fractional shares of Watson Common Stock will be issued in the Merger
and holders of Royce Common Stock will receive cash in lieu thereof. For each
fractional share of Watson Common Stock that would otherwise be issuable, each
eligible holder will receive an amount of cash equal to such fractional
proportion of the Average Closing Price per share of Watson Common Stock. Since
the actual number of shares of Watson Common Stock to be received by holders of
Royce Common Stock is based upon a formula calculated at a time after the Royce
shareholder vote, the Royce shareholders will not know the actual number of
shares of Watson Common Stock they will receive in the Merger at the time of the
shareholder vote.
During the period from October 1, 1996 to March 12, 1997, the closing price
of a share of Watson Common Stock as quoted on the Nasdaq NMS has been as high
as $45.875 and as low as $32.00. See also "Comparative Market Data."
The number of shares of Watson Common Stock issuable to holders of
currently outstanding Royce Common Stock in connection with the Merger and the
Exchange Ratio can be illustrated by the following table:
<TABLE>
<CAPTION>
SHARES OF WATSON
WATSON AVERAGE COMMON STOCK TO
CLOSING PRICE PER EXCHANGE BE RECEIVED BY
SHARE RATIO(A) ROYCE SHAREHOLDERS
- ----------------- -------- ------------------
<S> <C> <C>
$38.00 or less 0.191 2,579,324(maximum)
$39.00 0.186 2,513,187
$40.00 0.181 2,450,357
$41.00 0.177 2,390,593
$42.00 0.173 2,333,674
$43.00 0.169 2,279,402
$44.00 0.165 2,227,598
$45.00 0.161 2,178,095
$46.00 0.158 2,130,746
$47.00 or more 0.154 2,085,411(minimum)
</TABLE>
- ---------------
(a) Represents the number of shares of Watson Common Stock to be issued in
exchange for each share of Royce Common Stock, rounded to three decimal
points.
The value of the shares to be received by the Royce shareholders will
depend upon the actual market price of the Watson Common Stock. The effect of
the Collar will be to limit the maximum and minimum number of shares that will
be issuable to Royce shareholders to the maximum and minimum identified in the
above table.
The Exchange Ratio and the Average Closing Price will be adjusted in the
event of any stock split, reverse stock split, stock dividend, subdivision,
reclassification, split, combination, exchange, recapitalization or other
similar transaction with respect to Watson Common Stock or Royce Common Stock
occurring prior to the Effective Time, so that holders of shares of Royce Common
Stock will receive the same consideration as originally contemplated by the
terms of the Merger Agreement. From December 24, 1996 through the date of this
Proxy Statement/Prospectus, no such actions have occurred and none are
contemplated.
By way of illustration, based on 13,525,879 shares of Royce Common Stock
issued and outstanding on February 27, 1997, options and warrants to purchase
2,059,558 shares of Royce Common Stock outstanding on February 27, 1997, and
assuming the Average Closing Price is $43.50 (the last closing price of Watson
Common Stock on February 27, 1997), Watson will issue 0.167 of a share of Watson
Common Stock for each share of Royce Common Stock, or an aggregate of 2,254,313
shares of Watson Common Stock to the holders of all outstanding shares of the
Royce Common Stock upon the closing of the Merger, which excludes 343,260
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<PAGE> 13
shares of Watson Common Stock to be issued upon the exercise of the outstanding
options and warrants to purchase shares of Royce Common Stock. It is currently
anticipated that the closing of the Merger will occur on either the day of the
meeting or on the day following the date of the Meeting. Since the Average
Closing Price will be calculated immediately prior to the closing of the Merger,
the actual consideration to be paid to the Royce shareholders and the Exchange
Ratio may differ from the above example and there can be no assurance that the
price of the Watson Common Stock used for purposes of calculation of the Average
Closing Price will not be lower than the price at the time of the vote. Current
prices for the Watson Common Stock may be obtained free of charge prior to the
Effective Time by calling Royce's Investor Relations at 1-800-432-5682.
Subject to the Royce Board of Directors' ability to terminate the Merger in
the event it determines, in the exercise of its fiduciary duties, to withdraw
its recommendation of the Merger Agreement or the Merger, neither party has the
right to terminate the Merger Agreement based upon fluctuations in the Average
Closing Price. Royce believes that its Board of Directors would not withdraw its
recommendation unless it determined events have occurred that render the Merger
or the Exchange Ratio no longer fair to its shareholders, including but not
limited to, the withdrawal by Gruntal of its opinion that the terms of the
Merger were fair, from a financial point of view, to the holders of Royce Common
Stock.
OWNERSHIP OF WATSON AFTER THE MERGER
Based upon the number of outstanding shares of Watson Common Stock on
February 27, 1997 and of Royce Common Stock on February 27, 1997 and assuming
(i) no exercise of options or warrants for or conversion of securities
convertible into capital stock of Watson or Royce, (ii) no change in the price
of Watson Common Stock from the closing sale price on February 27, 1997 ($43.50
per share), and (iii) the issuance of 3.3 million shares of Watson Common Stock
in connection with the Oclassen Merger, immediately following the Merger, (a)
the former holders of Royce Common Stock will collectively hold approximately
5.3% of the issued and outstanding shares of Watson Common Stock; and (b) the
persons who held Watson Common Stock immediately prior to the Merger will hold
collectively approximately 94.7% of the issued and outstanding shares of Watson
Common Stock.
REASONS FOR THE MERGER; ADVANTAGES AND DISADVANTAGES OF THE MERGER
The Boards of Directors of both Watson and Royce considered a number of
potential advantages and disadvantages of the Merger. Watson's Board of
Directors believes that the material advantages of the Merger to Watson and its
stockholders are the effect on Watson's future estimated earnings per share, the
complementary product lines of the two entities, operating efficiencies created
by the Merger, the increased product pipeline, the rationalization of certain
product development activities and the expansion of Watson's existing and
off-patent prescription drug business. The Royce Board of Directors believes
that the material advantages of the Merger to Royce and its shareholders are a
diversified revenue base, an expanded product pipeline, stronger financial
resources and enhanced access to capital, a talented management team for the
combined company, the enhanced ability to recruit and retain employees and the
terms of the Merger, including the consideration to be received by the Royce
shareholders.
Each Board of Directors has recognized that there are potential
disadvantages of the Merger, including potential disruption in the businesses of
Royce and Watson following announcement of the Merger and during the combination
of the operations of the two companies, risk of non-consummation of the Merger,
risks of integration following the Merger and the possibility that the
anticipated advantages of the Merger as described above may not be realized. The
Watson Board of Directors recognized that disadvantages of the Merger include
the risk of overpayment of consideration otherwise justified based upon the
current level of earnings of Royce, the risk that some or all of Royce's
products for which ANDA submissions have been made will not be approved by the
FDA, or will not be approved when anticipated, potential disruption in Watson's
business, the risk of non-consummation of the Merger and the risks associated
with integrating the businesses, operations and personnel of Watson and Royce
following the Merger. The Royce Board of Directors also recognized that, as a
result of the Merger, the Royce shareholders will lose the exclusive opportunity
to develop and exploit
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<PAGE> 14
Royce's current and potential products and will, as stockholders of Watson, bear
the risks associated with the operation of the Watson business and will
experience dilution.
Although the Board of Directors of each of Watson and Royce carefully
considered the advantages and disadvantages of the Merger described above, the
Boards of Directors did not find it practicable to, and did not, quantify or
otherwise attempt to assign relative weights to the more specific advantages and
disadvantages considered. For a more complete discussion of the advantages and
disadvantages of the Merger, see "The Merger -- Watson's Reasons for the Merger;
Advantages and Disadvantages of the Merger" and "The Merger -- Royce's Reasons
for the Merger; Advantages and Disadvantages of the Merger."
THE BOARDS OF DIRECTORS OF WATSON AND ROYCE HAVE UNANIMOUSLY APPROVED THE
MERGER AGREEMENT AND THE MERGER. THE BOARD OF DIRECTORS OF ROYCE RECOMMENDS A
VOTE FOR APPROVAL AND ADOPTION OF THE MERGER AGREEMENT AND APPROVAL OF THE
MERGER BY ROYCE'S SHAREHOLDERS.
At the time the Merger Agreement was approved, the Board of Directors of
Watson believed that the terms of the Merger were fair to and in the best
interests of Watson and its stockholders. In reaching its determination, the
Board of Directors of Watson believed the Merger would create a significantly
stronger pharmaceutical business than either of the two companies experience
operating independently and would reduce risks to which Watson would be subject
as a stand-alone company; information concerning the financial performance,
condition and business operations of Watson and Royce; the presentation of Bear
Stearns & Co. Inc. ("Bear Stearns"), Watson's financial advisor, delivered to
Watson's Board at its meeting on December 19, 1996, and the opinion of Bear
Stearns to the effect that, as of December 20, 1996, the Merger was fair, from a
financial point of view, to the Watson stockholders; the terms and conditions of
the Merger and the Merger Agreement; the fact that the Merger will be accounted
for as a pooling of interests; and the likelihood that the Merger will be
consummated. For a more complete discussion of the factors considered by the
Watson Board of Directors in determining to approve the Merger Agreement and the
Merger, see "The Merger -- Watson's Reasons for the Merger" and "The
Merger -- Approval of the Board of Directors of Watson; Advantages and
Disadvantages of the Merger."
At the time the Merger Agreement was approved, the Board of Directors of
Royce believed that the terms of the Merger were fair to and in the best
interests of Royce and its shareholders. In reaching its determination, the
Board of Directors of Royce considered Royce's strategic alternatives;
information concerning the financial performance, condition and business
operations of Watson and Royce; the presentation of Gruntal & Co., Incorporated
("Gruntal"), Royce's financial advisor, delivered to Royce's Board at its
meeting on December 23, 1996; and the opinion of Gruntal to the effect that as
of the date of the execution of the Merger Agreement, the terms of the Merger
were fair, from a financial point of view, to the holders of Royce Common Stock;
the existing trading market for Watson Common Stock; the fact that the Merger
would be a tax free transaction accounted for as a pooling of interests; the
opportunity for Royce's shareholders to continue to share in the potential for
long-term gains from their investment in Royce through their ownership of Watson
Common Stock following the Merger; the terms and conditions of the Merger; the
likelihood that the Merger will be consummated; and the advantages and
disadvantages of the Merger to Royce and its shareholders described above. For a
more complete discussion of the factors considered by the Royce Board of
Directors in determining to recommend approval and adoption of the Merger
Agreement and approval of the Merger, see "The Merger -- Royce's Reasons for the
Merger; Advantages and Disadvantages of the Merger."
A VOTE TO APPROVE AND ADOPT THE MERGER AGREEMENT BY THE COMPANY'S
SHAREHOLDERS WILL BE DEEMED APPROVAL OF THE EXCHANGE RATIO.
An approval of the Exchange Ratio by a holder of Royce Common Stock will be
deemed to be an election by such holder to exchange his or her shares of Royce
Common Stock at the Exchange Ratio stated herein and absent a showing of fraud
or bad faith in connection with the Merger such approval may foreclose any later
claim by such holder that such Exchange Ratio was unfair.
At the closing of the Merger, outstanding options and warrants to purchase
shares of Royce Common Stock (collectively, "Company Options") will be converted
into the right to purchase that number of shares of
8
<PAGE> 15
Watson Common Stock as the holder of such Company Options would have been
entitled to receive had they exercised such Company Options prior to the
consummation of the Merger and participated in the Merger. As of February 27,
1997 there were outstanding options and warrants to purchase 2,059,558 shares of
Royce Common Stock. Additionally, at the closing of the Merger, the options to
purchase shares of Royce Common Stock issued pursuant to Royce's 1992 and 1995
Stock Option Plans (which will be converted into options to purchase shares of
Watson Common Stock, as described above) will, in accordance with the terms of
such plans, immediately vest. In addition, certain options issued pursuant to
the currently outstanding employment agreement between the Company and Patrick
J. McEnany, the Company's Chairman, President and Chief Executive Officer, will,
in accordance with the terms of such agreement, immediately vest. All other
options and warrants will continue to vest in accordance with the vesting
schedules or acceleration provisions contained in the agreements evidencing such
options.
OPINION OF FINANCIAL ADVISORS
Gruntal is acting as the financial advisor to Royce in connection with the
Merger and has rendered an opinion to Royce's Board of Directors that the terms
of the Merger are fair, from a financial point of view, to Royce's shareholders.
The full text of the opinion of Gruntal is set forth as Annex B to this Proxy
Statement/ Prospectus. See "Opinion of Royce's Financial Advisor," and Annex B.
Bear Stearns acting as financial advisor to Watson in connection with the
Merger, has rendered an opinion to Watson's Board of Directors to the effect
that the Exchange Ratio to be paid by Watson in the Merger is fair to Watson
from a financial point of view, as of December 20, 1996. The full text of the
opinion is set forth as Annex C to the Proxy Statement/Prospectus. See "Opinion
of Watson's Financial Advisor" which is annexed hereto as Annex C.
RECOMMENDATION OF THE ROYCE BOARD OF DIRECTORS
Royce's Board of Directors has unanimously adopted the Merger Agreement,
authorized the Merger and the transactions contemplated in the Merger Agreement,
and has determined that the Merger is fair to, and in the best interest of,
Royce and the Royce shareholders. Royce's Board of Directors recommends approval
and adoption of the Merger Agreement by Royce's shareholders. In reaching its
decision to adopt the Merger Agreement and to recommend the Merger, Royce's
Board considered a number of factors. See "The Merger -- Background of the
Merger" and "-- Reasons for the Merger," and "Interests of Certain Persons in
the Merger."
INTERESTS OF CERTAIN PERSONS IN THE MERGER
Each of the directors and officers of Royce are shareholders and/or option
holders of Royce. As a result, they will receive the same consideration as other
shareholders and option holders of Royce in the Merger. However, in considering
the recommendation of the Board of Directors of Royce with respect to the
Merger, Royce shareholders should be aware that Patrick J. McEnany, Chairman,
President and Chief Executive Officer of Royce, has certain additional interests
in the Merger.
In particular, upon the effective date of the Merger, Patrick J. McEnany
will execute a new three-year employment agreement with Watson and the Company
whereby Mr. McEnany will remain as the President of Royce after the Merger and
will also become a Vice President of Watson in charge of Corporate Development.
The new employment agreement will replace the existing employment agreement
between the Company and Mr. McEnany.
Under the terms of the new employment agreement, Mr. McEnany will receive:
(i) a base salary of $200,000 per annum (adjusted annually for increases in the
cost of living); (ii) the right to receive a bonus of up to $150,000 during the
first year of the agreement by meeting certain targets, and discretionary
bonuses in future years; (iii) customary benefits consistent with the other
officers of Watson; and (iv) an option (vesting over five years) to purchase
100,000 shares of Watson Common Stock at an exercise price equal to the last
closing price of shares of Watson Common Stock on the Effective Date.
The new employment agreement will also provide that if Mr. McEnany
terminates the agreement after one year or for "good reason" (as defined in the
employment agreement) or if Watson terminates the agreement for any reason other
than cause, Mr. McEnany will receive severance benefits of $350,000 payable
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<PAGE> 16
over the year following his termination of employment. Additionally, in the
event that Mr. McEnany's employment agreement is terminated by Watson for any
reason other than cause or by Mr. McEnany for "good reason," Mr. McEnany will
become a consultant to Watson for a term to end in 2002. During the term of his
employment and for a period of one year after the termination of Mr. McEnany's
employment with Watson and the Company, Mr. McEnany will be prohibited from
competing with Watson in the development, manufacture, sale and marketing of
generic prescription products. Additionally, Mr. McEnany's consulting agreement
with Watson and the Company will terminate if Mr. McEnany competes with Watson
in the development, sale and marketing of generic prescription products. See
"The Merger -- Interests of Certain Persons in the Merger."
As of February 27, (i) Mr. McEnany, either directly or indirectly owned of
record, 459,053 shares (or 3.4%) of the then outstanding Royce Common Stock,
excluding shares to be issued to him upon the exercise of outstanding options
and warrants; and (ii) Royce's directors and executive officers as a group
owned, of record, 799,952 shares (or 5.9%) of the then outstanding Royce Common
Stock, excluding shares to be issued to them upon the exercise of outstanding
options and warrants. Approval and adoption of the Merger Agreement requires the
affirmative vote of the holders of a majority of the shares of Royce Common
Stock outstanding on the Record Date. All directors and executive officers of
Royce have indicated that they will vote for the approval and adoption of the
Merger Agreement and approval of the Merger.
ADDITIONAL SECURITIES REGISTERED IN THE REGISTRATION STATEMENT
This Registration Statement also registers the issuance by Watson of up to
300,314 shares of Watson Common Stock issuable to the holders of 941,666
outstanding Royce warrants and 1,117,892 outstanding Royce options upon the
exercise of such warrants and options. See "The Merger Agreement -- Company
Options" and "Description of Watson Capital Stock -- Additional Securities
Registered in the Registration Statement."
GOVERNANCE
Following the Merger, holders of shares of Royce Common Stock will be
holders of shares of Watson Common Stock and will not have any direct ownership
interest in Royce. However, as holders of Watson Common Stock, the holders of
Royce Common Stock will have an indirect interest in Royce, which will be a
wholly-owned subsidiary of Watson. Following the consummation of the Merger, (a)
the Chairman of the Board and Chief Executive Officer of Watson will be Dr.
Allen Chao, and the President of Watson will be Dr. Melvin D. Sharoky; (b) the
Board of Directors of Watson will consist of Dr. Allen Chao, Dr. Melvin D.
Sharoky, Dr. Alec D. Keith, Michel J. Feldman, Albert F. Hummel, Michael Fedida
and Ronald R. Taylor; (c) the executive officers of Watson will be Dr. Allen
Chao, Dr. Melvin Sharoky and Dr. David Hsia, Senior Vice President, Scientific
Affairs (except that in connection with the Merger and the Oclassen Merger,
Patrick J. McEnany, Glenn A. Oclassen and Terry L. Johnson may be deemed to be
"executive officers" of Watson under applicable securities laws); (d) the
Chairman of the Board of Royce will be Dr. Allen Chao, the President of Royce
will be Patrick J. McEnany and the Secretary of Royce will be Michel J. Feldman;
(e) the Board of Directors of Royce will consist of Dr. Allen Chao, Patrick J.
McEnany and Frederick Wilkinson, Senior Vice President -- Sales and Marketing
and Vice President -- Business Development of Watson Laboratories, Inc., a
wholly-owned subsidiary of Watson ("Watson Labs"). Other than Patrick J.
McEnany, who will become the Vice President, Corporate Development of Watson, no
director or officer of Royce will become an officer or member of the Board of
Directors of Watson in connection with the Merger. Additionally, upon
consummation of the Oclassen Merger, no director or officer of Oclassen will
become an officer or member of the Board of Directors of Watson.
FEDERAL INCOME TAX CONSEQUENCES
The obligation of each of Royce and Watson to consummate the Merger is
conditioned upon the receipt by Royce and Watson of an opinion from each of
D'Ancona & Pflaum, counsel to Watson, and Akerman, Senterfitt & Eidson, P.A.,
counsel to Royce, to the effect that, for federal income tax purposes, the
Merger will constitute a tax free reorganization within the meaning of Sections
368(a)(1)(A) and 368(a)(2)(E) of the
10
<PAGE> 17
Internal Revenue Code of 1986, as amended (the "Code"). Such tax opinions have
been rendered and the material tax consequences are summarized herein. See "The
Merger -- Federal Income Tax Consequences." If, as anticipated, the Merger
qualifies as a tax free reorganization, among other things, no gain or loss
would be recognized by the Company's shareholders as a result of the Merger,
except gain or loss recognized on the receipt of cash paid in lieu of fractional
shares. The Merger Agreement does not require the parties to obtain a ruling
from the Internal Revenue Service as to the tax consequences of the Merger. The
Company's shareholders are urged to consult their own tax advisors regarding the
particular tax consequences of the Merger to them.
FEDERAL SECURITIES LAWS CONSEQUENCES
The Watson Common Stock issuable in connection with the Merger has been
registered under the Securities Act. Accordingly, there will be no restrictions
upon the resale or transfer of such shares by the Company's shareholders who are
not deemed to be "affiliates" of the Company, as such term is used in Rule 145
under the Securities Act. With respect to those shareholders who may be deemed
to be affiliates of the Company, Rule 144 and Rule 145 under the Securities Act
place certain restrictions on the transfer of Watson Common Stock which may be
received by them pursuant to the Merger. Additionally, it is a condition to the
consummation of the Merger that all persons deemed "affiliates" of the Company
enter into an agreement with Watson whereby each such person agrees not to sell
their shares of Watson Common Stock received by them in connection with the
Merger until combined operating results covering a minimum thirty-day period of
Royce and Watson are publicly released. See "The Merger Agreement -- Conditions
Precedent."
ACCOUNTING TREATMENT
Both Watson and Royce believe that the Merger will qualify as a pooling of
interests for accounting and financial reporting purposes and have been so
advised by their respective independent public accountants. Consummation of the
Merger is conditioned upon, among other things, the receipt by Watson of a
letter from its independent public accountants, dated the closing date of the
Merger, stating that the Merger will qualify as a pooling of interests for
accounting and financial reporting purposes, and the receipt by Royce of a
letter from its independent public accountants, dated the closing date of the
Merger, indicating that Royce has not taken any action that would preclude it
from entering into a transaction that would be treated as a pooling of interests
for accounting and financial reporting purposes. See "The Merger
Agreement -- Conditions Precedent" and "The Merger -- Accounting Treatment."
EFFECTS OF THE MERGER ON RIGHTS OF SHAREHOLDERS; SUMMARY OF COMPARATIVE RIGHTS
OF SHAREHOLDERS
As a result of the Merger, Royce's shareholders will become stockholders of
Watson. Royce is organized under the laws of Florida while Watson is organized
under the laws of Nevada. The following is a summary of certain material
differences between (i) Nevada corporate law and the Articles of Incorporation
and Bylaws of Watson and (ii) Florida corporate law and the Articles of
Incorporation and Bylaws of Royce. For a more detailed discussion of the
comparative rights of the shareholders of Watson and Royce see "Comparative
Rights of Shareholders."
(i) Number of Directors. Watson's Articles of Incorporation provide that
the number of directors of Watson shall be nine persons. The Royce Bylaws
provide that the number of directors shall not be less than five nor more than
nine persons.
(ii) Anti-Takeover Provisions. The combined company may be subject to the
provisions of the Nevada's anti-takeover laws. The Nevada Combination with
Interested Stockholders Statute prevents an "interested stockholder" and an
applicable Nevada corporation from entering into a "combination" unless certain
conditions are met. The Nevada Control Share Acquisition Statute prohibits an
acquiror, under certain circumstances, from voting shares of a target
corporation's stock after crossing certain threshold ownership percentages
unless the acquiror obtains the approval of the target corporation's
stockholders. Such provisions may make an unsolicited acquisition of control of
Watson more difficult or expensive.
11
<PAGE> 18
ABSENCE OF DISSENTERS' RIGHTS
Holders of Royce Common Stock will not be entitled to dissenters' rights as
a result of the Merger. Under Florida law, dissenters' rights are generally
unavailable to the holders of Royce Common Stock because the Royce Common Stock
was, on the Record Date, held by more than 2,000 shareholders of record. See
"Dissenters' Rights."
REGULATORY APPROVAL
The obligations of Watson and Royce to consummate the Merger are subject to
the expiration of the waiting period applicable to the consummation of the
Merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR
Act") and the rules promulgated thereunder. Watson and Royce filed the
Pre-Merger Notification under the HSR Act with the Federal Trade Commission and
the Antitrust Division of the U.S. Department of Justice on January 10, 1997.
The waiting period under the HSR Act expired on February 9, 1997. See "The
Merger Agreement -- Conditions Precedent" and "The Merger -- Regulatory
Approval."
NO SOLICITATION
Under the terms of the Merger Agreement, the Company is prohibited from,
directly or indirectly, soliciting or encouraging the initiation of any
inquiries, proposals or offers regarding any acquisition, merger, takeover bid
or sale of all or substantially all of its assets. However, if the Company's
Board of Directors determines in good faith that it would be consistent with its
fiduciary responsibilities to approve or recommend an unsolicited proposal which
it deems superior to the Merger (the "Alternative Proposal"), then the Company
shall be entitled to enter into the Alternative Proposal and terminate the
Merger Agreement. In such event, Royce will be obligated to pay Watson the
Termination Fee described below.
CONDITIONS PRECEDENT
The consummation of the Merger is subject to a number of conditions. See
"The Merger Agreement -- Conditions Precedent."
TERMINATION OF THE MERGER
The Merger Agreement may be terminated and the Merger abandoned at any time
prior to the consummation of the Merger: (i) by the mutual consent of the Boards
of Directors of the Company and Watson; (ii) by the Board of Directors of either
the Company or Watson if there has been a material breach by the other of any
representation or warranty in the Merger Agreement or of any covenant in the
Merger Agreement, which breach of a covenant has not been, or cannot be, cured
within 30 days after written notice thereof; (iii) by the Board of Directors of
either the Company or Watson if the Merger has not occurred by April 30, 1997
(except that neither the Company nor Watson shall be entitled to terminate if
such party's willful and material violation of the Merger Agreement caused the
Merger not to be consummated by such date); (iv) by the Board of Directors of
either the Company or Watson if the required approval of the shareholders of the
Company shall not have been obtained (except that the Company shall not be
entitled to terminate if it caused or aided in such failure); (v) by the Board
of Directors of either the Company or Watson if a governmental authority shall
have issued a final and non-appealable order or ruling permanently restraining,
enjoining, or otherwise prohibiting the Merger or compelling Watson, the Sub or
the surviving corporation of the Merger to dispose of or hold separate all or a
material portion of the respective businesses or assets of Watson or the
Company, or sell or license any material product of Watson or the Company; (vi)
by the Board of Directors of the Company if it determines in good faith and
pursuant to the exercise of its fiduciary duties, to withdraw its recommendation
of the Merger Agreement and/or Merger; (vii) by the Board of Directors of the
Company or Watson if the Company receives an Alternative Proposal, and the Board
of Directors of the Company accepts such Alternative Proposal and recommends
such Alternative Proposal to its shareholders; (viii) by the Board of Directors
of the Company or Watson if the Board of Directors of the other shall have
withdrawn or modified in a manner materially adverse to the other, its approval
or recommendation
12
<PAGE> 19
of the Merger Agreement and/or the Merger (other than upon the happening of an
event described in (ii) above); or (ix) by the Company if Watson, prior to the
Effective Date, enters into any transaction, or series of related transactions,
or enters into any agreement relating to the foregoing, where Watson would (A)
require the approval of its shareholders pursuant to Nevada General Corporate
Law, or (B) issue or propose to issue in excess of twenty-percent (20%) of the
outstanding Watson Common Stock in connection with such transaction, or series
of related transactions, calculated on a fully-diluted basis after giving effect
to the consummation of the contemplated transaction between Watson and Oclassen
and the consummation of such new transaction or series of related transactions.
Subject to the Royce Board of Director's ability to terminate the transaction in
the event it determines, in the exercise of its fiduciary duties, to withdraw
its recommendation of the Merger Agreement or the Merger, neither party has the
right to terminate the Merger Agreement based upon fluctuations in the Average
Closing Price.
TERMINATION FEE
In the event the Merger Agreement is terminated by Royce or Watson as a
result of (i) Royce entering into an Alternative Proposal or (ii) because the
Royce Board of Directors shall have withdrawn or modified its approval or
recommendation of the Merger Agreement and the Merger, in a manner materially
adverse to Watson, and the Company enters into an agreement or an understanding
with respect to an Alternative Proposal within nine (9) months of the date of
termination and thereafter consummates such transaction, then Watson shall be
entitled to receive from Royce a cash fee of $3,000,000 (the "Termination Fee").
Additionally, if the Merger Agreement is terminated by Royce or Watson because
of Royce's acceptance of an Alternative Proposal and Royce does not enter into
an agreement with regard to such Alternative Proposal within nine (9) months of
the termination of the Merger Agreement or such proposal does not close within
eighteen (18) months of such termination, Royce shall reimburse Watson for its
out of pocket costs and expenses incurred in connection with the Merger
Agreement and the consummation and negotiation of the transactions contemplated
by the Merger Agreement, including legal, professional and service fees and
expenses, which shall be payable within 12 months from the date of termination
of the Merger Agreement. If the fees described above are not paid when due, all
amounts owing will accrue interest at a rate equal to 12% per annum.
13
<PAGE> 20
SUMMARY HISTORICAL FINANCIAL DATA
Set forth below are selected summary historical financial data of Watson
and Royce which are based upon the historical financial statements of Watson and
Royce. The following data for each of the years ended December 31, 1993, 1994
and 1995 and as of December 31, 1994 and 1995 are derived from the respective
company's audited consolidated financial statements and the notes thereto, as
well as the respective Management's Discussion sections included elsewhere in
this Proxy Statement/Prospectus. Historical financial data for Watson and Royce
for the years ended December 31, 1991 and 1992 and as of December 31, 1991, 1992
and 1993 are derived from audited financial statements not included herein.
Historical financial data of Watson and Royce for the nine months ended
September 30, 1995 and 1996 and as of September 30, 1996 has been derived from
and should be read in conjunction with the unaudited financial statements
included elsewhere in this Proxy Statement/Prospectus. The unaudited data as of
September 30, 1996 and for the nine months ended September 30, 1996 and 1995,
for each of Watson and Royce reflect, in the opinion of management of Watson and
Royce, respectively, all adjustments necessary for a fair presentation of such
data and are not necessarily indicative of the results which may be expected for
any other interim period or for the year ending December 31, 1996.
WATSON PHARMACEUTICALS, INC.
SUMMARY HISTORICAL CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31,(1) SEPTEMBER 30,
------------------------------------------------------ ---------------------
1991(2) 1992(3) 1993(4)(5) 1994(4) 1995(4)(6) 1995(4)(6) 1996
-------- ------- ---------- ------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues.................................... $ 30,802 $34,773 $70,838 $94,858 $152,935 $109,639 $142,017
Net income (loss)........................... (55,204) (6,090) 50,417 36,545 47,890 31,011 53,617
Earnings (loss) per share................... (1.72) (0.18) 1.42 1.00 1.29 0.84 1.43
Weighted average number of common and common
equivalent shares outstanding............. 32,036 32,938 35,504 36,515 37,143 36,987 37,624
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, (1)
---------------------------------------------------- SEPTEMBER 30,
1991 1992 1993 1994 1995 1996
-------- -------- -------- -------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Current assets........................................ $ 40,987 $ 57,118 $155,025 $172,912 $197,634 $256,609
Working capital....................................... 23,618 31,534 131,943 154,661 168,812 221,684
Total assets.......................................... 122,238 130,516 235,672 262,316 322,121 395,194
Long-term debt and deferred partnership liability..... 2,736 11,589 17,385 19,091 3,577 3,116
Total stockholders' equity............................ 81,426 77,872 185,081 223,370 289,035 357,153
</TABLE>
- ---------------
(1) Watson merged with Circa Pharmaceuticals, Inc. ("Circa") in July 1995 in a
transaction accounted for as a pooling of interests. Accordingly, the
financial data presented include the accounts of Circa for all periods
presented.
(2) In 1991, Circa was both a defendant and a plaintiff in a variety of legal
proceedings. A provision for legal settlements of $73.4 million was recorded
in 1991 for the costs related to these now-settled legal matters.
(3) In 1992, Circa recorded a loss of $15.6 million for its share of the
operating losses of a partnership formed with Rhone-Poulenc Rorer, Inc.
("RPR") to develop Dilacor XR(R). See Note 6 to Watson's consolidated
financial statements included in the Company's Annual Report on Form 10-K
for 1995.
(4) In 1993, Circa recorded a gain of $14.5 million related to the sale of
approximately 847,000 common shares of Marsam Pharmaceuticals, Inc.
("Marsam"). In 1994 and 1995, Circa disposed of its remaining investment in
Marsam and recorded gains of $3.2 million and $6.2 million, respectively.
(5) Also in 1993, as a result of Watson's 1995 merger with Circa, an income tax
benefit of $29.8 million was recorded which was the result of the reduction
in the valuation allowance related to net deferred tax assets. These net
deferred tax assets resulted principally from net operating loss
carryforwards and tax credit carryforwards generated by Circa prior to its
merger with Watson. Previously, these net deferred tax assets were fully
reserved by Circa.
(6) The costs associated with the merger of Watson and Circa resulted in a
one-time charge of $13.9 million during the third quarter of 1995.
14
<PAGE> 21
ROYCE LABORATORIES, INC.
SUMMARY HISTORICAL CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------------- -----------------
1991 1992 1993 1994 1995 1995 1996
------ ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net sales............................................... $1,991 $ 2,422 $ 3,519 $ 6,191 $10,503 $ 6,522 $17,216
Net income (loss)....................................... 64 (2,898) (3,933) (1,477) (2,336) (1,513) 1,214
Earnings (loss) per share............................... 0.01 (0.31) (0.41) (0.14) (0.19) (0.12) 0.09
Weighted average number of common and common equivalent
shares outstanding.................................... 7,897 9,321 9,493 10,554 12,352 12,190 14,013
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------- SEPTEMBER 30,
1991 1992 1993 1994 1995 1996
------ ------ ------ ------ ------- -------------
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Current assets.............................................. $3,064 $6,066 $3,400 $7,048 $10,284 $14,170
Working capital............................................. 2,410 5,344 2,800 5,325 7,045 11,389
Total assets................................................ 3,578 6,657 4,065 8,111 12,093 17,588
Long-term debt and other long-term liabilities.............. 12 4 -- 33 181 1,053
Total stockholders' equity.................................. 2,912 5,931 3,465 6,355 8,673 13,754
</TABLE>
WATSON/OCLASSEN SUMMARY SUPPLEMENTARY UNAUDITED CONDENSED COMBINED FINANCIAL
DATA
Effective February 27, 1997, the Company consummated its merger with
Oclassen. The summary supplementary unaudited condensed combined financial
information of Watson and Oclassen set forth below gives effect to that merger
under the pooling of interests accounting method. Such supplementary information
assumes the merger had been effective at January 1 of each period presented for
the statement of operations information and on September 30, 1996 and December
31, 1995, 1994 and 1993 for the balance sheet information. The supplementary
information is presented for illustrative purposes only and is not necessarily
indicative of the operating results or financial position that would have
occurred if the merger had been consummated prior to February 27, 1997, nor is
it necessarily indicative of the future operating results or financial position
of the combined companies. The supplementary information should be read in
conjunction with the "Supplementary Consolidated Financial Statements of
Watson," including the notes thereto, included elsewhere herein.
WATSON/OCLASSEN
SUMMARY SUPPLEMENTARY UNAUDITED CONDENSED COMBINED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS
YEARS ENDED DECEMBER 31, ENDED
----------------------------- SEPTEMBER 30,
1993 1994 1995 1996
------- -------- -------- -------------
<S> <C> <C> <C> <C>
SUPPLEMENTARY CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues.................................................... $95,503 $122,912 $181,971 $166,293
Net income.................................................. 51,603 38,502 50,517 56,377
Net income available to common stockholders................. 51,494 36,585 47,800 54,339
Net income per common share:
Primary................................................... 1.42 .98 1.27 1.41
Fully diluted(1).......................................... 1.33 .98 1.27 1.36
Shares used in per share calculation:
Primary................................................... 36,132 37,144 37,778 38,519
Fully diluted(1).......................................... 38,748 37,144 37,778 41,339
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------- SEPTEMBER 30,
1994 1995 1996
-------- -------- -------------
<S> <C> <C> <C>
SUPPLEMENTARY CONSOLIDATED BALANCE SHEET DATA:
Current assets.............................................. $199,766 $224,470 $286,607
Working capital............................................. 173,154 188,046 243,978
Total assets................................................ 290,357 352,142 428,204
Long-term debt and other long-term liabilities.............. 20,770 4,303 3,128
Mandatorily redeemable preferred stock...................... 33,933 36,650 38,688
Total stockholders' equity.................................. 209,042 274,765 343,759
</TABLE>
- ---------------
(1) The effects of anti-dilutive securities were excluded from the calculation
of fully-diluted net income (loss) per common share.
15
<PAGE> 22
WATSON/OCLASSEN/ROYCE
SUMMARY UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL DATA
The summary unaudited pro forma condensed combined financial data of
Watson/Oclassen/Royce assumes that Watson's merger with Royce is accounted for
under the pooling of interests method of accounting. The Company's merger with
Oclassen was consummated effective February 27, 1997. Such pro forma data
assumes that these transactions had been effective at January 1 of each period
presented for the pro forma statement of operations data and on September 30,
1996 for the pro forma balance sheet data. The pro forma data is presented for
informational purposes only and is not necessarily indicative of the operating
results or financial position that would have occurred if the merger had been
consummated, nor is it necessarily indicative of the future operating results or
financial position of the combined companies (Watson, Oclassen and Royce). This
summary unaudited pro forma condensed combined data should be read in
conjunction with the Unaudited Pro Forma Condensed Combined Financial
Statements, including the notes thereto, included elsewhere in this Proxy
Statement/Prospectus.
WATSON/OCLASSEN/ROYCE
SUMMARY UNAUDITED PRO FORMA
CONDENSED COMBINED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED
----------------------------- SEPTEMBER 30,
1993 1994 1995 1996
------- -------- -------- -------------
<S> <C> <C> <C> <C>
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS DATA:
Revenues.................................................... $99,022 $129,103 $192,474 $183,509
Net income.................................................. 47,670 37,025 48,181 57,591
Net income available to common stockholders................. 47,561 35,108 45,464 55,553
Net income per common share:
Primary................................................... 1.26 .90 1.14 1.36
Fully diluted............................................. 1.18 .90 1.14 1.32
Shares used in per share calculation:
Primary................................................... 37,770 38,966 39,910 40,931
Fully diluted............................................. 40,386 38,966 39,910 43,751
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
1996
-------------
<S> <C>
PRO FORMA CONDENSED COMBINED BALANCE SHEET DATA:
Current assets.............................................. $286,277
Working capital............................................. 240,867
Total assets................................................ 431,292
Long-term debt and other long-term liabilities.............. 4,181
Total stockholders' equity.................................. 381,701
</TABLE>
16
<PAGE> 23
COMPARATIVE PER SHARE DATA
The following table sets forth certain historical per share data of Watson
and Royce and supplementary per share data for Watson and Oclassen and the
Watson/Oclassen/Royce combined per share data on an unaudited pro forma basis,
based on the assumption that the Merger occurred at the beginning of the
earliest period presented and was accounted for as a pooling of interests. The
pro forma comparative per share data gives effect to the Merger at an assumed
Exchange Ratio of 0.173 (assuming the Average Closing Price is $42.00). Book
value per share for the pro forma combined presentation is based upon
outstanding common shares, adjusted to include the shares of Watson Common Stock
issued upon consummation of the Oclassen Merger and the Watson Common Stock to
be issued in the Merger and assumes that the Merger had been effective at the
end of the period presented. In addition, the following table sets forth the
earnings and book value for Royce on an unaudited per share equivalent pro forma
basis. The equivalent pro forma earnings and book value is calculated by
multiplying the pro forma combined per share amounts by the Exchange Ratio of
0.173. The pro forma comparative per share data does not purport to represent
what Watson's financial position or results of operations would actually have
been had the Merger occurred at the beginning of the earliest period presented
or to project Watson's financial position or results of operations for any
future date or period. This data should be read in conjunction with the
unaudited pro forma condensed combined financial statements included elsewhere
herein and the separate historical financial statements and notes thereto of
Watson and Royce and the Supplementary Consolidated Financial Statements of
Watson and notes thereto included elsewhere in this Proxy Statement/Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS
YEARS ENDED DECEMBER 31, ENDED
-------------------------- SEPTEMBER 30,
1993 1994 1995 1996
------ ------ ------ -------------
<S> <C> <C> <C> <C>
Watson -- Historical:
Earnings........................................... $ 1.42 $ 1.00 $ 1.29 $1.43
Book value......................................... 5.21 6.24 7.95 9.70
Watson-Oclassen -- Supplementary:
Earnings -- Primary................................ $ 1.42 $ 0.98 $ 1.27 $1.41
Earnings -- Fully diluted.......................... 1.33 0.98 1.27 1.36
Book value......................................... 5.22 6.22 7.85 9.33
Watson-Oclassen-Royce -- Pro Forma Combined:
Earnings -- Primary................................ $ 1.26 $ 0.90 $ 1.14 $1.36
Earnings -- Fully diluted.......................... 1.18 0.90 1.14 1.32
Book value......................................... 5.00 6.02 7.62 9.00
Royce -- Historical:
Earnings (loss).................................... $(0.41) $(0.14) $(0.19) $0.09
Book value......................................... 0.35 0.53 0.68 1.02
Equivalent Pro Forma Combined for Royce:
Earnings -- Primary................................ $ 0.22 $ 0.16 $ 0.20 $0.24
Earnings -- Fully diluted.......................... 0.20 0.16 0.20 0.23
Book value......................................... 0.87 1.04 1.32 1.56
</TABLE>
17
<PAGE> 24
COMPARATIVE MARKET DATA
Watson Common Stock is traded on the Nasdaq NMS under the symbol "WATS" and
the Royce Common Stock is traded on the Nasdaq SmallCap Market under the symbol
"RLAB". The following table sets forth, for the calendar quarters indicated, the
high and low bid prices per share reported on the Nasdaq NMS for the Watson
Common Stock and the Nasdaq SmallCap Market for the Royce Common Stock.
<TABLE>
<CAPTION>
WATSON ROYCE
COMMON STOCK COMMON STOCK
------------------ -----------------
HIGH LOW HIGH LOW
------- ------- ------- ------
<S> <C> <C> <C> <C>
1995:
First Quarter........................................ $33.000 $20.000 $ 8.813 $4.500
Second Quarter....................................... 40.000 28.250 8.063 5.375
Third Quarter........................................ 44.250 32.750 9.625 6.125
Fourth Quarter....................................... 50.000 39.500 10.625 7.188
1996:
First Quarter........................................ $49.250 $37.000 $12.000 $8.500
Second Quarter....................................... 48.250 36.500 10.375 4.875
Third Quarter........................................ 39.875 26.000 5.500 3.875
Fourth Quarter....................................... 45.500 31.750 7.063 3.625
1997:
First Quarter (through March 12, 1997)............... $46.000 $40.625 $ 7.125 $6.750
</TABLE>
The last reported sale prices per share of Watson Common Stock and Royce
Common Stock on (i) December 24, 1996, the date the Merger Agreement was entered
into, were $43.50 and $6.19, respectively, and (ii) on March 12, 1997, the
latest practicable date prior to the date of this Proxy Statement/Prospectus,
were $42.94 and $7.03, respectively.
Watson has not paid any cash dividends on the Watson Common Stock and has
no present intention of paying cash dividends in the near future.
As of February 27, 1997, there were approximately 1,993 record holders of
Watson Common Stock and approximately 9,100 record holders of Royce Common
Stock.
SHAREHOLDERS ARE URGED TO OBTAIN CURRENT MARKET QUOTATIONS FOR THE WATSON
COMMON STOCK AND THE ROYCE COMMON STOCK. NO ASSURANCE CAN BE GIVEN AS TO THE
MARKET PRICE OF THE WATSON COMMON STOCK AFTER THE MERGER.
18
<PAGE> 25
RISK FACTORS
This Proxy Statement/Prospectus contains forward-looking statements within
the meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. Actual results could differ materially from those projected in the
forward-looking statements as a result of the risk factors set forth below and
elsewhere in this Proxy Statement/Prospectus. In addition to the other
information in this Proxy Statement/Prospectus, the following factors should be
considered carefully before voting upon the Merger proposal.
Integration of the Businesses. The Merger involves the integration of two
companies that have previously operated independently. There can be no assurance
that Watson and Royce will not encounter difficulties in integrating the
operations of the two companies. Any delays or unexpected costs incurred in
connection with such integration could have a material adverse effect on the
combined company's business, operating results or financial condition.
Furthermore, there can be no assurance that the operations, managements and
personnel of the two companies will be compatible or that Watson or Royce will
not experience the loss of key personnel.
Interests of Certain Persons in the Merger. Certain members of management
of Royce and the Royce Board of Directors have interests in the Merger that are
in addition to the interests of Royce shareholders generally. Specifically, by
virtue of the Merger (i) all options currently outstanding under existing Royce
stock option plans will be assumed by Watson and (ii) Patrick J. McEnany will
enter into an employment agreement with Watson which provides for among other
things, the grant of additional options to purchase shares of Watson Common
Stock and severance payments under certain circumstances to Mr. McEnany in the
event of his termination of employment. See "The Merger -- Interests of Certain
Persons in the Merger."
No Control Over Royce. As a result of the Merger, the shareholders of
Royce will effectively relinquish direct control over the business of Royce.
Royce will become a wholly-owned subsidiary of Watson, and thus, the continuing
interest of such shareholders in the business and financial condition of Royce
will be an indirect interest, as stockholders of Watson. As Watson stockholders,
Royce shareholders will be entitled to vote on all matters submitted to a vote
by Watson stockholders, together with all other Watson stockholders. The Royce
shareholders will lose the right to vote on any matter relating to the business
of Royce after the Merger.
Comparative Rights of Shareholders. As a result of the Merger, the
shareholders of Royce, a Florida corporation, will become stockholders of
Watson, a Nevada corporation. While the corporate law of Florida is essentially
similar to the corporate law of Nevada, and the Articles of Incorporation and
Bylaws of Watson are similar, in many respects, to the Articles of Incorporation
and Bylaws of Royce, certain differences exist which are identified in this
Proxy Statement/Prospectus under "Comparative Rights of Shareholders."
Conditions to the Merger. The Merger Agreement provides for certain
conditions to the consummation of the Merger. The non-occurrence of any such
condition may mean that the Merger will not be consummated. Moreover, any waiver
of a material condition to the Merger, such as the conditions that (i) the
Merger qualify for pooling of interests treatment for accounting purposes and
(ii) the Merger qualify as a tax free reorganization under the Internal Revenue
Code of 1986, as amended (the "Code"), will require a resolicitation of Royce
shareholders prior to consummation of the Merger.
Future Acquisitions. Watson is actively reviewing various candidates for
potential acquisitions of technologies, products or product rights and
businesses complementary to Watson's business. While, except for the Merger
Agreement and the Oclassen Merger Agreement (see "Watson's Business -- Recent
Developments"), Watson currently has not entered into any definitive agreements
with respect to any such acquisition, Watson may do so in the future. The impact
of such an announcement on the market price of a company's stock is often
uncertain. Consequently, an announcement of any such acquisition may have a
material adverse effect upon the market price of Watson Common Stock. In
addition, an acquisition may be disruptive to the management of the combined
company, and there can be no assurance that any such disruption will not have a
material adverse effect on the business or financial condition of the combined
company.
No Control Over Joint Ventures. A substantial portion of Watson's net
income is derived from joint ventures and a royalty arrangement. In addition, a
substantial portion of Watson's efforts in developing
19
<PAGE> 26
controlled-release technology is primarily conducted through joint ventures.
These arrangements involve various partners. Watson does not control the joint
ventures or the commercial exploitation of the licensed products, and there can
be no assurance that such joint ventures will be profitable. In addition,
certain of these arrangements, including Watson's arrangement with Rhone-Poulenc
Rorer, Inc. ("RPR") relating to Dilacor XR(R), have competition restrictions
which may restrict the development or marketing of the existing or future
products of either Watson or the joint venture. To the extent any such
restrictions are enforced, such restrictions could affect future revenues and
have a material adverse effect on the combined company. See "-- Uncertainty of
Royalty and Joint Venture Income."
Dependence Upon New Product Introductions. Watson's and Royce's future
results of operations will depend, to a significant extent, upon their ability
to successfully commercialize new off-patent and proprietary pharmaceutical
products in a timely manner. Newly introduced off-patent products with limited
or no off-patent competition are typically sold at higher selling prices, often
resulting in increased gross profit margins. As competition from other
manufacturers intensifies, selling prices typically decline. New products must
be developed, tested and manufactured and, in addition, must meet regulatory
standards and receive requisite regulatory approvals. The development and
commercialization process is time-consuming and costly. Delays in any part of
the process or the inability of Watson and Royce to obtain regulatory approval
for their products could adversely affect the combined company's quarterly and
annual operating results. Moreover, there can be no assurance that any of
Watson's or Royce's products, if and when developed and approved, can be
successfully commercialized.
Competition. Watson competes, and the combined company will compete, with
off-patent drug manufacturers, brand-name pharmaceutical companies that
manufacture off-patent drugs, the original manufacturers of brand-name drugs
that continue to be produced after patent expirations and manufacturers of new
drugs that may compete with Watson's off-patent drugs. Royce experiences
substantial competition in connection with the sale of its generic prescription
drugs. Watson's competitors vary depending upon product categories and, within
each product category, upon dosage strengths. Such competitors include the major
brand name and off-patent manufacturers of pharmaceuticals doing business in the
United States. Many competitors have been in business for a longer period of
time than either Watson or Royce, have a greater number of products on the
market and have greater financial and other resources. Because selling prices of
pharmaceutical products typically decline as competition intensifies, the
maintenance of profitable operations will be dependent, in part, on both
companies' ability to maintain efficient production capabilities and to develop
and introduce new products in a timely manner. There can be no assurance that
developments by others will not render Watson's or Royce's products or
technologies noncompetitive or obsolete.
Government Regulation. All pharmaceutical manufacturers are subject to
extensive regulation by the federal Food and Drug Administration ("FDA") and
other federal and state agencies. Moreover, Watson and Royce are subject to the
periodic inspection of their facilities and operations and the testing of their
products by the FDA. The FDA has extensive enforcement powers over
pharmaceutical manufacturers, including the power to withhold approvals of new
products, to force the voluntary recall of products to delay or prevent product
sales and to halt operations. Further, after an Abbreviated New Drug Application
("ANDA") or New Drug Application ("NDA") has been approved, current FDA
procedures may delay initial product shipment. Any manufacturer failing to
comply with FDA requirements may be unable to obtain approvals for the
introduction of new products. Watson and Royce are dependent on receiving FDA
approvals prior to marketing and shipping their respective products. There can
be no assurance, however, that the FDA will approve products either pending
before the FDA or under development, or that the rate, timing and cost of FDA
approvals will not adversely affect Watson's or Royce's product introduction
plans or results of operations. In recent years, the FDA's approval process of
ANDA off-patent products has become more rigorous, time-consuming and costly,
and neither Watson nor Royce can predict the extent to which they may be
affected by legislative and regulatory developments concerning their respective
products, operations or the healthcare field generally. The Uruguay Round
Agreements Act ("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 the longer of 17 years from the date of patent
grant or 20 years from the date of patent application. These URAA changes could
postpone approval eligibility of some ANDAs. Regulatory
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compliance issues or regulatory changes affecting Watson's or Royce's operations
or the approval or shipment of products could have a material adverse effect
upon both the companies' businesses. In addition, political pressure to contain
healthcare costs at the federal and state levels is increasing. There may be
future legislative or executive programs to reform the healthcare system, to
increase access to healthcare for the presently uninsured, to control the
continued escalation of healthcare expenditures or to use healthcare
reimbursement policies to help control the federal deficit. Regulatory
compliance issues or regulatory changes affecting Watson's or Royce's operations
or the approval or shipment of products could have a material adverse effect
upon Watson's or Royce's businesses.
Dependence on Key Personnel. The success of Watson's present and future
operations will depend, to a great extent, upon the experience, abilities and
continued services of certain executive officers of Watson, including Dr. Allen
Chao. In addition, the success of Royce's continuing operations will depend on
Royce's officers after the Merger, including Dr. Allen Chao and Patrick J.
McEnany. The loss of the services of these officers could have a material
adverse effect on the combined company. Watson has entered into employment
agreements with the following executive officers: Dr. Allen Chao, Dr. Melvin
Sharoky and Dr. David C. Hsia. Watson does not maintain key-man life insurance
on the lives of any of its officers. The success of the combined company also
depends upon its ability to attract and retain other highly qualified
scientific, managerial, sales and manufacturing personnel. However, when two
companies merge, there is a risk of departure of employees due to factors
relating to the combination process, and such departures may occur with respect
to the combined company. Competition for such personnel is intense. In this
respect, Watson and Royce compete with numerous pharmaceutical and healthcare
companies, as well as universities and nonprofit research organizations. There
can be no assurance that the combined company will continue to attract and
retain qualified personnel.
Potential Volatility of Stock Price and Absence of Dividends. The market
prices for securities of companies engaged primarily in pharmaceutical
development have been volatile, and the market price of the Watson Common Stock
may be volatile. Fluctuations in Watson's or Royce's operating results, the
announcement of technological innovations or new commercial products by Watson,
Royce or their competitors, governmental regulation, regulatory approvals,
developments relating to patents or proprietary rights, publicity regarding
actual or potential clinical results with respect to products under development
by Watson, Royce or others, political developments or proposed legislation in
the healthcare industry, and other investment considerations, may have a
significant impact on the market price of the Watson Common Stock. Watson has
not paid any cash dividends since inception, and, after the Merger, Watson does
not anticipate paying cash dividends in the foreseeable future.
Fluctuations in Quarterly Operating Results. Watson's results of
operations have fluctuated on a quarterly basis in the past, and may continue to
fluctuate. Watson believes such fluctuations are primarily due to new product
introductions and a variety of other factors including, without limitation, the
purchasing practices of Watson's customers, changes in the degree of competition
for Watson's products and the timing of new approvals.
Product Development. Although Watson and Royce intend to maintain
extensive product development activities, income from such efforts will not be
realized until the products have been approved by the FDA and successfully
marketed. No assurance can be given that any product development expenditures
will ever result in revenue. Further, in connection with its proprietary drug
delivery systems, Watson will depend on certain pharmaceutical company partners
to fund a portion of the costs of product development, testing, regulatory
approval and marketing. Such partners may abandon a product at any time, and
there can be no assurance that Watson could replace such collaborative
arrangements or successfully develop, test and market such products on their
own.
Patents and Proprietary Rights. Watson's success with its proprietary
products will depend in part on its ability to obtain patent protection for its
products and preserve its trade secrets. Watson has 15 U.S. patents issued or
allowed, three U.S. patents pending and numerous foreign patents issued and
pending. No assurance can be given, however, that Watson's patent applications
will be approved or that any patents will provide competitive advantages for its
products or will not be challenged or circumvented by competitors.
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In connection with Watson's and Royce's production of off-patent drugs,
recent changes to the patent law resulting from passage of the URAA will
lengthen the term of some granted patents. Patents that may be issued based upon
pending applications will have a patent term that is the longer of 17 years from
patent grant or 20 years from patent application. Watson and Royce also rely on
trade secrets and proprietary know-how which they seek to protect, in part,
through confidentiality agreements with their respective partners, customers,
employees and consultants. There can be no assurance that these agreements will
not be breached, that Watson or Royce will have adequate remedies for any
breach, or that Watson's or Royce's trade secrets will not otherwise become
known or be independently developed by competitors.
Watson and Royce 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, if at all, or that any licensed patents or proprietary rights
will be valid and enforceable. In a pending case, the U.S. Supreme Court has
agreed to consider the standard promulgated by the Federal Circuit Court of
Appeals for determining patent infringement. The U.S. Supreme Court's ruling
could impact the ability of Watson to enforce its patents and to defend against
potential patent infringement claims by third parties. In Hilton Davis Co. v.
Warner-Jenkinson Co., the U.S. Supreme Court will consider whether to adopt a
new standard for determining infringement under the doctrine of equivalents,
which may affect the breadth of protection afforded by a patent. The U.S.
Supreme Court's decision may broaden or narrow the breadth of any of Watson's
United States patents or any United States patents for which Watson has a
license or any third party's patents which potentially may be asserted against
Watson. Although neither Watson nor Royce is aware of any claim of patent
infringement, the companies' ability to commercialize their products will depend
on their not infringing the patents of others. Litigation concerning patents and
proprietary technologies can be protracted and expensive. Any such litigation
may have an adverse effect on the combined company's business, financial
condition or results of operations.
Dependence on Certain Products. During 1995, five products in the
hydrocodone bitartrate/acetaminophen product group sold by Watson accounted for
approximately 44% of Watson's total revenues. In addition, Watson's royalty
income from RPR sales of Dilacor XR(R) represented 14.5% of Watson's total
revenues in 1995. In 1994, three products in this product group accounted for
approximately 52% of Watson'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 Watson's total revenues. Due to FDA approval of products that
will compete with Watson's hydrocodone products group, management anticipates
increased price competition with respect to the hydrocodone group, and
consequently, Watson may experience a reduction in future sales of such products
which could have an adverse effect on the financial condition and results of
operations of Watson and the combined company.
During 1995, four products sold by Royce accounted for approximately 58% of
Royce's total revenues. In 1994, four products sold by Royce accounted for
approximately 69% of Royce's total revenues. Royce expects that a significant
portion of its revenues for the next few years will be dependent upon sales of
its currently marketed products. Limited or reduced commercial acceptance of
these products or reluctance of physicians to prescribe these products due to
adverse side effects, or otherwise, could have an adverse effect on the combined
company's business, financial condition or results of operations.
Uncertainty of Royalty and Joint Venture Income. Watson's royalty income
from RPR sales of Dilacor XR(R) represented approximately 30.5% of Watson's
pre-tax income for the year ended December 31, 1995. Royalties are based on the
prescriptions written, as defined, for the product Dilacor XR(R), which lost
exclusivity in May 1995. Watson's 50% equity interest in the earnings of
Somerset Pharmaceuticals, Inc. ("Somerset") were generated from the sale of one
product, Eldepryl(R). Watson's share of Somerset's earnings represented
approximately 34.1% of pre-tax income for the year ended December 31, 1995.
Exclusivity on Eldepryl(R) expired in June 1996. See "Risk Factors -- Loss of
Exclusive Rights to Market Certain Products." Somerset is developing an
Eldepryl(R) transdermal patch for treatment of Alzheimers Disease 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
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other companies of additional competitive products, could have a material
adverse effect on the financial condition and results of operations of Watson
and the combined company.
Subsequent Event -- Somerset. In connection with an examination of
Somerset's federal tax returns for the three years ended December 31, 1995,
representatives of the Internal Revenue Service, on March 7, 1997, have reviewed
with Somerset a draft "Notice of Proposed Adjustments" that contains a proposed
adjustment to Somerset's use of tax credits under section 936 of the Code. Under
the proposed adjustment Somerset could be subject to approximately $9 million
(50% of which would be Watson's share) of additional income tax and interest
charges that have not been accrued as of December 31, 1996. Management of
Somerset believes that Somerset has met all of the requirements to qualify for
the tax credits available under Code section 936, and intends to vigorously
defend its position on this matter. However, any adverse outcome of this issue
may effectively reduce Watson's equity in earnings from joint ventures during
1997.
Dependence Upon Certain Suppliers. Some materials used in Watson's and
Royce's products are currently available only from sole suppliers thereof. In
accordance with industry practice, such supply arrangements are not typically
evidenced by written contracts. In addition, sources for materials for Watson's
and Royce's products must be approved by the FDA and/or the Drug Enforcement
Agency ("DEA") and, in many instances, only one source has been approved for
certain materials in Watson's or Royce's products. Any interruption of materials
from sole source suppliers or delays in FDA or DEA approval of new suppliers or
price increases by such sole source suppliers could have a material adverse
effect on Watson's or Royce's business.
Loss of Exclusive Rights to Market Certain Products. Patent exclusivity
expired for Somerset's Eldepryl(R) product in June of 1996. In August 1996,
three competitors received FDA approval to market a tablet form of the product
which competes with Somerset's capsule form of Eldepryl(R). Watson's management
anticipates that Watson's Somerset joint venture earnings were reduced in 1996
and will be reduced in subsequent years due to this increased competition. For
the year ended December 31, 1995, Watson earned royalties of $22.2 million on
Dilacor XR(R). The Dilacor XR(R) product lost patent exclusivity in May of 1995,
and, as a result, heightened competition and lower profit margins may result.
However, to date, no such competition has entered the market. The loss of patent
exclusivity with respect to these products could have a material adverse effect
on the financial condition and results of operations of Watson and the combined
company.
Product Liability and Insurance. The design, development and manufacture
of Watson's and Royce's products involve an inherent risk of product liability
claims and associated adverse publicity. Insurance coverage is expensive,
difficult to obtain and may not be available in the future on acceptable terms,
or at all. Watson currently maintains product liability insurance coverage in
the amount of $15 million per incident and $15 million aggregate coverage.
Although Watson and Royce currently maintain liability insurance for all of
their products, there can be no assurance that the coverage limits of Watson's
or Royce's insurance policies will be adequate. A claim brought against Watson
or Royce, whether fully covered by insurance or not, could have a material
adverse effect upon the combined company.
Certain Anti-Takeover Provisions. The combined company may be subject to
the provisions of Nevada's antitakeover laws. The Nevada Combination with
Interested Stockholders Statute prevents "interested stockholders" and an
applicable Nevada corporation from entering into a "combination" unless certain
conditions are met. A combination means any merger or consolidation with an
"interested stockholder," or any sale, lease, exchange, mortgage, pledge,
transfer or other disposition, in one transaction or a series of transactions,
with an "interested stockholder" having: (i) an aggregate market value equal to
5% or more of the aggregate market value of the assets of the corporation; (ii)
an aggregate market value equal to 5% or more of the aggregate market value of
all outstanding shares of the corporation; or (iii) representing 10% or more of
the earning power or net income of the corporation. An "interested stockholder"
means the beneficial owner of 10% or more of the voting shares of a corporation,
or an affiliate or associate thereof. A corporation may not engage in a
"combination" within three years after the interested stockholder acquires his
or her shares unless the combination or purchase is approved by the board of
directors or a majority of the voting power held by disinterested stockholders,
or if the consideration to be paid by the interested stockholder is at least
equal to the highest of: (i) the highest price per share paid by the interested
stockholder within the
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three years immediately preceding the date of the announcement of the
combination or in the transaction in which he or she became an interested
stockholder, whichever is higher, (ii) the market value per common share on the
date of announcement of the combination or the date the interested stockholder
acquired the shares, whichever is higher, or (iii) if higher for the holders of
preferred stock, the highest liquidation value of the preferred stock. The
Control Share Acquisition Statute prohibits an acquiror, under certain
circumstances, from voting shares of a target corporation's stock after crossing
certain threshold ownership percentages, unless the acquiror obtains the
approval of the target corporation's stockholders. The Control Share Acquisition
Statutes specifies three thresholds: one-fifth or more but less than one-third,
one-third or more but less than a majority and a majority or more of the voting
power of the corporation in the election of directors. Once an acquiror crosses
one of the above thresholds, those shares acquired in such offer or acquisition
and those shares acquired within the preceding ninety days become Control Shares
and such Control Shares are deprived of the right to vote until disinterested
stockholders restore the right. The Control Shares Acquisition Statute also
provides that in the event Control Shares are accorded full voting rights and
the acquiring person has acquired a majority or more of all voting rights and
the acquiring person has acquired a majority or more of all voting power, all
other stockholders who do not vote in favor of authorizing voting rights to the
Control Shares are entitled to demand payment for the fair value of their
shares. The board of directors is to notify the stockholders within twenty days
after such an event has occurred that they have the right to receive the fair
value of their shares in accordance with statutory procedures established
generally for dissenters' rights. The Control Share Acquisition Statute
currently may not apply to Watson because Watson does not believe it has 100 or
more stockholders who are residents of the State of Nevada.
Such provisions may make an unsolicited acquisition of control of Watson
more difficult or expensive. In addition, provisions of Watson's Articles of
Incorporation permitting the issuance of Preferred Stock by the Board of
Directors and the existence of a staggered board of directors may also make an
unsolicited acquisition of control more difficult or expensive. See "Comparative
Rights of Stockholders" and "-- Anti-Takeover Provisions."
Voting Dilution. Royce's shareholders will suffer dilution in their voting
rights in connection with the Merger. Based on the capitalization of the
companies as of February 27, 1997, and assuming 3.3 million shares of Watson
Common Stock are issued pursuant to the Oclassen Merger, Royce's shareholders
will own approximately 5.3% of the outstanding shares of the combined company
after the Merger, rather than 100% of the outstanding shares of Royce.
No-Shop Provisions. The Merger Agreement contains certain "no-shop
provisions" which prohibit Royce from soliciting Alternative Proposals or,
subject to the Board's fiduciary duties to Royce's shareholders, negotiating
with a potential acquiror. These provisions could deter other parties who might
be interested in Royce and could deter an auction process with respect to a
potential sale of Royce that could result in the maximization of value to be
received by shareholders of Royce in connection with such a sale.
Closing. The closing of the Merger is subject to the conditions contained
in the Merger Agreement. Many of these conditions are beyond the control of
Watson and Royce. Although Watson and Royce believe that such conditions will be
fully satisfied, there can be no assurance that the closing of the Merger will
occur. The Closing is subject to the satisfaction of certain significant
conditions, including, among others, approval by the shareholders of Royce, the
receipt by Watson and Royce of an opinion from their independent public
accountants with respect to certain matters relating to the applicability of
pooling of interests accounting treatment for the Merger, the receipt of
regulatory approval under the HSR Act and the absence of any material adverse
change in the business results of operations or financial condition of either
Watson or Royce. In addition, the Merger Agreement may be terminated by either
party if the closing does not occur by April 30, 1997. See "The Merger
Agreement -- Conditions Precedent."
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THE MEETING
MATTERS TO BE CONSIDERED AT THE MEETING
At the Meeting, holders of Royce Common Stock will consider and vote upon a
proposal to approve and adopt the Merger Agreement, to approve the Merger and to
consider any other matters that are properly brought for a vote.
ROYCE'S BOARD OF DIRECTORS HAS APPROVED THE MERGER AGREEMENT AND THE MERGER
AND RECOMMENDS THAT THE SHAREHOLDERS VOTE FOR THE APPROVAL AND ADOPTION OF THE
MERGER AGREEMENT.
RECORD DATE; SHARES ENTITLED TO VOTE; QUORUM
The Royce Board of Directors has fixed the close of business on February
27, 1997 as the Record Date. Only holders of record of Royce Common Stock at the
close of business on the Record Date will be entitled to receive notice of and
to vote at the Meeting. On the Record Date there were 13,525,879 shares of Royce
Common Stock outstanding. Each such share is entitled to one vote. A majority of
the outstanding shares of Royce Common Stock on the Record Date must be
represented in person or by proxy at the Meeting in order for a quorum to be
present and business to be transacted at the Meeting. Abstentions will have the
effect of a vote against the Merger, as will the failure of holders of Royce
Common Stock to sign and return a Proxy.
Brokers will not vote shares as to which the brokers do not have
discretionary authority to vote ("broker non-votes"). Since the approval and
adoption of the Merger Agreement requires the affirmative vote of the holders of
a majority of the shares of Royce Common Stock outstanding on the Record Date, a
broker non-vote will have the effect of a vote against the Merger.
VOTES REQUIRED
Approval and adoption of the Merger Agreement will require the affirmative
vote of the holders of a majority of the outstanding shares of Royce Common
Stock on the Record Date.
As of the Record Date, Royce's directors and executive officers were the
owners of 799,952 shares of Royce Common Stock or approximately 5.9% of the then
outstanding shares of Royce Common Stock. See "Royce's Security Ownership of
Certain Beneficial Owners and Management."
VOTING OF PROXIES
Shares of Royce Common Stock represented by properly executed Proxies,
received at or prior to the Meeting, will be voted in the manner specified in
the Proxies by the holders of such shares. Properly executed Proxies which do
not contain voting instructions will be voted FOR approval and adoption of the
Merger Agreement. Any Company shareholder who abstains from voting and all
broker non-votes will be counted for purposes of determining whether a quorum
exists. An abstention or broker non-vote has the same effect as a vote against
the Merger.
If any other matters are properly presented for consideration at the
Meeting, the persons named in the Proxy and acting thereunder will have
discretion to vote on such matters in accordance with their judgment.
REVOCABILITY OF PROXIES
The grant of a Proxy does not preclude a shareholder from voting in person
or otherwise revoking a Proxy. Attendance at the Meeting will not in and of
itself constitute revocation of a Proxy. A Proxy may be revoked at any time
before its exercise by filing with the Corporate Secretary, 5350 N.W. 165th
Street, Miami, Florida 33014, an instrument of revocation or a duly executed
proxy bearing a later date, or by attendance at the Meeting and voting in
person.
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SOLICITATION OF PROXIES
The Company will bear the cost of the solicitation of Proxies from its
shareholders. In addition to solicitation by mail, directors, officers and
employees of the Company may solicit Proxies from shareholders by telephone,
telecopy or telegram or in person. Such persons soliciting Proxies will not be
additionally compensated, but will be reimbursed for reasonable out-of-pocket
expenses incurred in connection with such solicitation. The Company has also
engaged Morrow & Co., Inc., a professional proxy solicitation firm, to assist in
such solicitation at an estimated fee of $10,000, including disbursements. The
Company will reimburse brokerage firms, nominees, fiduciaries and other
custodians for the cost of forwarding solicitation materials to the beneficial
owners of shares held of record by them.
SHAREHOLDERS SHOULD NOT SEND STOCK CERTIFICATES WITH THEIR PROXY CARDS.
FOLLOWING THE EFFECTIVE DATE OF THE MERGER, THE COMPANY'S SHAREHOLDERS WILL BE
PROVIDED WITH INSTRUCTIONS AND A LETTER OF TRANSMITTAL RELATING TO THE EXCHANGE
OF THEIR STOCK CERTIFICATES.
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THE MERGER
The terms of the Merger are set forth in the Merger Agreement which is
attached to this Proxy Statement/Prospectus as Annex A and incorporated herein
by reference. The description of the Merger Agreement contained in this Proxy
Statement/Prospectus does not purport to be complete and is qualified in its
entirety by reference to the Merger Agreement. All shareholders are urged to
read the Merger Agreement in its entirety.
GENERAL DESCRIPTION
The Merger Agreement provides for a business combination between Watson and
the Company in which a wholly-owned subsidiary of Watson established for
purposes of the Merger would be merged with and into the Company in a
transaction intended to qualify as a tax free reorganization for federal income
tax purposes and to be accounted for as a pooling of interests. As a result of
the Merger, the Company would become a wholly-owned subsidiary of Watson.
EFFECTIVE DATE OF THE MERGER
The Merger will become effective upon the filing of Articles of Merger (the
"Articles of Merger") with the Florida Department of State (the "Effective
Date"). The Articles of Merger will be filed as promptly as practicable after
the approval by the Company's shareholders has been obtained and all other
conditions to the Merger have been satisfied or waived. It is presently expected
that the Merger will be consummated on or about April 16, 1997 or as soon
thereafter as such conditions are satisfied.
BACKGROUND OF THE MERGER
The terms and conditions of the Merger were determined through arm's-length
negotiations between the management and the Boards of Directors of Watson and
Royce. In determining the definitive terms of the Merger Agreement, numerous
factors were considered by the Boards of Directors of Watson and Royce. See
"Reasons for the Merger" below. The following is a brief discussion of these
negotiations and certain related events.
In connection with the continuing efforts of Watson to position itself for
the future, management of Watson from time to time engages in discussions with
third parties relating to possible joint ventures, strategic business alliances
and business combinations. The Board of Directors of Watson recognizes that the
increased costs of healthcare and the potential reform of the nation's
healthcare system have resulted in many changes to pharmaceutical companies,
including the acquisitions of off-patent pharmaceutical companies, consolidation
among brand pharmaceutical companies, consolidation of brand and off-patent
pharmaceutical companies, the acquisitions of pharmacy benefit management
companies by brand pharmaceutical companies, and the introduction of off-patent
pharmaceuticals directly by the brand pharmaceutical companies. The Board of
Directors of Watson was concerned that the financial condition of Watson could
be jeopardized as a result of increased competition, resulting in lower margins,
and that, with this competition, Watson might be less able to develop and market
new off-patent and proprietary products more rapidly than its competitors,
resulting in a smaller market share and lower profitability. As a result, the
Board of Directors of Watson recognized that, to increase stockholder value in
the long term, it would be beneficial for Watson to pursue a business
combination with Royce in order to more effectively compete in the changing
healthcare market.
In late 1995 and early 1996, Royce's management and Board of Directors
began to focus on issues relating to the Company's long-term goals and strategic
plans. Management believed at that time that the Company was poised for
significant growth during the next few years, based upon anticipated approvals
of new products. They also believed that it would be important for Royce to
align itself with one or more technology partners to allow the Company to
develop products which were other than immediate release generic pharmaceutical
products more quickly than such products could be developed if the Company
sought to develop them on its own. The Company's Board and management also
recognized that the dynamics of the generic pharmaceutical industry were
changing, competition was becoming more of a factor and the likelihood
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that a company such as Royce would be the sole source of supply on a large
generic product were becoming less likely than it had been in previous years.
Based upon these factors, the Company's Board determined to pursue a
strategy of searching for one or more strategic partners with technology which
the Company felt was necessary to develop off-patent pharmaceutical products in
alternative delivery systems. The Company's Board authorized management to
pursue opportunities which might be available, and to further this objective,
the Company's Board authorized management to retain an investment banker to
assist the Company in seeking various opportunities. In that regard, in February
1996, Royce engaged Gruntal to assist the Company in its search for one or more
strategic technology partners.
During this same period of time, in late November 1995, Patrick J. McEnany,
the Company's Chairman, President and CEO and Dr. Allen Chao, Watson's Chairman
and CEO, met at an industry conference. At their meeting, Dr. Chao and Mr.
McEnany had general discussions regarding the dynamics of the off-patent drug
industry and the status of their respective companies. Dr. Chao and Mr. McEnany
also discussed the ongoing consolidation within the off-patent drug industry and
Dr. Chao expressed an interest in pursuing a dialogue with Mr. McEnany as to a
possible amalgamation of the two companies.
As a result of these discussions, in December 1995, Royce and Watson
entered into a confidentiality agreement and exchanged financial and other
information regarding their respective business activities. Additionally, in
late January 1996, Mr. McEnany visited Watson's Corona, California manufacturing
and research and development facilities. During this and subsequent meetings,
Dr. Chao and Mr. McEnany continued to discuss their respective businesses, the
changing nature of the off-patent drug industry and how their companies might
perform if they were combined. However, no agreements were reached during these
discussions.
Similarly, in May 1996 and June 1996, respectively, Dr. Chao and Mr.
McEnany met in New York and Corona and continued their dialogue regarding the
off-patent drug industry and what a combined Royce and Watson might look like.
Again, no agreements were reached during these discussions.
In late July 1996, at Watson's regularly scheduled board meeting, the
Watson Board discussed the potential acquisition of Royce.
During the spring and summer of 1996, Royce also had discussions with
various potential strategic technology partners, none of whom appeared to fit
the Company's long term objectives. During this period, Dr. Chao and Mr. McEnany
continued their discussions at a meeting in New York and by telephone on various
occasions and Dr. Chao advised Mr. McEnany that he would like to pursue further
discussions towards an amalgamation of Watson and Royce.
Dr. Chao and Mr. McEnany met in Dallas, Texas on August 29, 1996. At that
meeting, they continued their discussions as to the synergies which might be
achieved if the two companies were combined. Dr. Chao informally suggested at
that meeting a price at which he was prepared to recommend to his board to
acquire all of Royce's outstanding securities (on a fully diluted basis,
accounting for the value of outstanding options and warrants) in a tax free
reorganization transaction accounted for as a pooling of interests. After this
meeting, Mr. McEnany agreed to allow Watson's FDA consultant to commence due
diligence with respect to Royce preparatory to further discussions and, between
September 16-19, 1996, Watson's FDA consultant visited Royce's operations and
conducted an FDA regulatory and commercial due diligence on Royce.
On September 4, 1996, Dr. Chao provided Mr. McEnany with a draft term sheet
setting forth the proposed terms as he had described them at the meeting on
August 29. Such term sheet proposed a price per share of $6.30, at which Watson
was prepared to acquire the outstanding shares of Royce, and provisions
concerning the treatment of outstanding options and warrants. The term sheet did
not address any proposed collars, break-up fees or walk-away rights. After
several follow up telephone conversations between Watson's and Royce's chief
executive officers, Watson submitted a revised term sheet on September 9, 1996
which addressed the same issues as the September 4 term sheet. At a regularly
scheduled board meeting of Watson on September 24, 1996, Dr. Chao advised the
Watson Board on the status of the Royce negotiations. No formal action was taken
by the Watson Board at such meeting but the Board authorized Dr. Chao to
continue
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negotiations with Royce's management with respect to a possible acquisition of
Royce. At a regular meeting of Royce's Board held on September 26, 1996, Mr.
McEnany advised the Board regarding his discussions with Dr. Chao, as well as
the status of his discussions with potential strategic technology partners, but
stated his belief that it would be premature for the Board to consider any of
these arrangements until more definitive terms could be negotiated. He advised
the Board that he would report back to them as his discussions progressed. On
October 11, 1996, Watson finalized its intention to hire Bear Stearns as its
financial advisor in connection with the potential acquisition of Royce.
On October 11, 1996, Mr. McEnany and Royce's counsel met with Dr. Chao in
New York to discuss the terms of a potential merger of the two companies. At
that meeting, Mr. McEnany advised Dr. Chao that the Company had commenced
negotiations with one potential strategic technology partner and had identified
a second potential strategic technology partner. He stated that the Company was
at a crossroads and needed to decide whether it was in the Company's best
interest to pursue one of these proposed strategic technology relationships or
merge into and become part of a larger entity such as Watson. Dr. Chao agreed
that discussions should be pursued to determine whether an acceptable
arrangement could be achieved.
In October 1996, the Company was faced with a decision as to whether to
pursue a possible strategic alliance with a technology partner or to seek to
determine whether an acceptable agreement could be reached with Watson. The
Company believed that by remaining independent, it might achieve a certain level
of success, with corresponding increases in the value in its share price to the
Company's shareholders. The Company also recognized that there might be factors
which might not allow the Company to achieve the level of success that it was
then projecting, which might result in the share price of the Company's common
stock not trading at the projected level. The Company also believed that at the
right merger consideration, an agreement with Watson might offer the Company's
shareholders more long term value than the Company might achieve as a stand
alone entity. As a consequence of this analysis, the Company made the decision
in October 1996 to pursue a transaction with Watson to determine whether
acceptable terms could be reached which would potentially give the shareholders
of Royce greater long term value than that offered by the Company's plan to
remain an independent company and pursue one or more alliances with strategic
technology partners. At the time this decision was made, the Company put all
negotiations with strategic technology partners on hold, believing that these
negotiations (or negotiations with other parties who might be identified who
might become strategic technology partners to the Company) could be restarted in
the future if an acceptable agreement was not reached with Watson. At the time
that this decision was made, negotiations with potential strategic partners had
not progressed to the point where there were specific transactions to be
considered as an alternative to the merger with Watson.
At a regularly scheduled board meeting of Watson on October 18, 1996, Dr.
Chao again advised the Watson Board on the status of the Royce negotiations. No
formal action was taken by the Watson Board at such meeting but the Board
authorized Dr. Chao to continue negotiations with Royce's management with
respect to a possible acquisition of Royce.
On October 28, 1996, Dr. Chao and Mr. McEnany met for several hours in New
York. In that meeting, Dr. Chao proposed a revised price at which Watson was
prepared to acquire the outstanding shares of Royce. The terms of Mr. McEnany's
employment by Watson after the Merger were also discussed. Other essential terms
of the proposed merger (i.e. collars, break-up fees and walk-away rights) were
not discussed at this meeting.
Thereafter, on November 4, 1996, Watson issued another term sheet to Royce
with respect to the proposed transaction. The term sheet left blank the proposed
collars on the purchase price, which Mr. McEnany and Dr. Chao agreed would be
negotiated at a later date. On November 5, 1996, Dr. Chao, Watson's counsel, Mr.
McEnany and Royce's counsel participated in a conference call during which the
terms of the proposed term sheet were discussed. After the telephone conference,
many issues remained unresolved including whether outstanding stock options
would reduce the consideration payable to Royce shareholders, the size of the
break-up fee, the collars and the ability for either party to terminate the
Merger based upon fluctuations in the Average Closing Price.
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On November 14, 1996, Royce's Board met to consider the Company's available
opportunities. The Board determined at that meeting that while the Company's
prospects as an independent company continued to be positive, the opportunities
afforded to the Company and its shareholders as part of a combined operation
with Watson could be more favorable. The Board also determined that it was in
the best interest of the Company and its shareholders for the Company to
continue to pursue an arrangement with Watson. In furtherance of that objective,
the Board directed the Company's management to continue its negotiation with
Watson.
Between November 12-14, 1996, representatives of Watson, their counsel and
investment bankers conducted a legal and financial due diligence investigation
of Royce. Shortly thereafter, on November 18, 1996, Watson presented Royce's
management and counsel with a first draft of an Agreement and Plan of Merger
with respect to the proposed merger.
During the period between November 18, 1996 through December 16, 1996, (i)
Royce's management, counsel and investment bankers conducted a due diligence
investigation of Watson; (ii) Watson's management, counsel and investment
bankers continued their due diligence investigation of Royce, and (iii) Watson
and Royce negotiated the terms of the definitive Agreement and Plan of Merger
and the exhibits thereto. The discussions relating to the Merger Agreement
focused on, among other things, the representations and warranties to be made by
Royce and Watson and on each party's respective obligations between the date of
the Merger Agreement and the closing of the Merger.
On December 11 and 12, 1996 and on December 16, 1996, representatives of
Royce and Watson, their counsel and financial advisors, met in Chicago to
attempt to negotiate the final definitive financial terms of the proposed merger
(i.e. exchange ratio, collar and break-up fees), the treatment of outstanding
options and warrants to purchase Royce Common Stock, and the terms of Mr.
McEnany's post-Merger employment with Watson. At these meetings, and during the
period between these meetings, the parties actively discussed their views
regarding the proposed financial terms of the merger. They also reviewed and
conducted further due diligence on the results of operations and prospects of
both entities and on the potential synergies which each party believed might be
achieved if a merger were to be consummated. The decision to increase the
proposed price per share was taken following direct discussions between Dr. Chao
and Mr. McEnany, each acting with the advice of their respective financial
advisors and legal counsel.
At the meeting on December 16, 1996, after considering all of these
matters, the managements of Royce and Watson, subject to the approval of their
respective Boards, agreed that they would recommend a proposed exchange of Royce
shares for Watson shares based upon a price of $7.25 for each outstanding share
of Royce Common Stock on the effective date of the Merger, subject to a collar
on the price of Watson Common Stock of between $38.00 and $47.00 per share. They
also agreed that each Royce option and warrant outstanding on the effective date
of the Merger would automatically convert into an option or warrant to purchase
shares of Watson Common Stock. Furthermore, the parties agreed upon a $3 million
break-up fee if Royce entered into an Alternative Proposal within nine months
after the termination of the Merger and Royce later consummated such Alternative
Proposal. The parties also tentatively agreed on the terms of Mr. McEnany's
employment agreement with Watson.
At a meeting on December 19, 1996, Watson's Board approved the Merger
Agreement. At a meeting on December 23, 1996, Royce's Board met to consider the
proposed terms of the Merger Agreement. At that time, the Board gave approval to
the Merger Agreement and directed Royce's senior management to complete the
final negotiations of the Merger Agreement and to execute and deliver the Merger
Agreement on behalf of Royce. In making each of their respective financial
decisions, the Board of Directors of both Watson and Royce received opinions of
their financial advisors as to the fairness of the transaction from a financial
point of view.
The final negotiations of the terms of the Merger Agreement, and Mr.
McEnany's employment agreement and the other exhibits to the Merger Agreement,
took place between December 20, 1996 and December 24, 1996, and the Merger
Agreement was executed and delivered late in the afternoon on December 24, 1996.
A press release announcing the Merger was disseminated before the opening of
business on December 26, 1996 (the first business day after the Merger Agreement
was executed and delivered).
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Effective as of March 4, 1997, the parties amended the Merger Agreement to
extend the termination date thereof to April 30, 1997.
REASONS FOR THE MERGER
Joint Reasons for the Merger.
Based upon their respective experiences and internal analysis of the
current environment in the generic drug industry, Royce's and Watson's
respective Boards decided that there are significant opportunities for a well
capitalized off-patent pharmaceutical firm with a strong technology base and
that the combination of the two entities should help Watson to become a more
significant factor in the pharmaceutical industry on a going forward basis. The
Boards of each company were aware of the substantial consolidation which is
ongoing in the off-patent pharmaceutical industry and believed that larger
well-capitalized entities will have better opportunities in the off-patent
pharmaceutical industry in the future.
In reaching their decisions regarding the Merger, the respective Boards of
the two companies considered: (i) the potential for modest increases in
operating efficiencies for the combined company, primarily relating to selling
expenses and general and administrative expenses, which could allow the combined
company to achieve economies of scale unavailable to either company on a
stand-alone basis; (ii) the complementary product lines of the two entities; and
(iii) that the combined company should realize the benefits of increased product
innovation through the combination of Royce's and Watson's research and
development operations.
Watson's Reasons for the Merger; Advantages and Disadvantages of the Merger.
At a meeting held on December 19, 1996, the Watson Board of Directors
determined that the Merger was fair to the Watson stockholders from a financial
point of view and approved the Merger Agreement. In reaching its conclusion to
approve the Merger Agreement, the Watson Board of Directors considered the
following factors as well as the reasons set forth above:
1. The effects on its future estimated earnings per share due to the
acquisition of Royce and whether such transaction would be accretive or
dilutive to Watson's stockholders. Watson believes that the combination of
the businesses and product pipelines of Watson and Royce and the
elimination of certain overlapping costs associated with the existing
businesses, will allow Watson to expand its presence in the off-patent
pharmaceutical market and enable Watson to achieve a marginal increase in
its earnings per share in 1997 and in subsequent years;
2. The fact that both Watson and Royce devote significant resources to
product development and both companies have a number of products in the
development pipeline. Watson believes that combining the companies and
their product development activities through the Merger will result in an
enhanced product pipeline when compared to the product pipeline of each
company prior to the Merger and may result in a rationalization of product
development efforts. There can be no assurance that any of the products
currently in development by Watson or Royce will ever be successfully
developed, receive required regulatory approvals or be successfully
marketed. However, by expanding and diversifying the combined company's
product pipeline through the Merger, the failure to successfully develop,
receive required approvals or successfully market any particular product
under development is likely to have less severe effects on the business,
operations or financial condition of the combined company, than such event
would have on the business operations or financial condition of either
Watson or Royce alone;
3. The terms and conditions of the Merger, the Merger Agreement and
related matters. In considering the terms of the Merger, particular
attention was given by the Watson Board of Directors to (a) the
consideration to be received by the Royce shareholders, including the
structure and terms of the pricing collar, (b) the treatment of outstanding
options and warrants to purchase Royce Common Stock and (c) the termination
provisions, including the potential payment by the Company of a $3,000,000
break up fee in the event the Company terminates the Merger Agreement and
subsequently enters into an Alternative Proposal (as defined in the Merger
Agreement). The Board of Directors of Watson considered the terms of the
Merger Agreement as a whole (and not individually) and, given its
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experience in similar transactions, analysis of comparable transactions and
advice of Watson's financial and legal advisors, determined to approve the
Merger and adopt the Merger Agreement. See "The Merger -- Approval of the
Board of Directors of Watson."
4. The historical and current financial conditions, results of
operations, prospects and businesses of Royce and Watson before and after
giving effect to the Merger;
5. Current market conditions, historical market prices, and trading
information for both the Royce Common Stock and the Watson Common Stock;
6. The opinion of Bear Stearns that as of the date of its opinion, the
Exchange Ratio was fair, from a financial point of view, to Watson; and
7. The expectations that the complementary businesses of Watson and
Royce, as described above, including their respective philosophies, will
provide significant growth opportunities after consummation of the Merger.
The Watson Board of Directors believes that the material disadvantages of
the proposed Merger to Watson and its stockholders are the following:
1. The Watson Board of Directors recognized and considered the risk
that the aggregate consideration to be paid by Watson to acquire Royce
might exceed the amount of consideration justified based upon the current
level of earnings of Royce and based on the price of Watson Common Stock
and the pricing collar. However, the Board concluded that such risk did not
outweigh the perceived advantages of the Merger. The Watson Board of
Directors also recognized and considered the risk that Royce may not
achieve its anticipated future financial performance due to factors both
within Royce's control and factors outside Royce's control. If such
performance is not met by Royce, the consideration paid by Watson to
acquire Royce might exceed the amount of consideration justified for such
acquisition. Additionally, the Watson Board of Directors considered that
Watson would have no ability to terminate the Merger due to fluctuations in
the Average Closing Price.
2. There can be no assurance that any of Royce's products currently in
development will ever receive the required regulatory approvals from the
FDA. Consequently, the Watson Board of Directors considered the risk that
such products will not be approved and that Watson will never realize the
potential revenues from the production and sale of these products.
3. Watson may experience disruption in its business or employee base
as a result of uncertainty following announcement of the Merger and during
the combination of the operations of Watson and Royce if the Merger is
consummated. Such disruption has not occurred to date, but remains a risk
of the Merger.
4. The Watson Board of Directors recognized and considered the risk
that the Merger will not be consummated. If the Merger is not consummated,
the public announcement of the Merger and non-consummation of the Merger
may have an adverse effect on the market price of Watson Common Stock.
5. The Watson Board of Directors also considered the risks associated
with integrating the businesses, operations and personnel of Watson and
Royce following the Merger and the possibility that the modest anticipated
benefits of the Merger (through the expansion and diversification of
product pipelines, the benefits of increased product innovation through the
combination of research and development activities, the elimination of
certain overlapping costs, the enhanced marketing capabilities and the
ability to more effectively compete with larger pharmaceutical companies)
will not be realized. See "Risk Factors -- Integration of the Businesses."
Although the Watson Board of Directors carefully considered the advantages
and disadvantages of the Merger described above, Watson's Board of Directors did
not find it practicable to, and did not, quantify or otherwise attempt to assign
relative weights to the specific advantages and disadvantages considered.
However, after discussing and considering the advantages and disadvantages, the
Watson Board of Directors approved the Merger and the adoption of the Merger
Agreement. See "The Merger -- Approval by the Board of Directors of Watson."
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Royce's Reasons for the Merger; Advantages and Disadvantages of the Merger.
At a meeting held on December 23, 1996, the Royce Board of Directors
determined that the Merger was advisable and in the best interest of the Royce
shareholders and approved the Merger Agreement. In reaching its conclusion to
approve the Merger Agreement and to recommend adoption of the Merger Agreement
by the Royce shareholders, the Royce Board considered various factors,
including, without limitation, the following:
1. The arms-length negotiation with Watson, which resulted in the
agreement by Watson to acquire all outstanding Royce Common Stock, and to
assume outstanding options and warrants in exchange for Watson Common Stock
which represented approximately a 42% premium (assuming an Exchange Ratio
based upon a Watson stock price within the collars established under the
Merger Agreement) over the average closing price for the Royce Common Stock
for the ten-day period ended December 17, 1996 ($5.11 per share);
2. The historical and current financial conditions, results of
operations, prospects and businesses of Royce and Watson before and after
giving effect to the Merger;
3. Current market conditions, historical market prices, and trading
information for both the Royce Common Stock and the Watson Common Stock and
the expectation that the substantially higher average daily trading volume
of Watson Common Stock will create better liquidity of investment for Royce
shareholders;
4. The structure of the Merger, which provides that the Royce
shareholders will receive an equity interest in a larger, more diversified
pharmaceutical company with a stronger balance sheet and cash flow and with
depth of management personnel and training resources;
5. The expectation that the Merger will afford the Royce shareholders
the opportunity to receive Watson Common Stock in a tax free transaction;
6. The relative probability of completion, attractiveness and timing
of various other alternatives available to Royce and the belief that being
part of Watson was more likely to provide greater value to Royce's
shareholders than remaining independent;
7. The expectation that the Merger will be beneficial to the employees
of Royce;
8. The opinion of Gruntal that as of the date of the Merger Agreement,
the terms of the Merger were fair, from a financial point of view, to
Royce's shareholders (in considering the opinion of Gruntal, the Royce
Board of Directors was aware of, among other things, the terms of Gruntal's
engagement by Royce and the fees payable to Gruntal thereunder, and
Gruntal's ownership of warrants to purchase 283,333 shares of Royce Common
Stock; see "Opinion of Royce's Financial Advisor");
9. The expectation that the complementary businesses of Watson and
Royce, as described above, including their respective operating
philosophies, will provide significant growth opportunities after
consummation of the Merger; and
10. The belief that Watson's experienced management team, its
reputation in the pharmaceutical industry and investment community, and its
history of profitable operations while maintaining a high growth rate will
be beneficial to the shareholders of Royce.
The Royce Board of Directors believes that the material disadvantages to
Royce and its shareholders concerning the proposed Merger are the following:
(i) The Royce Board recognized and considered the risk that Royce
shareholders would lose control over the future operations of Royce
following the Merger, including the opportunity to develop and exploit
Royce's current and potential products for their sole benefit and the
possibility that the combined company would make strategic decisions that
differ from those that Royce would make absent the Merger;
(ii) The risk that prior to or following consummation of the Merger,
the trading price of Watson Common Stock would drop below its level at the
time the Merger was negotiated or closed. The Royce
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Board of Directors also recognized and considered the risk that Watson may
not achieve its anticipated future performance due to factors both within
Watson's control and outside Watson's control. If the price of Watson
Common Stock declines or such performance is not met by Watson, the
consideration paid by Watson to acquire Royce might be less than the
consideration justified for such acquisition;
(iii) The Royce Board also recognized and considered the potential
commercial repercussions to Royce in the event the Merger was not
consummated. The Royce Board of Directors was concerned that if the Merger
was not consummated, after being publicly announced, Royce's reputation
might be damaged (even if the non-consummation of the Merger was not the
result of either action or inaction by Royce) which would limit strategic
alternatives available to Royce in such event, such as aligning Royce with
one or more strategic partners. Accordingly, Royce's Board of Directors
deemed it important that the Merger Agreement have minimal risk of
termination regardless of the market value of Watson Common Stock during
the period between signing of the Merger Agreement and consummation of the
Merger. In considering the terms of the Merger, particular attention was
given to (a) the consideration to be received by the Royce shareholders,
including the structure and terms of the minimum and maximum Average
Closing Price, (b) the treatment of outstanding options and warrants to
purchase Royce Common Stock, (c) the extent of the indemnification
obligations of Royce and Watson and (d) the conditions under which the
Merger Agreement could be terminated. The Royce Board also considered the
no-shop provisions of the Merger Agreement which (a) prohibit Royce from
soliciting Alternative Proposals or, subject to the Board's fiduciary
duties to Royce shareholders, from negotiating with a potential acquiror,
and (b) obligate Royce to pay the Termination Fee, if the Merger Agreement
is terminated as a result of Royce entering into an Alternative Proposal or
because the Royce Board of Directors shall have withdrawn or modified its
approval of the Merger Agreement and the Merger and certain other
conditions are met, or, under certain circumstances, require the
reimbursement of Watson by Royce for Watson's out of pocket costs and
expenses incurred in connection with the Merger Agreement. The Royce Board
of Directors recognized and considered the fact that the no-shop provisions
would essentially prevent Royce from considering or entering into any other
acquisition transaction with a party other than Watson. In addition, the
Royce Board of Directors recognized and considered (a) the terms of the
employment agreement to be entered into with Patrick J. McEnany by Watson
and (b) the fiduciary duties of the Royce Board of Directors in view of the
fact that Mr. McEnany was an interested director on the Royce Board of
Directors. See "Interests of Certain Persons in the Merger." The Royce
Board of Directors believes that the retention of a key officer and
employee of Royce after the consummation of the Merger will be an important
factor in any future development of the Royce business and considered such
employment agreement to be reasonable in scope and an effective means for
retaining such officer following the Merger. In addition, the Royce Board
recognized and considered its fiduciary duties in view of the fact that Mr.
McEnany, as a member of the Royce Board, has certain additional interests
in the Merger but that the impact of any such interest was not material to
the Royce Board's decisions regarding the Merger since he was the sole
interested director on the Royce Board and all of the other members of the
Royce Board determined to approve the Merger and adopt the Merger
Agreement. The Royce Board of Directors also reviewed and considered the
possible lack of independence of Gruntal due to its stockholdings in Royce
but determined, after receiving advice from counsel, to accept Gruntal's
fairness opinion and to advise the Company's shareholders of the existence
of Gruntal's warrants so that the shareholders could consider this issue in
voting on the Merger.
(iv) Royce shareholders will suffer dilution in their voting rights in
connection with the Merger. Based on the capitalization of the companies as
of February 27, 1997, and assuming 3.3 million shares of Watson Common
Stock are issued pursuant to the Oclassen Merger, Royce shareholders will
own approximately 5.3% of the outstanding shares of the combined company
after the Merger rather than 100% of the outstanding shares of Royce.
The Royce Board of Directors considered the fact that no auction process
has been conducted with respect to a potential sale of Royce. The provisions of
the Merger Agreement prohibit Royce from soliciting Alternative Proposals or,
subject to the Board's fiduciary duties to Royce shareholders, negotiating with
a potential acquiror of Royce. The Board was aware that these provisions could
be a deterrent to other parties
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who might be interested in a business combination with Royce. However, Watson
required such provisions as a condition to executing the Merger Agreement. The
Royce Board of Directors believed that the Merger would be in the best interests
of Royce and its shareholders as it would provide Royce shareholders with the
opportunity to continue to participate in an entity strengthened through a
business combination with Watson.
In view of the wide variety of factors considered, both positive and
negative, the Royce's Board of Directors did not find it practicable to, and did
not, quantify or otherwise assign relative weights to the specific factors
considered in reaching its determination. Rather, Royce's Board of Directors
viewed its determination and recommendations as being based on the totality of
the information presented to it and considered by it. Individual members of
Royce's Board of Directors may have given different weight to different factors.
THE ROYCE BOARD OF DIRECTORS BELIEVES THAT THE MERGER IS IN THE BEST
INTERESTS OF ROYCE SHAREHOLDERS AND RECOMMENDS THAT ROYCE SHAREHOLDERS VOTE FOR
THE MERGER.
INTERESTS OF CERTAIN PERSONS IN THE MERGER
In considering the recommendation of the Company's Board of Directors with
respect to the Merger Agreement and the transactions contemplated thereby, the
Company's shareholders should be aware that certain members of the management
and the Board of Directors of the Company have certain interests in the Merger
in addition to the interests of the Company's shareholders generally.
Proposed Employment Agreement with Watson. In conjunction with the closing
of the Merger, Watson will enter into an Employment Agreement with Patrick J.
McEnany, the Chairman, President and Chief Executive Officer of the Company (the
"Employment Agreement"). The Employment Agreement will be for a three-year term
and will provide that Mr. McEnany will remain as the President of the Company
and will also become a Vice President of Watson in charge of Corporate
Development. The Employment Agreement will replace the currently existing
employment agreement between the Company and Mr. McEnany.
Under the Employment Agreement, Mr. McEnany will receive: (i) a base salary
of $200,000 per annum (adjusted annually for increases in the cost of living);
(ii) the right to receive a bonus of up to $150,000 during the first year of the
agreement by meeting certain targets, and discretionary bonuses in future years;
(iii) customary benefits consistent with the other officers of Watson; and (iv)
an option (vesting over five years) to purchase 100,000 shares of Watson Common
Stock at an exercise price equal to the last closing price of shares of Watson
Common Stock on the Effective Date.
The Employment Agreement will also provide that if Mr. McEnany terminates
the agreement after one year or for "good reason" (as defined in the Employment
Agreement) or if Watson terminates the Employment Agreement for any reason other
than cause, Mr. McEnany will receive severance benefits of $350,000 payable over
the year following the termination of employment. Additionally, in the event
that Mr. McEnany's Employment Agreement is terminated by Watson for any reason
other than cause or by Mr. McEnany for "good reason," Mr. McEnany will become a
consultant to Watson for a term to end in 2002. In return for becoming a
consultant, all options granted to Mr. McEnany pursuant to the Employment
Agreement will continue to vest in accordance with the terms of the Employment
Agreement. Mr. McEnany will be prohibited from competing with Watson in the
development, manufacture, sale and marketing of generic prescription products
during the term of such Employment Agreement and for a one-year period after
termination of Mr. McEnany's employment with Watson and the Company.
Additionally, Mr. McEnany's consulting agreement with Watson and the Company
shall terminate upon Mr. McEnany competing with Watson in the development, sale
and marketing of generic prescription drugs. While Mr. McEnany intends to abide
by the terms of the Employment Agreement, including the non-compete provisions,
the enforceability of such provisions is subject to doubt and no assurance can
be given that a court would in fact enforce such provisions.
Acceleration of Options. At the closing of the Merger, outstanding Company
Options will be converted into the right to purchase that number of shares of
Watson Common Stock as the holder of such Company Options would have been
entitled to receive had they exercised such Company Options prior to
consummation
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of the Merger and participated in the Merger. Company Options issued pursuant to
the Company's 1992 and 1995 Stock Option Plans and options granted to Mr.
McEnany under the terms of his present employment agreement with the Company,
will, in accordance with the terms of the plans and such agreement, immediately
vest at the closing of the Merger. All other Company Options will continue to
vest in accordance with the vesting or acceleration provisions contained in the
agreements evidencing such Company Options. As of February 27, 1997, the
officers and directors of Royce held options currently exercisable for 622,233
shares of Royce Common Stock. See "Royce's Security Ownership of Certain
Beneficial Owners and Management."
As of February 27, 1997, the estimated number of shares issuable to Royce's
officers and directors upon the exercise of 746,733 Company Options held by
them, including those that vest upon closing of the Merger, is 142,626 based
upon the maximum Exchange Ratio of 0.191.
INDEMNIFICATION OF OFFICERS AND DIRECTORS
After the Effective Time, Watson has agreed to, and agreed to cause the
surviving corporation of the Merger to, indemnify and hold harmless each person
who is or was an officer or director of the Company and its subsidiaries (each
an "Indemnified Person") as of December 24, 1996 from and against all damages,
liabilities, judgments and claims (and related expenses including, but not
limited to, attorney's fees and amounts paid in settlement) based upon or
arising from his or her capacity as an officer or director of the Company or its
subsidiaries, to the extent provided to officers and directors of Watson and to
the extent provided by law. Subject to an Indemnified Person's obligation to
refund any advances in accordance with the Florida Business Corporation Act,
Watson agreed to advance all litigation costs reasonably incurred by such
Indemnified Party in accordance with applicable law.
FEDERAL INCOME TAX CONSEQUENCES
The respective obligations of Watson and Royce are conditioned on the
receipt of opinions of their respective counsel, D'Ancona & Pflaum and Akerman,
Senterfitt & Eidson, P.A. (which opinions have been rendered), to the effect
that the Merger will be treated for federal income tax purposes as a
reorganization within the meaning of Section 368(a) of the Code. See "The Merger
Agreement -- Conditions Precedent," and "-- Limitation on Opinion and
Discussion." Such tax opinions have been filed as exhibits to the Registration
Statement of which this Proxy Statement/Prospectus is a part. If the Merger is
treated as a reorganization within the meaning of Section 368(a) of the Code,
the following are the expected results:
Consequences to the Company Shareholders. Generally no gain or loss will
be recognized by the Company shareholders upon their receipt in the Merger of
Watson Common Stock (except to the extent of cash received in lieu of a
fractional share of Watson Common Stock).
The aggregate tax basis of Watson Common Stock received in the Merger will
be the same as the aggregate tax basis of Royce Common Stock surrendered in
exchange therefore, excluding any basis allocated to fractional shares for which
cash is received.
The holding period, for federal income tax purposes, of each share of
Watson Common Stock received by each Royce shareholder in the Merger will
include the period during which the Royce shareholder held his or her Royce
Common Stock surrendered in exchange therefore, provided that the Royce Common
Stock is held as a capital asset at the time of the Merger.
Cash payments received in lieu of a fractional share should be treated as
if a fractional share of Watson Common Stock had been issued in the Merger and
then redeemed by Watson. A Royce shareholder receiving such cash should
generally recognize gain or loss upon such payment equal to the difference (if
any) between the amount of cash received and the shareholder's basis in the
fractional share (which will be a pro rata portion of the shareholder's basis in
the shareholder's Royce Common Stock).
Consequences to the Company and Watson. The Merger will result in no gain
or loss to Watson or Royce.
Limitation on Opinion and Discussion. The foregoing discussion is intended
only as a summary of material federal income tax consequences of the Merger
under current law and does not purport to be a complete analysis or description
of all potential tax effects of the Merger. The summary does not address the tax
consequences that may be important to shareholders subject to special tax
treatment, such as insurance companies, corporations subject to the alternative
minimum tax, banks, dealers in securities, tax exempt
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organizations, or foreign persons, or to shareholders who acquired their shares
of Royce Common Stock as compensation. No information is provided herein with
respect to the tax consequences, if any, of the Merger under foreign, state,
local or other tax laws. The discussion is based on the current provisions of
the Code and Treasury Regulations promulgated thereunder, published Revenue
Rulings, published Revenue Procedures and existing administrative rulings and
court decisions in effect as of the date hereof. All of the foregoing are
subject to change (which could be retroactive) and any such change could effect
the accuracy of this discussion. No ruling on any of the issues discussed below
will be sought from the Internal Revenue Service ("Service"). Therefore the
Service is not precluded from challenging the tax free reorganization status of
the Merger.
COMPANY SHAREHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE
SPECIFIC TAX CONSEQUENCES TO THEM OF THE MERGER, INCLUDING TAX RETURN REPORTING
REQUIREMENTS, THE APPLICABILITY AND EFFECT OF FEDERAL, STATE, LOCAL AND OTHER
APPLICABLE TAX LAWS AND THE EFFECT OF ANY PROPOSED CHANGES IN THE TAX LAWS.
FEDERAL SECURITIES LAWS CONSEQUENCES
The Watson Common Stock issuable in connection with the Merger has been
registered under the Securities Act. Accordingly, there will be no restrictions
upon the resale or transfer of such shares by the Company's shareholders, except
for those shareholders who are deemed to be "affiliates" of the Company as such
term is used in Rule 144 and Rule 145 under the Securities Act.
With respect to those shareholders who may be deemed to be affiliates of
the Company, Rule 144 and Rule 145 place certain restrictions on the transfer of
the shares of Watson Common Stock which may be received by them pursuant to the
Merger. Additionally, it is a condition to the consummation of the Merger that
all persons deemed to be "affiliates" of the Company enter into an agreement
with Watson whereby each such person agrees not to sell their shares of Watson
Common Stock received by them in connection with the Merger until combined
operating results covering a minimum thirty-day period of Royce and Watson are
publicly released. Persons who may be deemed to be affiliates of the Company
generally include individuals who, or entities which, directly or indirectly,
controls or are controlled by or are under common control with the Company and
may include certain officers and directors of the Company as well as principal
shareholders of the Company. This Proxy Statement/Prospectus does not cover
resales of Watson Common Stock received by any person who may be deemed to be an
affiliate of the Company.
REGULATORY APPROVAL
Certain acquisitions such as the Merger are reviewed by the Antitrust
Division of the Department of Justice (the "Antitrust Division") or the Federal
Trade Commission (the "FTC") to determine whether such transactions comply with
applicable antitrust laws. Under the provisions of the HSR Act, the Merger
cannot be consummated until notifications have been given and certain
information has been furnished to the FTC and the Antitrust Division and certain
waiting period requirements of the HSR Act had been satisfied. Information was
filed with the Antitrust Division and the FTC under the HSR Act by Watson and
Royce on January 10, 1997. The waiting period under the HSR Act expired on
February 9, 1997. Notwithstanding such early termination, at any time before or
after consummation of the Merger, the FTC or the Antitrust Division could take
such action under the antitrust laws as they deem necessary or desirable in the
public interest, including seeking to enjoin the consummation of the Merger or
seeking divestiture of substantial assets of Watson or the Company. At any time
before or after the Effective Date, and notwithstanding that the HSR Act waiting
period has been terminated, Florida (or any other state having appropriate
jurisdiction) could take such action under the antitrust laws as it deems
necessary or desirable. Such action could include seeking to enjoin the
consummation of the Merger or seeking divestiture by Watson of the Company or
certain of the businesses of Watson or the Company. Private parties may also
seek to take legal action under antitrust laws under certain circumstances.
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ACCOUNTING TREATMENT
Both Watson and the Company believe that the Merger will qualify as a
pooling of interests for accounting and financial reporting purposes and have
been so advised by their respective independent public accountants. Consummation
of the Merger is conditioned upon, among other things, the receipt by Watson of
a letter from its independent public accountants, dated the closing date of the
Merger, stating that the Merger will qualify as a pooling of interests for
accounting and financial reporting purposes, and the receipt by Royce of a
letter from its independent public accountants, dated the closing date of the
Merger, indicating that Royce has not taken any action that would preclude it
from entering into a transaction that would be treated as a pooling of interests
for accounting and financial reporting purposes.
Under this method of accounting, the assets and liabilities of Watson and
the Company will be combined based on the respective carrying values of the
accounts in the historical financial statements of each entity. Results of
operations of the combined company will include income of Watson and the Company
for the entire fiscal period in which the combination occurs and the historical
results of operations of the separate companies for fiscal years prior to the
Merger will be combined and reported as the results of operations of the
combined company.
DELISTING; EXCHANGE ACT REGISTRATION
Following completion of the Merger, it is expected that the Royce Common
Stock will cease being traded on the Nasdaq Small CapMarket and that Royce's
registration under the Exchange Act will be terminated. Accordingly, Royce will
no longer be required to file periodic reports with the Commission.
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OPINION OF ROYCE'S FINANCIAL ADVISOR
Gruntal was engaged by Royce pursuant to an engagement letter, dated
December 4, 1996 (the "Engagement Letter"), to act as Royce's financial advisor
in connection with the Merger. In connection with such engagement, Royce
requested that Gruntal render an opinion as to the fairness, from a financial
point of view, of the terms of the Merger to Royce's shareholders.
On December 23, 1996, in connection with the evaluation of the Merger by
Royce's Board of Directors, Gruntal made an oral presentation to Royce's Board
with respect to the Merger, subsequently confirmed in writing, that, as of the
date of such opinion, and subject to certain assumptions, factors and
limitations set forth in such written opinion, as summarized below, the terms of
the Merger were fair, from a financial point of view, to the holders of Royce
Common Stock. Gruntal confirmed its December 23, 1996 oral opinion by delivery
of its written opinion, dated December 24, 1996. Gruntal updated its opinion on
February 27, 1997 (the "Gruntal Opinion").
Gruntal has previously rendered investment banking services to Royce,
including acting as placement agent for Royce's 1994 and 1995 private placements
of securities and acting as warrant solicitation agent in connection with
Royce's winter 1995/96 warrant call. In connection with rendering these
services, Gruntal received cash commissions and warrants to purchase shares of
Royce Common Stock. Gruntal continues to hold warrants to purchase 283,333
shares of Royce Common Stock, of which 200,000 shares may be purchased at an
exercise price of $3.50 per share and 83,333 shares may be purchased at an
exercise price of $6.00 per share. Pursuant to the terms of the Merger, these
warrants will be assumed by Watson and will become exercisable for a number of
shares of Watson Common Stock equal to the number of shares of Royce Common
Stock subject to the respective warrants multiplied by the Exchange Ratio at an
exercise price per share equal to the warrant exercise price immediately prior
to the Effective Date divided by the Exchange Ratio. Gruntal is a market maker
for Royce Common Stock and Watson Common Stock and may at any time hold a long
or short position in such securities.
Gruntal is an investment banking firm that, as a customary part of its
investment banking activities, is regularly engaged in the valuation of
businesses and their securities in connection with mergers and acquisitions,
negotiated underwritings, private placements and valuations for estate,
corporate and other purposes. Gruntal regularly publishes research reports,
regarding the generic pharmaceutical industry and the businesses and securities
of publicly owned companies in that industry, including Royce and Watson.
Royce's Board selected Gruntal as Royce's financial advisor because of its
expertise, reputation and familiarity with the generic pharmaceutical industry
and because of its familiarity with Royce.
Pursuant to the terms of the Engagement Letter, Gruntal was paid $25,000
upon execution of the Engagement Letter and $75,000 was payable to Gruntal upon
the delivery of the Gruntal Opinion. In addition, Gruntal is entitled to receive
a financial advisory fee in the amount of $400,000 upon consummation of the
Merger. Royce agreed to indemnify Gruntal against certain liabilities, including
liabilities under the federal securities laws, and to reimburse Gruntal up to
$15,000 for their reasonable out-of-pocket expenses in connection with this
engagement. Royce also agreed to reimburse Gruntal for the fees and
disbursements of Gruntal's counsel.
THE FULL TEXT OF THE GRUNTAL OPINION, WHICH SETS FORTH THE ASSUMPTIONS
MADE, MATTERS CONSIDERED AND THE LIMITS ON THE REVIEW UNDERTAKEN, IS INCLUDED AS
ANNEX "B" TO THIS PROXY STATEMENT/PROSPECTUS. ROYCE'S SHAREHOLDERS ARE URGED TO
READ SUCH OPINION CAREFULLY IN ITS ENTIRETY. THE SUMMARY OF THE GRUNTAL OPINION
SET FORTH IN THIS PROXY STATEMENT/ PROSPECTUS IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO THE FULL TEXT OF SUCH OPINION.
The Gruntal Opinion was prepared for the Royce Board of Directors and is
directed only to the fairness, from a financial point of view, to the
shareholders of Royce of the terms of the Merger and does not constitute a
recommendation to any Royce shareholder as to how to vote with respect to the
Merger. Gruntal was not retained as an advisor or agent to Royce shareholders or
any other person, other than as an advisor to the
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Royce Board. The Exchange Ratio was determined in arm's length negotiations
between Royce and Watson, in which negotiations Gruntal advised Royce. No
restrictions or limitations were imposed by Royce upon Gruntal with respect to
the investigations made or the procedures followed by Gruntal in rendering its
opinion.
In arriving at its opinion, Gruntal reviewed certain financial and other
publicly available information concerning Royce and Watson and certain internal
financial forecasts and other information with respect to the business,
operation and prospects of each of Watson and Royce furnished to Gruntal by the
respective managements of Watson and Royce. Gruntal reviewed, among other
information, (i) the audited financial statements for Royce for the years ended
December 31, 1993, 1994 and 1995, the unaudited financial statements for the
nine months ended September 30, 1995 and 1996, respectively, and preliminary
financial statements for the year ended December 31, 1996; (ii) Watson's 1995
Annual Report on Form 10-K, its quarterly report on Form 10-Q for the period
ended September 30, 1996 and its preliminary financial statements for the year
ended December 31, 1996; and (iii) certain other publicly available information
concerning Royce and Watson. Gruntal also held discussions with members of the
senior management of each of Watson and Royce regarding the business operations,
present conditions and prospects of their respective companies and the strategic
operating benefits they anticipated from the Merger. In addition, Gruntal (i)
reviewed the reported price and trading activity for Royce Common Stock and
Watson Common Stock; (ii) compared certain financial and stock market
information for Royce and Watson with similar information of certain selected
public companies that Gruntal deemed to be reasonably similar to Royce and
Watson; (iii) reviewed the financial terms of certain business combinations
which it deemed relevant in whole or in part to the Merger; (iv) reviewed the
Merger Agreement; and (v) performed such other studies and analyses and
considered such other factors as it deemed appropriate for the purpose of
rendering its opinion.
In connection with its review, Gruntal assumed and relied upon the accuracy
and completeness of the financial and other information used by it in arriving
at its opinion without independent verification and Gruntal did not assume any
responsibility to independently verify any of such information. As to all legal
matters, Gruntal relied on advice of counsel to Royce. Gruntal further relied
upon the assurances of the respective managements of Royce and Watson that such
managements were not aware of any facts that would make such information
inaccurate or misleading. Gruntal also relied upon the statements and
information provided by Royce's and Watson's managements concerning the
business, operations and strategic benefits and implications of the Merger. With
respect to financial forecasts and other information relating to the prospects
of Watson and Royce provided to Gruntal by the managements of Royce and Watson,
Gruntal assumed that such information was reasonably prepared on a basis
reflecting the best available estimates and judgments of such managements as to
the likely future financial performance of Watson and Royce. Gruntal expressed
no view as to such information or the assumptions on which it was based. In
arriving at its opinion, Gruntal did not conduct physical inspections of Royce's
and Watson's facilities and did not make or obtain, or assume any responsibility
for making or obtaining, any independent evaluation or appraisals of the assets
or liabilities of Watson or Royce. Gruntal assumed, with the consent of Royce
and Watson, that receipt of Watson Common Stock will be tax-free for federal
income tax purposes to the shareholders of Royce and that neither Royce nor
Watson will recognize income, gain or loss as a result of the Merger.
The Gruntal Opinion was based upon market, economic, financial and other
conditions as they existed on, and the information made available to Gruntal as
of, its date. It should be understood that although subsequent developments may
affect its opinion, Gruntal does not have any obligation to update, revise or
reaffirm the Gruntal Opinion. Gruntal's opinion does not constitute an opinion
or imply any conclusion as to the likely trading range for the Watson Common
Stock following consummation of the Merger. Gruntal was not requested to solicit
or entertain any other offers for the acquisition of Royce. Gruntal's opinion
also does not address Royce's underlying business decision to effect the Merger
or constitute a recommendation to any Royce shareholders as to how to vote with
respect to the Merger.
In connection with its oral presentation to Royce's Board on December 23,
1996, and the Gruntal Opinion dated February 27, 1997, Gruntal performed certain
financial and comparative analyses, including all material analyses described
below. The summary of Gruntal analyses set forth below does not purport to be a
complete description of the analyses underlying the Gruntal Opinion, but
includes a summary of the material valuation methodologies employed by Gruntal.
The preparation of a fairness opinion involves various
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determinations as to the most appropriate and relevant methods of financial
analysis and the application of those methods to the particular circumstances,
and therefore such an opinion is not readily susceptible to summary description.
Furthermore, in arriving at its fairness opinion, Gruntal did not attribute any
particular weight to any analysis or factor considered by it, but rather made
qualitative judgments as to the significance and relevance of each analysis and
factor. Accordingly, Gruntal believes that its analyses must be considered as a
whole and that considering any portions of such analyses and of the factors
considered, without considering all analyses and factors, could create a
misleading or incomplete view of the process underlying its opinion. In its
analyses, Gruntal made numerous assumptions with respect to industry
performance, general business and economic conditions and other matters, many of
which are beyond the control of Watson and Royce. Any estimates contained in
Gruntal's analyses are not necessarily indicative of actual values or predictive
of future results or values, which may be significantly more or less favorable
than as set forth therein.
The following is a summary of all material financial analyses utilized by
Gruntal in rendering its opinion. Such summary does not purport to be a complete
description of the analyses performed or all of the factors considered by
Gruntal in connection with its opinion.
Comparable Company Analysis. Using publicly available information, Gruntal
compared selected historical, current and projected operating and financial
data, stock data and financial ratios for Royce and Watson with certain data
from selected publicly traded companies engaged in the generic pharmaceutical
business that, in Gruntal's judgement, were most closely comparable to Royce and
Watson. The companies selected were Alpharma, Inc., Barr Laboratories, Inc.,
Copley Pharmaceutical, Inc., Faulding Inc., Mylan Laboratories, Inc.,
Pharmaceutical Resources, Inc., Teva Pharmaceutical Industries and, with respect
to Royce, Watson (the "Comparable Companies"). Gruntal reviewed, among other
things, the following data with respect to the Comparable Companies: (i)
operating statement data, including latest twelve months ("LTM") net revenues;
(ii) LTM operating cash flow ("LTM EBITDA"); (iii) LTM operating income ("LTM
EBIT"); (iv) LTM net income; (v) estimated 1997 net income; (vi) estimated 1998
net income, and (vii) selected balance sheet data, including book value. All
1997 and 1998 results are based on publicly available estimates from the
Institutional Brokers Estimate System ("IBES"). Utilizing this information,
Gruntal calculated a range of market multiples for the Comparable Companies by
dividing the "Enterprise Value" (total common shares outstanding multiplied by
closing market price per share on February 23, 1997 ("Market Equity Value"),
plus total debt and preferred stock, minus cash and cash equivalents) for each
Comparable Company by, among other things, such company's LTM net revenues, LTM
EBITDA and LTM EBIT, and by dividing each of the Comparable Company's Market
Equity Value by, among other things, the company's LTM net income, estimated
1997 and 1998 net incomes and book value. For the Royce Comparable Companies:
(i) the LTM net revenue multiples ranged from 1.09x to 4.27x (1.93x mean), (ii)
the LTM EBITDA multiples ranged from 9.31x to 36.16x (22.25x mean), (iii) the
LTM EBIT multiples ranged from 16.56x to 55.09x (30.82x mean), (iv) the LTM net
income multiples ranged from 21.52x to 77.39x (43.55x mean), (v) the estimated
1997 net income multiples ranged from 18.29x to 55.47x (32.06x mean), (vi) the
estimated 1998 net income multiples ranged from 14.58x to 22.19x (17.72x mean),
and (vii) the book value multiples ranged from 0.99x to 6.82x (3.22x mean).
Based on a price of $7.25 for each outstanding share of Royce Common Stock,
Royce's implied multiples, calculated on the same basis as the Comparable
Companies, were as follows: (i) LTM net revenues -- 4.24x, (ii) LTM EBITDA
- -- 73.25x, (iii) LTM EBIT -- 133.21x, (iv) LTM net income -- 173.70x, (v)
estimated 1997 net income -- 41.42x, (vi) estimated 1998 net income based on
IBES figures were not available, and (vii) book value -- 7.33x.
With respect to Watson, utilizing the same analysis, Gruntal calculated a
range of market multiples for the Comparable Companies by dividing the
Enterprise Value for each Comparable Company by, among other things, such
companies' LTM net revenues, LTM EBITDA and LTM EBIT, and by dividing each of
the Comparable Company's Market Equity Value by, among other things, the
company's LTM net income, estimated 1997 and 1998 net incomes and book value.
For the Watson Comparable Companies: (i) the LTM net revenue multiples ranged
from 1.09x to 4.27x (1.93x mean), (ii) the LTM EBITDA multiples ranged from
9.31x to 36.16x (23.62x mean), (iii) the LTM EBIT multiples ranged from 18.72x
to 55.09x (34.39x
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mean), (iv) the LTM net income multiples ranged from 29.96x to 77.39x (49.06x
mean), (v) the estimated 1997 net income multiples ranged from 21.99x to 55.47x
(34.36x mean), (vi) the estimated 1998 net income multiples ranged from 14.58x
to 22.19x (18.18x mean), and (vii) the book value multiples ranged from 0.99x to
6.82x (3.09x mean).
Based upon the closing price per share of Watson's Common Stock on February
23, 1997 of $41.875 Watson's implied multiples, calculated on the same basis as
the Comparable Companies, were as follows: (i) LTM net revenues -- 7.06x, (ii)
LTM EBITDA -- 15.40x, (iii) LTM EBIT -- 16.56x, (iv) LTM net income -- 21.52x,
(v) estimated 1997 net income -- 18.29x, (vi) estimated 1998 net
income -- 15.45x, and (vii) book value -- 4.12x. Gruntal compared the Watson
Comparable Company ratios to those of Watson and concluded that the Watson
multiples were consistent with the range of multiples derived from Watson
Comparable Companies. Gruntal believes that the multiples of EBITDA, EBIT and
net income are more relevant particularly since Watson has significant equity in
earnings from joint ventures and other non-operating income which are not
included in revenues.
Because of the inherent differences in the business, operations, and
prospects of Royce and Watson and the businesses, operations and prospects of
the Royce and Watson Comparable Companies, Gruntal believes it was inappropriate
to, and therefore did not rely solely on the quantitative results of the
analysis, but rather also made qualitative judgments concerning differences
between the financial and operating characteristics and prospects of the Royce
and Watson Comparable Companies that would affect the public trading values of
each as compared to Royce and Watson. In this regard, Gruntal considered the
state of the generic drug industry (in which Royce operates), competitive
factors such as the product pipeline, operating infrastructure and distribution
network of the companies, and such industry characteristics as price competition
and erosion of operating margins. These qualitative judgements were utilized to
confirm the findings based on Gruntal's quantitative analysis. These qualitative
judgments did not result in specific conclusions but rather were part of
Gruntal's evaluation.
Comparable Transaction Analysis. Gruntal reviewed selected
publicly-available financial data, including Enterprise Value (at the effective
date of the transaction) to net revenues, Enterprise Value to EBITDA, Enterprise
Value to EBIT, Market Equity Value to net income and Market Equity Value to book
value, regarding seven acquisitions of selected generic pharmaceutical
companies. The seven transactions selected, which took place between November
1993 and May 1996, were as follows: (i) the acquisition of Biocraft
Laboratories, Inc. by Teva Pharmaceutical Industries, (ii) the acquisition of
Marsam Pharmaceuticals, Inc. by Schein Pharmaceuticals, Inc., (iii) the
acquisition of Circa Pharmaceuticals, Inc. by Watson Pharmaceuticals, Inc., (iv)
the acquisition of Zenith Laboratories, Inc. by Ivax Corp., (v) the acquisition
of Hi-Tech Pharmacal Co. Inc. by Circa Pharmaceuticals Inc., (vi) the
acquisition of McGaw Inc. by Ivax Corp. and (vii) the acquisition of a majority
interest in Copley Pharmaceutical Inc. by Hoechst Celanese Corp.
Gruntal calculated the multiples of each of these aforementioned selected
data points based upon the seven selected transactions. The range of multiples
calculated was as follows: (i) Enterprise Value to LTM net revenues was 1.36x
and 5.38x, (ii) Enterprise Value to LTM EBITDA was 10.49x and 37.39x, (iii)
Enterprise Value to LTM EBIT was 14.02x and 40.83x, (iv) Market Equity Value to
LTM net income was 27.34x and 62.60x, and (v) Market Equity Value to book value
was 1.40x and 10.90x. Accordingly, the calculated mean and median multiples were
as follows: (i) Enterprise Value to LTM net revenues were 3.53x and 3.46x,
respectively; (ii) Enterprise Value to LTM EBITDA were 22.58x and 19.86x,
respectively; (iii) Enterprise Value to LTM EBIT were 26.99x and 26.55x,
respectively; (iv) Market Equity Value to LTM net income were 45.77x and 44.62x,
respectively; and (v) Market Equity Value to book value were 5.31x and 4.60x,
respectively. Based on a price of $7.25 for each outstanding share of Royce
Common Stock, Royce's implied multiples were as follows: (i) Enterprise Value to
estimated (based on preliminary figures for December 31, 1996) net
revenues -- 4.28x, (ii) Enterprise Value to estimated EBITDA -- 73.85x, (iii)
Enterprise Value to estimated EBIT -- 134.30x, (iv) Market Equity Value to
estimated net income -- 173.70x, and (v) Market Equity Value to estimated book
value -- 7.33x. Based on an assumed Merger consideration value of $98 million,
the implied multiples for Royce were above the range of the aforementioned
multiples. None of such acquisitions, however, took place under market
conditions or competitive circumstances that were directly comparable to those
of the Merger, and each of the acquired companies is distinguishable from Royce
in certain respects. Accordingly, an analysis of the results for the foregoing
is not mathematical nor necessarily
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precise; rather it involves complex consideration and judgment concerning
differences in financial and operating characteristics of companies and other
factors that could affect results. In particular, Gruntal considered the
strategic fit of the merger of Watson and Royce, Royce's current product mix and
product pipeline, the form of consideration offered by Watson and the tax
characteristics of the Merger. These qualitative judgements were utilized to
confirm the findings based on Gruntal's quantitative analysis. These qualitative
judgments do not lead to specific conclusions regarding the transaction value or
multiples, but rather were part of Gruntal's evaluation.
Premium Analysis. Gruntal analyzed the percentage premiums of offer values
over market values in each of the aforementioned seven selected transactions.
This analysis demonstrated that in these seven transactions, the high, low, mean
and median premium paid based upon the price of the target's stock: (i) one day
prior to the announcement of the transaction was 57.5%, 10.0%, 32.3% and 29.2%,
respectively, and (ii) four weeks prior to the announcement of the transaction
was 66.9%, 28.7%, 51.1% and 55.6%, respectively. Gruntal compared this data
against the average closing price of Royce Common Stock for the 10 day period
ending December 17, 1996 ($5.11 per share). Utilizing the mean premium for the
seven selected transactions one day and four weeks prior to announcement of the
selected transactions, Gruntal implied a share price for Royce Common Stock of
$6.76 per share and $7.72 per share, respectively, and determined that the
premium being paid in the Merger (at an exchange ratio $7.25 per Royce share,
assuming that Watson Common Stock continues to trade between $38.00 and $47.00
per share) was comparable to the premium paid in the selected transactions. On a
percentage basis, a price of $7.25 per share represents a premium of 41.88% over
Royce's average closing price of $5.11 per share on December 17, 1996.
Contribution Analysis. Gruntal analyzed the contribution of each of Royce
and Watson to the pro forma 1996 operating results and the projected 1997 and
1998 operating results of the combined entity (for 1997 and 1998 including the
pro forma effect of the acquisition of Oclassen), with and without the synergies
anticipated by Royce and Watson management. The synergies estimated by Royce and
Watson, post merger, included certain savings of selling, general and
administrative expenses. Without synergies, for 1996 (based upon preliminary
figures for Royce and Watson), Royce would have contributed 10.31% of revenues,
5.84% of gross profit, .85% of operating profit (5.86% with synergies), .77% of
pre-tax income (3.32% with synergies) and 1.09% of net income (4.81% with
synergies). For projected 1997 and 1998, these figures, without synergies, were
11.08% and 11.43%, respectively of net revenues, 6.65% and 7.52%, respectively,
of gross profit, 3.57% and 4.56%, respectively, of operating profit (6.49% and
6.62%, respectively, with synergies), 3.06% and 4.21%, respectively, of pre-tax
net income (4.96% and 5.56%, respectively, with synergies), and 4.46% and 5.60%,
respectively, of net income (7.25% and 7.66%, respectively, with synergies).
Gruntal then calculated that the number of shares of Watson Common Stock to be
issued to the Royce shareholders will range from 2,085,411 (if the Average
Closing Price of Watson Common Stock is $47.00 or above on the Effective Date),
or 5.25% of Watson's outstanding common stock on a pro forma basis, to 2,579,324
(if the Average Closing Price of Watson Common Stock is $38.00 or less on the
Effective Date), or 6.42% of Watson's outstanding common stock on a pro forma
basis.
Gruntal also tested the accretion (dilution) of the Merger for 1996 (based
on preliminary figures) and projected for 1997 and 1998 (for 1997 and 1998
including the pro forma effect of the acquisition of Oclassen), at Watson stock
prices of $38.00, $42.00 and $47.00. Analyses were prepared with and without
synergies and with and without the availability of Royce's net operating tax
loss carryforwards (applying a 40% tax rate on Royce's pre-tax income). Gruntal
found that in all circumstances for 1996, the Merger would have been dilutive.
For 1997, Gruntal determined that the transaction would only be accretive with
the use of Royce's tax loss carryforward and the realization of anticipated
synergies from the proposed transaction. For 1998, the transaction was accretive
only with the anticipated synergies, but was not reliant on the use of Royce's
tax loss carryforward.
Discounted Cashflow Analysis. Gruntal performed a discounted cashflow
("DCF") analysis for Royce on a standalone basis, based upon a three year and
five year projection using financial information provided by Royce management
for the years ending December 31, 1997 through December 31, 2001. For each of
the two DCF analyses, Gruntal discounted the projected unleveraged free cash
flows (earnings before interest, taxes, plus depreciation and amortization, less
capital expenditures) for the respective three years and five years and the
terminal value (calculated as a multiple of EBIT). From this Enterprise Value,
Gruntal subtracted all
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debt obligations appearing on Royce's preliminary balance sheet at December 31,
1996 and added the cash balance on such balance sheet to arrive at an implied
equity value ("Equity Value"). The terminal value was computed by applying
multiples ranging from 6.00x to 10.00x to the forecasted EBIT of the last year
projected. Gruntal applied a discount rate of 17.5% based on its estimates of
Royce's weighted average cost of capital. Further, Gruntal performed sensitivity
analyses to understand the effects on Equity Value from changes in the terminal
value. Based on management's three year projections for the calendar years
ending December 31, 1997 through December 31, 1999, the implied Equity Value for
Royce ranged from $49.6 million to $72.0 million. Due to the high proportion of
value contribution associated with the terminal value, a sensitivity analysis
was performed assuming the terminal value was 80.0% or 120.0% of the foregoing
terminal value. With these changes the implied Equity Value for Royce ranged
from $42.9 million to $83.3 million. Based on management's five-year projections
for the calendar years ending December 31, 1997 through December 31, 2001, the
implied Equity Value for Royce ranged from $89.2 million to $130.2 million. As
in the three year analysis, due to the high proportion of value contribution
associated with the terminal value, a sensitivity analysis was performed
applying a factor of 60% or 80% of the foregoing terminal value. With these
changes the implied Equity Value for Royce ranged from $64.6 million to $109.7
million. Gruntal noted the assumed merger consideration value of $98 million
exceeded the range of implied Equity Value based on three years of projections
and was within the range of implied Equity Value based on five years of
projections. Gruntal considered the former to be more relevant in light of the
high degree of uncertainty in the later years due to the significant risks in
the industry.
Historical Price and Volume Analysis. Gruntal reviewed the daily closing
price and volume of Royce Common Stock during the one, two, three and four and
one-half year periods ended December 17, 1996 and Watson Common Stock during the
one, two and three year periods ended December 17, 1996. Gruntal also indexed
Royce's and Watson's stock performance over the one, two and three year period
against an index of the stock prices over such periods of the Comparable
Companies. Gruntal noted that on an indexed basis, Watson's stock price has
outperformed Royce's stock price over the last half of 1996 and over a three
year period, but that Royce's stock price on an indexed basis had outperformed
Watson on a two year basis (except that over the last six months, Watson and
Royce had traded on a comparable basis). They also noted that over a one, two
and three year period, Watson had outperformed the Comparable Company index, but
that Royce had only outperformed the Comparable Company index over the two year
period. Gruntal also tested the frequency distribution for price sensitivity of
both Royce and Watson Common Stock. Gruntal noted that both Royce and Watson
experienced significant volatility and a net decline in stock price during the
twelve months ended December 17, 1996, largely as a result of the competitive
market environment for new drugs and investor sentiment about the generic drug
industry. As to Royce, the high, low and average closing prices for Royce Common
Stock for the 12 month period ended December 17, 1996 were $11.75, $3.88 and
$7.38, respectively. Royce Common Stock declined more than 25% on June 14, 1996
as a result of the unforeseen intense competition for several of its major new
drugs. The high, low and average closing prices for Royce Common Stock for the
six month period ended December 17, 1996 were $6.06, $3.88 and $4.74,
respectively. Gruntal noted the assumed exchange price of $7.25 per share
represents a premium to the six month average, high and low share price and a
slight discount to the 12-month average share price.
As to Watson, the high, low and average closing prices for Watson Common
Stock for the 12 month period ended December 17, 1996 were $49.25, $26.00 and
$39.45, respectively. Gruntal also determined that over the last year,
approximately 41% of the trades of Watson's Common Stock have been in the range
of $39.00 to $46.50. The collar range of $38.00 to $47.00 per share of Watson
Common Stock provided certain protection against the volatility in Watson Common
Stock to preserve the $98 million of value to Royce's shareholders.
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OPINION OF WATSON'S FINANCIAL ADVISOR
Watson retained Bear Stearns to act as its financial advisor and to render
its fairness opinion to Watson's Board of Directors as to the fairness of the
Merger, from a financial point of view, to the stockholders of Watson.
Bear Stearns delivered its written opinion, dated December 19, 1996, to the
Board of Directors of Watson to the effect that, as of such date, the Merger was
fair, from a financial point of view, to the stockholders of Watson. No
restrictions were imposed by Watson's Board of Directors upon Bear Stearns with
respect to the investigations made or procedures followed by Bear Stearns in
rendering its opinion.
The full text of Bear Stearns' fairness opinion (which opinion will not be
updated) which sets forth certain assumptions made, certain procedures followed
and certain matters considered by Bear Stearns, is attached as Annex C to this
Proxy Statement/Prospectus. As set forth therein, Bear Stearns relied upon and
assumed, without independent verification, the accuracy and completeness of the
financial and other information provided to it by Royce and Watson. With respect
to Royce's and Watson's projected financial results and estimates of potential
synergies that could be achieved upon consummation of the Merger, Bear Stearns
assumed that they were reasonably prepared on bases reflecting the best
currently available estimates and judgments of the respective managements as to
their expected future performance. Bear Stearns did not assume any
responsibility for the independent verification of any of such information or of
the projections provided to it and Bear Stearns further relied upon the
assurances of the managements of Royce and Watson that they are unaware of any
facts that would make the information or projections provided to Bear Stearns
incomplete or misleading. In arriving at its opinion, Bear Stearns did not
perform or obtain any independent appraisal of the assets or liabilities of
Royce or Watson. Bear Stearns' opinion was necessarily based on economic, market
and other conditions, and the information made available to it, as of the date
of its opinion. Bear Stearns further assumed that the Merger would be accounted
for in accordance with the pooling of interests method of accounting under the
requirements of APB No. 16.
Bear Stearns' opinion addresses only the fairness of the Merger from a
financial point of view to Watson. The opinion is for the benefit and use of the
Board of Directors of Watson in its consideration of the Merger. The opinion
does not constitute a recommendation of the Merger over any alternative
transactions which may be available to Watson and does not address the
underlying business decision of the Board of Directors to proceed with or effect
the Merger. Furthermore, the opinion does not constitute a recommendation by
Bear Stearns to any stockholder to vote in favor of the transaction.
The summary of the opinion of Bear Stearns set forth in this Proxy
Statement/Prospectus is qualified in its entirety by reference to the full text
of such opinion.
In rendering its fairness opinion, Bear Stearns: (i) reviewed a draft of
the Merger Agreement dated December 24, 1996; (ii) reviewed Royce's Annual
Reports to Shareholders and Annual Reports on Form 10-K for the fiscal years
ended December 31, 1993 through 1995, and its Quarterly Report on Form 10-Q for
the period ended September 30, 1996; (iii) reviewed certain operating and
financial information, including projections, provided to Bear Stearns by
Royce's management relating to its business and prospects; (iv) met with certain
members of Royce's senior management to discuss its operations, historical
financial statements and future prospects; (v) reviewed Watson's Annual Reports
to Shareholders and Annual Reports on Form 10-K for the fiscal years ended
December 31, 1993 through 1995, and its Quarterly Report on Form 10-Q for the
period ended September 30, 1996; (vi) reviewed certain operating and financial
information, including projections, provided to Bear Stearns by Watson's
management relating to its business and prospects; (vii) reviewed analyses
provided to Bear Stearns by Watson's management relating to the anticipated pro
forma impact on Watson of the Merger; (viii) met with certain members of
Watson's senior management to discuss its operations, historical financial
statements and future prospects; (ix) reviewed the historical prices and trading
volumes of the common shares of Royce and Watson; (x) reviewed publicly
available financial data and stock price performance of companies which Bear
Stearns deemed generally comparable to Royce; (xi) reviewed the terms of recent
acquisitions of companies which Bear Stearns deemed generally comparable to
Royce; and (xii) conducted such other studies, analyses, inquiries and
investigations as Bear Stearns deemed appropriate.
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The following is a brief summary of financial analyses used by Bear Stearns
in connection with providing its opinion to the Board of Directors of Watson.
Comparable Company Analysis. Using publicly available data, Bear
Stearns compared selected historical and projected financial and operating
data, and selected stock market data, of Royce to the corresponding data of
the following generic drug companies Alpharma Inc.; Watson; Barr
Laboratories, Inc.; Copley Pharmaceutical, Inc.; IVAX Corporation; Mylan
Laboratories Inc.; and Teva Pharmaceutical Industries Ltd. (collectively,
the "Comparable Companies"). The Comparable Companies were chosen by Bear
Stearns as companies that, based on publicly available data, possess
general business, operating and financial characteristics representative of
companies in the industry in which Royce operates, although Bear Stearns
recognizes that each of the Comparable Companies is distinguishable from
Royce in certain respects. Bear Stearns considered with respect to the
Comparable Companies, among other things, (i) operating statement data,
including latest reported twelve months (previous four quarters, or "LTM"),
earnings before interest, taxes, depreciation and amortization ("EBITDA")
and earnings before interest and taxes ("EBIT"); (ii) LTM earnings per
share ("EPS"), estimated calendar 1996 EPS and estimated calendar 1997 EPS;
(iii) projected five year EPS growth rates; and (iv) historical stock price
performance. Earnings per share estimates and projected five year EPS
growth rates were obtained from the Institutional Brokers Estimate System
("IBES").
Bear Stearns calculated market multiples for the Comparable Companies
based on closing stock prices as of December 13, 1996. Bear Stearns then
compared those multiples to the multiples being paid for Royce in the
Merger based on the assumed Merger consideration of $7.25 per share. In
analyzing the multiples being paid by Watson in the Merger, Bear Stearns
calculated multiples based on (i) Royce's stand-alone earnings; and (ii)
Royce's stand-alone earnings adjusted for the anticipated level of cost
synergies as estimated by Watson management. Net income multiples for Royce
were calculated on a fully-taxed basis.
For the Comparable Companies, Enterprise Value (market value of equity
plus total debt minus cash and cash equivalents) to LTM EBITDA multiples
ranged from 6.8x to 81.3x with a harmonic mean of 17.6x and Enterprise
Value to LTM EBIT multiples ranged from 11.0x to 34.9x with a harmonic mean
of 18.8x (two of the Comparable Companies' LTM EBIT multiples were
considered not meaningful since LTM EBIT was negative). These multiples
compare to synergy-adjusted multiples of 20.3x and 22.7x for Enterprise
Value to LTM EBITDA and Enterprise Value to LTM EBIT, respectively, for
Royce, and stand-alone multiples of 122.4x and 329.8x for Enterprise Value
to LTM EBITDA and Enterprise Value to LTM EBIT, respectively, for Royce.
For the Comparable Companies, LTM EPS multiples ranged from 14.7x to 37.0x
with a harmonic mean of 23.5x (three of the Comparable Companies' LTM EPS
multiples were considered not meaningful since LTM EPS was negative),
estimated calendar 1996 EPS multiples ranged from 21.2x to 31.6x with a
harmonic mean of 25.4x (three of the Comparable Companies' estimated
calendar 1996 EPS multiples were considered not meaningful since estimated
calendar 1996 EPS was negative), and estimated calendar 1997 EPS multiples
ranged from 14.1x to 26.9x with a harmonic mean of 19.1x. These multiples
compare to synergy-adjusted multiples of 37.7x, 32.5x and 18.2x LTM EPS,
projected calendar 1996 EPS and projected calendar 1997 EPS, respectively,
for Royce, and stand-alone multiples of 385.6x, 146.2x and 32.4x LTM EPS,
projected calendar 1996 EPS and projected calendar 1997 EPS, respectively,
for Royce. Bear Stearns noted that the projected five year EPS growth rate
for the Comparable Companies ranged from 15.0% to 33.0% with an arithmetic
mean of 26.7%. This compares to an implied growth rate of fully-taxed EPS
from 1997 through 2001 of 45.2% for Royce based on projections prepared by
Royce management.
In comparing the multiples being paid for Royce to the ranges of
multiples presented by the Comparable Company Analysis, Bear Stearns noted
that the multiples being paid to Royce were (i) substantially higher than
the multiples observed in the Comparable Companies when calculated on the
basis of Royce's stand-alone earnings; (ii) generally near the high end of
or above the range of multiples observed in the Comparable Companies when
calculated on the basis of Royce's synergy-adjusted historical earnings
(including estimated full year 1996 results); and (iii) well within the
range when calculated on the basis of projected (1997) synergy-adjusted
earnings. In evaluating the data
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summarized above, Bear Stearns considered the comparison of 1997 multiples
most relevant since (i) Royce has a very high projected EPS growth rate
compared to the Comparable Companies, and (ii) Watson's management has a
high degree of confidence that Royce's 1997 projections will be achieved.
Bear Stearns further considered the multiples calculated including
estimated synergies to be most relevant since Watson management has a high
degree of confidence that such synergies will be achieved particularly in
light of the similarities and overlaps in the two companies' business
systems.
Precedent Transaction Analysis. Bear Stearns reviewed and analyzed
publicly available information for six transactions involving the
acquisition of generic drug companies. The transactions selected included
all significantly sized acquisitions of U.S. generic drug companies since
1993 for which sufficient data was available to analyze purchase multiples.
The transactions considered included the acquisitions of Biocraft
Laboratories Inc. by Teva Pharmaceutical Industries Ltd.; Marsam
Pharmaceuticals, Inc. by Schein Pharmaceutical, Inc.; Circa
Pharmaceuticals, Inc. by Watson; Zenith Laboratories, Inc. by IVAX
Corporation; 28.3% of Schein Pharmaceutical, Inc. by Bayer AG; and 51.0% of
Copley Pharmaceutical, Inc. by Hoechst Celanese Corporation. Although these
various merger and acquisition transactions were used for comparison
purposes, none of such transactions took place under market conditions or
competitive circumstances that were directly comparable to those of the
Merger, and each of the acquired generic drug companies is distinguishable
from Royce in certain respects. Accordingly, an analysis of the results
described below is not mathematical nor necessarily precise; rather, it
involves complex considerations and judgments concerning differences in
financial and operating characteristics of companies and other factors that
would necessarily affect the acquisition value of Royce versus the
acquisition values of the companies to which Royce was being compared.
For the selected transactions, Bear Stearns reviewed the financial
terms and prices paid in such transactions in terms of (i) the Enterprise
Value of such transactions as a multiple of LTM sales, LTM EBITDA and LTM
EBIT prior to the announcement of such transactions, (ii) the equity
purchase price of such transactions as a multiple of LTM net income prior
to the announcement of such transactions and projected net income based on
research analysts' estimates immediately prior to the announcement of such
transactions and (iii) the one month premium of such transactions based on
the equity purchase price per share and the acquired company's stock price
one month prior to the announcement of such transactions. For the six
generic drug company transactions, the multiples of Enterprise Value to LTM
sales ranged from 2.5x to 14.8x. The harmonic mean multiples of the
Enterprise Value to LTM sales for the six generic drug company transactions
and for Royce were 4.4x and 4.5x, respectively. For the six generic drug
company transactions, the multiples of Enterprise Value to LTM EBITDA
ranged from 11.8x to 77.1x. The harmonic mean multiples of the Enterprise
Value to LTM EBITDA for the six generic drug company transactions, for
Royce based on synergy-adjusted earnings and for Royce based on stand-alone
earnings were 28.1x, 20.3 and 122.4x, respectively. For the six generic
drug company transactions, the multiples of Enterprise Value to LTM EBIT
ranged from 12.9x to 67.5x (the acquisition of Biocraft Laboratories Inc.
by Teva Pharmaceutical Industries Ltd. LTM EBIT multiple was considered not
meaningful since LTM EBIT was negative.) The harmonic mean multiples of the
Enterprise Value to LTM EBIT for the six generic drug company transactions,
for Royce based on synergy-adjusted earnings and for Royce based on
stand-alone earnings were 29.8x, 22.7x and 329.8x, respectively. For the
six generic drug company transactions, the multiples of equity purchase
price to LTM net income ranged from 21.3x to 67.0x (the acquisition of
Biocraft Laboratories Inc. by Teva Pharmaceutical Industries Ltd. LTM net
income multiple was considered not meaningful since LTM net income was
negative). The harmonic mean multiples of the equity purchase price to LTM
net income for the six generic drug company transactions, for Royce based
on fully-taxed, synergy-adjusted net income and for Royce based on
fully-taxed, stand-alone net income were 41.1x, 37.7x and 385.6x,
respectively. For the six generic drug company transactions, the multiples
of equity purchase price to projected net income ranged from 12.1x to 60.6x
(the acquisition of Biocraft Laboratories Inc. by Teva Pharmaceutical
Industries Ltd. projected net income multiple was considered not meaningful
since projected net income was negative). The harmonic mean multiples of
the equity purchase price to projected net income for the six generic drug
company transactions, for Royce based on fully-taxed, synergy-adjusted net
income and for Royce based on fully-taxed, stand-alone net income were
24.3x, 18.2x and 32.4x, respectively. The
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one month premiums ranged from 14.3% to 57.4% with an average of 42.8% for
those five of the precedent transactions involving the acquisition of
public companies with three of the transactions having a premium of 50% or
more. These one month premiums compare to a 52.6% premium for Royce based
on an assumed per share purchase price of $7.25 and Royce's closing stock
price one month prior to December 13, 1996.
In comparing the multiples being paid for Royce to the multiples paid
in the precedent transactions, Bear Stearns noted that the multiples of
earnings being paid for Royce were generally higher than in the precedent
transactions when calculated on the basis of Royce's stand-alone earnings
and were generally lower than in the precedent transactions when calculated
on the basis of Royce's synergy-adjusted earnings. Bear Stearns believes
that given Royce's low level of current and near-term stand-alone earnings
and the substantial overlaps between the business systems of Watson and
Royce, the level of anticipated cost synergies relative to acquired
stand-alone earnings is substantially higher in the Merger than in most of
the precedent transactions (Bear Stearns believes that anticipated cost
synergies were negligible or very modest for several of the precedent
transactions). Accordingly, Bear Stearns believes that a comparison of the
multiples being paid in the Merger to the multiples paid in the precedent
transactions is most relevant if the multiples being paid in the Merger are
considered on a synergy-adjusted basis.
Discounted Cash Flow Analyses. Bear Stearns performed a discounted
cash flow analysis of Royce based upon financial projections prepared by
Royce's management for calendar years ending December 31, 1997 through
December 31, 2001 ("Royce Projections Without Synergies"). Bear Stearns
also performed a discounted cash flow analysis of Royce based upon
financial projections prepared by Royce's management adjusted to include
anticipated cost synergies as estimated by Watson management ("Royce
Projections With Synergies"). Using discount rates ranging from 14% to 16%
per annum reflecting Bear Stearns' estimate of Royce's weighted average
after-tax cost of capital, Bear Stearns calculated the present value of the
projected Free Cash Flows (as defined below) for each of the fiscal years
ending December 31, 1997 through 2001 and the present value of the terminal
value (the "Terminal Value") of Royce at December 31, 2001. As used in Bear
Stearns' analysis, "Free Cash Flow" means, for each fiscal year, earnings
before interest, taxes, depreciation and amortization, less estimated
taxes, less capital expenditures and less incremental working capital
requirements. The Terminal Value was computed by applying multiples of
between 16.0x and 20.0x the forecasted unlevered net income of Royce for
the fiscal year ended December 31, 2001. To calculate the aggregate net
present value of the equity of Royce, Bear Stearns subtracted total debt
minus cash and cash equivalents of Royce from the sum of the present value
of the projected Free Cash Flows, the present value of the Terminal Value
and the present value of the expected tax savings from Royce's available
tax net operating loss carryforward. Based on this analysis and the
assumptions set forth above, Bear Stearns calculated the equity value per
share of Royce Common Stock to be between $11.71 and $15.02 for the Royce
Projections With Synergies and between $9.27 and $11.88 for the Royce
Projections Without Synergies. Bear Stearns noted the calculated range of
equity value per share of Royce Common Stock exceeded the assumed Merger
consideration of $7.25 per share for both the Royce Projections With
Synergies and the Royce Projections Without Synergies.
Bear Stearns also performed sensitivity analyses to understand the
impact of alternative projection assumptions on Royce's implied per share
discounted cash flow value. The projections supplied by Royce management
assume a substantial increase in sales and earnings between 1997 and 2001.
Bear Stearns performed sensitivity analyses which assumed that Royce's
stand-alone level of earnings in 2001 only reached between approximately
one-third and two-thirds of the projected level. Assuming that Royce's
stand-alone level of earnings only reached two-thirds of the projected
level by the year 2001, Bear Stearns calculated the equity value per share
of Royce Common Stock to be between $9.26 and $11.75 based on the Royce
Projections With Synergies and between $6.83 and $8.65 based on the Royce
Projections Without Synergies. Bear Stearns noted that, assuming Royce's
stand-alone level of earnings in 2001 only reached two-thirds of the
projected level by the year 2001, the calculated range of equity value per
share of Royce Common Stock exceeded the assumed Merger consideration of
$7.25 per share for the Royce
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Projections With Synergies and included the assumed Merger consideration of
$7.25 per share and for the Royce Projections Without Synergies. Assuming
that Royce's stand-alone level of earnings only reached one-third of the
projected level by the year 2001, Bear Stearns calculated the equity value
per share of Royce Common Stock to be between $5.76 and $7.24 based on the
Royce Projections With Synergies and between $3.76 and $4.73 based on the
Royce Projections Without Synergies. Bear Stearns noted that, assuming
Royce's stand-alone level of earnings in 2001 only reached one-third of the
projected level by the year 2001, the calculated range of equity value per
share of Royce Common Stock fell below the assumed Merger consideration of
$7.25 per share for both the Royce Projections With Synergies and the Royce
Projections Without Synergies. In evaluating the relevance of the per share
discounted cash flow values implied by a projection forecast which assumes
that Royce's earnings will only reach one-third of the level projected by
Royce's management for the year 2001, Bear Stearns noted the belief of
Watson's management that such a projection forecast was overly conservative
and that Royce's stand-alone earnings were likely to be significantly above
the level assumed in such a forecast.
The range of multiples and discount rates used in the analysis
described above were chosen to reflect the growth prospects and relative
risk of Royce and were selected by Bear Stearns based on its review
(including discussions with management of Royce) of the results and the
prospects of Royce and Bear Stearns' expertise in securities valuation
generally.
Contribution Analysis. Bear Stearns analyzed the projected pro forma
contribution of each of Royce and Watson (pro forma to include the
acquisition of Oclassen Pharmaceuticals, Inc.), to the earnings of the
combined company, if the Merger were to be consummated. Using earnings
estimates prepared by the respective managements and cost synergy estimates
prepared by Watson's management, Bear Stearns calculated the contributions
of Royce and Watson to the pro forma pre-tax earnings and net income of the
combined company. Such analysis indicated that, based on respective
managements projections for 1997, 1998 and 1999, Royce's relative
contribution to the financial results of the combined company would be (i)
5.2%, 6.2% and 5.8% of pre-tax earnings with synergies, (ii) 3.4%, 4.2% and
4.3% of pre-tax earnings without synergies, (iii) 6.8%, 7.3% and 5.5% of
net income with synergies and (iv) 5.0%, 5.6% and 4.1% of net income
without synergies. Bear Stearns noted that the 5.0% to 6.1% (approximately
5.5% based on Watson's closing stock price of $42.25 on December 18, 1996)
of the pro forma fully diluted number of shares for the combined company to
be owned by former Royce stockholders is generally less than or in line
with Royce's relative earnings contributions with synergies.
Pro Forma Combination Analysis. Bear Stearns analyzed earnings per
share estimates for 1997 and 1998 both for Watson, pro forma to include the
acquisition of Oclassen Pharmaceuticals, Inc. and, on a pro forma basis,
for the combined company after the Merger. These analyses were based upon
financial projections provided by the senior managements of Watson and
Royce. Such analyses took into account cost synergy estimates prepared by
Watson's management. Based on managements' projections and assuming the
aforementioned synergies and an Exchange Ratio of 0.1716 based on Watson's
closing stock price of $42.25 on December 18, 1996, such analysis showed
accretion in Watson's fully diluted earnings per share in 1997 and 1998.
Bear Stearns performed a sensitivity analysis which analyzed the EPS impact
in 1997 and 1998 to Watson based on achieving various percentages of
Royce's pre-tax earnings as prepared by Royce's management. Bear Stearns'
analysis indicated that the acquisition would not be dilutive in 1997 or
1998 even if only 50% of Royce's projected pre-tax earnings were achieved.
The preparation of a fairness opinion is a complex process and is not
necessarily susceptible to partial analysis or summary description. Selecting
portions of the analyses or of the summary set forth above, without considering
the analysis as a whole, could create an incomplete view of the processes
underlying Bear Stearns' opinion. In arriving at its opinion, Bear Stearns
considered the results of all such analyses. They were prepared for the purposes
of providing its opinion as to the fairness of the Merger, from a financial
point of view, to the stockholders of Watson. Analyses of future results are not
necessarily indicative of actual future results, which may be significantly more
or less favorable than suggested by such analyses. As described above, Bear
Stearns opinion and presentation to the Watson Board was one of many factors
taken into consideration by the Watson Board in making its determination to
approve the Merger Agreement. The foregoing analysis does not purport to be a
complete description of the analysis performed by Bear Stearns.
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The Watson Board of Directors retained Bear Stearns based upon its
experience and expertise. Bear Stearns is an internationally recognized
investment banking and advisory firm. Bear Stearns, as part of its investment
banking business, is continuously engaged in the valuation of businesses and
securities in connection with mergers and acquisitions, negotiated
underwritings, competitive biddings, secondary distributions of listed and
unlisted securities, private placements and valuations for corporate and other
purposes. In the course of its market making and other trading activities, Bear
Stearns may, from time to time, have a long or short position in, and may buy
and sell, securities of Watson and Royce. In the past, Bear Stearns and its
affiliates have provided financial advisory and financing services to Watson and
have received customary fees for the rendering of these services.
Pursuant to a letter dated December 10, 1996, Watson agreed to pay Bear
Stearns a fee of $250,000 for rendering its opinion in connection with the
Merger and, upon consummation of the Merger, an additional fee of $250,000 for
its financial advisory work. Watson has also agreed to reimburse Bear Stearns
for its reasonable out-of-pocket expenses, including the reasonable fees and
disbursements of counsel, and to indemnify Bear Stearns and certain related
persons against certain liabilities in connection with the engagement of Bear
Stearns, including certain liabilities under the federal securities laws.
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THE MERGER AGREEMENT
The following is a brief summary of the material provisions of the Merger
Agreement, a copy of which is attached as Annex A to this Proxy
Statement/Prospectus and is incorporated herein by reference. The description of
the Merger Agreement contained in the Proxy Statement/Prospectus does not
purport to be complete and is qualified in its entirety by reference to the full
text of the Merger Agreement.
GENERAL
The Board of Directors of Watson and Royce, meeting separately, each
authorized the execution and performance of the Merger Agreement.
EFFECTIVE TIME; EFFECT OF MERGER
If the Merger Agreement is approved and adopted by the requisite vote of
the shareholders of Royce, and all other conditions to the obligations of the
parties to consummate the Merger are satisfied or waived, the Merger will become
effective upon the appropriate filings being delivered to the Department of
State of the State of Florida (the "Effective Time"). The Effective Time is
expected to occur on or around April 16, 1997 (the "Effective Date"). As of the
Effective Time, the Sub will be merged with and into Royce, with Royce
continuing as the surviving corporation of the Merger and as the wholly-owned
subsidiary of Watson. The separate corporate existence of Sub will terminate
upon consummation of the Merger, and each share of common stock of the Sub shall
be converted into one share of Royce Common Stock (as the surviving
corporation). In addition, Watson will issue to the holders of Royce Common
Stock the aggregate number of shares of Watson Common Stock which is equal to
the Exchange Ratio multiplied by the number of outstanding shares of Royce
Common Stock, subject to adjustment as described below.
CLOSING DATE
Consummation of the Merger and the other transactions contemplated by the
Merger Agreement (the "Closing") will take place three business days after the
satisfaction of the conditions set forth in the Merger Agreement; or such other
date as agreed to by the parties. The date on which the Closing takes place is
referred to as the "Closing Date".
ARTICLES OF MERGER
Upon the satisfaction or waiver of all of the conditions to the Merger set
forth in the Merger Agreement, and provided that the Merger Agreement has not
been terminated, the Sub and the Company will cause Articles of Merger to be
prepared, executed, delivered and filed with the Florida Department of State,
upon which the Merger will become effective.
CONVERSION OF SHARES
Under the terms of the Merger Agreement, in connection with the Merger the
holder of each share of Royce Common Stock shall receive a number of shares of
Watson Common Stock as is equal to the following (the "Exchange Ratio"): $7.25
divided by the average daily closing price (the "Average Closing Price") of a
share of Watson Common Stock as reported on the Nasdaq NMS and as reported in
The Wall Street Journal for the ten consecutive trading days ending on the
trading day immediately preceding the effective date of the Merger (the
"Effective Date"). If the Average Closing Price (i) exceeds $47.00, the Average
Closing Price will be deemed to be $47.00 for purposes of calculating the
Exchange Ratio; and (ii) if less than $38.00, the Average Closing Price will be
deemed equal to $38.00 for purposes of calculating the Exchange Ratio.
If from December 24, 1996 through the Effective Time, the outstanding
shares of Watson Common Stock or Royce Common Stock are changed into a different
number of shares or a different class as a result of a stock split, reverse
stock split, stock dividend, subdivision, reclassification, split, combination,
exchange, recapitalization or other similar transaction, the Exchange Ratio and
Average Closing Price shall be appropriately adjusted so that the holders of
shares of Royce Common Stock shall receive the consideration that has been
contemplated by the terms of the Merger Agreement. From December 24, 1996
through the date of this Proxy Statement/Prospectus, no such actions have
occurred and none are contemplated.
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A VOTE TO APPROVE AND ADOPT THE MERGER AGREEMENT BY THE COMPANY'S
SHAREHOLDERS WILL BE DEEMED APPROVAL OF THE EXCHANGE RATIO AND ANY ADJUSTMENTS
THERETO.
EXCHANGE OF SHARES
Watson has authorized American Stock Transfer & Trust Company to serve as
exchange agent (the "Exchange Agent") for the exchange of stock certificates
representing Royce Common Stock (each a "Certificate"), for stock certificates
representing Watson Common Stock and for the payment of cash in lieu of
fractional shares that would otherwise be issued as described above. Promptly
after the Effective Date, but no later than five (5) business days after the
Effective Date, Watson will deliver to the Exchange Agent certificates
representing the number of whole shares of Watson Common Stock to which the
holders of shares of Royce Common Stock are entitled to receive in connection
with the Merger as well as cash for the payment of fractional share interests.
As soon as practicable after the Effective Date, the Exchange Agent will
mail to each record holder of Royce Common Stock a letter of transmittal (the
"Letter of Transmittal") and instructions for use in effecting the surrender of
the Certificates for exchange and payment. Delivery will be effected and risk of
loss and title to the Certificates will pass only upon proper delivery of the
Certificates representing Royce Common Stock to the Exchange Agent. Upon
surrender to the Exchange Agent of a Certificate, together with a duly executed
Letter of Transmittal, the holder of such Certificate will be entitled to
receive in exchange therefor one or more certificates as requested by the holder
representing that number of whole shares of Watson Common Stock to which such
holder of Royce Common Stock will have become entitled and a check representing
a cash payment for any fractional share interests. No interest will be paid or
accrued on the cash payable upon surrender of Certificates.
From and after the Effective Time, until surrendered, each Certificate
therefore representing shares of Royce Common Stock will be deemed for all
corporate purposes, to evidence the ownership of the number of whole shares of
Watson Common Stock into which such shares of Royce Common Stock have been
converted. Unless and until any such certificates shall be so surrendered, the
holder of such Certificates will not be entitled to receive payment of any
dividends on such shares of Watson Common Stock payable to the holders thereof
after the Effective Time. Upon surrender of the certificates previously
representing shares of Royce Common Stock, the holder thereof will receive
Certificates representing the number of whole shares of Watson Common Stock to
which such holder shall be entitled and the amount of dividends or other
distributions that shall have been payable to holders of record of Watson Common
Stock on or after the Effective Time with respect to such shares of Watson
Common Stock, without interest. Any dividends payable to holders of record of
Watson Common Stock as of any record date prior to the Effective Time will not
be payable to holders of certificates previously representing Royce Common
Stock.
After the Merger, each holder of a Certificate representing any shares of
Royce Common Stock will thereafter cease to have any rights with respect to such
shares of Royce Common Stock, except for the right to receive, without interest,
shares of Watson Common Stock and cash for fractional interests of Watson Common
Stock upon the surrender of such Certificate. Each share of Royce capital stock
held in Royce's treasury or owned by Watson or any of its subsidiaries at the
Effective Time will cease to be outstanding and will be canceled and retired
without payment of any consideration therefor.
At or after the Effective Time, there will be no transfers on the transfer
books of Royce of shares of Royce Common Stock which were outstanding
immediately prior to the Effective Time. In the event of a transfer of ownership
of Royce Common Stock which is not registered in the transfer records of Royce,
a certificate representing the proper number of shares of Watson Common Stock,
together with a check for the cash to be paid in lieu of fractional shares, if
any, and unpaid dividends and distributions, if any, may be issued to such a
transferee if the Certificate representing such Royce Common Stock is presented
to the Exchange Agent, accompanied by all documents required to evidence and
effect such transfer and to evidence that any applicable stock transfer taxes
have been paid.
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No fractional shares of Watson Common Stock will be issued upon
consummation of the Merger. In lieu thereof, each Royce shareholder who would
otherwise be entitled to a fractional share will be paid an amount of cash,
without interest, equal to the such fractional proportion of the Average Closing
Price per share of Watson Common Stock.
SHAREHOLDERS SHOULD NOT SEND STOCK CERTIFICATES WITH THEIR PROXY CARDS.
FOLLOWING THE EFFECTIVE DATE OF THE MERGER, THE COMPANY'S SHAREHOLDERS WILL BE
PROVIDED WITH A LETTER OF TRANSMITTAL AND INSTRUCTIONS RELATING TO THE EXCHANGE
OF THEIR STOCK CERTIFICATES.
COMPANY OPTIONS
As of February 27, 1997, there were outstanding the following Company
Options (including warrants):
<TABLE>
<S> <C>
1992 Stock Option Plan:..................................... 285,168
1995 Stock Option Plan:..................................... 207,643
Options granted outside of a Company plan:.................. 625,081
Warrants.................................................... 941,666
---------
Total.................................................. 2,059,558
</TABLE>
Under the Merger Agreement, each of such options and warrants will become
an option or warrant to purchase a number of whole shares of Watson Common Stock
equal to the number of shares of Royce Common Stock into which such Company
Option is exercisable immediately prior to the Effective Date multiplied by the
Exchange Ratio (rounded to the nearest whole share with 0.5 rounded upward) at
an option or warrant exercise price determined by dividing the exercise price of
such option or warrant immediately prior to the Effective Date by the Exchange
Ratio (the option price per share, as so determined, being rounded to the
nearest full cent with $0.005 rounded upward).
In accordance with the Company's 1992 and 1995 Stock Option Plans, each
Company Option granted under either of such Plans, whether or not then
exercisable, will automatically become fully vested and immediately exercisable
upon consummation of the Merger. Company Options granted outside of a Company
plan will not become fully vested and immediately exercisable upon consummation
of the Merger and will vest in accordance with their original terms, subject to
the acceleration provisions of such agreements. As of the Effective Time, the
provisions of the Company's stock option plans providing for issuance or grant
of any of the Company's Common Stock will be deleted. The options previously
granted will remain subject to the Company's stock option plans, with all
actions to be taken under such plans by the Company's Board of Directors or a
committee thereof, after the Effective Date, to be taken by Watson Board of
Directors or a committee thereof. See "Merger -- Interests of Certain Persons in
the Merger."
REPRESENTATIONS AND WARRANTIES
The Merger Agreement contains various representations and warranties. The
representations and warranties of Watson relate to, among other things: (a)
Watson and the Sub's existence, good standing and corporate authority; (b) the
authorization of the Merger Agreement and other documents by Watson and the Sub,
(c) the absence of restrictions and conflicts with the Merger Agreement; (d)
Watson's reports filed with the Commission; (e) the use of brokers; (f) the
opinion of Watson's financial advisor; (g) the shares of Watson Common Stock to
be issued in the Merger; (h) capitalization; (i) the absence of certain changes
with respect to Watson and the Sub since September 30, 1996; (j) litigation
matters; (k) information in this Proxy Statement/Prospectus; (l) the tax and
accounting treatment of the Merger; (m) compliance with laws; (n) compliance
with rules and regulations of the FDA and the related laws; and (o) Watson's
books and records.
The representations and warranties of the Company relate to, among other
things: (a) the Company's organization, standing and qualification; (b) its
capitalization; (c) its subsidiaries; (d) its other ownership interests; (e) its
constituent documents; (f) its authorization of the Merger Agreement and other
related documents; (g) the absence of restrictions and conflicts with the Merger
Agreement; (h) compliance with laws; (i) compliance with the rules and
regulations of the FDA and other related laws; (j) books and records;
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(k) reports filed with the Commission; (l) accounts receivable; (m) inventory;
(n) bank accounts; (o) intellectual property; (p) title to property; (q) real
estate; (r) contracts; (s) insurance; (t) litigation; (u) warranties; (v)
products liability; (w) arbitration; (x) taxes; (y) ERISA matters; (z) labor
matters; (aa) environmental matters; (bb) interim conduct of business; (cc)
affiliated transactions; (dd) significant customers, suppliers and employees;
(ee) material adverse changes; (ff) bribes; (gg) absence of indemnifiable
claims; (hh) undisclosed liabilities; (ii) brokers; (jj) tax reorganization;
(kk) opinion of financial advisor; (ll) information supplied in this Proxy
Statement/Prospectus; and (mm)takeover statutes.
CERTAIN COVENANTS
Each of Watson and the Company have agreed, among other things, to use its
reasonable efforts to: (a) proceed promptly to make or give the necessary
applications, notices, requests and filings in order to obtain the HSR Act
approvals; (b) cooperate with the other and use its commercially reasonable
efforts to: (i) receive all necessary and appropriate consents of third parties
to the Merger Agreement, (ii) satisfy all requirements prescribed by law, and
(iii) effect the Merger at the earliest practicable date; and (c) cooperate with
the other in the preparation of the Registration Statement and this Proxy
Statement/Prospectus. In connection therewith, the Company has agreed that it
shall not, among other items, without the prior written consent of Watson: (a)
with certain exceptions, issue shares of capital stock; (b) amend its
organizational documents; (c) with certain exceptions, pledge or encumber its
assets, except for taxes not currently due; (d) fail to maintain books and
records; (e) declare or pay any dividends or redeem, purchase or otherwise
acquire shares of Royce capital stock; (f) enter into any transaction outside
the ordinary course of business; or (g) take action which would prevent the tax
free nature of the transaction or "pooling of interests" accounting treatment.
CONDITIONS PRECEDENT
The respective obligations of Watson and the Company to consummate the
Merger are subject to the fulfillment of several conditions, including among
others, that:
(a) the Merger Agreement will have been approved and adopted by the
affirmative vote of the holders of a majority of all of the outstanding
shares of Royce Common Stock;
(b) the waiting periods (and any extensions thereof) applicable to the
Merger under the HSR Act shall have expired or been terminated;
(c) no preliminary or permanent injunction or other order or decree by
any federal or state court which prevents the consummation of the Merger or
materially changes the term or conditions of the Merger Agreement shall
have been issued and remain in effect;
(d) the Registration Statement of which this Proxy
Statement/Prospectus is a part and the registration statement on Form S-3
required under the Merger Agreement to register certain of the Company
Options will have been declared effective by the Commission and no stop
order suspending the effectiveness of the Registration Statement or the
Form S-3 registration statement shall have been issued, no action, suit,
proceeding or investigation by the Commission to suspend the effectiveness
thereof shall have been initiated and be continuing and all necessary
approvals under state securities laws relating to the issuance or trading
of Watson Common Stock to be issued under the Merger Agreement shall have
been received (note that the parties currently intend to file a
post-effective amendment to the Registration Statement in satisfaction of
this condition);
(e) all material consents, authorizations, orders and approvals of (or
filings or registrations with) any governmental commission, board or other
regulatory body required in connection with the execution, delivery and
performance of the Merger Agreement shall have been obtained or made,
except for filings in connection with the Merger and any other documents
required to be filed after the Effective Time;
(f) the Watson Common Stock to be issued to the Royce shareholders in
connection with the Merger will have been authorized for listing on the
Nasdaq NMS, subject only to official notice of issuance;
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(g) Watson shall have received the opinion of D'Ancona & Pflaum,
counsel to Watson, dated the Closing Date, to the effect that the Merger
will be treated for federal income tax purposes as a reorganization within
the meaning of Section 368(a) of the Code, and that Royce and Watson will
each be a party to that reorganization within the meaning of Section 368(b)
of the Code.
(h) Royce shall have received the opinion of Akerman, Senterfitt &
Eidson P.A., counsel to Royce, dated the Closing Date, to the effect that
the Merger will be treated for federal income tax purposes as a
reorganization within the meaning of Section 368(a) of the Code, and that
Royce and Watson will each be a party to that reorganization within the
meaning of Section 368(b) of the Code.
(i) Watson shall have received the opinion of Price Waterhouse LLP,
dated the Closing Date, to the effect that the Merger will be treated as a
pooling of interests for accounting purposes.
(j) The Company shall have received from Price Waterhouse LLP, a
letter, dated the Closing Date, indicating that the Company has not taken
any action that would preclude the Company from entering into a transaction
that will be treated as a pooling of interests for accounting purposes.
(k) Patrick J. McEnany shall have executed and delivered an employment
agreement providing for certain employment services to be performed by him.
Except as may be waived by Watson, the obligations of Watson and the
Sub to consummate the transactions contemplated by the Merger Agreement are
subject to the satisfaction of the following additional conditions, among
others:
(a) the representations and warranties of the Company contained in the
Merger Agreement and in all documents delivered in connection therewith
will be true and correct as of the Closing Date in all material respects,
and the Company will have performed, in all material respects, all of its
agreements contained in the Merger Agreement to be performed by the Company
prior to or on the Closing Date;
(b) the Company will have delivered to Watson certified copies of the
resolutions of the Company's Board of Directors and Shareholders approving
and adopting the Merger Agreement, the related documents and the
transactions contemplated thereby;
(c) Watson shall have received from Akerman, Senterfitt & Eidson,
P.A., counsel to the Company, an opinion in form and substance satisfactory
to Watson;
(d) from December 24, 1996 through the Effective Time, there shall not
have occurred any event that has had, would have or would be reasonably
likely to have a material adverse effect in the financial condition,
business, operations or prospects of the Company;
(e) Royce shall have received all necessary consents with respect to
any contract, lease, purchase order, sales order, license agreement,
permit, environmental permit and license which are required as a result of
a change of control of Royce except in those instances where failure to
receive any such consent would not have a material adverse effect on the
Company; and
(f) the Company shall have executed and delivered such other documents
and taken such other actions as Watson shall reasonably request.
Except as may be waived by the Company, the obligations of the Company to
consummate the transactions contemplated by the Merger Agreement are subject to
the satisfaction of the following conditions, among others:
(a) the representations and warranties of Watson and the Sub contained
in the Merger Agreement and in any documents delivered in connection
therewith will be true and correct as of the Closing Date in all material
respects, and Watson will have performed, in all material respects, with
all of its agreements contained in the Merger Agreement to be performed
with by Watson prior to or on the Closing Date;
(b) Watson will have delivered to the Company certified copies of the
resolutions of Watson's and the Sub's Board of Directors approving and
adopting the Merger Agreement, related documents and the transactions
contemplated thereby;
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(c) the receipt by the Company of opinions from D'Ancona & Pflaum,
counsel for Watson, in form and substance satisfactory to the Company;
(d) From December 24, 1996 through the Effective Time, there shall not
have occurred any event that has had, would have or would be reasonably
likely to have a material adverse effect in the financial condition,
business, operations or prospects of Watson and its subsidiaries, taken as
a whole; provided, that such an event will not be deemed to have occurred
solely as a result of fluctuations in the value of Watson Common Stock due
to or arising from any public disclosures by Watson (including Somerset),
including, without limitation, disclosures relating to Watson's entering
into any other transactions (including, without limitation, transactions
relating to the acquisition of assets, stock or merger transactions);
(e) the Company shall have received a letter from Gruntal, dated the
Closing Date, to the effect that the Merger or the Exchange Ratio, as the
case may be, continues to be fair to the shareholders of Royce from a
financial point of view; and
(f) Watson and Sub shall have executed and delivered such other
documents and taken such other action as the Company shall reasonably
request.
TERMINATION
The Merger Agreement provides that it may be terminated and the Merger may
be abandoned at any time on or before the Effective Time:
(a) by mutual consent of the Board of Directors of the Company and
Watson;
(b) by the Board of Directors of either the Company or Watson if there
has been a material breach by the other party of any representation or
warranty set forth in the Merger Agreement or of any covenant contained in
the Merger Agreement, which breach of a covenant, has not, or cannot be,
cured within 30 days after written notice thereof;
(c) by the Board of Directors of either the Company or Watson if the
Merger has not occurred by April 30, 1997 (except that neither party shall
be entitled to terminate if such party is in willful and material violation
of the Merger Agreement which has caused the Merger not to be consummated
by such date);
(d) by the Board of Directors of either the Company or Watson if the
required vote of the shareholders of the Company shall not have been
obtained (except that the Company shall not be entitled to terminate if it
caused or aided in such failure);
(e) by the Board of Directors of either the Company or Watson if a
governmental authority shall have issued a final and non-appealable order
or ruling permanently restraining, enjoining or otherwise prohibiting the
Merger or compelling Watson, the Sub or the surviving corporation of the
Merger to dispose of or hold separate a material portion of the respective
businesses or assets of Watson or the Company, or sell or license any
material product of Watson or the Company;
(f) by the Board of Directors of the Company if it determines in good
faith and pursuant to the exercise of its fiduciary duties, to withdraw its
recommendation of the Merger Agreement and/or Merger;
(g) by the Board of Directors of the Company or Watson if the Company
received an Alternative Proposal, and the Board of Directors of the Company
accepts such Alternative Proposal and recommends such Alternative Proposal
to its shareholders;
(h) by the Board of Directors of the Company or Watson if the Board of
Directors of the other shall have withdrawn or modified in a manner
materially adverse to the other, its approval or recommendation of the
Merger Agreement and/or the Merger (other than upon the happening of an
event described in (b) above);
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(i) by the Board of Directors of the Company or Watson, if the Company
determines to withdraw its recommendation of the Merger; or
(j) by the Company if Watson, prior to the Effective Date, enters into
any transaction, or series of related transactions, or enters into any
agreement relating to the foregoing, where Watson would (A) require the
approval of its shareholders pursuant to Nevada General Corporate Law or
(B) issue or propose to issue in excess of twenty-percent (20%) of the
outstanding Watson Common Stock in connection with such transaction, or
series of related transactions, calculated on a fully diluted basis after
giving effect to the consummation of the contemplated transaction between
Watson and Oclassen and the consummation of such new transaction or series
of related transactions. Neither party has the right to terminate the
Merger Agreement based upon fluctuations in the Average Closing Price.
NO SOLICITATION; TERMINATION FEE
Under the terms of the Merger Agreement, the Company is prohibited from,
directly or indirectly, soliciting or encouraging the initiation of any
inquiries, proposals or offers regarding any acquisition, merger, takeover bid
or sale of all or substantially all of its assets. However, if the Company's
Board of Directors determines that it would be consistent with its fiduciary
responsibilities to approve or recommend an Alternative Proposal, then the
Company shall be entitled to enter into the Alternative Proposal and terminate
the Merger Agreement. In such event, Royce will be obligated to pay Watson the
Termination Fee described below.
In the event the Merger Agreement is terminated by the Company or Watson as
a result of (i) Royce entering into a Alternative Proposal or (ii) because the
Company's Board of Directors shall have withdrawn or modified its approval or
recommendation of the Merger Agreement or the Merger in a manner material
adverse to Watson, and the Company enters into an agreement or an understanding
with respect to an Alternative Proposal within nine (9) months of the date of
termination and thereafter consummates such transaction, then Watson shall be
entitled to receive from the Company, a cash fee of $3,000,000 (the "Termination
Fee").
Additionally, if the Merger Agreement is terminated by the Company or
Watson because of Royce's acceptance of an Alternative Proposal and Royce does
not enter into an agreement with regard to such Alternative Proposal within nine
(9) months of the termination of the Merger Agreement or such proposal does not
close within eighteen (18) months of such termination, Royce shall reimburse
Watson for its out of pocket costs and expenses incurred in connection with the
Merger Agreement and the consummation and negotiation of the transactions
contemplated by the Merger Agreement, including legal, professional and service
fees and expenses, which shall be payable within 12 months from the date of
termination of the Merger Agreement. If the fees described above are not paid
when due, all amounts owing will accrue interest at a rate equal to 12% per
annum.
EXPENSES
Each of Watson and the Company will pay its own expenses (including,
without limitation, financial, legal and tax advice) incurred in connection with
the Merger Agreement and the transactions contemplated thereby except that the
parties agreed to share equally all expenses incurred in connection with the
printing and mailing of this Proxy Statement/Prospectus to the Royce
shareholders. The costs of merging the operations of Watson and Royce are
expected to result in a charge to Watson's earnings following the Merger.
MODIFICATION AND WAIVERS
The parties may at any time mutually amend in writing the Merger Agreement
or any other agreements contemplated thereby, or individually waive in writing
satisfaction of any of the conditions set forth therein; provided, however, that
(i) any waiver of a material condition to the Merger, including the conditions
that (a) the Merger qualify as a pooling of interests for accounting purposes,
and (b) the Merger qualify as a tax-free reorganization under the Code, will
require a resolicitation of Royce shareholders prior to consummation of the
Merger and (ii) after the holders of Royce Common Stock have approved the
Merger, no
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amendment may be made which by law requires the further approval of the holders
of Royce Common Stock without obtaining such further approval.
COMPARATIVE RIGHTS OF SHAREHOLDERS
Upon consummation of the Merger, holders of Royce Common Stock will become
holders of Watson Common Stock and the rights of former Royce shareholders will
be governed by the Watson Certificate of Incorporation, the Watson Bylaws and
the Nevada General Corporation Law (the "Nevada Act").
Shareholders should note the following summary of certain material
provisions of, and the material differences between, the Nevada Act and the
Florida Business Corporation Act (the "FBCA") as they affect the rights of
shareholders of Royce. The following comparison of the Nevada Act and Watson's
Certificate of Incorporation and Bylaws, on the one hand, and the FBCA and
Royce's Articles of Incorporation and Bylaws, on the other, is not intended to
be complete and is qualified in its entirety by reference to Watson's
Certificate of Incorporation and Bylaws and Royce's Articles of Incorporation
and Bylaws. Copies of the Watson Certificate of Incorporation and Bylaws are
available for inspection at the offices of Watson and copies will be sent to the
holders of Royce Common Stock upon request. Copies of the Company's Articles of
Incorporation and Bylaws are available for inspection at the offices of the
Company and copies will be sent to the holders of Royce Common Stock upon
request.
DISTRIBUTIONS TO SHAREHOLDERS
Under the Nevada Act and the FBCA, a corporation may make distributions to
shareholders as long as, after giving effect to such distribution, the
corporation will be able to pay its debts as they become due in the usual course
of business and the corporation's total assets will not be less than the sum of
its total liabilities plus (unless the articles of incorporation permit
otherwise) the amount that would be needed, if the corporation were to be
dissolved at the time of the distribution, to satisfy the preferential rights
upon dissolution of shareholders whose preferential rights are superior to those
receiving the distribution.
DISSENTERS' RIGHTS
A stockholder of a Nevada corporation, with certain exceptions, has the
right to dissent from, and obtain payment for the fair value of his shares in
the event of (1) a merger or consolidation to which the corporation is a party,
(2) consummation of a plan of exchange to which the corporation is a party as
the corporation whose shares will be acquired, if the stockholder is entitled to
vote on the plan, and (3) any corporate action taken pursuant to a vote of the
stockholders to the extent that the articles of incorporation, bylaws or a
resolution of the board of directors provides that voting or non-voting
stockholders are entitled to dissent and obtain payment for their shares. The
Nevada Act provides that unless a corporation's articles of incorporation
provide otherwise (which Watson's Articles of Incorporation do not), a
stockholder does not have dissenters' rights with respect to a plan of merger or
share exchange if the shares held by the stockholder are either listed on a
national securities exchange, or included in the national market system by the
National Association of Securities Dealers, Inc., or held of record by 2,000 or
more stockholders. A stockholder of record of a Nevada corporation may dissent
as to less than all the shares registered in his name only if he dissents with
respect to all shares beneficially owned by any one person and notifies the
corporation in writing of the name and address of each person on whose behalf he
asserts dissenters' rights. In such event, the stockholder's rights will be
determined as if the shares to which he dissents and his other shares were
registered in the names of different stockholders.
The FBCA provides dissenters' rights in connection with (i) a merger,
except that such rights are not provided when (a) no vote of the shareholders is
required for the merger or (b) shares of the corporation are listed on a
national securities exchange, traded on Nasdaq NMS, or held of record by fewer
than 2,000 shareholders; (ii) a sale of substantially all the assets of a
corporation; (iii) amendments to the articles of incorporation that may
adversely affect the rights or preferences of shareholders; and (iv) a Control
Share Acquisition (as described below).
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While dissenters' rights provisions under the Nevada Act and the FBCA are
essentially similar, situations could theoretically arise in which dissenters'
rights, which would be available under the FBCA, are not available under the
Nevada Act.
STATE TAKEOVER LAWS
Watson may be subject to the provisions of Nevada's anti-takeover laws
known respectively as the "Combination with Interested Stockholders Statute" and
the "Control Share Acquisition Statute."
The Combination with Interested Stockholders Statute prevents "interested
stockholders" and an applicable Nevada corporation from entering into a
"combination" unless certain conditions are met. A combination means any merger
or consolidation with an "interested stockholder", or any sale, lease, exchange,
mortgage, pledge, transfer or other disposition, in one transaction or a series
of transactions, with an "interested stockholder" having: (i) an aggregate
market value equal to 5% or more of the aggregate market value of the assets of
the corporation; (ii) an aggregate market value equal to 5% or more of the
aggregate market value of all outstanding shares of the corporation; or (iii)
representing 10% or more of the earning power or net income of the corporation.
An "interested stockholder" means the beneficial owner of 10% or more of the
voting shares of a corporation, or an affiliate or associate thereof. A
corporation may not engage in a "combination" within three years after the
interested stockholder acquires his shares unless the combination or purchase is
approved by the board of directors or a majority of the voting power held by
disinterested stockholders, or if the consideration to be paid by the interested
stockholder is at least equal to the highest of: (i) the highest price per share
paid by the interested stockholder within the three years immediately preceding
the date of the announcement of the combination or in the transaction in which
he became an interested stockholder, whichever is higher, (ii) the market value
per common share on the date of announcement of the combination or the date the
interested stockholder acquired the shares, whichever is higher, or (iii) if
higher for the holders of preferred stock, the highest liquidation value of the
preferred stock.
The Control Share Acquisition Statute prohibits an acquiror, under certain
circumstances, from voting shares of a target corporation's stock after crossing
certain threshold ownership percentages, unless the acquiror obtains the
approval of the target corporation's stockholders. The Control Share Acquisition
Statute specifies three thresholds: one-fifth or more but less than one-third,
one-third or more but less than a majority and a majority or more, of the voting
power of the corporation in the election of directors. Once an acquiror crosses
one of the above thresholds, those shares acquired in such offer or acquisition
and those shares acquired within the preceding ninety days become Control Shares
and such Control Shares are deprived of the right to vote until disinterested
stockholders restore the right. The Control Shares Acquisition Statute also
provides that in the event Control Shares are accorded full voting rights and
the acquiring person has acquired a majority or more of all voting power, all
other stockholders who do not vote in favor of authorizing voting rights to the
Control Shares are entitled to demand payment for the fair value of their
shares. The board of directors is to notify the stockholders within twenty days
after such an event has occurred that they have the right to receive the fair
value of their shares in accordance with statutory procedures established
generally for dissenters' rights. The Control Share Acquisition Statute
currently does not apply to Watson because Watson does not have 100 or more
stockholders who are residents of the state of Nevada.
Section 607.0901 of the FBCA, informally known as the "Fair Price Statute,"
provides that the approval of the holders of two-thirds of the voting shares of
a company, other than the shares owned by an Interested Shareholder (as
hereinafter defined) would be required in order to effectuate certain
transactions, including without limitation a merger, sale of assets, sale of
shares and reclassification of securities involving a corporation and an
Interested Shareholder (and "Affiliated Transaction"). An "Interested
Shareholder" is defined under the FBCA as beneficial owner of more than 10% of
the voting shares outstanding. The foregoing special voting requirement is in
addition to the vote required by any other provision of the FBCA or a
corporation's articles of incorporation.
The special voting requirement does not apply in any of the following four
circumstances: (i) the Affiliated Transaction is approved by a majority of the
corporation's disinterested directors; (ii) the Interested Shareholder has
beneficially owned 80% of the corporation's voting shares for five years; (iii)
the Interested
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Shareholder beneficially owns 90% of the corporation's voting shares; or (iv)
all of the following conditions are met: (A) the cash and fair value of other
consideration to be paid per share to all holders of voting shares equals the
highest per share price calculated pursuant to various methods set forth in
Section 607.0901 of the FBCA, (B) the consideration to be paid in the Affiliated
Transaction is in the same form as previously paid by the Interested
Shareholder, and (C) during the portion of the three years preceding the
announcement date that the Interested Shareholder has been an Interested
Shareholder, except as approved by a majority of the disinterested directors,
there shall have been no default in payment of preferred stock dividends, no
decrease in common stock dividends, no increase in the voting shares owned by
the Interested Shareholder, and no benefit to the Interested Shareholder from
loans, guaranties or other financial assistance or tax advantages provided by
the corporation.
A corporation may "opt out" of the provisions of Section 607.0901 by
electing to do so in its original articles of incorporation or by adopting an
amendment to its articles of incorporation or bylaws opting out and having such
amendment approved by the holders of a majority of the voting shares not held by
the Interested Shareholder, its affiliates or associates. The amendment will not
be effective until 18 months after such vote, and will not apply to any
Affiliated Transaction with someone who is an Interested Shareholder on or prior
to the effective date of the amendment. The Company has not opted out of the
provisions of Section 607.0901.
A person who inadvertently becomes an Interested Shareholder (for example,
as a result of a corporation's repurchase of some of its shares) may promptly
divest himself of enough stock to fall below the 10% threshold so that no
special vote would apply to a transaction with that shareholder, so long as such
person has not otherwise been an Interested Shareholder within the five years
preceding the first public announcement of the transaction.
Section 607.0902 of the FBCA, informally known as the "Florida Acquisition
Statute," provides that the voting rights to be accorded Control Shares (as
defined below) of a Florida corporation that has (i) 100 or more shareholders,
(ii) its principal place of business, its principal office, or substantial
assets in Florida, and (iii) either (A) more than 10% of its shareholders
residing in Florida, (B) more than 10% of its shares owned by Florida residents,
or (C) 1,000 shareholders residing in Florida, must be approved by a majority of
each class of voting securities of the corporation, excluding those shares held
by interested persons, before the Control Shares will be granted any voting
rights.
"Control Shares" are defined in the FBCA to be shares acquired in a Control
Share Acquisition (as defined below) that, when added to all other shares of the
issuing corporation owned by such person, would entitle such person to exercise,
either directly or indirectly, voting power within any of the following ranges:
(a) 20% or more but less than 33% of all voting power of the corporation's
voting securities, (b) 33% or more but less than a majority of all voting power
of the corporation's voting securities, or (c) a majority or more of all of the
voting power or the corporation's voting securities. A "Control Share
Acquisition" is defined in the FBCA as an acquisition, either directly or
indirectly, by any person of ownership of, or the power to direct the exercise
of voting power with respect to, outstanding Control Shares. Section 607.0902
also states that, if provided in the articles of incorporation or bylaws of a
corporation prior to their acquisition, Control Shares may be redeemed by the
corporation for fair value in certain circumstances. Finally, unless otherwise
provided in a corporation's articles of incorporation or bylaws prior to a
Control Share Acquisition, in the event Control Shares are accorded full voting
rights and the acquiring person has acquired Control Shares with a majority or
more of all voting power, all shareholders shall have dissenters' rights.
Section 607.0902 further provides that, in certain circumstances, an
acquisition of shares that otherwise would be governed by its provisions does
not constitute a Control Share Acquisition. Among such circumstances are
acquisitions of shares approved by the corporation's board of directors and
mergers effected in compliance with the applicable provisions of the FBCA, if
the corporation is a party to the agreement of merger.
COMPANY TAKEOVER PROVISIONS
In addition to state law provisions, Royce's Articles of Incorporation
contain certain provisions that may be considered to have an anti-takeover
effect, including restrictions on removal of members of Royce's Board
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of Directors, as discussed above, the elimination of the shareholder action by
written consent in lieu of a shareholder meeting and supermajority approval for
certain business combinations. As a result of the Merger, the benefits and/or
detriments of such provisions will no longer be available to holders of Royce
Common Stock who exchange such shares in the Merger for shares of Watson Common
Stock.
LIMITATION ON DIRECTOR'S LIABILITY
The Nevada Act allows a corporation to provide in its articles of
incorporation that a director or officer will not be personally liable for
monetary damages to the corporation or its stockholders for breach of fiduciary
duty as a director or officer, except that such provision must not eliminate or
limit the liability of a director or officer for (i) acts or omissions which
involve intentional misconduct, fraud or a knowing violation of the law; or (ii)
the payment of distributions to stockholders. The Articles of Incorporation of
Watson limit a director's and officer's liability to the events specified in the
Nevada Act.
The FBCA provides that a director of a corporation will not be personally
liable for monetary damages for breach of his fiduciary duty as a director,
unless the director's breach of duty involves: (i) a violation of the criminal
law; (ii) a transaction from which the director derived an improper personal
benefit; (iii) an unlawful payment of a dividend or unlawful stock repurchase or
redemption; (iv) in a derivative proceeding or one by or in the right of a
shareholder, conscious disregard for the best interest of the corporation or
willful misconduct; or (v) in a proceeding by or in the right of someone other
than the corporation or a shareholder, recklessness or an act or omission that
was committed in bad faith, with malicious purpose or in a manner exhibiting
wanton and willful disregard of human rights, safety or property. Consequently,
situations may arise in which an existing Royce shareholder, following the
Merger, would have less ability to bring an action against an officer or
director of Watson.
CALLING A SPECIAL MEETING OF SHAREHOLDERS
The FBCA provides that a special meeting of shareholders can be called by
(i) a corporation's board of directors; (ii) the persons authorized by the
articles of incorporation or bylaws; or (iii) the holders of not less than 10%
of all votes entitled to be cast on any issue to be considered at the proposed
special meeting. A corporation's articles of incorporation can require a higher
percentage of votes, up to a maximum of 50%, to call a special meeting of
shareholders. The Company's Bylaws provide that special meetings of shareholders
shall be held only when called by the Board of Directors pursuant to a
resolution adopted by a majority of the Board of Directors.
The Nevada Act contains no similar provision for the calling of a special
meeting of stockholders.
AMENDMENTS TO BYLAWS
The Nevada Act permits the directors of a Nevada corporation to amend the
bylaws of the corporation, subject to the bylaws, if any, adopted by the
stockholders. Watson's Bylaws provide that the Board of Directors has the power
to make, alter, amend or repeal the Bylaws. Under the FBCA, a corporation's
board of directors may amend or repeal the bylaws unless such power is expressly
reserved to the shareholders in the articles of incorporation or the FBCA or the
shareholders expressly provide, in amending or repealing all or any part of the
bylaws, that the board of directors may not amend or repeal the affected bylaws.
AMENDMENT TO ARTICLES OF INCORPORATION
Under the Nevada Act, the board of directors must adopt a resolution
setting forth any proposed amendment to the articles of incorporation and
declaring its advisability, and must call a meeting of the stockholders entitled
to vote for the consideration thereof. A majority of the stockholders entitled
to vote must approve the amendment. If any proposed amendment would alter any
preference or any right given to any class or series of outstanding shares, then
the amendment must be approved by the vote, in addition to the affirmative vote
otherwise required, of the holders of shares representing a majority of the
voting power of each class or series affected by the amendment, regardless of
limitations or restrictions on the voting power thereof.
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Under the FBCA, unless the articles of incorporation provide otherwise, the
board of directors of a corporation may, without shareholder action, adopt
certain amendments to the articles of incorporation, including, but not limited
to, amendments (i) to delete the names and addresses of the initial directors;
(ii) to delete the name and address of the initial registered agent or
registered office, if a statement of change is filed with the Department of
State; (iii) to delete the authorization for a class or series of shares
authorized in the articles if no shares of such series or class are issued; (iv)
to change the par value for a class or series of shares; (v) to increase or
decrease the number of authorized shares, and to make any other changes
necessary or appropriate to assure that the rights or preferences of each holder
of issued and outstanding shares of all classes and series will not be adversely
affected by the combination or division; (vi) to make certain changes to the
corporation's name; or (vii) to make any other change expressly permitted by the
FBCA to be made without shareholder approval. All other amendments to the
articles of incorporation of a Florida corporation must be approved by the
majority of all the votes entitled to be cast by that voting group, unless the
articles require a greater or lesser vote. The Company's Articles of
Incorporation may be amended upon the affirmative vote of 80% of the outstanding
shares.
MERGER WITH SUBSIDIARY
The Nevada Act permits a parent corporation owning at least 90% of the
outstanding shares of each class of a subsidiary corporation to merge the
subsidiary into itself without the approval of the stockholders of such parent
corporation. The FBCA permits the merger of a subsidiary into its parent without
shareholder approval if 80% of each class of stock of the subsidiary is owned by
the parent corporation.
INDEMNIFICATION
Under the Nevada Act and the FBCA, a corporation may generally indemnify
its officers, directors, employees and agents against expenses incurred in any
proceeding (other than derivative actions), if they acted in good faith and in a
manner they reasonably believed to be in or not opposed to the best interests of
the corporation and, with respect to any criminal action or proceeding, had no
reasonable cause to believe their conduct was unlawful. A similar standard is
applicable in derivative actions, except that indemnification may be made only
for (i) expenses and certain amounts paid in settlement and (ii) in the event
the person seeking indemnification has been adjudicated liable, amounts are
deemed proper, fair and reasonable by the appropriate court upon application
thereto. The Nevada Act and the FBCA both provide that to the extent such
persons have been successful in the defense of any proceeding, they must be
indemnified by the corporation against expenses. Both the Nevada Act and the
FBCA also provide that if a corporation does not so indemnify such persons, they
may seek, and a court may order, indemnification under certain circumstances
even if the board of directors or stockholders of the corporation have
determined that the persons are not entitled to indemnification.
In addition, under both the Nevada Act and the FBCA, expenses incurred by
an officer or director in connection with a proceeding may be paid by the
corporation in advance of the final disposition, upon receipt of an undertaking
by such director or officer to repay such amount if such director or officer is
ultimately found not to be entitled to indemnification by the corporation.
The Bylaws of Watson and Royce provide that directors and officers and
former directors and officers will be indemnified to the fullest extent
permitted by law.
DERIVATIVE ACTIONS
Under the Nevada Rules of Civil Procedure (the "Nevada Rules") and the
FBCA, a person may not bring a derivative action unless the person was a
stockholder of the corporation at the time of the challenged transaction or
unless the person acquired the shares by operation of law from a person who was
a stockholder at such time. Both the Nevada Rules and the FBCA provide that a
complaint in a derivative proceeding must be verified and must allege with
particularity the efforts, if any, made by the plaintiff to obtain the desired
action, and the reasons for his failure to obtain the action he desires.
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The Nevada Rules also provide that a derivative action may not be
maintained if it appears that the plaintiff does not fairly and adequately
represent the interests of stockholders. The FBCA provides that a court may
dismiss a derivative proceeding if it determines that any of the following
groups made a determination in good faith after conducting a reasonable
investigation, that the maintenance of the derivative suit is not in the best
interests of the corporation: (i) a majority vote of independent directors
present at a meeting of the board of directors, if the independent directors
constitute a quorum; (ii) a majority vote of a committee consisting of two or
more independent directors appointed by a majority vote of independent directors
present at a meeting of the board of directors, whether or not such independent
directors constitute a quorum; or (iii) a panel of one or more independent
persons appointed by the court upon motion by the corporation. Under both the
Nevada Rules and the FBCA, an action will not be dismissed, compromised or
settled without court approval.
The FBCA provides further that, upon termination of the proceeding, a court
may require the plaintiff to pay the defendant's reasonable expenses (including
attorneys' fees) incurred in defending the proceeding if it finds that the
proceeding was commenced without reasonable cause. Further, the FBCA permits a
court to award reasonable expenses for maintaining the proceeding (including
attorneys' fees) to a successful plaintiff or to the person commencing the
proceeding who receives any relief, whether by judgment, compromise or
settlement.
STOCKHOLDER INSPECTION OF BOOKS AND RECORDS
Under the Nevada Act a stockholder who has been a stockholder of record of
a Nevada corporation for at least six months preceding his demand or who owns 5%
or more of the issued and outstanding shares of stock of the corporation (or who
has been authorized in writing by such holders) is entitled to inspect and copy
a list of the names of the corporation's stockholders during regular business
hours if the stockholder gives at least five business days' prior written demand
to the corporation. A stockholder of a Nevada corporation must hold, or be
authorized by the holders of, 15% of the outstanding shares in order to review
the books and records of the corporation. The Nevada Act provides further that a
corporation may deny any demand for inspection if the stockholder refuses to
furnish the corporation an affidavit that such inspection is not desired for a
purpose not related to his interest in the corporation as a stockholder.
Pursuant to Watson's Bylaws, a stockholder may inspect and copy Watson's
Articles of Incorporation, Bylaws, stockholder lists, corporate minutes and
accounting books and records to the fullest extent permitted under the Nevada
Act.
The Company's Bylaws permit any person who has been a holder of record of
one quarter of one percent of shares or of voting trust certificates therefor at
least six months immediately proceeding his demand or is the holder of, or the
holder of record of voting trust certificates for, at least five percent of the
outstanding shares of the corporation, to inspect and copy the books, records of
accounts, minutes and record of shareholders of the Company upon written demand.
Consequently, unless a Royce shareholder will, following the Merger, own 15% or
greater of the issued and outstanding shares of Watson Common Stock, such
shareholder will have more limited rights of inspection under the Nevada Act
than such shareholder had as a Royce shareholder.
QUORUM FOR STOCKHOLDER MEETINGS
Under the Nevada Act, unless otherwise provided in a corporation's articles
of incorporation or bylaws, a majority of shares entitled to vote on a matter
constitutes a quorum at a meeting of stockholders. Similarly, under the FBCA, a
majority of shares entitled to vote constitutes a quorum unless the
corporation's articles of incorporation provide otherwise. Under the Nevada Act,
the articles of incorporation or bylaws may provide for a greater or lesser
quorum requirement. The FBCA provides that the articles of incorporation may
increase or decrease the quorum requirement, except that the quorum may not be
less than one-third of the shares entitled to vote.
The bylaws of both Watson and Royce provide that the presence in person or
by proxy of a majority of the shares entitled to vote will constitute a quorum.
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BOARD VACANCIES
Both the Nevada Act and FBCA provide that a vacancy on the board of
directors may be filled by the affirmative vote of a majority of the remaining
directors, although less than a quorum of the board of directors, unless the
articles of incorporation provide otherwise. The FBCA also provides that a
vacancy on the board of directors may be filled by the affirmative vote of a
majority of the shareholders.
Watson's Articles of Incorporation provides that vacancies created by newly
created directorships will be filled by a majority of directors then in office,
provided that a quorum is present. All other vacancies will be filled by a
majority of directors then in office, even if less than a quorum.
Royce's Bylaws provide that all vacancies will be filled by a majority vote
of directors then in office (not by shareholder vote).
REMOVAL OF DIRECTORS
Under the Nevada Act, any director may be removed from office by the vote
of stockholders representing not less than two-thirds of the voting power of the
issued and outstanding stock entitled to voting power unless the articles of
incorporation require the concurrence of a lesser percentage of the stock
entitled to voting power in order to remove a director. Watson's Bylaws provide
that any director may be removed from office with or without cause, at a meeting
called expressly for that purpose, by the vote or written consent of the holders
of a majority of the outstanding shares of the corporation.
Under the FBCA, shareholders may remove one or more directors with or
without cause, unless the articles of incorporation provide that directors may
be removed only for cause, at a meeting of the shareholders called expressly for
that purpose. If a director is elected by a voting group of shareholders, only
the shareholders of that voting group may participate in the vote to remove such
director. The Company's Bylaws provide that a director may be removed from
office at any time, but only for cause and only by the affirmative vote of the
holders of at least 80% of the voting power of all of the shares of the
corporation entitled to vote for the election of directors.
CLASSIFIED BOARD OF DIRECTORS
The Nevada Act provides that a corporation's board of directors may be
divided into various classes with staggered terms of office. Both the Watson
Bylaws and the Royce Bylaws provide that the Boards of Directors of the
respective corporations may be divided into three classes of directors, as
nearly equal in number as reasonably possible. One class of directors may be
elected each year for a three-year term.
Classification of directors may have the effect of making it more difficult
for stockholders to change the composition of the Watson Board of Directors. At
least two annual meetings of stockholders, instead of one, will generally be
required to effect a change in the majority of the Watson Board. Such a delay
may help ensure that Watson's directors, if confronted by a stockholder
attempting to force a proxy contest, a tender or exchange offer or other
extraordinary corporate transaction, would have sufficient time to review the
proposal as well as any available alternatives to the proposal and to act in
what they believe to be the best interests of the stockholders.
The classification provisions could also have the effect of discouraging a
third party from initiating a proxy contest, making a tender offer or otherwise
attempting to obtain control of Watson, even though such a transaction could be
beneficial to Watson and its stockholders. The classification of the Watson
Board of Directors might also increase the likelihood that incumbent directors
will retain their positions.
NUMBER OF DIRECTORS
Watson's Articles of Incorporation provide that the number of directors
shall be nine persons. Royce's Bylaws provide that the number of directors shall
not be less than five nor more than nine persons.
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LOANS TO AND GUARANTEES OF OBLIGATIONS OF OFFICERS AND EMPLOYEES
Under the FBCA, a loan to, guarantee of an obligation of, or other
assistance to an officer, director, or employee of the corporation, requires the
determination of the board of directors of the corporation that the loan,
guarantee or assistance may reasonably be expected to benefit the corporation.
The Nevada Act contains no comparable provision, although it provides that
directors exercising their powers may consider, among other things, the
interests of the employees and the long-term as well as the short-term interests
of the corporation and its stockholders. Consequently, an existing Royce
shareholder may, following the Merger, have less ability to challenge any such
loans as a Watson stockholder.
Under the FBCA, any contract or transaction (including a loan or guarantee)
between the corporation and any of its directors, or between the corporation and
any other organization in which the corporation's directors are also directors
of officers, or have a financial interest, is voidable unless approved by a
majority of the disinterested directors or the shareholders after the fact of
such relationship is disclosed to such directors or shareholders, or unless the
transaction is fair to the corporation at the time it is approved. The Nevada
Act has a similar requirement except that such transactions may be approved by
the majority vote of stockholders holding a majority of the voting power, and
such transactions are also permissible if the fact of the common directorship,
office or financial interest is not disclosed or known to the director or
officer when the transaction is brought before the board for action.
Consequently, transactions including interested persons may be more difficult to
challenge as shareholder of Watson than as a shareholder of Royce.
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DESCRIPTION OF WATSON CAPITAL STOCK
Watson is authorized to issue up to 500,000,000 shares of Common Stock,
$.0033 par value per share, 40,477,830 shares of which were issued and
outstanding at February 27, 1997, and 2,500,000 shares of Preferred Stock, none
of which were outstanding as of the date hereof.
WATSON COMMON STOCK
The holders of Watson Common Stock are entitled to one vote for each share
held of record on all matters on which stockholders are entitled or permitted to
vote. Such holders may not cumulate votes in the election of directors. The
holders of Watson Common Stock are entitled to receive such dividends as may
lawfully be declared by the Watson Board of Directors out of funds legally
available therefor and to share pro rata in any other distribution to the
holders of Watson Common Stock. The holders of Watson Common Stock are entitled
to share ratably in Watson's assets remaining after payment of liabilities in
the event of any liquidation, dissolution or winding up of the affairs of
Watson. The holders of Watson Common Stock have no preemptive rights. There are
no conversion rights, redemption or sinking fund provisions or fixed dividend
rights with respect to the Watson Common Stock. All outstanding shares of Common
Stock are fully paid and non-assessable, and the shares of Watson Common Stock
to be issued pursuant to the Merger Agreement will be fully paid and
non-assessable.
WATSON PREFERRED STOCK
The Watson Board of Directors has the authority to issue Preferred Stock in
one or more series and to fix the rights, preferences, privileges and
restrictions thereof, including dividend rights, dividend rates, conversion
rights, voting rights, terms of redemption, redemption prices, liquidation
preferences and the number of shares constituting any series or the designation
of such series, without further vote or action by the Watson stockholders. The
issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of Watson without further action by the
stockholders and may adversely affect the voting and other rights of the holders
of Watson Common Stock. At present, Watson has no plans to issue any of the
Preferred Stock.
ADDITIONAL SECURITIES REGISTERED IN THE REGISTRATION STATEMENT
This Registration Statement also registers the issuance by Watson of shares
of Watson Common Stock to the holders of the following outstanding options and
warrants of Royce. In connection with the Merger, each of the following Royce
options and warrants will become an option or warrant to purchase a number of
whole shares of Watson Common Stock equal to the number of shares of Royce
Common Stock into which such options or warrants are exercisable immediately
prior to the Effective Date multiplied by the Exchange Ratio (rounded to the
nearest whole share with 0.5 rounded upward) at an option or warrant exercise
price determined by dividing the exercise price of such option or warrant
immediately prior to the Effective Date by the Exchange Ratio (the option price
per share, as so determined, being rounded to the nearest full cent with $.005
rounded upward).
Gruntal Warrants. Gruntal holds warrants to purchase up to 283,333
shares of Royce Common Stock, 200,000 of which are exercisable at $3.50 per
share ("Gruntal Warrant 1") and 83,333 of which are exercisable at $6.00
per share ("Gruntal Warrant 2") (Gruntal Warrant 1 and Gruntal Warrant 2
may sometimes be collectively referred to as the "Gruntal Warrants"). As a
result of the Merger, assuming an Average Closing Price of $43.50 per share
(the last closing price of Watson Common Stock on February 27, 1997),
Gruntal Warrant 1 may be exercised for 33,333 shares of Watson Common Stock
at an exercise price of $21.00 per share and Gruntal Warrant 2 may be
exercised for 13,889 shares of Watson Common Stock at an exercise price of
$36.00 per share.
Gruntal Warrant 1 is exercisable until August 12, 1999 and Gruntal
Warrant 2 is exercisable until July 21, 1998. The Gruntal Warrants may be
exercised in cash. Alternatively, the holder of the Gruntal Warrants, may
at any time and from time to time exercise the Gruntal Warrants, in whole
or in part, by surrendering the warrant certificate in exchange for the
number of shares of Watson Common Stock
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equal to (x) the number of shares as to which the particular Gruntal
Warrant is being exercised, multiplied by (y) a fraction, the numerator of
which is the market price of the Watson Common Stock at the date of
exercise less the exercise price and the denominator of which is such
market price. The holders of the Gruntal Warrants also have certain demand
and piggyback registration rights. If such registration should involve an
underwriting agreement, such underwriting agreement would include, among
other things, customary indemnification and contribution obligations.
The Gruntal Warrants were issued to Gruntal as part of their
compensation for acting as the placement agent for Royce's 1994 and 1995
private placements.
Series F Warrants. During the fourth quarter of 1994, Royce issued
warrants (the "Series F Warrants") to purchase up to 658,333 shares of
Royce Common Stock at an exercise price of $15.00 per share as part of a
settlement of certain class action litigation. As a result of the Merger,
assuming an Average Closing Price of $43.50 per share (the last closing
price of Watson Common Stock on February 27, 1997), the Series F Warrants
would allow the holders thereof the right to purchase an aggregate of
109,722 shares of Watson Common Stock at an exercise price of $90.00 per
share.
The Series F Warrants are exercisable until December 31, 1999. The
Company has the right to call the Series F Warrants under certain
conditions if the market price of Royce Common Stock exceeds $18 per share
($108.00 per share of Watson Common Stock after the Merger, assuming an
Average Closing Price of $43.50 per share) for 20 consecutive trading days.
Major Option. One of Royce's customers, Major Pharmaceuticals, Inc.
("Major"), holds an option to purchase up to 50,000 shares of Royce Common
Stock (the "Major Option") at an exercise price of $6.00 per share. The
option was granted in return for the customer agreeing that Royce would be
Major's sole source of supply for certain products for a period of five
years. As a result of the Merger, due to a change of control provision
contained in the agreement documenting the Major Option, the Major Option
will become fully vested at the Effective Time of the Merger. Additionally,
as a result of the Merger, the Major Option will allow the holder thereof
to purchase, assuming an Average Closing Price of $43.50 per share (the
last closing price of Watson Common Stock on February 27, 1997), 8,333
shares of Watson Common Stock at an exercise price of $36.00 per share.
The Major Option is exercisable until February 25, 2002, and is not
transferable. Major may pay the exercise price in cash. Alternatively,
Major has the right at any time and from time to time to convert the Major
Option into shares of Watson Common Stock. Upon exercise of such conversion
right with respect to any shares subject to options, Major will receive
(without payment by Major of any cash) that number of shares of Watson
Common Stock equal to the quotient obtained by dividing (x) the fair market
value of such options on the conversion date, which value shall be
determined by subtracting (A) the aggregate option price of the converted
option shares immediately prior to the exercise of the conversion right
from (B) the aggregate fair market value of such converted option shares on
the conversion date, by (y) the fair market value of one share of Watson
Common Stock on the conversion date.
Major has certain demand and piggyback registration rights under the
Major Option, and has the right to indemnification with respect to any
untrue or alleged untrue statements or omissions contained in such
registration statement except for statements or omissions made in reliance
on written information provided by Major specifically for use in the
preparation of such registration statement.
P&PSI Option. A consultant to the Company, Physician and
Pharmaceutical Services, Inc. ("P&PSI") holds an option to purchase up to
20,000 shares of Royce Common Stock (the "P&PSI Option") at an exercise
price of $10.50 per share if certain annual minimum net sales targets were
met by the consultant during 1997. If certain 1997 net sales targets are
met, P&PSI could earn on January 1, 1998, the right to receive upon
exercise up to 20,000 shares of Royce Common Stock underlying the P&PSI
Option. Assuming that P&PSI earns the right to exercise all 20,000 of the
shares underlying the P&PSI Option, and assuming an Average Closing Price
of $43.50 per share (the last closing price of Watson Common Stock on
February 27, 1997), P&PSI would have the right to purchase 3,333 shares of
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<PAGE> 74
Watson Common Stock at an exercise price of $63.00 per share upon the
exercise of the P&PSI Option.
The P&PSI Option will expire on December 31, 1999. Payment of the
option price may be made by cash or by delivery of Royce Common Stock
(Watson Common Stock after the Merger) having a fair market value equal to
the option price, or by a combination of cash and shares. The P&PSI Option
is not transferable.
Shares Issuable Upon the Exercise of Royce Options Granted Outside of
Plans to Non Employees of Royce. In addition to the Major Option, the
P&PSI Option and the options referred to below, as of February 27, 1997
Royce had outstanding options to purchase 62,915 shares of Royce Common
Stock which were granted outside of the Company's 1992 and 1995 Stock
Option Plans and which were held by persons who were not employees of the
Company. As a result of the Merger, these options collectively will allow
the holders to purchase, assuming an Average Closing Price of $43.50 per
share (the last closing price of Watson Common Stock on February 27, 1997),
10,486 shares of Watson Common Stock, at exercise prices ranging from
$24.00 to $152.46 per share.
Shares Issuable Upon the Exercise of Options Issued to Employees. As
of the date of this Proxy Statement/Prospectus, Royce had outstanding
options to purchase a total of 492,811 shares of Royce Common Stock
pursuant to the exercise of options underlying the Company's 1992 Plan and
1995 Plan, and 492,166 shares of Royce Common Stock issuable upon the
exercise of options held by employees of the Company whose options were
granted outside of any plan. As a result of the Merger, these options
collectively will allow the holders to purchase, assuming an Average
Closing Price of $43.50 per share (the last closing price of Watson Common
Stock on February 27, 1997) 164,163 shares of Watson Common Stock, at
exercise prices ranging from $18.00 to $152.46 per share.
WATSON TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for Watson's Common Stock is American
Stock Transfer & Trust Company.
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<PAGE> 75
WATSON'S BUSINESS
GENERAL
Watson develops, manufactures and markets a comprehensive array of
off-patent pharmaceuticals, and develops proprietary pharmaceutical products.
Watson pursues a balanced strategy of generating revenue through its
long-established off-patent pharmaceuticals business, capitalizing on its proven
capabilities to support the development of off-patent and proprietary products,
and seeking opportunities to acquire businesses, technologies and products to
broaden its technology platform. Watson's objective is to become a fully
integrated pharmaceutical company, which (i) develops and markets off-patent
pharmaceuticals and (ii) develops proprietary products and markets such products
worldwide through pharmaceutical companies, joint ventures and its own marketing
efforts. Watson targets difficult-to-produce niche pharmaceuticals, thereby
avoiding competition with traditional commodity-oriented off-patent
pharmaceutical companies. Watson also regularly reviews potential opportunities
to acquire or invest in technologies, products or product rights and businesses
compatible with its existing business. Except for the Merger Agreement and the
Oclassen Merger Agreement, Watson currently has not entered into any definitive
agreements with respect to any such acquisition, although Watson may do so in
the future. See "Risk Factors -- Future Acquisitions."
Watson 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 Watson's revenue mix resulting in a decreased emphasis upon
sales of off-patent products. Management expects this change in the revenue mix
to continue. Product sales of off-patent medications accounted for approximately
100% of total revenues in 1993 and for approximately 99% of total revenues in
1994. In 1995, sales of off-patent products accounted for approximately 85.5% of
total revenues and royalty income accounted for approximately 14.5% of total
revenues. A substantial portion of Watson's income is included in other income,
as a result of its joint ventures and investments, and is not reflected in its
revenue figures.
In July 1995, Watson strengthened and diversified its revenue base through
a merger with Circa Pharmaceuticals, Inc. ("Circa"). The merger, accounted for
as a pooling-of-interests, enhanced Watson's manufacturing capabilities and
increased its product development program, particularly in the area of
proprietary products. Watson also owns a 50% equity interest in Somerset, which
exclusively markets Eldepryl(R) for the treatment of Parkinson's disease. Watson
recorded equity in earnings of this joint venture of $24.8 million in 1995.
Patent exclusivity expired for Eldepryl(R)in June 1996. For the nine months
ended September 30, 1996, Watson experienced a decrease in earnings from
Somerset due to increased competition for Eldepryl(R) and increased research and
development expenditures. Watson's earnings from Somerset in 1997 and future
years may decrease substantially compared to 1996 due to decreased sales of
Eldepryl(R) and increased research and development expenditures in support of
the Phase III clinical trials on an Eldepryl(R) transdermal patch. See "Risk
Factors -- Loss of Exclusive Rights to Market Certain Products."
Circa and 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, Watson 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 patent exclusivity in May 1995. Watson and RPR intend to launch an
off-patent Dilacor XR(R) product, following approval by the FDA, as considered
appropriate. The costs and profits from the off-patent product are to be shared
equally by Watson and RPR.
Watson continues to expand its research and development efforts in the area
of proprietary product development through joint ventures, product acquisitions
and strategic alliances. Watson 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
Watson's increased investment in Andrx Corporation ("Andrx"), a company engaged
in the development of advanced controlled-release delivery systems for certain
orally-administered
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<PAGE> 76
drugs. In October 1995, Watson purchased additional Andrx common stock for
approximately $15.6 million, resulting in its present ownership of 15.6% of the
total outstanding common stock of Andrx.
Watson devotes significant resources to research and development, and
invests significantly in the development of proprietary products. Watson has
entered into certain licensing agreements with pharmaceutical companies under
which Watson typically retains manufacturing rights and receives product
development fees and royalties from future product sales. Licensing agreements
individually and in the aggregate have not generated significant revenue for
Watson, and currently no individual license agreement is material to Watson's
operations. Watson is also developing a number of proprietary products for which
it intends to retain all manufacturing and marketing rights.
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. Watson's
wholly-owned subsidiaries include Watson Labs, Watson (Asia), Corona
Pharmaceuticals, Inc. (currently inactive) and Circa.
RECENT DEVELOPMENTS
In addition to the Merger, Watson entered into a definitive Agreement and
Plan of Merger (the "Oclassen Merger Agreement") with Oclassen dated as of
September 25, 1996, as amended effective November 14, 1996 and effective
December 31, 1996 (the "Oclassen Merger") pursuant to which Oclassen agreed to
merge with a subsidiary of Watson created for the purpose of the Oclassen
Merger, with Oclassen surviving the Oclassen Merger as a wholly-owned subsidiary
of Watson. Oclassen develops specialty prescription pharmaceuticals to prevent
and treat skin diseases and markets these products to dermatologists. The
Oclassen Merger was consummated on February 27, 1997. To consummate the merger,
Oclassen shareholders received an aggregate of approximately 3.3 million shares
of Watson Common Stock.
Oclassen in-licenses pharmaceutical products, which have been developed
beyond the initial discovery phase, from United States and foreign
pharmaceutical companies and from universities and research institutions.
Oclassen completes product formulation and any preclinical development, conducts
clinical trials and brings products through the required regulatory approval
process and into the market. Oclassen markets its products to dermatologists
through its 60-person nationwide direct sales force. Oclassen believes that its
in-licensing, development and marketing strategy reduces the time, risks and
costs associated with product development and marketing.
In connection with the Oclassen Merger, Watson will enter into employment
agreements with each of Glenn A. Oclassen, the Chairman of Oclassen, Terry L.
Johnson, the President, Chief Executive Officer and a director of Oclassen, and
Anthony A. DiTonno, Vice President, Sales and Marketing of Oclassen, in
conjunction with the closing of the Oclassen Merger. These employment agreements
provide that Mr. Oclassen will serve as Vice Chairman of the Board of Directors
of Oclassen, Mr. Johnson will remain as the President and Chief Executive
Officer of Oclassen and Mr. DiTonno will remain as the Vice President, Sales and
Marketing of Oclassen. Watson filed a Registration Statement with the Commission
with respect to the shares of Watson Common Stock to be issued in connection
with the Oclassen Merger. See Watson's Form S-4 Registration Statement, as
amended (Registration No. 333-16275).
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FDA APPROVALS
On December 30, 1996 Watson received approval from the FDA for a new
once-daily, low-dose, capsule form of Microzide(TM) (hydrochlorothiazide) used
for the treatment of mild-to-moderate hypertension. The product is expected to
be launched in the first quarter of fiscal 1997.
In addition, in February 1997 Watson received FDA approval for NORCO(TM)
tablets (Hydrocodone Bitartrate/Acetaminophen 10 mg/325 mg). NORCO(TM) is the
highest single tablet dose of Hydrocodone Bitartrate with the lowest level of
Acetaminophen of all 10 mg Hydrocodone combination products indicated for the
relief of moderate to moderately severe pain. The product is expected to be
launched in the first quarter of fiscal 1997.
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<PAGE> 78
WATSON'S MANAGEMENT
The directors and executive officers of Watson, and their ages as of
January 15, 1997, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Allen Chao, Ph.D.......................... 51 Chairman and Chief Executive Officer
Melvin Sharoky, M.D....................... 46 President and Director
David C. Hsia, Ph.D....................... 52 Senior Vice President of Scientific Affairs
Alec D. Keith, Ph.D....................... 64 Director
Michel J. Feldman......................... 53 Secretary and Director
Albert F. Hummel.......................... 52 Director
Michael Fedida............................ 50 Director
Ronald R. Taylor.......................... 49 Director
</TABLE>
Dr. Chao has been Chief Executive Officer of Watson since August 1983,
Chairman of Watson since May 1996 and a director of Circa since July 1995. Dr.
Chao was President of Watson from August 1983 until July 1995. He is a
co-founder of Watson and has been a director of Watson and Watson Labs, since
its inception. Dr. Chao served as Director of Pharmaceutical Technology and
Packaging Development at Searle Laboratories, Inc. from September 1979 to August
1983, where he had overall responsibility for new product implementation and new
pharmaceutical technology development. He received a Ph.D. in industrial and
physical pharmacy from Purdue University in 1973. He currently serves on the
Board of Directors of Circa and Somerset.
Dr. Sharoky has been a director and President of Watson, and a director of
Watson Labs since July 1995. Dr. Sharoky has been President and Chief Executive
Officer of Circa since February 1, 1993. Dr. Sharoky joined Circa in 1988 as
Medical Director. In April 1991, he became Circa's Senior Vice President and
Director of Research and Development. From August 1992 through January 1993, Dr.
Sharoky served as Circa's Executive Vice President and Director of Research and
Development. Prior to joining Circa, Dr. Sharoky was Senior Vice President of
Contract Development for Pharmakinetics Laboratories, Inc., a drug research and
testing organization from 1986 through June 1988. He currently serves on the
Boards of Directors of Circa, Somerset and Andrx Corporation and is the
President of Somerset.
Dr. Hsia, a co-founder of Watson, is Senior Vice President of Scientific
Affairs and has served as a Vice President of Watson since 1984. He was Manager
of Pharmaceutical Technology at Searle Laboratories, Inc. from April 1980 to
April 1984 and had responsibility for the development of line extension products
and new pharmaceutical technologies. Dr. Hsia has been involved in the
development of pharmaceutical formulations for oral contraceptives, sustained
release products and novel dosage forms. Dr. Hsia received a Ph.D. in industrial
and physical pharmacy from Purdue University in 1975. Dr. Hsia is Dr. Chao's
brother-in-law.
Dr. Keith has been a director of Watson since 1991 and served as Watson's
Chairman from 1991 until he retired from that office in May 1996. He is
presently a consultant to Watson pursuant to a consulting agreement which he
entered into with Watson in July 1996. Dr. Keith has served as the Chairman of
Polydex Pharmaceuticals, Ltd., a Canadian company, since November 1996. Dr.
Keith was a co-founder of Zetachron, Incorporated ("Zetachron"), a subsidiary of
Watson from 1991 to 1995, and held senior executive positions at Zetachron from
1983. He is also Adjunct Professor of Biophysics at Pennsylvania State
University. From 1978 through 1982 he was Vice President of Research and
Development at Key Pharmaceuticals, Inc. Dr. Keith has authored many scientific
publications, has edited two books, and holds numerous domestic and foreign
pharmaceutical patents. He received a Ph.D. in genetics from the University of
Oregon in 1966.
Mr. Feldman has been a director of Watson since 1984 and its Secretary
since 1995. Mr. Feldman has been a partner in the law firm of D'Ancona & Pflaum,
Chicago, Illinois, since June 1991 and is counsel to Watson. He was formerly a
partner in the law firm of Keck, Mahin & Cate, Chicago, Illinois, from 1983 to
1991. Mr. Feldman received a J.D. from Northwestern University Law School in
1968 and is a Certified Public Accountant.
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<PAGE> 79
Mr. Hummel has been a director of Watson since March 1986, except for a
period from July 1991 to October 1991, and is a partner of Affordable
Residential Communities, a property management firm. Formerly, Mr. Hummel was
Chief Financial Officer of Watson from October 1991 to December 1994.
Mr. Fedida is a registered pharmacist and has served for the past five
years as an officer and director of several retail pharmacies wholly or
partially owned by him. In addition, Mr. Fedida has acted as a consultant,
without remuneration, to Watson in regard to certain marketing concepts. Mr.
Fedida became a director of Watson in July 1995.
Mr. Taylor has been a director of Watson since November 1994. Mr. Taylor
was a founder and was formerly Chairman of Pyxis Corporation, a San Diego-based
company engaged in the development and marketing of systems to help hospitals
and other healthcare providers efficiently manage drugs and supplies.
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<PAGE> 80
WATSON'S PRINCIPAL STOCKHOLDERS
The following table sets forth, as of January 31, 1997, the name, address
(where required) and holdings of each person (including any "group" as defined
in Section 13(d)(3) of the Securities Exchange Act of 1934) known by Watson to
be the beneficial owner of more than five percent of Watson's Common Stock, and
the amount of Common Stock beneficially owned by each of the directors and
executive officers of Watson, and by all directors and named executive officers
of Watson as a group.
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF
BENEFICIAL PERCENT
NAME OF BENEFICIAL OWNER OWNERSHIP(1) OF CLASS
------------------------ -------------------- ---------
<S> <C> <C>
American Express Company.................................... 2,296,300(2) 6.2%
IDS Tower 10
Minneapolis, Minnesota 55440
Allen Chao.................................................. 2,115,393(3)(4) 5.7%
311 Bonnie Circle
Corona, CA 91720
Phylis and David C. Hsia.................................... 1,147,593(3)(5) 3.1%
Melvin Sharoky.............................................. 625,293(6) 1.7%
Alec D. Keith............................................... 493,000(7) 1.3%
Albert F. Hummel............................................ 286,594(8) *
Michel J. Feldman........................................... 27,500(9) *
Michael Fedida.............................................. 26,500(10) *
Ronald R. Taylor............................................ 10,000(11) *
All current directors and executive
officers of Watson (8 persons)............................ 4,731,873 12.8%
</TABLE>
- ---------------
* Represents less than 1%
(1) Unless otherwise indicated in the footnotes to this table and pursuant to
applicable community property laws, Watson believes the persons named in
this table have sole voting and investment power with respect to all shares
of Watson Common Stock reflected in this table.
(2) As of December 31, 1996, based upon a Form 13G Report filed with the
Securities and Exchange Commission on January 31, 1997.
(3) Allen Chao and Phylis Hsia are siblings. David C. Hsia is married to Phylis
Hsia.
(4) Includes 478,793 shares of Watson Common Stock subject to outstanding
options, 793,213 shares of Watson Common Stock held by Allen Chao
Interests, Ltd., a partnership in which Dr. Chao is a controlling partner,
490,323 shares of Watson Common Stock held by MAL Investment Company, a
corporation of which Dr. Chao is a controlling stockholder, and 353,064
shares of Watson Common Stock held by the Allen Chao and Lee Hwa Chao
Family Trust.
(5) Includes 60,946 shares of Watson Common Stock held by Phylis Hsia, 46,786
shares of Watson Common Stock held by David C. Hsia, 1,052 shares of Watson
Common Stock held by Mrs. Hsia as custodian for the children of Dr. and
Mrs. Hsia, 119,000 shares of Watson Common Stock subject to outstanding
options held by Dr. Hsia, 20,000 shares of Watson Common Stock held by
David and Phylis Hsia Charitable Remainder Trust, 571,428 shares of Watson
Common Stock held by Hsia Interest Ltd., a partnership in which Dr. and
Mrs. Hsia are partners and 328,381 shares of Watson Common Stock held by
the Hsia Family Trust. Excludes 87,750 shares of Watson Common Stock held
in irrevocable trusts for the benefit of Dr. and Mrs. Hsia's children over
which Dr. and Mrs. Hsia have no voting or investment power.
(6) Includes 439,293 shares of Watson Common Stock held by Dr. Sharoky of which
86,000 shares are subject to forfeiture under certain circumstances
pursuant to the terms of Dr. Sharoky's employment agreement, 186,000 shares
of Watson Common Stock subject to outstanding options, 12,348 shares of
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<PAGE> 81
Watson Common Stock held by Dr. Sharoky as custodian for his three
children, and 411 shares of Watson Common Stock held by Dr. Sharoky as
custodian for his niece.
(7) All shares of Watson Common Stock are held by Dr. Keith. Mr. Hummel has an
option to purchase 132,000 shares of Watson Common Stock from Dr. Keith.
(8) Includes 76,378 shares of Watson Common Stock subject to outstanding
options, 12,216 shares of Watson Common Stock are held by Mr. Hummel, and
options to purchase 132,000 and 66,000 shares of Watson Common Stock from
Dr. Keith and Dr. Wallace C. Snipes (a former officer of Watson),
respectively.
(9) Includes 10,000 shares of Watson Common Stock subject to outstanding
options, 10,000 shares of Watson Common Stock held by Mr. Feldman, 1,500
shares of Watson Common Stock owned by Ercelle Feldman, the wife of Mr.
Feldman, for which Mr. Feldman disclaims beneficial ownership, and an
aggregate of 6,000 shares of Watson Common Stock owned by Mr. Feldman as
trustee for two of his sons, for which he disclaims beneficial ownership.
(10) Includes 26,500 shares of Watson Common Stock subject to outstanding
options.
(11) Shares of Watson Common Stock subject to outstanding options.
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<PAGE> 82
WATSON'S EXECUTIVE COMPENSATION
The following table sets forth the compensation paid or accrued to the
Company's Chief Executive Officer and each of the Company's executive officers
other than the Chief Executive Officer who served during 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION
COMPENSATION AWARDS
---------------------------- ------------
SECURITIES ALL OTHER
NAME AND PRINCIPAL SALARY BONUS UNDERLYING COMPENSATION
POSITION(1) YEAR ($) ($)(3) OPTIONS(#) ($)(4)
------------------ ---- ------- ------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Allen Chao, Ph.D.(5) 1996 400,000 300,000 100,000 4,750
Chairman and Chief Executive 1995 300,000 150,000 100,000 2,074
Officer 1994 260,608 137,500 50,000 4,529
Melvin Sharoky, M.D.(2)(5)(6) 1996 350,000 300,000 158,595
President 1995 300,000 150,000 386,000 6,494
1994 300,000 125,000 3,722
Alec D. Keith, Ph.D. 1996 105,162 3,029
Former Chairman of the Board 1995 175,000 25,000 75,000 4,620
1994 160,866 52,800 35,000 4,616
David C. Hsia, Ph.D. 1996 165,000 20,000 7,500 4,750
Senior Vice President, 1995 151,730 25,408 100,000 4,373
Scientific Affairs 1994 126,218 19,566 3,741
</TABLE>
- ---------------
(1) Drs. Chao, Sharoky and Hsia have entered into employment agreements with the
Company. Please refer to "Employment Agreements" below for details.
(2) Dr. Sharoky became an officer of the Company effective July 17, 1995.
Compensation reflects amounts earned throughout fiscal 1996 and prior years
while at Circa. Dr. Sharoky's compensation is disclosed for the periods
prior to the merger because the Company's financial statements have been
restated as a result of the merger with Circa. The financial statements
reflect all compensation paid by the Company to Dr. Sharoky for the three
years ended December 31, 1996.
(3) Pursuant to bonus formulas established by the Company's Compensation
Committee, Dr. Chao received the maximum annual bonuses in 1996, 1995 and
1994 as based upon net after-tax earnings of the Company. Dr. Sharoky
received a bonus for 1996 and 1995 as determined by the Company's
Compensation Committee and a bonus for 1994 as determined by Circa's
Compensation Committee. Bonuses paid to Dr. Hsia in 1996, 1995 and 1994
were based on the satisfaction of certain objective criteria set by the
Company's Chief Executive Officer.
(4) Amounts in 1996, 1995 and 1994 represent the Company's 401(k) contributions
on behalf of the named officers, above. Amounts in 1996, 1995 and 1994 for
Dr. Sharoky represented insurance premiums paid by the Company on a life
insurance policy in which Dr. Sharoky's wife is the named beneficiary. In
addition, other compensation to Dr. Sharoky in 1996 included $144,777 in
relocation expenses and $2,574 for the personal use of a company auto.
(5) Drs. Chao and Sharoky serve on the Board of Directors of Somerset, a joint
venture which is 50% owned by the Company. Dr. Chao was elected to the
Somerset Board of Directors in 1995 and received a director fee of $12,000
in 1996 and 1995. Dr. Sharoky has served on the Somerset Board of Directors
since 1993 and received director fees of $12,000 in each of 1996, 1995 and
1994. These fees were not paid by the Company and are not included in the
Summary Compensation Table above. Of the salary and bonus paid to Dr.
Sharoky in 1996, $300,000 was reimbursed by Somerset.
(6) Dr. Sharoky received an original grant of 258,000 restricted shares of
Common Stock of the Company. Such shares were subject to forfeiture in
decreasing annual increments if Dr. Sharoky voluntarily terminated his
employment, or if his employment was terminated for cause, prior to January
31, 1997. Such forfeiture provisions are no longer in effect.
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<PAGE> 83
EMPLOYMENT AGREEMENTS
Effective May 29, 1995, the Company entered into employment agreements with
each of Drs. Allen Chao and David C. Hsia (the "Senior Executives"), which will
terminate on May 31, 2000. These agreements provide that, among other things,
(i) Drs. Chao and Hsia will receive minimum annual salaries of $400,000 and
$165,000 per year, respectively; (ii) the Company cannot terminate the Senior
Executives' employment except by reason of death, disability or for cause; (iii)
in the event of termination on account of retirement or disability, the Company
will continue the Senior Executives' major medical coverage; and (iv) in the
event of termination without cause or for good reason (as described in the
employment agreements) subsequent to a change in control, the Senior Executives
are entitled to receive, among other things, certain severance benefits,
including an amount equal to 2.99 times their base salary and incentive
compensation. In addition, Dr. Chao is entitled to receive options to purchase
150,000 shares of the Company's Common Stock under the 1991 Plan, 100,000 of
which were granted in 1996 and 50,000 of which will be granted in 1997. Dr. Hsia
is entitled to receive options to purchase 100,000 shares of the Company's
Common Stock under the 1991 Plan. Such options granted to Drs. Chao and Hsia
vest over a five year period following each grant date.
Effective February 1997, the Company and Dr. Sharoky entered into a letter
agreement extending the term of Dr. Sharoky's prior employment agreement until
January 31, 1998. Pursuant to the letter agreement, (i) Dr. Sharoky will receive
base compensation of $375,000 during the term of the agreement; (ii) Dr. Sharoky
may receive a bonus of up to $140,000, based upon the Company's 1997
earnings-per-share, as well as a discretionary bonus based upon the performance
of Somerset; and (iii) Dr. Sharoky is entitled to certain severance benefits,
including a payment of 2.99 times the sum of his base compensation and incentive
compensation.
Effective July 18, 1996, Dr. Alec Keith resigned his employment with the
Company and its affiliates. At that time, the Company entered into a consulting
agreement with Dr. Keith, the term of which is one year. The consulting
agreement provides that: (i) Dr. Keith will provide at least two days'
consulting services to the Company each month during the term of the agreement;
(ii) Dr. Keith is to be paid a $2,000 monthly retainer, with additional payments
if he consults more than two days in a given month; and (iii) Dr. Keith is to
remain a director of the Company, to be compensated at a rate of $6,250 per
quarter.
OPTIONS
The following table sets forth certain information concerning individual
grants of stock options made during the year ended December 31, 1996, to each
named executive officer of the Company.
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
NUMBER OF % OF TOTAL ANNUAL RATES OF STOCK PRICE
SHARES OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OR OPTION TERM(1)
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION ---------------------------
NAME GRANTED(#) FISCAL YEAR ($ PER SHARE) DATE 5%($) 10%($)
- ---- ---------- ------------ ------------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Allen Chao 100,000 20.88% $33.875(2) 7/17/06 $2,130,381 $5,398,803
David C. Hsia 7,500 1.57% $ 27.50 8/19/06 $ 129,710 $ 328,709
</TABLE>
- ---------------
(1) The assumed annual rates of stock price appreciation of 5% and 10% are set
by Securities and Exchange Commission rules and are not intended as a
forecast of possible future appreciation in stock prices.
(2) These options were granted on July 17, 1996 pursuant to the July 17, 1995
merger with Circa and are exercisable at a rate of 20% per year over a
five-year period following the date of grant.
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<PAGE> 84
OPTION EXERCISES AND FISCAL YEAR-END VALUES
The following table sets forth certain information with respect to each
named executive officer concerning the exercise of options during the fiscal
year ended December 31, 1996, as well as any unexercised options held as of the
end of such fiscal year.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING VALUE OF UNEXERCISED
SHARES UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
ACQUIRED VALUE FY-END (#) FY-END($)
ON REALIZED EXERCISABLE/ EXERCISABLE/
NAME EXERCISE(#) ($) UNEXERCISABLE UNEXERCISABLE
---- ----------- -------- ---------------------- -----------------------
<S> <C> <C> <C> <C>
Allen Chao............ 30,000 $ 805,050 478,793/155,000 $15,877,972/$1,934,723
Melvin Sharoky........ 186,000/200,000 $3,020,875/$1,537,500
Alec D. Keith......... 15,000 $ 350,625
David C. Hsia......... 119,000/93,500 $4,083,563/$961,406
</TABLE>
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<PAGE> 85
WATSON'S SELECTED CONSOLIDATED
FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
FOR THE YEARS ENDED DECEMBER 31,(1) SEPTEMBER 30,
--------------------------------------------------- -------------------
1991 1992 1993 1994 1995 1995 1996(1)
-------- ------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Product sales.................................. $ 30,802 $34,773 $ 70,838 $ 93,649 $130,688 $ 93,626 $122,155
Royalty income................................. -- -- -- 1,209 22,247 16,013 19,862
-------- ------- -------- -------- -------- -------- --------
Total revenues......................... 30,802 34,773 70,838 94,858 152,935 109,639 142,017
-------- ------- -------- -------- -------- -------- --------
Cost of revenues............................... 21,506 23,291 39,207 48,972 64,996 47,005 56,842
Research and development....................... 9,556 8,217 15,085 18,980 18,573 13,922 12,467
Selling, general and administrative............ 17,206 14,944 15,682 13,342 17,030 12,528 13,371
Merger expenses(6)............................. 13,939 13,939
-------- ------- -------- -------- -------- -------- --------
Total operating expenses............... 48,268 46,452 69,974 81,294 114,538 87,394 82,680
-------- ------- -------- -------- -------- -------- --------
Operating income (loss)................ (17,466) (11,679) 864 13,564 38,397 22,245 59,337
-------- ------- -------- -------- -------- -------- --------
Equity in earnings of joint ventures........... 18,392 20,712 24,688 24,968 22,766 15,857 14,156
Investment and other income(4)................. 9,657 2,871 16,879 6,542 11,594 10,193 5,844
Gain from (provision for) legal
settlements(2)............................... (73,383) (6,297) 2,299
Partnership loss(3)............................ (15,598) (7,644)
-------- ------- -------- -------- -------- -------- --------
(45,334) 7,985 27,626 33,809 34,360 26,050 20,000
-------- ------- -------- -------- -------- -------- --------
Income (loss) before provision
(benefit) for income taxes........... (62,800) (3,694) 28,490 47,373 72,757 48,295 79,337
Provision (benefit) for income taxes(5)........ (7,596) 2,396 (21,927) 10,828 24,867 17,284 25,720
-------- ------- -------- -------- -------- -------- --------
Net income (loss)...................... $(55,204) $(6,090) $ 50,417 $ 36,545 $ 47,890 $ 31,011 $ 53,617
======== ======= ======== ======== ======== ======== ========
Earnings per common and common equivalent
share........................................ $ (1.72) $ (0.18) $ 1.42 $ 1.00 $ 1.29 $ 0.84 $ 1.43
======== ======= ======== ======== ======== ======== ========
Weighted average number of common and common
equivalent shares outstanding................ 32,036 32,938 35,504 36,515 37,143 36,987 37,624
======== ======= ======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
DECEMBER 31,(1) SEPTEMBER 30,
---------------------------------------------------- -------------------
1991 1992 1993 1994 1995 1995 1996(1)
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Current assets.................................. $ 40,987 $ 57,118 $155,025 $172,912 $197,634 $192,553 $256,609
Working capital................................. 23,618 31,534 131,943 154,661 168,812 165,944 221,684
Total assets.................................... 122,238 130,516 235,672 262,316 322,121 295,366 395,194
Long-term debt and capitalized lease
obligations................................... 2,736 3,991 2,143 5,058 3,577 7,670 3,116
Deferred partnership liability.................. 7,598 15,242 14,033
Total stockholders' equity...................... 81,426 77,872 185,081 223,370 289,035 261,087 357,153
</TABLE>
- ---------------
(1) Watson merged with Circa Pharmaceuticals, Inc. ("Circa") in July 1995 in a
transaction accounted for as a pooling of interests. Accordingly, the
financial data presented include the accounts of Circa for all periods
presented.
(2) In 1991, Circa was both a defendant and a plaintiff in a variety of legal
proceedings. A provision for legal settlements of $73.4 million was
recorded in 1991 for the costs related to these now-settled legal matters.
(3) In 1992, Circa recorded a loss of $15.6 million for its share of the
operating losses of a partnership formed with Rhone-Poulenc Rorer, Inc.
("RPR") to develop Dilacor XR(R). See Note 6 to Watson's consolidated
financial statements included in the Company's Annual Report on Form 10-K
for 1995.
(4) In 1993, Circa recorded a gain of $14.5 million related to the sale of
approximately 847,000 common shares of Marsam Pharmaceuticals, Inc.
("Marsam"). In 1994 and 1995, Circa disposed of its remaining investment in
Marsam and recorded gains of $3.2 million and $6.2 million, respectively.
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<PAGE> 86
(5) Also in 1993, as a result of Watson's 1995 merger with Circa, an income tax
benefit of $29.8 million was recorded which was the result of the reduction
in the valuation allowance related to net deferred tax assets. These net
deferred tax assets resulted principally from net operating loss
carryforwards and tax credit carryforwards generated by Circa prior to its
merger with Watson. Previously, these net deferred tax assets were fully
reserved by Circa.
(6) The costs associated with the merger of Watson and Circa resulted in a
one-time charge of $13.9 million during the third quarter of 1995.
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<PAGE> 87
WATSON'S MANAGEMENT'S DISCUSSION
Introductory note: The following discussion gives effect to the July 1995
merger between Watson and Circa as more fully described in Note 2 of the Notes
to Consolidated Financial Statements.
Watson cautions readers that certain important factors may affect Watson's
actual results and could cause such results to differ materially from any
forward-looking statements which may be deemed to have been made in this Report,
or which are otherwise made by or on behalf of Watson. Such factors include, but
are not limited to, changing market conditions; the availability and cost of raw
materials; the timely development, FDA approval and market acceptance of
Watson's products, the products producing royalties for Watson and the products
being developed and marketed by Watson's joint ventures; and other risks
detailed herein or detailed from time to time in the Watson's Securities and
Exchange Commission filings. In addition, the U.S. off-patent drug industry is
highly competitive, with pricing determined by many factors, including the
number and timing of product introductions. Although the price of an off-patent
product generally declines over time as competitors introduce additional
versions of the product, the actual degree and timing of price competition is
not predictable.
GENERAL
Watson has historically derived its revenues from the manufacture and sale
of off-patent pharmaceutical products. A substantial portion of Watson's net
income is included in other income, as a result of its earnings from joint
ventures and investments, and is not reflected in its revenue figures. While
sales of off-patent products continue to be the primary revenue source, certain
developments have occurred which have augmented Watson's revenue mix resulting
in a decreased proportion of sales of off-patent products to total revenues.
Product sales of off-patent medications accounted for approximately 100% of
total revenues in 1993 and for approximately 99% of total revenues in 1994. In
1995, sales of off-patent products accounted for approximately 85.5% of total
revenues and royalty income accounted for approximately 14.5% of total revenues.
The significant change in the revenue mix from 1994 to 1995 was largely due to
an increase in the contractual royalty rate from 1% in 1994 to 20% in 1995
earned by Watson on sales of Dilacor XR(R) by Rhone-Poulenc Rorer, Inc. ("RPR").
Dilacor XR(R) lost patent exclusivity in May 1995. As a result, royalty income
may decline as competitive generic versions of this drug enter the marketplace.
In July 1995, Watson strengthened and diversified its revenue base through
a merger with Circa. The merger, accounted for as a pooling-of-interests,
enhanced Watson's manufacturing capabilities and increased its product
development program, particularly in the area of proprietary products. Prior to
Watson's merger with Circa, in February 1990, as a result of an investigation by
the FDA, Circa ceased manufacturing and marketing all pharmaceutical products.
This investigation was a result of Circa's non-compliance with certain FDA rules
and regulations. Circa 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." As a result, Circa began operating under the
standard framework of the FDA. In November 1994, Circa received its first
product approval from the FDA since 1989. Such events were significant, and if
they were to recur, would have a material adverse effect on Watson's financial
position and results of operations. Watson endeavors to strictly adhere to FDA
requirements, as well as requirements of all other applicable government
agencies. Accordingly, management has no reason to believe that similar events
will occur in the future.
Watson owns a 50% equity interest in Somerset, which exclusively markets
Eldepryl(R) for the treatment of Parkinson's disease. Watson recorded equity in
earnings of this joint venture of $24.8 million in 1995. Patent exclusivity
expired for Eldepryl(R)in June 1996. Watson's earnings from Somerset in 1997 and
future years may decrease substantially due to decreased sales of Eldepryl(R)
and increased research and development expenditures in support of the Phase III
clinical trials on an Eldepryl(R) transdermal patch.
In 1989, Circa and RPR were partners in the development of Dilacor XR(R).
In connection with the Dilacor XR(R) development, Circa incurred a liability to
the partnership reflecting Watson's share of development and operating costs. At
December 31, 1993, the liability to the partnership was $15.2 million.
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<PAGE> 88
The partnership agreement was amended in April 1993, so that after September
1993, Watson earns a royalty from RPR's sales of Dilacor XR(R). The amended
partnership agreement also provides that all royalties earned will be used first
to offset the partnership liability. As royalties were earned in 1994 and 1995,
the partnership liability was reduced per the terms of this agreement. The
royalty revenues have been recorded gross of the partnership liability.
Dilacor XR(R) is used for the treatment of hypertension and angina. Royalty
income is determined based upon 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. As contractually specified, the
royalty percentage earned by Watson in 1994 on RPR's sales of Dilacor XR(R) was
1%, whereas in 1995 it was 20%. Dilacor XR(R) lost exclusivity in May 1995. This
loss of exclusivity did not have a significant impact on 1995 and 1996 sales of
Dilacor XR(R). However, if competitors introduce generic versions of this drug,
sales of Dilacor XR(R) are likely to decrease, resulting in a corresponding
decrease in Watson's royalty income. It is Watson's intention to launch a
generic Dilacor XR(R) as competition intensifies. Any future off-patent Dilacor
XR(R) profits are expected to be shared equally by both Watson and RPR. Actual
revenues, costs and profits, however, from any future collaboration, if any,
cannot be determined at this time.
Watson continues to expand its research and development efforts in the area
of proprietary product development through joint ventures, product acquisitions
and strategic alliances. Watson 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
Watson's increased investment in Andrx, a company engaged in the development of
advanced controlled-release delivery systems for certain orally-administered
drugs. In October 1995, Watson purchased additional Andrx common stock for
approximately $15.6 million, increasing its ownership to 19.5% of the total
outstanding common stock of Andrx, which was subsequently reduced to
approximately 15.6% as a result of an initial public offering and subsequent
stock option activity by Andrx.
Watson'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 Watson'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. Watson'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 Watson'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 Watson.
QUARTERLY FLUCTUATIONS
Watson's results of operations on a quarterly basis have fluctuated in the
past, and may continue to fluctuate. Watson believes such fluctuations are
primarily due to new product introductions and to a variety of additional
factors including, without limitation, purchasing practices of Watson's
customers and changes in the degree of competition regarding Watson's products.
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<PAGE> 89
RESULTS OF OPERATIONS
The following table represents selected components of Watson's results of
operations, in thousands of dollars and as percentages of revenues. The table
reflects Watson's merger with Circa for all periods presented.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------------------- ----------------------------------
1995 1994 1993 1996 1995
---------------- --------------- --------------- ---------------- ---------------
$ % $ % $ % $ % $ %
-------- ----- ------- ----- ------- ----- -------- ----- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Product sales................... $130,688 85.5% $93,649 98.7% $70,838 100.0% $122,155 86.0% $93,626 85.4%
Royalty income.................. 22,247 14.5 1,209 1.3 19,862 14.0 16,013 14.6
-------- ----- ------- ----- ------- ----- -------- ----- ------- -----
152,935 100.0 94,858 100.0 70,838 100.0 142,017 100.0 109,639 100.0
-------- ----- ------- ----- ------- ----- -------- ----- ------- -----
Operating expenses:
Cost of revenues................ 64,996 42.6 48,972 51.6 39,207 55.4 56,842 40.0 47,005 42.9
Research & development.......... 18,573 12.1 18,980 20.0 15,085 21.3 12,467 8.8 13,922 12.7
Selling, general &
administrative................ 17,030 11.1 13,342 14.1 15,682 22.1 13,371 9.4 12,528 11.4
Merger expenses................. 13,939 9.1 13,939 12.7
-------- ----- ------- ----- ------- ----- -------- ----- ------- -----
114,538 74.9 81,294 85.7 69,974 98.8 82,680 58.2 87,394 79.7
-------- ----- ------- ----- ------- ----- -------- ----- ------- -----
Operating income................ 38,397 25.1 13,564 14.3 864 1.2 59,337 41.8 22,245 20.3
-------- ----- ------- ----- ------- ----- -------- ----- ------- -----
Other income (expense):
Equity in earnings from joint
ventures...................... 22,766 14.9 24,968 26.3 24,688 34.9 14,156 10.0 15,857 14.5
Investment and other income,
net........................... 11,594 7.6 8,841 9.3 2,938 4.1 5,844 4.1 10,193 9.3
-------- ----- ------- ----- ------- ----- -------- ----- ------- -----
34,360 22.5 33,809 35.6 27,626 39.0 20,000 14.1 26,050 23.8
-------- ----- ------- ----- ------- ----- -------- ----- ------- -----
Income before provision (benefit)
for income taxes................ 72,757 47.6 47,373 49.9 28,490 40.2 79,337 55.9 48,295 44.0
Provision (benefit) for income
taxes........................... 24,867 16.3 10,828 11.4 (21,927) (31.0) 25,720 18.1 17,284 15.8
-------- ----- ------- ----- ------- ----- -------- ----- ------- -----
Net income........................ $ 47,890 31.3% $36,545 38.5% $50,417 71.2% $ 53,617 37.8% 31,011 28.3%
======== ===== ======= ===== ======= ===== ======== ===== ======= =====
</TABLE>
Fiscal Period Ended September 30, 1996 Compared With September 30, 1995
Revenues for the nine months ended September 30, 1996 were $142.0 million
compared to $109.6 million for the nine months ended September 30, 1995, an
increase of $32.4 million or 29.5%. The product sales component of revenues
increased $28.5 million or 30.5% in the first nine months of 1996 as compared to
the first nine months of 1995. The royalty income component of revenues
increased $3.8 million or 24.0% when compared to the nine months ended September
30, 1995. The increase in product sales was due to a combination of increased
sales of Watson's core products and the successful introduction of seven new
products subsequent to September 30, 1995. Net sales of new products for the
nine months ended September 30, 1996 amounted to $36.4 million or 29.8% of total
product sales for that period. As previously discussed, increased sales of new
products have been offset by minor decreases in sales of Watson's older core
products and certain of its Hydrocodone products. The increase in royalty income
was due to increased prescriptions written for Dilacor XR(R) during the nine
months ended September 30, 1996, as compared to the nine months ended September
30, 1995. The level of product sales and royalty income during the first nine
months may not be indicative of future sales and royalties during the remainder
of 1996.
Cost of revenues increased by $9.8 million to $56.8 million for the nine
months ended September 30, 1996, as compared to the nine months ended September
30, 1995. Gross profit margins increased to 53.5% in the nine months ended
September 30, 1996 from 49.8% in the nine months ended September 30, 1995. These
increases were due primarily to the increase in sales and to the higher than
average gross profit margins earned on certain new products sold during the
first nine months of 1996.
Research and development expenses decreased by $1.5 million or 10.5% to
$12.5 million for the first nine months of 1996. Watson continues to integrate
the product research and development activities of Circa and Watson following
the July 1995 merger. The level of research and development expenses incurred
during the first nine months may not be indicative of future research and
development expenses during the remainder of 1996.
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<PAGE> 90
Selling, general and administrative expenses increased by 6.7% to $13.4
million when compared to the nine months ended September 30, 1995, but decreased
as a percentage of revenues from 11.4% to 9.4%. Although selling, general and
administrative spending has increased, the growth of Watson's revenues has
outpaced the growth of these expenses.
Watson's equity in earnings from joint ventures was generated primarily
from its 50% ownership of Somerset. Total earnings from joint ventures decreased
by $1.7 million or 10.7% to $14.2 million, as compared to the first nine months
of 1995. This decrease was due in part to increased research and development
expenses at both Somerset and ANCIRC and due in part to increased competition
for Somerset's product. As previously discussed herein, management anticipates
the earnings from joint ventures for 1996 will be lower than the earnings from
joint ventures achieved in 1995.
Investment income increased by $1.8 million during the first nine months of
1996. This increase was primarily due to rising interest rates and a larger base
of invested cash during the nine months ended September 30, 1996. In the third
quarter of 1995, Watson incurred merger expenses of $13.9 million and recorded a
gain on the sale of common stock of Marsam Pharmaceuticals, Inc. ("Marsam") of
$6.2 million. These non-recurring items account for substantially all of the
change in other income between 1996 and 1995.
The provision for income taxes increased by $8.4 million in 1996, as
compared to 1995. Watson's effective income tax rate decreased from 35.8% in
1995 to 32.4% in 1996, due primarily to the non-deductibility of merger expenses
incurred in 1995.
Net income for the nine months ended September 30, 1996 increased by $22.6
million to $53.6 million or $1.43 per share from net income of $31.0 million or
$0.84 per share for the nine months ended September 30, 1995. The 1995 period
included Circa merger expenses and the Marsam gain, as previously discussed.
This increase was due to a combination of the absence of 1995's non-recurring
items and the increased revenues and gross profit margins Watson experienced in
the nine months ended September 30, 1996. Excluding such non-recurring items,
net income rose by $13.5 million or 33.6% as compared to the nine months ended
September 30, 1995. Weighted average common and common equivalent shares
outstanding increased by approximately 0.6 million shares in the first nine
months of 1996 as compared to 1995.
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 Watson's core
products, defined as products available in the marketplace for one year or
longer. In addition, Watson 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 a combination of 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, Watson has continued to
integrate the two research and development departments into one, eliminating
duplication and focusing efforts.
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
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<PAGE> 91
associated with new product introductions and an increase in administrative
support due to the overall growth of Watson. 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, Watson's growth in revenues
outpaced 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. Watson's portion of
ANCIRC's losses increased from $220,000 in 1994 to $1.7 million in 1995. In
October 1995, Watson amended its joint venture agreement with Andrx and became
equal partners in ANCIRC. Previously, Watson recognized 40% of the costs and
profits from ANCIRC.
In connection with the merger with Circa, Watson 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 common stock, a stock held
for investment purposes, as compared to a $3.2 million gain in 1994. During
1995, Watson disposed of its remaining investment in Marsam common stock. In
addition, during 1994, Watson 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 Food and Drug Administration.
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 Watson's 1994 legal expenses
due to the resolution of certain litigation matters.
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<PAGE> 92
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,
Watson recognized a loss from its partnership with RPR of $7.6 million. In
September 1993, the partnership agreement was amended to provide that Watson
would no longer share in profits and losses of the partnership and, instead
would earn 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 were remitted to Watson.
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 Watson'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, Watson 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 22.9%, compared
with an income tax benefit rate of 77.0% in 1993. As a result of the merger, the
1993 statement of operations 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 Watson has grown during the last three years, its overall liquidity
requirements have increased. The increases in accounts receivable, inventories,
and investment in property and equipment have been financed primarily by cash
flows from operating activities and from Watson'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 1994, 1995 and 1996.
Watson has experienced a significant increase in accounts receivable
balances over the last three years. This growth has been caused primarily by
increased product sales. Watson performs ongoing credit evaluations of its
customers and maintains reserves for potentially uncollectible accounts. Actual
losses have been within management's expectations.
Cash, Cash Equivalents and Marketable Securities
Cash equivalents are defined as highly liquid debt instruments with
original maturities of three months or less. Cash, cash equivalents and
marketable securities increased $65.1 million to $183.4 million at September 30,
1996 from $118.3 million at December 31, 1995. Cash flows from operating
activities provided $73.0 million for the nine months ended September 30, 1996,
an increase of $53.3 from the 1995 nine-month period. This net inflow was
supplemented by proceeds from the exercise of stock options ($4.8 million) and
offset by net purchases of marketable securities ($46.1 million), capital
expenditures ($7.5 million) and additional investments in joint ventures ($3.9
million).
Working Capital
Current assets increased $59.0 million to $256.6 million at September 30,
1996, compared to December 31, 1995, due primarily to a combination of the
increase in cash and marketable securities of $65.1 million, an increase in
inventories of $3.7 million and a decrease in deferred tax assets of $10.0
million. Current liabilities increased $6.1 million to $34.9 million at
September 30, 1996. This increase was due primarily to an increase in income
taxes payable of $7.0 million. As a result, working capital increased $52.9
million to $221.7 million at September 30, 1996 from $168.8 million at December
31, 1995.
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<PAGE> 93
Investments in Joint Ventures and Other Long-Term Investments
Watson presently owns approximately 15.6% of the outstanding common shares
of Andrx. Andrx completed its initial public offering in June 1996. Pursuant to
Statement of Financial Accounting Standards No. 115 "Accounting for Certain
Investments in Debt and Equity Securities," Watson considers its investment in
Andrx as an "available-for-sale" security and has recorded an unrealized holding
gain of $6.0 million to adjust the cost of this investment to its fair value at
September 30, 1996. This increase was a balance sheet adjustment only which did
not affect Watson's net income. The $6.0 million unrealized holding gain, plus
the net changes in Watson's investment in joint ventures (primarily Somerset),
account for the $10.8 million increase in these long-term assets from December
31, 1995 to September 30, 1996.
Capital Resources
Primarily as a result of funds from the 1993 public offerings and continued
cash flows from operations, Watson had cash and marketable securities of $183.4
million at September 30, 1996. Watson anticipates that its current cash balances
and marketable securities together with: (a) net cash provided by operating
activities; and (b) amounts available under its bank financing agreement will be
sufficient to fund its short-term working capital requirements and enable Watson
to continue its operations on a long-term basis. To the extent that additional
capital resources are required, such capital may be raised through bank
borrowings, equity offerings, or other means.
Watson regularly reviews potential opportunities to acquire or invest in
technologies, products or product rights. Watson also regularly reviews
potential acquisitions, investments or combinations involving businesses
compatible with its existing businesses and corporate objectives. Watson could
use sources other than cash, such as the issuance of debt or equity securities,
to finance any such acquisition or investment. If such an acquisition or
investment was completed, Watson's operating results and financial condition
could change materially in future periods.
Management believes that inflation does not have, and has not had, a
significant impact on Watson's revenues or operations.
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WATSON'S SUPPLEMENTARY
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
FOR THE YEARS ENDED DECEMBER 31, (1) SEPTEMBER 30, (1)
---------------------------------------------------- -------------------
1991 1992 1993 1994 1995 1995 1996(1)
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Product sales.............. $ 36,877 $ 50,914 $ 95,503 $121,703 $159,724 $114,821 $146,431
Royalties income........... 1,209 22,247 16,013 19,862
-------- -------- -------- -------- -------- -------- --------
Total revenues... 36,877 50,914 95,503 122,912 181,971 130,834 166,293
-------- -------- -------- -------- -------- -------- --------
Cost of revenues........... 23,068 28,089 47,400 57,957 74,274 53,836 63,941
Research and development... 11,364 10,995 18,316 22,565 22,350 16,926 16,021
Selling, general and
administrative........... 25,728 26,201 28,752 28,070 31,545 22,963 25,037
Merger expenses (6)........ 13,939 13,939
-------- -------- -------- -------- -------- -------- --------
Total operating
expenses....... 60,160 65,285 94,468 108,592 142,108 107,664 104,999
-------- -------- -------- -------- -------- -------- --------
Operating income
(loss)......... (23,283) (14,371) 1,035 14,320 39,863 23,170 61,294
-------- -------- -------- -------- -------- -------- --------
Equity in earnings of joint
ventures................. 18,392 20,712 24,688 24,968 22,766 15,857 14,156
Investment and other income
(4)...................... 10,162 5,573 17,904 7,768 12,755 4,942 6,707
Gain from (provision for)
legal settlements (2).... (73,383) (6,297) 2,299 6,126
Partnership loss (3)....... (15,598) (7,644)
-------- -------- -------- -------- -------- -------- --------
(44,829) 10,687 28,651 35,035 35,521 26,925 20,863
-------- -------- -------- -------- -------- -------- --------
Income (loss) before
provision (benefit)
for income taxes...... (68,112) (3,684) 29,686 49,355 75,384 50,095 82,157
Provision (benefit) for
income taxes (5)......... (7,596) 2,396 (21,917) 10,853 24,867 17,284 25,780
-------- -------- -------- -------- -------- -------- --------
Net income
(loss)......... $(60,516) $ (6,080) $ 51,603 $ 38,502 $ 50,517 $ 32,811 $ 56,377
======== ======== ======== ======== ======== ======== ========
Net income (loss) available
to common stockholders... $(60,604) $ (6,190) $ 51,494 $ 36,585 $ 47,800 $ 30,773 $ 54,339
======== ======== ======== ======== ======== ======== ========
PER SHARE DATA:
Earnings per share
-- Primary............ $ (1.86) $ (0.18) $ 1.42 $ 0.98 $ 1.27 $ 0.82 $ 1.41
======== ======== ======== ======== ======== ======== ========
-- Fully diluted...... $ 1.33 $ 1.36
======== ========
Weighted average number
of common and common
equivalent shares
outstanding
-- Primary (6)........ 32,520 33,537 36,132 37,144 37,778 37,621 38,519
======== ======== ======== ======== ======== ======== ========
-- Fully diluted...... 38,748 41,339
======== ========
</TABLE>
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<PAGE> 95
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
DECEMBER 31, (1) SEPTEMBER 30,
---------------------------------------------------- -------------
1991 1992 1993 1994 1995 1996
-------- -------- -------- -------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET
DATA:
Current assets............. $ 50,834 $ 77,570 $179,677 $199,766 $224,470 $286,607
Working capital............ 32,308 47,262 148,091 173,154 188,046 243,978
Total assets............... 132,325 151,734 261,722 290,357 352,142 428,204
Long-term debt and deferred
partnership
liabilities.............. 2,736 11,589 17,385 19,091 3,577 3,128
Mandatorily redeemable
preferred stock.......... 24,327 31,907 32,016 33,933 36,650 38,688
Total stockholders'
equity................... 65,865 62,314 170,611 209,042 274,765 343,759
</TABLE>
- ---------------
(1) Watson merged with Circa Pharmaceuticals, Inc. ("Circa") in July 1995 in a
transaction accounted for as a pooling of interests. On February 27, 1997,
Watson merged with Oclassen Pharmaceuticals, Inc ("Oclassen") in a
transaction accounted for as a pooling of interests. Accordingly, the
financial data presented include the accounts of Circa and Oclassen for all
periods presented.
(2) In 1991, Circa was both a defendant and a plaintiff in a variety of legal
proceedings. A provision for legal settlements of $73.4 million was
recorded in 1991 for the costs related to these now-settled legal matters.
(3) In 1992, Circa recorded a loss of $15.6 million for its share of the
operating losses of a partnership formed with Rhone-Poulenc Rorer, Inc.
("RPR") to develop Dilacor XR(R). See Note 6 to Watson's consolidated
financial statements included in the Company's Annual Report on Form 10-K
for 1995.
(4) In 1993, Circa recorded a gain of $14.5 million related to the sale of
approximately 847,000 common shares of Marsam Pharmaceuticals, Inc.
("Marsam"). In 1994 and 1995, Circa disposed of its remaining investment in
Marsam and recorded gains of $3.2 million and $6.2 million, respectively.
(5) Also in 1993, as a result of Watson's 1995 merger with Circa, an income tax
benefit of $29.8 million was recorded which was the result of reduction in
the valuation allowance related to net deferred tax assets. These net
deferred tax assets resulted principally from net operating loss
carryforwards and tax credit carryforwards generated by Circa prior to its
merger with Watson. Previously, these net deferred tax assets were fully
reserved by Circa.
(6) The costs associated with the merger of Watson and Circa resulted in a
one-time charge of $13.9 million during the third quarter of 1995.
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<PAGE> 96
WATSON'S SUPPLEMENTARY MANAGEMENT'S DISCUSSION
WATSON PHARMACEUTICALS, INC., AND OCLASSEN PHARMACEUTICALS, INC.
The following Supplementary Management's Discussion of Watson and Oclassen
reflects the February 27, 1997 merger between Watson and Oclassen which resulted
in Oclassen becoming a wholly owned subsidiary of Watson. The merger qualifies
as a tax free reorganization and was accounted for as a pooling-of-interests.
This Supplementary Management's Discussion includes the effects of Oclassen. See
Note 2 in the Supplementary Consolidated Financial Statements for further
discussion of the merger.
SUPPLEMENTARY RESULTS OF OPERATIONS -- WATSON AND OCLASSEN
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 mergers with Circa and Oclassen for all periods
presented.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------------------ -----------------------------------
1995 1994 1993 1996 1995
---------------- ---------------- ---------------- ---------------- ----------------
$ % $ % $ % $ % $ %
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Product sales................... $159,724 87.8% $121,703 99.0% $ 95,503 100.0% $146,431 88.1% $114,821 87.8%
Royalty income.................. 22,247 12.2 1,209 1.0 19,862 11.9 16,013 12.2
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total revenues............ 181,971 100.0 122,912 100.0 95,503 100.0 166,293 100.0 130,834 100.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Operating expenses:
Cost of revenues................ 74,274 40.8 57,957 47.2 47,400 49.6 63,941 38.5 53,836 41.1
Research and development........ 22,350 12.3 22,565 18.4 18,316 19.2 16,021 9.6 16,926 12.9
Selling, general and
administrative................ 31,545 17.3 28,070 22.8 28,752 30.1 25,037 15.1 22,963 17.6
Merger expenses................. 13,939 7.7 13,939 10.7
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total operating
expenses................ 142,108 78.1 108,592 88.4 94,468 98.9 104,999 63.1 107,664 82.3
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Operating income.................. 39,863 21.9 14,320 11.6 1,035 1.1 61,294 36.8 23,170 17.7
Other income (expenses):
Equity in earnings of joint
ventures...................... 22,766 12.5 24,968 20.3 24,688 25.9 14,156 8.5 15,857 12.1
Gain on sale of Marsam common
stock......................... 6,243 3.4 3,179 2.6 14,491 15.2 6,126 4.7
Investment and other income..... 6,512 3.6 4,589 3.7 3,413 3.6 6,707 4.0 4,942 3.8
Partnership loss................ (7,644) -8.0
Gain from (provision for) legal
settlement.................... 2,299 1.9 (6,297) -6.6
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total other income,net.... 35,521 19.5 35,035 28.5 28,651 30.0 20,863 12.5 26,925 20.6
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Income before provision for income
taxes........................... 75,384 41.4 49,355 40.1 29,686 31.1 82,157 49.4 50,095 38.3
Provision (benefit) for income
taxes........................... 24,867 13.7 10,853 8.8 (21,917) -22.9 25,780 15.5 17,284 13.2
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Net income........................ $ 50,517 27.7% $ 38,502 31.3% $ 51,603 54.0% $ 56,377 33.9% $ 32,811 25.1%
======== ===== ======== ===== ======== ===== ======== ===== ======== =====
</TABLE>
SUPPLEMENTARY WATSON AND OCLASSEN -- NINE MONTHS ENDED SEPTEMBER 30, 1996 AND
1995
Revenues for the nine months ended September 30, 1996 were $166.3 million
compared to $130.8 million for the nine months ended September 30, 1995, an
increase of $35.5 million or 27.1%. The product sales component of revenues
increased $31.6 million or 27.5% in the first nine months of 1996 as compared to
the first nine months of 1995. The royalty income component of revenues
increased $3.8 million or 24.0% when compared to the nine months ended September
30, 1995. The increase in product sales was due to a combination of increased
sales of Watson's core products and the successful introduction of nine new
products subsequent to September 30, 1995. Net sales of new products for the
nine months ended September 30, 1996 amounted to $38.0 million or 25.9% of total
product sales for that period. Increased sales of new products were offset by
minor decreases in sales of certain dosages of the Company's Hydrocodone
products and certain core products which are nearing the end of their
anticipated product life. The increase in royalty income was due to
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<PAGE> 97
increased prescriptions written for Dilacor XR(R) during the nine months ended
September 30, 1996, as compared to the nine months ended September 30, 1995. The
level of product sales and royalty income during the first nine months may not
be indicative of future sales and royalties during the remainder of 1996.
Cost of revenues increased $10.1 million to $63.9 million for the nine
months ended September 30, 1996, as compared to $53.8 million for the nine
months ended September 30, 1995. Gross profit margins increased to 56.3% in the
nine months ended September 30, 1996 from 53.1% in the nine months ended
September 30, 1995. These increases were due primarily to the increase in sales
and to the higher than average gross profit margins earned on certain new
products sold during the first nine months of 1996.
Research and development expenses decreased by $0.9 million or 5.3% to
$16.0 million for the first nine months of 1996. Watson continues to integrate
the research and development activities of Citca, following the July 1995
merger. Oclassen charged $0.5 million to research and development costs in 1996
in conjunction with the licensing of a topical antimicrobial technology from the
Symbollon Corporation. This agreement provides for milestone payments during the
development period. Oclassen also in-licensed a phototherapy technology from
Laboratories Bergaderm in 1996 which also provides for milestone payments during
the development period. The milestone payments on these agreements may result in
increased research and development costs in the future. The level of research
and development expenses incurred during the first nine months may not be
indicative of future research and development expenses during the remainder of
1996.
Selling, general and administrative expenses increased 9.0% to $25.0
million when compared to the nine months ended September 30, 1995, but decreased
as a percentage of revenues from 17.6% to 15.1% for the nine months ended
September 30, 1995 and 1996, respectively. Although selling, general and
administrative spending has increased, the growth of Watson's revenues has
outpaced the growth of these expenses.
In the third quarter of 1995, Watson incurred merger expenses of $13.9
million related to the acquisition of Circa. No such expenses were incurred
during the nine months ended September 30, 1996.
Watson's equity in earnings from joint ventures was generated primarily
from its 50% ownership of Somerset. Total earnings from joint ventures decreased
by $1.7 million or 10.7% to $14.2 million, as compared to the first nine months
of 1995. This decrease was due in part to increased research and development
expenses at both Somerset and ANCIRC and due in part to increased competition
for Somerset's product. As previously discussed herein, management anticipates
the earnings from joint ventures for 1996 will be lower than the earnings from
joint ventures achieved in 1995.
Investment income increased by $1.8 million during the first nine months of
1996. This increase was primarily due to improved investment rates and a larger
base of invested cash during the nine months ended September 30, 1996. In the
third quarter of 1995, Watson recorded a non-recurring gain on the sale of
common stock of Marsam Pharmaceuticals, Inc. ("Marsam") of $6.2 million. No such
gain was recorded during the nine month period ended.
The provision for income taxes increased by $8.5 million in 1996, as
compared to 1995. Watson's effective income tax rate decreased from 34.5% in
1995 to 31.4% in 1996, due primarily to the non-deductibility of certain merger
expenses incurred in 1995.
Net income for the nine months ended September 30, 1996 increased by $23.6
million to $56.4 million or $1.41 per share from net income of $32.8 million or
$0.82 per share for the nine months ended September 30, 1995. On a fully diluted
basis, earnings per share increased to $1.36 for the nine months ended September
30, 1996 as compared to $0.82 for the nine months ended September 30, 1995. The
1995 period included Circa merger expenses and the Marsam gain, as previously
discussed. This increase was due to a combination of the absence of the net of
1995's non-recurring items and the increased revenues and gross profit margins
experienced in the nine months ended September 30, 1996. Weighted average common
and common equivalent shares outstanding increased by approximately 0.9 million
and 3.7 million shares on a primary and fully diluted basis, respectively,
during the first nine months of 1996 as compared to 1995.
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<PAGE> 98
SUPPLEMENTARY WATSON AND OCLASSEN -- YEARS ENDED DECEMBER 31, 1995 AND 1994
Revenues for the year ended December 31, 1995 were $182.0 million compared
to $122.9 million for the year ended December 31, 1994, an increase of $59.1
million or 48.0%. The increase in revenues was composed of a $38.0 million
increase in product sales and $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) and a 14% increase in Oclassen's Monodox(R) sales. In addition, the
Company introduced eight products during 1995 which accounted for $12.9 million
in sales, or 8.1% 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 net
product sales of Dilacor XR(R) from 1% in 1994 to 20% in 1995. The royalty
percentage on Dilacor XR(R) will increase to 22% of product sales, as defined in
the agreement with RPR, in the years ending December 31, 1997 through 2000 and
then decline to 3% thereafter.
Cost of revenues increased $16.3 million to $74.3 million for the year
ended December 31, 1995 (an increase of 28.2%). Cost of revenues were 46.5% of
product sales in 1995 compared to 47.6% in 1994. This favorable decrease was due
to a combination of 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 $22.6 million in 1994 to $22.4 million in 1995, despite
increasing research and development efforts in the area of proprietary
pharmaceuticals. Following the merger with Circa, the Company began to integrate
the two research and development departments into one, eliminating duplication
of projects. The Company expects that 1996 research and development expenses
will be consistent with 1995 research and development expenses.
Selling, general and administrative expenses increased 12.4% to $31.5
million for 1995 from $28.1 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 Watson. As a percentage of revenues, these costs decreased
from 22.8% to 17.3% from 1994 to 1995, respectively, which reflected
management's efforts to control costs. In addition, Watson's growth in revenues
outpaced the growth in selling, general and administrative expenses.
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.
Equity in earnings from joint ventures decreased $2.2 million or 8.8% 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.
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 $10.9 million in 1994. The effective income tax rates for the years ended
December 31, 1995 and 1994 were 33.0% and 22.0%, respectively. This increase was
primarily attributable to increased taxable income and the non-deductibility of
a significant portion of merger expenses recognized in 1995.
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<PAGE> 99
Net income increased to $50.5 million in 1995 from $38.5 million 1994. As a
percentage of revenues, net income decreased to 27.7% in 1995 from 31.3%
principally due to the one-time merger expenses related to the merger with Circa
and the higher effective income tax rate in 1995.
SUPPLEMENTARY WATSON AND OCLASSEN -- YEARS ENDED DECEMBER 31, 1994 AND 1993
Revenues for the year ended December 31, 1994 were $122.9 million compared
to $95.5 million for the year ended December 31, 1993, an increase of $27.4
million or 28.7%. The increase in revenues was composed of a $26.2 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 $10.6 million to $58.0 million for the year
ended December 31, 1994 (an increase of 22.3%). Cost of revenues were 47.6% of
product sales in 1994 compared to 49.6% 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 23.2% to $22.6 million for 1994
from $18.3 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 Food and Drug Administration.
Selling, general and administrative expenses decreased 2.4% to $28.1
million in 1994 from $28.8 million in 1993. The $0.7 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. This decrease was
partially offset by an increase in Oclassen's sales force expenses to facilitate
its entry into the wound care business through its Iodosorb/Iodoflex product
line, which was in-licensed and introduced during 1994.
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 $7.8 million, a decrease of $10.1
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 $10.9 million, compared to an income tax benefit of
$21.9 million in 1993. The effective income tax rate in 1994 was 22.0%, compared
with an income tax benefit rate of 73.8% in 1993. As a result of the merger, the
1993 statement of operations reflected the reduction in the valuation allowance
relating to Circa's net deferred tax asset at December 31, 1993. In determining
that the net deferred tax asset was fully realizable by the Company, management
considered the prior operating results of Watson and Circa and the future plans
and expectations for the Company.
Net income as a percentage of revenues decreased to 31.3% for 1994 from
54.0%, principally from the income tax benefit recorded in 1993, as discussed
above.
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SUPPLEMENTARY WATSON AND OCLASSEN -- 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 1994, 1995 and 1996.
The Company has experienced a significant increase in accounts receivable
balances over the last three years. This growth has been caused primarily by
increased product sales. Watson performs ongoing credit evaluations of its
customers and maintains reserves for potentially uncollectible accounts. Actual
losses have been within management's expectations.
Cash, Cash Equivalents and Marketable Securities
Cash equivalents are defined as highly liquid debt instruments with
original maturities of three months or less. Cash, cash equivalents and
marketable securities increased $66.8 million to $203.8 million at September 30,
1996 from $137.0 million at December 31, 1995. Cash flows from operating
activities provided $74.8 million for the nine months ended September 30, 1996,
an increase in $54.5 from the 1995 nine-month period. This net inflow was
supplemented by proceeds from the exercise of stock options ($5.0 million) and
offset by net purchases of marketable securities ($45.4 million), capital
expenditures ($8.0 million) and additional investments in joint ventures ($3.9
million).
Working Capital
Current assets increased $62.1 million to $286.6 million at September 30,
1996 compared to December 31, 1995, due primarily to a combination of the
increase in cash and marketable securities of $66.8 million, an increase in
inventories of $4.3 million and a decrease in deferred tax assets of $10.0
million. Current liabilities increased $6.2 million to $42.6 million at
September 30, 1996. This increase was due primarily to an increase in income
taxes payable of $7.0 million. As a result, working capital increased $55.9
million to $244.0 million at September 30, 1996 from $188.0 million at December
31, 1995.
Investments in Joint Ventures and Other Long-Term Investments
Watson presently owns approximately 15.6% of the outstanding common shares
of Andrx. Andrx completed its initial public offering in June 1996. Pursuant to
Statement of Financial Accounting Standards No. 115 "Accounting for Certain
Investments in Debt and Equity Securities," Watson considers its investment in
Andrx as an "available-for-sale" security and has recorded an unrealized holding
gain of $6.0 million to adjust the cost of this investment to its fair value at
September 30, 1996. The $6.0 million unrealized holding gain, plus the net
changes in Watson's investment in joint ventures (primarily Somerset), account
for the $10.8 million increase in these long-term assets from December 31, 1995
to September 30, 1996.
Capital Resources
Primarily as a result of proceeds from the 1993 public offerings and
continued cash flows from operations, the Company had cash and marketable
securities of $203.8 million at September 30, 1996. Watson anticipates that its
current cash balances and marketable securities together with: (a) net cash
provided by operating activities; and (b) amounts available under its bank
financing agreements will be sufficient to fund its short-term working capital
requirements and enable Watson to continue its operations on a long-term basis.
To the extent that additional capital resources are required, such capital may
be raised through bank borrowings, equity offerings, or other means.
The Company regularly reviews 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
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<PAGE> 101
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.
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<PAGE> 102
WATSON'S CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS
In 1985, Watson 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.
Watson leased a facility in Pennsylvania from a partnership in which Dr.
Alec D. Keith, a director of Watson, 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. Watson had 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. Watson guaranteed the partnership's
mortgage on the building. This lease was terminated in January 1997 pursuant to
a termination agreement between the parties thereto.
In July 1996, Watson entered into a consulting agreement with Dr. Alec D.
Keith, a director of Watson, pursuant to which Dr. Keith will provide research
and development-related services to Watson. The agreement will expire in July
1997 and includes automatic one-year extension terms which are cancellable by
either party on the annual renewal date. The agreement requires Watson to pay
minimum consulting fees of $2,000 per month, plus expenses.
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ROYCE'S BUSINESS
GENERAL
Royce develops, manufactures and markets generic prescription drugs in
solid dosage form (tablets and capsules). Tablets and capsules comprise the
largest portion of the prescription pharmaceutical market. At present, Royce
manufactures and markets 20 generic prescription drugs in 42 dosage strengths
and has received approval for an additional drug in 3 dosage strengths which it
has not yet commenced manufacturing and marketing. Additionally, the Company
has, at present, ANDAs pending with the FDA for 9 new products in 15 dosage
strengths.
Royce's objective is to increase the number of products offered while being
an efficient, low cost manufacturer of generic pharmaceuticals. Royce's product
development strategy is to focus on selected niche or overlooked products and on
products whose brand name equivalents have U.S. sales of over $100 million. The
Company has identified a number of products that it believes offer growth
opportunities, such as drugs having a controlled substance as one of their
active ingredients and used in pain management, and selected drugs with
difficult-to-develop formulations. Royce sells its products, manufactured under
its own or a customer's private label, primarily to drug wholesalers, generic
drug distributors, retail buying groups, managed care organizations and drug
chains. Royce also manufactures products for private label customers.
PRODUCTS
Royce has received the required approvals for the following products, all
except one of which it currently markets:
<TABLE>
<CAPTION>
NUMBER OF ANDA
BRAND NAME THERAPEUTIC DOSAGE APPROVAL
PRODUCT NAME EQUIVALENT CLASS STRENGTHS DATE
------------ ---------- ----------- --------- --------
<C> <S> <C> <C> <C> <C>
1. Alprazolam(1) Xanax(R) Tranquilizer 3 January 1997
2. Pentazocine and Naloxone Hydrochloride Talwin NX(R) Narcotic 1 January 1997
analgesic
3. Propoxyphene Hydrochloride and Wygesic(R) Narcotic 1 December 1996
Acetaminophen analgesic
4. Carisoprodol(1) Soma(R) Muscle relaxant 1 December 1996
5. Hydrocodone Bitartrate/Acetaminophen Lorcet(R), Lortab(R) Narcotic 6 March 1996
Vicodin(R), analgesic
Vicodin(R)ES,
Lorcet(R) Plus
6. Captopril(1) Capoten(R) Anti-hypertensive 4 February 1996
7. Hydroxychloroquine Sulfate(2) Plaquenil(R) Anti-rheumatoid 1 November 1995
Arthritis
8. Piroxicam(1) Feldene(R) Anti-inflammatory 2 September 1995
9. Pindolol(1) Visken(R) Anti-hypertensive 2 February 1995
10. Acetaminophen and Codeine Phosphate(3) Tylenol(R) with Narcotic 3 December 1994
Codeine analgesic
11. Cyclobenzaprine Hydrochloride(1) Flexeril(R) Muscle relaxant 1 November 1994
12. Hydroxyzine Hydrochloride Atarax(R) Tranquilizer 3 March 1994
13. Baclofen Lioresal(R) Muscle relaxant 2 January 1994
14. Lorazepam Ativan(R) Tranquilizer 3 October 1991
15. Perphenazine and Amitriptyline Triavil(R) Anti-depressant 4 October 1991
Hydrochloride
16. Amiloride Hydrochloride and Moduretic(R) Anti-hypertensive 1 July 1991
Hydrochlorothiazide
17. Doxepin Hydrochloride Sinequan(R) Tranquilizer 3 March 1991
18. Chlorzoxazone Parafon Forte(R) Muscle relaxant 1 August 1989
19. Yohimbine Hydrochloride Yocon(R) Sympathicolytic 1 Not Required
and mydriatic
20. Quinine Sulfate Capsules(4) None Anti-malarial 1 Not Required
21. Quinine Sulfate Tablets(4) None Anti-malarial 1 Not Required
</TABLE>
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- ---------------
(1) Each of these products is subject to a license agreement between Royce and
Royce Research and Development Limited Partnership (the "Partnership"). See
"Strategic Relationships."
(2) This product is subject to a license agreement between Royce and the
formulator of the drug. See "Strategic Relationships".
(3) Royce is not marketing this drug at this time, but rather is currently
evaluating the profit potential for this drug prior to manufacturing and
marketing it.
(4) In April 1995, the FDA published a proposed rule stating that Quinine
Sulfate will become a prescription drug and urging manufacturers to comply
with the prescription labeling requirements. In July 1995, Royce converted
labeling for this product to bring it into compliance with the proposed FDA
rule.
During 1996, 3 products each accounted for more than 10% of sales (the
largest of these products accounted for 23% of sales) and together, accounted
for approximately 59% of such sales. During 1995, four of Royce's products each
individually accounted for more than 10 percent of Royce's gross sales (the
largest of these products accounted for approximately 18% of Royce's gross
sales) and together collectively accounted for approximately 58% of Royce's
gross sales. During 1994, four of the Company's products each individually
accounted for more than 10% of Royce's gross sales (the largest of these
products accounted for approximately 22% of Royce's gross sales) and together
collectively accounted for approximately 69% of Royce's gross sales. Royce
believes that as new products are developed and approved, sales of Royce's
largest products relative to total sales and Royce's dependence thereon may vary
from period to period.
Royce currently has ANDA submissions pending with the FDA for 9 additional
products. Of the products currently pending, 4 are narcotic analgesics, 1 is a
tranquilizer, 1 is an anti-convulsant, 1 is an anti-hypertensive and 2 are
anti-inflammatory. Six of these products have controlled substances as one of
their active ingredients. Except for two of the products, patent protection for
all of the products as to which Royce has an ANDA pending has expired.
Products with a controlled substance as one of their active ingredients are
subject to extensive regulation and to a quota system which requires approval of
the DEA before controlled substance raw materials can be purchased. Although
there can be no assurance, Royce believes that it will receive a sufficient
quota of the controlled substance raw materials required to manufacture and
market its controlled substance products. See "Government Regulation" and "Raw
Materials" below.
PRODUCT DEVELOPMENT STRATEGY
Royce has pursued a strategy of developing a variety of generic products,
focusing primarily on selected niche or overlooked opportunities, as well as on
drugs whose brand-name equivalents have U.S. sales of over $100 million.
Products are chosen for development primarily based on the patent or marketing
exclusivity expiration date, market size and potential, anticipated competition,
availability of active ingredients and manufacturing requirements.
Royce has identified a number of products that it believes offer growth
opportunities, such as drugs having a controlled substance as one of their
active ingredients which are used in pain management, certain smaller products
for which patent protection has expired and which are not being marketed by
other generic drug manufacturers and selected drugs with difficult-to-develop
formulations. Royce believes that products such as these will offer a
significant opportunity and generally face less competition in the marketplace.
Royce also focuses on developing generic versions of high-volume drugs
whose patent or marketing exclusivity is nearing expiration. Royce seeks to be
among the first to offer such products. While such high-volume drugs generally
face significant competition, even a small market share of a drug generating in
excess of $100 million in revenue would be significant and would enable the
Company to broaden the range of products which it offers to its customers.
Recent changes in U.S. patent terms connected with the General Agreement on
Tariffs and Trade (GATT) have resulted in extensions to the patent terms for
several products which Royce is considering for future development.
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Royce believes that the time required for the development and approval of
the products which it plans to market should take approximately two to three
years from the time Royce identifies a drug for which it will seek an ANDA
through the date that FDA approval is obtained. This time period has, in the
past, been longer and may be longer in the future. Royce is presently engaged in
research and development with respect to more than 15 generic prescription
products. There can be no assurance as to whether products can be developed or
whether ANDAs filed will be approved. See "Government Regulation" below for a
description of the approval process for ANDAs.
SALES AND MARKETING
Royce markets its products to drug wholesalers, generic drug distributors,
retail buying groups, drug chains, other drug manufacturers, health care
institutions and governmental agencies. Royce markets its products primarily
through direct contact by the Company's regional sales managers, telemarketing
efforts, responding to requests for proposals and bids, and through independent
sales representatives. Royce advertises in trade journals and uses direct
mailing to independent drug stores, among other promotional activities targeted
to the pharmaceutical industry.
Royce sells its products either under its own label (approximately 60% of
net sales for 1996) or under a customer's private label (approximately 40% of
net sales for 1996). The Company intends to continue manufacturing products
under a customer's private label and believes that its willingness to offer
private label products provides an additional opportunity for growth, since many
of the larger generic drug manufacturers do not manufacture private label
products.
Royce has over 325 customers, which include various divisions of large
individual wholesalers. Customer service is an integral part of Royce's focus.
Maintaining adequate inventories, making timely delivery of its products and
providing support services are emphasized by Royce in order to serve its
customers better.
During 1996, Zenith-Goldline accounted for 21% of Royce's sales. During
1995, two of Royce's customers, Qualitest and Zenith-Goldline, accounted for 13%
and 12%, respectively, of Royce's net sales. During 1994, sales to two of
Royce's customers accounted for 14% and 10%, respectively, of the Company's net
sales. No other customer accounted for more than 10% of net sales in either
1996, 1995 or 1994. Royce's top ten customers for these years accounted for
approximately 58%, 62% and 60%, respectively, of net sales. The loss of any of
these customers may have an adverse effect on Royce's operations.
STRATEGIC RELATIONSHIPS
Royce believes that strategic marketing relationships with customers and
drug companies in the U.S. and other countries could contribute to increased
sales and gross profit. Royce has entered into several agreements with this
objective in mind.
Royce has a license agreement with Wille Laboratories, PTY. Ltd. ("Wille"),
a pharmaceutical manufacturer located in Queensland, Australia. The license
permits Wille to develop, manufacture and market the licensed products in the
Pacific Rim markets, including Australia, New Zealand, Japan, Taiwan and Hong
Kong (the "Territory"). The only product licensed to Wille at this time is
Captopril. Under the agreement, Royce will receive a minimal initial fee and
additional minimal fees while Wille is pursuing regulatory approvals to
manufacture and market the licensed products in the Territory. Thereafter, if
Wille is able to obtain such requisite approvals, the Company will receive a
royalty from Wille with respect to any sales of the licensed products by Wille
in the Territory. There can be no assurance that any regulatory applications
filed by Wille with the appropriate governmental authorities in the Territory
will be approved. Although Royce and Wille have agreed that Captopril will be
licensed under the agreement, there can be no assurance that any other products
will be licensed under such agreement. Royce is not obligated under such
agreement to license any products to Wille other than Captopril, and Wille is
not obligated to accept a license for any additional product from Royce.
Royce has an agreement with a customer whereby the customer agreed to
engage Royce as its sole supplier of Royce's present and future products for a
five year period, subject to certain exceptions. In return,
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Royce granted the customer stock options to purchase up to 50,000 shares of
Royce Common Stock at $6.00 per share, the market price on the date of grant.
Such options vest at the rate of 9,000 per year, with 5,000 options vesting upon
entering into this agreement. In connection with this agreement, Royce recorded
a charge to earnings of approximately $66,000 in 1995 and $39,000 in 1996.
Royce has a license agreement with Pharmascience, Inc. ("Pharmascience"), a
Canadian pharmaceutical company. Pursuant to the agreement, Pharmascience
licensed the right to manufacture or purchase from Royce at normal selling
prices and distribute eight of the Company's products under the Pharmascience
private label (including two products as to which Royce does not presently have
an approved ANDA). In connection with the agreement, Pharmascience is obligated
to seek regulatory approval of these products for sale in Canada. Canada has a
generic drug approval procedure similar to that of the United States. Royce will
receive a royalty of 5% on Pharmascience's net sales of the licensed products in
Canada for a period of five years starting from the date of the first commercial
sale of each licensed product by Pharmascience, if and when the products are
approved for sale in Canada.
Royce has an agreement with Duramed Pharmaceuticals, Inc. ("Duramed"),
whereby Duramed markets and distributes nine of the Company's current products
(excluding Hydroxychloroquine Sulfate, Captopril and Hydrocodone Bitartrate) on
an exclusive basis to a select group of warehousing drug chains and to other
classes of trade, on a non-exclusive basis, under the Duramed label. The
agreement is for an initial three-year term, renewable annually thereafter.
With respect to one of its products, Royce has a perpetual license
agreement with the formulator of the drug whereby Royce has agreed to pay the
formulator a sliding royalty with a maximum of 10% of net sales of this product
for a ten-year period. In 1994, Royce paid the formulator certain fees
(approximately $70,000) when Royce received an acceptable bioequivalency study
for this drug and charged such fees to expense. In 1995, Royce issued 10,695
shares of unregistered common stock upon the filing of an ANDA for this drug and
accordingly charged $24,000 to expense. Additionally, Royce expensed royalties
of $38,000 for this product in 1995 and $210,000 in 1996.
Royce Research and Development Limited Partnership I (the "Partnership")
developed five products (the "Licensed Drugs") pursuant to the terms of a
license agreement (the "License Agreement") between Royce and the Partnership.
The Partnership was funded with approximately $1.0 million. Royce Research
Group, Inc., a wholly-owned subsidiary of Royce, is the general partner of the
Partnership, for which it earns an administrative fee based on sales of the
Licensed Drugs, and, owns a one percent interest in the Partnership.
Unaffiliated investors own the limited partnership interests.
Under the terms of the License Agreement, Royce granted to the Partnership
an exclusive irrevocable license to the Licensed Drugs (for a term of five years
from the date of the first commercial sale of each of the Licensed Drugs), and
received from the Partnership licensing fees for the Licensed Drugs, third party
out-of-pocket expenses for raw materials and bioequivalency studies relating to
the Licensed Drugs, and $50,000 for a one percent royalty interest in the gross
revenues derived from the commercial sale of Piroxicam for a three-year period
from the time it is first commercially sold. After the expiration of such
five-year term, all rights to the Licensed Drugs revert back to Royce. All of
the Partnership funds were expended developing the five Licensed Drugs. As of
February 27, 1997, Royce had received approvals for all of the Licensed Drugs
and Piroxicam.
In return for funding the development of the Licensed Drugs, the
Partnership will receive a royalty of 10% of the net revenues generated by sales
of the Licensed Drugs over a five-year term commencing with the first commercial
sales of these drugs. During 1996 and 1995, the Company incurred royalty
expenses of $225,000 and $69,000, respectively, related to the sale of the
Licensed Drugs and Piroxicam.
COMPETITION
Royce competes with generic drug manufacturers, brand name pharmaceutical
companies that manufacture or market generic drugs, the original manufacturers
of brand name drugs that continue to produce such drugs after their respective
patents expire or introduce generic versions of their branded products, and
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manufacturers of new drugs that may compete with Royce's generic drugs. Many
competitors have a greater number of products on the market and have greater
financial and other resources than Royce, allowing them to devote greater
resources to research and development and marketing.
The generic drug industry is highly competitive. Most generic drugs enjoy
relatively short periods of limited competition. The introduction of a new
generic drug typically is followed by the introduction of other competitive
generic products into the marketplace, which results in significant declines in
prices and profit margins. Generic drug manufacturers must frequently introduce
new products in order to retain their profitability and sales volume. 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. Royce believes
that price is a significant competitive factor, particularly as the number of
generic manufacturers which produce a particular product increases. Royce's
current product line consists mainly of mature generic pharmaceutical products.
Royce faces competition with respect to these products. The Company's product
development strategy is, in part, intended to attempt to market products subject
to lower levels of competition.
The principal competitive factors in the generic pharmaceutical market are
the ability to be one of the first to introduce a product after a patent
expires, product price, product quality, methods of distribution, reputation,
customer service and breadth of product line. Royce believes that its commitment
to service and quality and its willingness to produce private label products for
its customers enhances its ability to compete with other drug manufacturers.
Royce's brand-name competitors may, in the future, attempt to prevent or
discourage the use of generic equivalents through litigation and negative public
relations campaigns. Some brand-name competitors also have introduced generic
versions of their own branded products prior to the expiration of the patents
for such drugs, which may result in a retention of a larger portion of the
market share available to generic products by these companies following
expiration of the applicable patents.
GOVERNMENT REGULATION
General
The research and development, manufacture and marketing of Royce's products
are subject to regulation by the FDA and the DEA 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 Royce's products.
Almost every state and the District of Columbia has drug product selection
legislation that repeals, in part or in whole, previous laws prohibiting the
substitution of generic drugs in prescriptions for their brand-name
counterparts. Drug product selection legislation generally permits or encourages
pharmacists to substitute equivalent generic prescription drug products for
brand-name pharmaceutical products prescribed by physicians, usually where such
substitution has been either authorized or not prohibited by the prescribing
physician.
The Federal Food, Drug, and Cosmetic ("FDC") Act, the Controlled Substances
Act ("CSA"), and other federal statutes and regulations govern or influence all
aspects of Royce'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 can involve the recall of products, as well as the
refusal by the FDA 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.
Food and Drug Administration
Except in limited circumstances, FDA approval is required before any dosage
form of any new drug, including generic equivalents of a previously approved
drug, can be marketed. A drug that is not generally
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recognized by qualified experts as safe and effective for its intended use, or
that is a generic equivalent of a previously approved prescription drug, is
deemed to be a "new" drug requiring FDA approval. There are two primary types of
applications currently needed to obtain FDA approval of a new drug, a full new
drug application ("NDA") and an ANDA.
The full NDA typically applies to any drug with active ingredients not
previously approved by the FDA. For the NDA, a prospective manufacturer must
conduct and submit to the FDA complete pre-clinical and clinical studies to
prove that drug's safety and efficacy. The FDA usually requires two adequate and
well-controlled clinical studies to support approval, as well as pre-clinical
animal toxicology studies for supporting safety. An NDA may also be submitted
for a drug with a previously approved active ingredient if the abbreviated
procedure discussed below is not available. If a company obtains approval of a
full NDA for a drug with an active ingredient that has not been previously
approved by the FDA, that company is generally entitled to five years of
marketing exclusivity during which period ANDAs may not be filed for FDA
approval. None of Royce's products currently in development is believed to
require a full NDA.
An ANDA is similar to an NDA except that the FDA waives the requirement to
conduct complete pre-clinical and clinical studies to prove safety and efficacy.
Instead, for drugs that contain the same active ingredient and are intended for
the same use as drugs already approved for use in the United States, the FDA
ordinarily requires only bioavailability data demonstrating that the generic
drug formulation is, within an acceptable range, bioequivalent to a previously
approved drug. "Bioequivalence" compares the bioavailability of one oral dosage
form of a drug product with another and, when established, indicates that the
rate of absorption and the levels of concentration of the generic drug in the
body are substantially equivalent to those of the previously approved equivalent
drug. "Bioavailability" indicates the rate of absorption and levels of
concentration of a drug in the bloodstream needed to produce a therapeutic
effect. The FDA review period can last between 12 and 30 months and the outcome
is not certain. Royce's products have been and in the future will likely be
developed pursuant to the ANDA procedure.
All applications for FDA approval of drug products must contain information
relating to product formulation, stability, manufacturing process, packaging,
labeling and quality control. 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 manufacturing and processing of drugs. Such compliance
requires considerable Company time and resources in the area of production and
quality control studies performed to establish that the drug will be safe and
effective for its intended uses. Royce believes that it is in substantial
compliance with cGMP requirements.
The FDA may not approve an ANDA if applicable regulatory criteria,
including compliance with cGMP requirements, are not satisfied. The FDA may
require additional testing, or manufacturing or quality control changes. Even if
such data are submitted and such changes are made, the FDA may ultimately decide
that the ANDA does not satisfy the criteria for approval. Following approval of
an ANDA, the FDA expects the applicant to conduct extensive in-process and
finished products 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 post-approval or pre-shipment validation process. Only after all
processes have been shown through test data to produce consistent results within
quality specifications will the FDA permit commercial distribution. Accordingly,
following the approval of an ANDA, several weeks or months may be 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.
In 1988, the House Subcommittee on Oversight and Investigations launched an
investigation into possible wrongdoing by FDA officials and several generic drug
manufacturers pertaining to the ANDA approval process. Concurrently, the U.S.
Department of Justice initiated a similar investigation. Both investigations
revealed instances of criminal activity by certain FDA employees and by the drug
manufactur-
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ers and their employees. Five FDA employees pleaded guilty to fraud and the FDA
was accused of being lax in its regulation of the generic drug industry. Several
generic pharmaceutical manufacturers were charged with giving illegal gratuities
to certain FDA officials, substituting branded products for their own in studies
required by the FDA, or engaging in other fraudulent or unapproved product
development practices. As a result of these investigations, over 200 generic
products were recalled, an extensive investigation of the generic pharmaceutical
business was initiated by the FDA, and there was a dramatic slowing of the ANDA
approval process.
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 approvals and suspend applications to market generic 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 if the applicant is under active federal criminal investigation
for (i) bribery, or (ii) making material false statements in connection with any
ANDA, or 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 also
has authority to withdraw approval of an ANDA under certain circumstances and to
seek civil penalties. The FDA can also significantly delay the approval of any
ANDAs under the Application Integrity Policy. See "Validity Assessment Program"
below.
All new drugs require FDA premarket approval. However, certain products may
be exempt from such approval if they were marketed in the United States prior to
1938 and were subject to the Food and Drugs Act of 1906 and whose labeling has
not changed since 1938. On this basis, Royce and certain other firms currently
market Yohimbine Hydrochloride and Quinine Sulfate without NDA or ANDA approval.
However, there is no assurance that the FDA will continue to agree with this
basis for marketing and will not require the products to be removed from the
market until such an application is approved.
Quinine Sulfate is currently the subject of FDA review. In May 1993, the
FDA published a final order removing Quinine Sulfate from the market as an
internal analgesic. In August 1994, the FDA published a final order removing
Quinine Sulfate from the market for treating nocturnal leg cramps. Quinine
Sulfate is currently available for treating the chills and fever of malaria. In
April 1995, the FDA published a Notice of Proposed Rulemaking to make Quinine
Sulfate available only as a prescription drug. This notice encouraged voluntary
compliance on the part of Quinine Sulfate manufacturers and Royce is in
compliance with this and all other FDA requirements concerning Quinine Sulfate.
It is the Company's understanding that the FDA is working on proper labeling for
Quinine Sulfate and that the FDA will not take any action which results in the
removal of Quinine Sulfate from the marketplace. However, no assurance can be
given in this regard.
Sales of products are also subject to regulatory requirements governing
human clinical trials, and regulations regarding workplace safety, environmental
protection and hazardous substance controls, among others. Royce believes that
it is in substantial compliance with all such laws which are applicable to its
business.
Drug Enforcement Administration
Certain products are regulated under the CSA, which requires controlled
substance distributors and controlled substance manufacturers to be registered
with the DEA. The DEA has extensive enforcement powers over controlled substance
manufacturers and distributors, including the power to seize products, enjoin
the manufacture or distribution of these products, or criminally prosecute
and/or impose fines against firms and individuals that violate the CSA or DEA
regulations.
Royce is currently subject to the CSA and DEA regulations for marketing and
distribution of certain of its pending and approved products. Royce believes
that it has complied with all requirements imposed on the controlled substance
products sold or proposed for sale or testing by Royce relating to the premarket
development, research, production, sale and marketing thereof, pursuant to the
federal CSA and applicable state controlled substances laws. Furthermore, Royce
believes that it has complied with all requirements
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imposed on implementing regulations promulgated by the DEA thereunder, and any
policies issued by the DEA concerning the development, production, distribution,
sale and marketing of such controlled substances, including any conditions for
approval or acknowledgments, such as issuance of all registration and licensing
applications, and/or any other requirements, such as physical security, record
keeping, reporting and filing requirements, that are specific to such controlled
substances.
VALIDITY ASSESSMENT PROGRAM
The Application Integrity Policy ("AIP") was established by the Office of
Generic Drugs of the FDA "to investigate wrongful acts by some firms submitting
ANDAs, such as committing fraud, making untrue statements of material facts,
committing bribery, or paying illegal gratuities." Under this policy, if the
agency suspects fraud in any new drug application, it may defer substantive
review of the application until the applicant has taken the appropriate
corrective actions to establish the scientific data's reliability. A company
suspected of fraudulent activity in the submission of an application may be
placed in the Validity Assessment Program.
The Validity Assessment Program was established by the FDA as part of its
Application Integrity Policy (originally called the Fraud, Untrue Statements of
Material Facts, Bribery and Illegal Gratuities Policy). The Validity Assessment
Program is intended to establish means by which a drug company or other
regulated firm, suspected by the FDA of seeking to subvert the FDA's review and
approval of premarket applications, may seek to restore the FDA's confidence in
the integrity of its applications.
In order to be removed from the Validity Assessment Program, a company must
have an audit performed by an outside consultant to identify all the wrongful
acts associated with the application submitted to the FDA, and provide all the
reports to the FDA; develop procedures and controls to prevent the violations
from recurring; provide the FDA with a written corrective action plan to ensure
the validity and integrity of product application data; and remove from
authority anyone responsible for any fraudulent conduct that may have been
discovered. If the FDA determines that a company has satisfied the requirements
of the Validity Assessment Program, it will remove Royce from such program and
continue its substantive review of the new drug applications pending before the
FDA.
In February 1992, in connection with an inspection of Royce's manufacturing
facility, the FDA raised questions about the data underlying Royce's ANDAs for
Minoxidil, one of Royce's previously approved products. After investigating the
FDA's concerns with respect to this product, Royce withdrew this product. The
Company also investigated, and in May 1992 withdrew, its ANDAs for a second
product, Haloperidol, after similar questions were raised regarding the data
underlying these ANDAs. These products were developed and these ANDAs were
approved in 1986 and 1987, prior to employment by Royce of Royce's current
management and product development personnel. In Royce's and the FDA's
investigations of these applications, which investigations took place between
February 1992 and April 1992, it was determined that there were a number of
apparent discrepancies in the underlying data that support these applications
and that there was insufficient documentation to justify certain of the
instances where data was not included in these applications. Based on these
findings, Royce voluntarily withdrew its ANDAs relating to these two products
and initiated a product recall for these products.
In early April 1992, the FDA conducted a further examination of the
Company's ANDA for Piroxicam (Royce had received a tentative approval of its
ANDA for Piroxicam in September 1991). On April 21, 1992, Royce was advised by
the FDA that its ANDA for Piroxicam was deficient and, therefore, not approvable
as submitted. The FDA enumerated a number of discrepancies and inconsistencies
contained in the ANDA, which had originally been filed in 1989, and advised the
Company that unless these issues were resolved to their satisfaction, Royce
might have to provide data on new test batches manufactured in accordance with
cGMP, including the results of new bioequivalency studies, as appropriate, to
support approval of the product.
Royce was placed in the Validity Assessment Program in July 1992. During
the period in which Royce was in the Validity Assessment Program, the FDA did
not review any of Royce's pending ANDAs or accept ANDAs for new products.
Further, during this period, the Company's ANDAs for all of its pending and
approved products were audited by Company personnel under the supervision of an
independent consultant
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approved by the FDA. The FDA also conducted an intensive inspection of Royce's
facility and all of the documentation supporting the Company's pending and
approved ANDAs. Additionally, Royce was required to develop procedures and
controls to prevent violations from recurring and provide the FDA with a
corrective action plan to assure the validity and integrity of Royce's product
application data. Royce was released from the Validity Assessment Program on
December 16, 1993. In connection with its release from the Validity Assessment
Program, Royce withdrew its then pending ANDA for Piroxicam. Royce filed a new
ANDA for this product in March 1994, which ANDA was approved in September 1995.
Since its release from the Validity Assessment Program, Royce has received ANDA
approvals for thirteen products.
HEALTH CARE POLICY AND REIMBURSEMENT
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 and political pressure to contain health care costs at the federal
and state levels is increasing. In addition, Medicaid legislation requires that
all pharmaceutical manufacturers rebate to individual states a percentage of
their revenues arising from Medicaid-reimbursed drug sales. In 1996, the
required rebate for generic drug manufacturers was 11% of Medicaid-reimbursed
drug sales.
Political, economic and regulatory influences are subjecting the health
care industry in the United States to fundamental change. During 1994, the
Clinton administration proposed comprehensive legislation, known as the Health
Security Act, to reform the health care system (which legislation did not pass).
The Health Security Act mandated basic health care benefits for all Americans,
sought to control health care expenditures by placing caps on private health
insurance premiums and Medicare and Medicaid spending, and proposed the creation
of large insurance purchasing alliances. Although the proposed Health Security
Act did not contain any provisions which directly regulate generic drug
manufacturers, members of the Clinton administration and Congress have expressed
interest in controlling the prices that pharmaceutical companies charge for
their products. The Health Security Act did contain inducements for patients and
providers to use generic drugs, where available. Members of Congress have
introduced other health care reform proposals whose possible impact on generic
drug manufacturers is uncertain. None of these proposals has been adopted. In
addition, several states in which Royce distributes its products have passed or
are considering their own health care reform legislation. Royce anticipates that
Congress and state legislatures will continue to review and assess alternative
health care delivery systems and payment methodologies and that public debate on
these issues will continue. Because of the uncertainties regarding the ultimate
features of reform initiatives and their enactment and implementation, Royce
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 generic drug industry in
general or Royce in particular.
Royce believes that managed care currently affects and will continue in the
future to affect Royce's business by creating increased demand for generic drugs
as part of the health care cost containment strategy of managed care.
RAW MATERIALS
The raw materials essential to Royce's business are purchased primarily
from U.S. distributors of bulk pharmaceutical chemicals manufactured abroad. The
ANDA process requires specification of raw material suppliers, and only one
source has been approved for the active ingredient used in all but three of
Royce's products. The Company has filed supplements with the FDA to add a second
source of supply for five of its other products. There can be no assurance as to
if and when Royce's other supplements will be approved. In the event that raw
materials from a specified supplier were to become unavailable, FDA approval of
a new supplier, if available, would be required, which could cause a delay of
between six and twelve months in the manufacture of the drugs involved and the
consequent loss of revenues. Royce experienced some raw material shortages
during 1995 and 1996. There can be no assurance that such shortages will not
recur in the future. Additionally, arrangements with foreign suppliers are
subject to certain additional risks, including the availability of governmental
clearances, import/export duties, political instability, currency fluctuations
and
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restrictions on the transfer of funds. Certain controlled substances are also
subject to a DEA quota system and may not be available in sufficient quantities
for Royce to realize its sales potential of such products.
Royce entered into a development agreement with a raw material supplier to
develop two products and to purchase its raw materials requirements for these
products from the supplier. The Company has received FDA approval for one of the
products and currently has an ANDA pending for the other product. So long as
Royce obtains approval of its pending ANDA within a specified time period and
thereafter satisfies certain purchase requirements, the supplier has agreed that
Royce shall be its exclusive customer for this raw material in the United
States, Canada and Mexico. There can be no assurance that Royce will obtain
approval of the ANDA filed for the remaining product.
PRODUCT LIABILITY
Product liability claims constitute a risk to all pharmaceutical
manufacturers. Royce maintains what it believes to be adequate product liability
insurance, although there can be no assurance that the coverage limit of such
policy will be adequate or that the cost of such insurance will not increase.
Royce's insurance provides coverage on a claims-made basis and is subject to
annual renewal. The insurance may not be available in the future on acceptable
terms or at all.
PATENTS, TRADEMARKS, AND LICENSES
Since Royce's current business is manufacturing products for which patents
have expired, it is not anticipated that any of the Company's products in the
near future will be patented. However, the Company may develop new products and
obtain patents for them in the future. The name Royce(R) and its design are
registered as a trademark with the Department of State of Florida and with the
U.S. Patent and Trademark Office.
EMPLOYEES
Royce employed 144 persons as of February 14, 1997. No employees are
members of a collective bargaining unit under a union representation contract.
Royce believes that its relationships with its employees are good.
PROPERTIES
Royce's manufacturing plant is located in a 25,000 square foot leased
facility in Miami, Florida under a lease expiring July 31, 2000. Additionally,
on January 1, 1997, Royce leased an additional 10,200 square feet of space
attached to the existing premises. Royce also has two five-year renewal options.
Annual rent, excluding taxes, insurance and common area maintenance, after
taking possession of such additional space totals $151,000, subject to annual
cost of living increases. Under the lease, Royce has an option to purchase the
entire 35,200 square foot building, and an adjacent building of approximately
42,000 square feet, throughout the term of the lease, including renewal periods.
In October 1994, Royce entered into a lease for a 40,000 square foot
facility. The lease is for a period of 10 1/2 years, commencing on November 1,
1994 and ending on April 30, 2005. Royce has two additional five year options.
Included in the lease are options to purchase the leased property during the
first year and the sixth year of the lease term and a right of first refusal to
purchase any buildings owned by the lessor to the east of the leased property.
The lease can be terminated by Royce upon 180-day written termination notice and
payment of a termination fee. Annual rent under this lease, excluding taxes,
insurance and common area maintenance, totals $195,000. Royce commenced
occupancy of this second facility in May 1995. Currently, it houses Royce's
administrative, sales and finance departments, warehouse operations and research
and development laboratories. During 1996, Royce moved its research and
development laboratory into the new facility.
Royce owns significantly all of its manufacturing and laboratory equipment.
Royce has equipment for all stages of manufacturing tablets and capsules,
including machinery for blending and agitating raw materials,
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compressing tablets, encapsulation, bottling and packaging, and labeling. Royce
currently contracts for tablet coating with outside vendors and intends to
perform tablet coating at its manufacturing facility in the near future. Royce's
laboratory also includes computerized testing and data analysis equipment for
quality control and is also equipped for in-house research and development.
COMPANY LEGAL PROCEEDINGS
In February 1993, the Securities and Exchange Commission (the "SEC")
initiated a formal investigation into possible violations of the federal
securities laws by the Company and certain of its officers and directors. The
SEC's examination focused on the Company's public disclosure during the period
between July 1991 and April 1992 regarding the status of the Company's
abbreviated new drug applications ("ANDAs") for Piroxicam and Minoxidil and on
sales of securities during this period by certain persons, including certain
Company executive officers and/or directors.
On May 2, 1996, the Company and Patrick J. McEnany, the Company's Chairman
and Chief Executive Officer, entered into a settlement (the "Settlement") with
the SEC resolving the SEC's formal investigation with respect to the Company and
Mr. McEnany, without admitting or denying that a violation of the securities
laws had occurred. As part of the Settlement, the Company and Mr. McEnany
consented to the granting of a civil injunction requiring them to comply with
the federal securities laws in the future.
Further, in connection with the Settlement, Mr. McEnany paid a $25,000
administrative fine, which amount was reimbursed to Mr. McEnany by the Company
under the indemnification provisions of the Company's Articles of Incorporation
and By-Laws. The Company believes that the Settlement brings to a close the
SEC's investigation of the Company and Mr. McEnany.
In January 1994, the Company was served with a suit brought by one of its
shareholders who opted out of the Company's settlement of the class action
litigation settled during 1993. The suit, Dinesh Shah v. Royce Laboratories,
Inc. and Chatfield Dean & Co., Inc., 94 CIV 0061 (S.D. N.Y.) which was also
brought against one of the underwriters of the Company's January 1992 public
offering, alleged that the Company's January 9, 1992 prospectus was false and
misleading. In August 1996, the Company settled this matter for $25,000 in cash.
On August 4, 1995, the Company was sued by Bristol-Myers Squibb Company,
Inc. and E.R. Squibb & Sons, Inc. (collectively, "Bristol-Myers") in the
Southern District of Florida with respect to the Company's ANDA for Captopril
(Case No. 95-1682-CIV-Davis). In July 1996, this suit was dismissed without any
liability to the Company.
OTHER LEGAL PROCEEDINGS
On September 6, 1996, the Company became aware of the filing of a complaint
for injunctive and other civil relief (the "Complaint") by the SEC against three
Company employees who allegedly traded securities of the Company while in the
possession of material non-public information. The Complaint also names as
defendants three other persons who allegedly traded securities of the Company
based upon material non-public information provided to them by one of the
Company employee defendants.
The complaint alleges that Abul Bhuiyan, Nilkanth Patel and Hasmukh Patel
violated Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange
Act") by purchasing and, in the case of Messrs. Patel and Patel, selling shares
of the Company's common stock while in the possession of material non-public
information. The alleged improper purchases and sales occurred in September 1991
and April 1992, respectively. The Complaint also alleges that all of the
defendants except Mr. Bhuiyan violated Section 17(a) of the Securities Act of
1933, as amended (the "Securities Act"), by reason of their purchase and sales.
The suit seeks as to all defendants injunctive relief enjoining the
defendants from future violations of Section 10(b) and 10b-5 under the Exchange
Act and, as to all defendants except Mr. Bhuiyan, enjoining them from future
violations of Section 17(a) under the Securities Act. the suit also seeks
disgorgement from all of the defendants except Mr. Bhuiyan. Finally, the suit
seeks penalties under Section 21A(a) of the Securities Act from each defendant
of up to three times his profits gained and losses avoided as a result of the
violations alleged in the Complaint.
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After reviewing the allegations contained in the Complaint, the Company
took certain corrective actions. These actions were as follows: (i) the Company
removed Mr. Bhuiyan as an executive officer of the Company (although Mr. Bhuiyan
remains an employee of the Company in a product development function); (ii) the
Company terminated Nilkanth Patel as an employee of the Company; and (iii) the
Company reprimanded Hasmukh Patel, but retained him as an employee of the
Company (Mr. Patel is an analytical research and development manager for the
Company).
The Company does not believe that the outcome of this suit will have a
material adverse impact on the Company, its business, financial position or
results of operations.
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ROYCE'S SELECTED CONSOLIDATED
FINANCIAL INFORMATION
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------------ -----------------
1991 1992 1993 1994 1995 1995 1996
------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA(1)
Net sales.............................. $ 1,991 $ 2,422 $ 3,519 $ 6,191 $10,503 $ 6,522 $17,216
Cost of goods sold..................... 1,417 2,345 3,017 4,538 7,143 4,784 11,200
------- ------- ------- ------- ------- ------- -------
Gross profit........................... 574 77 502 1,653 3,360 1,738 6,016
Expenses related to product recalls.... -- 570(3) -- -- -- -- --
Research and development............... 196 283 305 960 2,212 1,235 1,252
Selling, general and administrative
expenses............................. 698 2,284 2,084 2,298 3,634 2,122 3,633
Write-off of inventory................. -- -- 768(4) -- -- -- --
------- ------- ------- ------- ------- ------- -------
Operating income (loss)................ (320) (3,060) (2,655) (1,605) (2,486) (1,619) 1,131
Other income (expense), net............ 42 162 (1,278)(5) 128 150 106 115
------- ------- ------- ------- ------- ------- -------
Income (loss) from operations before
income taxes......................... (278) (2,898) (3,933) (1,477) (2,336) (1,513) 1,246
Income taxes........................... -- -- -- -- -- -- 32
------- ------- ------- ------- ------- ------- -------
Income (loss) from operations before
extraordinary items.................. (278) (2,898) (3,933) (1,477) (2,336) (1,513) 1,214
Net extraordinary items................ 346(2) -- -- -- -- -- --
------- ------- ------- ------- ------- ------- -------
Net income (loss)...................... 68 (2,898) (3,933) (1,477) (2,336) (1,513) 1,214
Dividends on redeemable preferred
stock................................ (4) -- -- -- -- -- --
------- ------- ------- ------- ------- ------- -------
Net income (loss) applicable to common
shareholders......................... $ 64 $(2,898) $(3,933) $(1,477) $(2,336) $(1,513) $ 1,214
======= ======= ======= ======= ======= ======= =======
Earnings (loss) from operations per
share................................ $ (.03) $ (.31) $ (.41) $ (.14) $ (.19) $ (.12) $ .09
Extraordinary item per share........... .04 -- -- -- -- -- --
------- ------- ------- ------- ------- ------- -------
Earnings (loss) per share.............. $ .01 $ (.31) $ (.41) $ (.14) $ (.19) $ (.12) $ .09
======= ======= ======= ======= ======= ======= =======
Weighted average number of common and
common equivalent shares
outstanding.......................... 7,897 9,321 9,493 10,554 12,352 12,190 14,013
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30,
1991 1992 1993 1994 1995 1996
------ ------ ------ ------ ------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA(1)
Total assets....................................... $3,578 $6,657 $4,065 $8,111 $12,093 $17,588
Long term debt..................................... 12 4 -- 33 181 1,053
Total liabilities.................................. 666 726 600 1,756 3,420 3,834
Stockholders' equity............................... 2,912 5,931 3,465 6,355 8,673 13,754
</TABLE>
- ---------------
(1) Certain amounts presented in prior years' financial data have been
reclassified to conform to the current year's presentation.
(2) Gain on settlement of indebtedness.
(3) In May 1992, the Company issued a recall of two products for which it
voluntarily withdrew its ANDA's after investigating FDA questions about the
data underlying the ANDA's. The expenses related to the product recalls
consisted of inventory writedowns and credit memos issued to customers as a
result of products returned to the Company.
(4) Represents write-off of inventory and related matters. See Note 7 of Notes
to Royce's Consolidated Financial Statements.
(5) Includes a charge against earnings of $1,336 in connection with the
settlement of certain class action and other litigation. See Note 7 of Notes
to Royce's Consolidated Financial Statements.
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ROYCE'S MANAGEMENT'S DISCUSSION
THE FINANCIAL INFORMATION INCLUDED HEREIN SHOULD BE READ IN CONJUNCTION
WITH THE ROYCE CONSOLIDATED FINANCIAL STATEMENTS, INCLUDING THE NOTES THERETO.
THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 ARE REFERRED TO HEREIN AS
"1995," "1994" AND "1993." THIS PROXY STATEMENT/PROSPECTUS CONTAINS CERTAIN
FORWARD LOOKING STATEMENTS WHICH INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S
ACTUAL RESULTS COULD DIFFER FROM THE RESULTS ANTICIPATED HEREIN AS A RESULT OF
THE FACTORS SET FORTH IN THIS PROXY STATEMENT/PROSPECTUS.
GENERAL
The Company has incurred substantial operating losses in the past and had
accumulated deficit of approximately $16.6 million at September 30, 1996.
The Company's future profitability, to a large extent, will depend upon the
Company's ability to successfully commercialize additional generic
pharmaceutical products. Products must be developed and tested, meet strict
regulatory standards, receive requisite regulatory approvals and be manufactured
on a cost-effective basis before successful commercialization can be achieved.
The development and commercialization process is time consuming and costly.
Delays in any part of the process or the inability of the Company to obtain
regulatory approvals for its products could materially adversely affect the
Company's future results of operations. The Company believes that it takes
between 12 and 30 months from the time an ANDA is filed to the time it is
approved, although such time period has been longer in the past and may be
longer in the future. The Company is dependent on the FDA approval process to
introduce new products to the market. There can be no assurance as to when the
Company will have new products to market, or that if products are approved, they
can be successfully commercialized.
The Company's revenues, gross profit margins and net profitability may vary
significantly from quarter to quarter, as well as in comparison to the
corresponding quarter of the preceding year. Revenue variations may result from,
among other factors, the timing of FDA approvals, the timing of initial
shipments of newly approved drugs and the purchasing practices of the Company's
customers. Additionally, gross profit margins may vary due to, among other
factors, when new products are approved for manufacture and marketing, as well
as competition relating to such products. Net profits or losses may also vary
due to the foregoing, plus the timing and amounts of research and development
("R & D") spending. The Company's R & D costs are expensed as incurred,
resulting in charges to earnings prior to the realization of any revenues from a
product.
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
30, and 1995
Net sales for the first nine months of 1996 were $17.2 million,
representing an increase of $10.7 million or 164% over net sales of $6.5 million
for the first nine months of 1995. Approximately 67% of the increase in net
sales was attributable to the sales of products which were introduced by the
Company after September 30, 1995 ("New Products"), while the remaining 33% of
the increase in net sales was attributable to sales of products which were
introduced by the Company before September 30, 1995 ("Existing Products"). Most
of the increase in net sales of New Products was the result of
Hydroxychloroquine Sulfate and the Hydrocodone line of products. Most of the
increase in net sales of Existing Products was attributable to increased sales
of Quinine Sulfate. A material portion of Quinine Sulfate sales for the first
nine months of 1996 were to one customer. Three products each accounted for more
than 10% of 1996 sales and together, accounted for approximately 57% of such
sales. Total units sold for the first nine months of 1996 increased 55% compared
to the same period in 1995. Industry-wide changes in the distribution of generic
drugs led to widespread price decreases for generic products in the quarter
ended September 30, 1996. Due to price competition, the Company believes that
for the quarter ending December 31, 1996, net sales will be slightly below net
sales for the quarter ended September 30, 1996.
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Gross profit for the first nine months of 1996 was $6.0 million, or 35% of
net sales, compared to $1.7 million, or 27% of net sales for the first nine
months of 1995. Gross profit, as well as the gross profit margin, increased due
to the introduction of New Products and sales increases of Existing Products,
both of which caused an improvement in the operating leverage on the Company's
fixed costs of manufacturing. The Company believes that price competition will
continue in the foreseeable future, which will likely continue to depress prices
and gross margins further. However, the Company also believes that new products
launched in the future will likely have a positive impact on margins, the extent
of which will depend on the level of competition for such new products.
The Company's R&D expenses were approximately the same in the first nine
months of 1996 ($1.3 million) as in the first nine months of 1995 ($1.2
million).
Selling, General and Administrative ("SG&A") expenses increased 71% to $3.6
million or 21% of net sales in the first nine months of 1996, versus SG&A of
$2.1 million or 33% of net sales in the first nine months of 1995. Approximately
39% of the increase in SG&A expenses was attributable to increases in certain
variable expenses which increase in relation to sales. Advertising expenses
associated with the launch of New Products accounted for 14% of the increase in
SG&A expenses. Payroll and benefits accounted for 23% of the increase in SG&A
expenses and, along with increases in other SG&A expenses, were due mainly to
the growth of the Company's operations.
The Company recorded $32,000 of income tax expense in the first nine months
of 1996, which was the Company's estimate of alternative minimum taxes incurred
for the period, after utilizing net operating loss carryforwards to offset 90%
of taxable income. As a result of the above factors, the Company's net income
for the first nine months of 1996 was $1.2 million, compared to a net loss of
$1.5 million for the first nine months of 1995. Earnings for the year ending
December 31, 1996 are expected to be approximately $800,000 due to expected
lower revenue and gross profit margins in the quarter ending December 31, 1996.
1995 Compared to 1994
Net sales for 1995 were $10.5 million, representing an increase of $4.3
million or 70% over net sales of $6.2 million for 1994. Approximately 52% of the
increase in net sales was attributable to sales of products which were
introduced by the Company during 1995 ("1995 New Products"),while the remaining
48% of the increase in net sales was attributable to sales of products in the
Company's product line during 1994 ("1994 Existing Products"). Approximately 64%
of the increase in 1995 New Products was attributable to the December 1995
launch of Hydroxychloroquine Sulfate. The majority of the increase in sales of
1994 Existing Products was attributable to a full year's inclusion of two
products introduced during 1994 and increased sales of Quinine Sulfate, a
prescription drug for the treatment of malaria. See
"Royce's -- Business-Government Regulation" for a description of the FDA drug
review on Quinine Sulfate. With the occurrence of the FDA drug review on Quinine
Sulfate, the competition in the marketplace for this drug has been reduced and
as a result, the Company's market share for this product has increased. While
the Company expects that demand for this product will be strong for 1996, it is
likely that unit sales of this drug will decline in the long-term.
The gross profit for 1995 was $3.4 million, or 32% of net sales, compared
to $1.7 million, or 27% of net sales for 1994. Gross profits, as well as the
gross profit margin, increased due to the introduction of 1995 New Products and
sales increases of 1994 Existing Products, both of which caused an improvement
in the operating leverage on the Company's fixed costs of manufacturing.
The Company increased its R&D expenses to $2.2 million or 21% of net sales
in 1995 versus $1.0 million or 16% of net sales in 1994. In actual dollars, R&D
expense increased 130%. The increase in R&D spending, both in dollars and
percentage of sales, reflects the Company's commitment to increasing its R&D
expenditures as it believes such efforts are vital to the future growth of the
Company.
SG&A expenses increased 58% to $3.6 million or 35% of net sales in 1995,
versus $2.3 million or 37% of net sales in 1994. Approximately 14% of the
increase in SG&A expenses was attributable to legal fees associated with the
Company's litigation over Captopril (See Note 10(IV) of the Notes to
Consolidated Financial Statements for the year ended December 31, 1995). In
addition, the Company's reserve for bad
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debts was increased by $200,000 as a result of a substantial increase in trade
receivables from 1994 levels. The remaining increase in SG&A expenses was
attributable, in part, to increases in certain variable expenses which increased
in relation to sales, such as royalties. General and administrative expenses
were also impacted by increases in payroll and related expenses due to pay
increases and personnel additions, as well as higher rent and depreciation
associated with the Company's new facility.
As a result of the above factors, the Company's operating loss for 1995 was
$2.5 million, compared to $1.6 million for 1994. After accounting for other
income and interest expense, the net loss was $2.3 million for 1995 compared to
a net loss of $1.5 million for 1994.
1994 Compared to 1993
Net sales for 1994 were $6.2 million, representing an increase of $2.7
million or 76% over net sales of $3.5 million for 1993. The increase in net
sales was attributable to unit sales increases of all of the Company's products,
as well as the introduction of two new products during 1994.
The Company's gross profit for 1994 was $1.7 million, or 27% of net sales,
compared to a gross profit of $502,000 or 14% of net sales for 1993. The
increase in the gross profit margin was primarily the result of increased sales
volumes, as well as the introduction of two new products during 1994.
R&D expenses for 1994 were $960,000, which represented 15% of net sales,
compared to $305,000 or 8% of net sales for 1993.
SG&A expenses were $2.3 million for 1994, which represented an increase of
$200,000 over SG&A expenses of $2.1 million in 1993. SG&A expenses as a
percentage of net sales were 37% for 1994, compared to 59% for 1993. The dollar
increase in SG&A was attributable, in large part, to higher selling expenses
(including freight expenses resulting from increased sales), as well as higher
advertising expenses. Increased general and administrative expenses from year to
year resulted primarily from increased payroll expense as a result of personnel
additions required to support increased sales and operations. This increase was
offset during 1994 by significantly lower legal expenses than in 1993. SG&A, as
a percentage of net sales, decreased due to economies of scale resulting from
increased sales during 1994.
Additionally, during 1993, the Company recognized charges (primarily
non-cash) of $1.3 million relating to the settlement of two lawsuits, plus a
write-off of Piroxicam inventory and related matters in the amount of $768,000.
After accounting for other income and interest expense, as well as the factors
described above, the net loss for 1994 was $1.5 million, compared to a net loss
of $3.9 million for 1993.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
To date, the Company has historically financed itself through sales of its
equity securities. In early 1996, the Company received net proceeds of $3.4
million from the exercise of 581,333 Private Warrants (See Note 5 of the Notes
to Consolidated Financial Statements for the nine months ended September 30,
1996). As of September 30, 1996, the Company received $742,500 in net proceeds
from the issuance of long-term debt and entered into a $546,000 capital lease
agreement (see Note 3 of the Notes to Consolidated Financial Statements for the
nine months ended September 30, 1996) to finance equipment purchases.
Cash and cash equivalents increased $1.7 million from year end 1995. This
increase represents the $4.4 million received from financing activities less
$1.2 million used mainly to increase inventories and $1.5 million used for
property and equipment purchases.
Inventories at September 30, 1996 increased by $1.6 million over year end
1995 due to the introduction of new products, increased sales volumes of Quinine
Sulfate, and management's decision to increase inventories to improve service
levels. The Company expects that its inventory level will be stable during the
remainder of 1996.
Capital expenditures for the nine months ended September 30, 1996 were $1.5
million. These purchases consisted mainly of manufacturing equipment and plant
improvements to meet growing production needs and the construction of a new
research and development laboratory.
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If the Merger is not completed, the Company may continue to require
additional capital. The Company's recent profitability has positively impacted
cash flow, however profits have not yet reached the level where they can fund
all of the Company's capital requirements. Additionally, if the Merger is not
completed, the Company believes that continued growth in sales will be necessary
for the Company to generate sufficient cash flow from operations to be able to
internally fund its capital requirements over the next 12 months. The Company
expects that once it has established a history of earnings, revolving credit
bank financing on cost effective terms should become available. Also, if the
Merger is not completed, the Company may have to sell additional securities to
help finance its business plans and/or strategic alliances or acquisitions in
the next year. There can be no assurance that necessary capital will be
available in the future when and if it is required. If the Company is unable to
maintain sufficient capital, it will likely be forced to reduce the level of its
research and development efforts and to make other necessary changes to its
present business plans until such funding can be secured.
The Company believes its capital needs would be satisfied following the
Merger based on Watson's strong financial condition. The Company has incurred
significant costs associated with the Merger and the Merger Agreement is
terminable under certain circumstances. If, pursuant to the Merger Agreement,
the Merger is terminated for reasons other than because of the acceptance of an
alternative offer from another acquirer, the Company will bear all of its
expenses associated with this Merger, which are estimated to total $500,000. If
the Merger Agreement is terminated because of the acceptance of an alternative
offer, the Company could be obligated to pay Watson termination fees or Watson's
Merger expenses.
113
<PAGE> 120
ROYCE'S SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of the Record Date, certain information
regarding the Common Stock, owned of record or beneficially by (i) each person
who owns beneficially more than 5% of the outstanding Royce Common Stock; (ii)
each of the Company's directors; and (iii) all directors and executive officers
as a group. The address for each beneficial owner is c/o the Company, 5350
Northwest 165th Street, Miami, Florida 33014.
<TABLE>
<CAPTION>
SHARES APPROXIMATE
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED PERCENT OF CLASS(1)
------------------------ ------------------ --------------------
<S> <C> <C>
Patrick J. McEnany(2)..................................... 746,550 5.3
Rick A. Wilber(3)......................................... 225,329 1.6
Richard W. Gross, Esq.(4)................................. 71,229 *
Gregory Reed, M.D.(5)..................................... 61,015 *
Charles J. Simons(6)...................................... 46,580 *
Hubert E. Huckel, M.D.(7)................................. 33,333 *
Ogden R. Reid(8).......................................... 3,333 *
J. William Grant(9)....................................... 4,583 *
Jacqueline Allee.......................................... 2,000 *
All Directors and Executive Officers as a Group (15
persons)(10)............................................ 1,422,185 10.1
</TABLE>
- ---------------
* Less than 1%
(1) Based on 13,525,879 shares of Common Stock outstanding, plus, as to each
person, the exercise of their currently exercisable options and options
becoming exercisable within the next 60 days.
(2) Includes 148,673 shares owned of record by Equisource Capital, Inc., of
which Mr. McEnany is the sole shareholder. Includes options to acquire
287,497 shares of Common Stock at exercise prices ranging from $2.64 per
share to $25.41 per share. Excludes unvested options to purchase 50,000
shares of Common Stock at an exercise price of $6.75 per share. Also
excludes 17,333 shares owned by Mr. McEnany's wife. Mr. McEnany disclaims
any beneficial interest in the shares owned by his wife.
(3) Includes options to acquire 28,330 shares of Common Stock at exercise
prices ranging from $4.00 per share to $25.41 per share.
(4) Includes options to acquire 34,163 shares of Common Stock at exercise
prices ranging from $4.00 per share to $25.41 per share.
(5) Includes options to acquire 33,747 shares of Common Stock at exercise
prices ranging from $4.00 per share to $25.41 per share.
(6) Includes options to acquire 22,914 shares of Common Stock at exercise
prices ranging from $4.00 per share to $9.31 per share.
(7) Includes options to acquire 3,333 shares of Common Stock at an exercise
price of $9.31 per share. Excludes 100 shares owned by Dr. Huckel's son.
Dr. Huckel disclaims any beneficial interest in the shares owned by his
son.
(8) Includes options to acquire 3,333 shares of Common Stock at an exercise
price of $9.31 per share.
(9) Includes options to acquire 4,583 shares at an exercise price of $25.41 per
share.
(10) Includes vested options and options to vest within the next 60 days to
purchase an aggregate of 622,233 shares of Common Stock granted to
directors and executive officers. Excludes unvested options to purchase an
aggregate of 161,167 shares of Common Stock granted to executive officers.
114
<PAGE> 121
DISSENTERS' RIGHTS
Holders of Royce Common Stock will not be entitled to dissenters' rights or
appraisal rights as a result of the Merger. Under Florida law, dissenters'
rights and related appraisal rights are unavailable to the holders of Royce
Common Stock because the Royce Common Stock was, on the Record Date, held by
more than 2,000 shareholders of record.
LEGAL MATTERS
The validity of the issuance of the Watson Common Stock being offered
hereby will be passed upon for Watson by D'Ancona & Pflaum, Chicago, Illinois.
As of the date of this Proxy Statement/Prospectus, Michel J. Feldman, a partner
of D'Ancona & Pflaum and a director and Secretary of Watson, beneficially owned
27,500 shares of Watson Common Stock. In addition, other members of D'Ancona &
Pflaum own additional shares of Watson Common Stock, which ownership is not
material in the aggregate. The federal income tax consequences in connection
with the Merger have been passed upon for Watson by D'Ancona & Pflaum. The
federal income tax consequences of the Merger and certain other matters have
been passed upon for Royce by Akerman, Senterfitt & Eidson, P.A., Miami,
Florida.
EXPERTS
The consolidated financial statements of Watson Pharmaceuticals, Inc. as of
December 31, 1995 and 1994 and for each of the three years in the period ended
December 31, 1995 included in this Proxy Statement/Prospectus and incorporated
in this Proxy Statement/Prospectus by reference to the Annual Report on Form
10-K/A for the year ended December 31, 1995 have been so incorporated in
reliance on the report of Price Waterhouse LLP, independent accountants, given
on the authority of said firm as an expert in accounting and auditing.
The consolidated financial statements of Royce Laboratories, Inc. as of
December 31, 1995 and 1994 and for each of the three years in the period ended
December 31, 1995 included in this Proxy Statement/Prospectus, have been so
included in reliance on the report of Price Waterhouse LLP, independent
certified public accountants, given on the authority of said firm as experts in
auditing and accounting.
The consolidated balance sheet of Circa as of December 31, 1994 and the
consolidated statements of operations, retained earnings, and cash flows for
each of the two years in the period ended December 31, 1994, incorporated by
reference in this Proxy Statement/Prospectus, have been incorporated herein in
reliance on the report of Coopers & Lybrand L.L.P., independent accountants,
given on the authority of that firm as experts in accounting and auditing.
The consolidated financial statements of Somerset Pharmaceuticals, Inc. as
of December 31, 1995 and 1994 and for each of the three years in the period then
ended incorporated in this prospectus by reference from the Annual Report on
Form 10-K/A of Watson Pharmaceuticals, Inc. for the year ended December 31, 1995
have been audited by Deloitte & Touche LLP, independent auditors, as stated in
their report, which is included and incorporated herein by reference, and have
been so incorporated in reliance upon the report of such firm given upon their
authority as experts in accounting and auditing.
The audited financial statements and financial statement schedule of
Oclassen Pharmaceuticals, Inc. as of December 31, 1995 and for each of the three
years in the period ended December 31, 1995 (not presented herein), to the
extent and for the periods indicated in their report, have been audited by
Arthur Andersen LLP, independent public accountants, and are included herein in
reliance upon the authority of said firm as experts in giving said report.
115
<PAGE> 122
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Royce's Consolidated Financial Statements
Years Ended December 31, 1995, 1994 and 1993
Report of Independent Certified Public Accountants........ F-2
Consolidated Balance Sheets at December 31, 1995 and
1994................................................... F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1995, 1994 and 1993....................... F-4
Consolidated Statement of Changes in Stockholders' Equity
for the Three Years Ended December 31, 1995............ F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1995, 1994 and 1993....................... F-6
Notes to Consolidated Financial Statements................ F-7
Nine Months Ended September 30, 1996 and 1995 (unaudited)
Consolidated Balance Sheets at September 30, 1996 and
December 31, 1995...................................... F-20
Consolidated Statements of Operations for the Nine Months
Ended September 30, 1996 and 1995...................... F-21
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 1996........... F-22
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1996 and 1995...................... F-23
Notes to Consolidated Financial Statements................ F-24
Watson's Consolidated Financial Statements
Years Ended December 31, 1995, 1994 and 1993
Report of Independent Accountants......................... F-27
Consolidated Balance Sheets as of December 31, 1995 and
1994................................................... F-32
Consolidated Statements of Income for each of the Three
Years in the Period Ended December 31, 1995............ F-33
Consolidated Statements of Stockholders' Equity for each
of the Three Years in the Period Ended December 31,
1995................................................... F-34
Consolidated Statements of Cash Flows for each of the
Three Years in the Period Ended December 31, 1995...... F-35
Notes to Consolidated Financial Statements................ F-36
Watson's Supplementary Consolidated Financial Statements
Supplementary Consolidated Balance Sheets as of December
31, 1995 and 1994...................................... F-50
Supplementary Consolidated Statements of Income for each
of the Three Years in the Period Ended December 31,
1995................................................... F-51
Supplementary Consolidated Statements of Stockholders'
Equity for each of the Three Years in the Period Ended
December 31, 1995...................................... F-52
Supplementary Consolidated Statements of Cash Flows for
each of the Three Years in the Period Ended December
31, 1995............................................... F-54
Notes to Supplementary Consolidated Financial
Statements............................................. F-56
Watson's Consolidated Financial Statements -- Nine Months
Ended September 30, 1996 and 1995 (unaudited)
Consolidated Balance Sheets as of September 30, 1996 and
December 31, 1995...................................... F-74
Consolidated Statements of Income for the Nine Months
Ended September 30, 1996 and 1995...................... F-75
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1996 and 1995...................... F-76
Notes to Consolidated Financial Statements................ F-78
Watson's Supplementary Consolidated Financial
Statements -- Nine Months Ended September 30, 1996
(unaudited)
Supplementary Consolidated Balance Sheets as of September
30, 1996 and December 31, 1995......................... F-80
Supplementary Consolidated Statements of Income for the
Nine Months Ended September 30, 1996 and 1995.......... F-81
Supplementary Consolidated Statements of Cash Flows for
the Nine Months Ended September 30, 1996 and 1995...... F-82
Notes to Supplementary Consolidated Financial
Statements............................................. F-84
Unaudited Pro Forma Condensed Combined Financial Statements
Unaudited Pro Forma Condensed Combined Statements of
Income................................................. F-87
Unaudited Pro Forma Condensed Combined Balance Sheets..... F-91
Notes to Unaudited Pro Forma Condensed Combined Financial
Statements............................................. F-94
</TABLE>
F-1
<PAGE> 123
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Royce Laboratories, Inc.
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Royce Laboratories, Inc. and its subsidiary 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 conducted our
audits of these statements 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 provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
/s/ Price Waterhouse LLP
Miami, Florida
February 28, 1996
F-2
<PAGE> 124
ROYCE LABORATORIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARES)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1994
-------- --------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 2,291 $ 3,323
Accounts receivable, net of allowances of $909 and $385,
respectively........................................... 3,466 1,453
Inventories............................................... 4,212 2,049
Prepaid expenses and other current assets................. 315 223
-------- --------
Total current assets.............................. 10,284 7,048
Property and equipment, net................................. 1,732 980
Other assets................................................ 77 83
-------- --------
$ 12,093 $ 8,111
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 2,521 $ 1,376
Accrued liabilities....................................... 628 322
Current maturities of long-term debt...................... 90 25
-------- --------
Total current liabilities......................... 3,239 1,723
Long-term debt.............................................. 181 33
-------- --------
Total liabilities................................. 3,420 1,756
-------- --------
Commitments and contingencies............................... -- --
-------- --------
Stockholders' equity:
Common stock, $.005 par value, 35,000,000 shares
authorized; 12,838,466 and 11,954,451 shares issued,
respectively........................................... 64 60
Additional paid-in capital................................ 26,471 21,821
Accumulated deficit....................................... (17,851) (15,515)
Treasury stock (2,500 shares, at cost).................... (11) (11)
-------- --------
Total stockholders' equity........................ 8,673 6,355
-------- --------
$ 12,093 $ 8,111
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 125
ROYCE LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1995 1994 1993
---------- ---------- ---------
<S> <C> <C> <C>
Net sales................................................... $10,503 $ 6,191 $ 3,519
Cost of Goods sold.......................................... (7,143) (4,538) (3,017)
---------- ---------- ---------
Gross profits............................................... 3,360 1,653 502
Expenses:
Research and development.................................. (2,212) (960) (305)
Selling, general and administrative....................... (3,634) (2,298) (2,084)
Write-off of inventory.................................... -- -- (768)
---------- ---------- ---------
Operating loss.............................................. (2,486) (1,605) (2,655)
---------- ---------- ---------
Other income (expense):
Interest income........................................... 161 64 64
Interest expense.......................................... (36) (10) (4)
Settlement of lawsuits.................................... -- -- (1,336)
Miscellaneous income (expense)............................ 25 74 (2)
---------- ---------- ---------
150 128 (1,278)
---------- ---------- ---------
Net loss.................................................... $(2,336) $(1,477) $(3,933)
========== ========== =========
Per share data:
Loss per share.............................................. $ (.19) $ (.14) $ (.41)
========== ========== =========
Weighted average number of shares outstanding............... 12,352,235 10,554,228 9,493,428
========== ========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 126
ROYCE LABORATORIES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER 31, 1995
(IN THOUSANDS EXCEPT SHARES)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
------------------- PAID IN ACCUMULATED TREASURY STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT STOCK EQUITY
---------- ------ ---------- ----------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1992...... 9,361,572 $47 $16,000 $(10,105) $(11) $ 5,931
Issuance of common stock exercise
of options...................... 168,254 1 138 -- -- 139
Issuance of common stock in
payment of Company
obligations..................... 268,801 1 1,327 -- -- 1,328
Net Loss.......................... -- -- -- (3,933) -- (3,933)
---------- --- ------- -------- ---- -------
BALANCE AT DECEMBER 31, 1993...... 9,798,627 49 17,465 (14,038) (11) 3,465
Issuance of common stock to
employees....................... 3,254 -- 26 -- -- 26
Payment of debt by a director..... -- -- 38 -- -- 38
Issuance of common
stock -- exercise of warrants
and options..................... 152,570 1 200 -- -- 201
Issuance of common
stock -- private placement...... 2,000,000 10 4,116 -- -- 4,126
Reclassification of loan to
director........................ -- -- (24) -- -- (24)
Net loss.......................... -- -- -- (1,477) -- (1,477)
---------- --- ------- -------- ---- -------
BALANCE AT DECEMBER 31, 1994...... 11,954,451 60 21,821 (15,515) (11) 6,355
Issuance of common stock in
payment of Company
obligations..................... 12,017 -- 32 -- -- 32
Issuance of common
stock -- exercise of options.... 38,665 -- 131 -- -- 131
Costs related to stock options
earned by a customer............ -- -- 57 -- -- 57
Collection of loan from officer... -- -- 27 -- -- 27
Adjustment related to 1994 private
placement....................... -- -- (15) -- -- (15)
Issuance of common
stock -- private placement...... 833,333 4 4,418 -- -- 4,422
Net loss.......................... -- -- -- (2,336) -- (2,336)
---------- --- ------- -------- ---- -------
BALANCE AT DECEMBER 31, 1995...... 12,838,466 $64 $26,471 ($17,851) ($11) $ 8,673
========== === ======= ======== ==== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 127
ROYCE LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS EXCEPT IN SUPPLEMENTAL DISCLOSURES)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1995 1994 1993
------- ------- -------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................... $(2,336) $(1,477) $(3,933)
Adjustments to reconcile net loss to net cash used in
operating activities:
Stock issued in settlement of lawsuits.................... -- -- 1,319
Depreciation.............................................. 301 211 139
Change in operating assets and liabilities:
(Increase) in accounts receivable......................... (2,013) (650) (494)
(Increase) decrease in inventories........................ (2,163) (821) 953
(Increase) in prepaid expenses and other current assets... (92) (75) (55)
Decrease (increase) in other assets....................... 9 (60) 4
Increase (decrease) in accounts payable................... 1,145 1,087 (195)
Increase in accrued liabilities........................... 395 40 87
------- ------- -------
Net cash used in operating activities............. (4,754) (1,745) (2,175)
------- ------- -------
Cash flows from investing activities:
Acquisition of property and equipment..................... (955) (548) (217)
------- ------- -------
Net cash used in investing activities............. (955) (548) (217)
------- ------- -------
Cash flows from financing activities:
Proceeds from issuance of long-term debt.................. 171 75 --
Repayments of long-term debt.............................. (59) (20) (9)
Net proceeds from issuance of common stock................ 4,538 4,299 138
Payment of debt by a director or officer.................. 27 38 --
------- ------- -------
Net cash provided by financing activities......... 4,677 4,392 129
------- ------- -------
Net (decrease) increase in cash and cash equivalents........ (1,032) 2,099 (2,263)
Cash and cash equivalents, beginning of year................ 3,323 1,224 3,487
------- ------- -------
Cash and cash equivalents, end of year...................... $ 2,291 $ 3,323 $ 1,224
======= ======= =======
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
During 1995, 1994 and 1993, the Company made cash payments for interest of
approximately $26,000, $10,000 and $4,000, respectively.
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
In 1995, the Company issued 12,017 shares of unregistered common stock in
satisfaction of contract obligations.
In 1995, the Company incurred $101,000 in capital lease obligations for new
equipment.
In 1994, the Company issued 30,600 shares of common stock to Paradise
Valley Securities, Inc. ("PVS") (See Note 8(III)(H)).
In 1993, in connection with a settlement of certain class action
litigation, the Company issued 250,000 shares of common stock (See Note 7(I)).
In addition, in 1993, the Company issued 18,801 shares of unregistered common
stock in lieu of cash payments for services rendered.
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 128
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
NOTE 1. OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
I. OPERATIONS
Royce Laboratories, Inc. (the "Company") is a Florida corporation engaged
in developing, manufacturing and marketing generic prescription and
non-prescription drugs in solid dosage form (tablets and capsules). The Company
sells its products primarily to U.S. based drug wholesalers, generic drug
distributors, retail buying groups, managed care organizations and drug chains.
In October 1991, the Company formed a wholly-owned subsidiary, Royce
Research Group, Inc. ("RRGI") to engage, through a licensing agreement with the
Company, in the development and marketing of five generic prescription drugs
(See Note 9).
II. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies followed by the Company in
the preparation of the accompanying financial statements is presented below.
(A) Principles of consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary. All significant intercompany
balances and transactions have been eliminated.
(B) Fair value of financial instruments
The financial instruments included in the Company's balance sheets are cash
and cash equivalents and long-term debt. These instruments were carried at
amounts approximating fair value at December 31, 1995 and 1994. The fair value
of long-term debt was estimated based on future cash flows discounted at current
interest rates available to the Company for instruments with similar maturities
and characteristics.
(C) Concentration of credit risk
The Company is potentially subject to a concentration of credit risk
consisting of its accounts receivable, the entire balance of which is due from
generic drug distributors, wholesalers, retail buying groups, managed care
organizations and drug chains. The Company assesses the financial strength of
its customers and does not require collateral. The Company maintains reserves
for potential losses from uncollectible accounts.
(D) Cash and cash equivalents
Cash on hand, deposits in banks, and money market funds, and other highly
liquid investments with an original maturity of three months or less, are
considered cash and cash equivalents.
(E) Inventory
Inventory is stated at the lower of cost or market. Cost is determined
principally by the first-in, first-out method.
(F) Property and equipment
Property and equipment is stated at cost, less accumulated depreciation and
amortization. Depreciation is computed using the straight-line method over the
estimated useful lives of the assets. Amortization of leasehold improvements is
computed using the straight-line method over the shorter of the lease term or
F-7
<PAGE> 129
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
estimated useful lives of the related assets. Expenditures for repairs and
maintenance are charged to expense as incurred, while expenditures which extend
the useful lives of assets are capitalized.
(G) Income taxes
The Company records income taxes using the liability method. Under this
method, deferred tax assets and liabilities are determined based upon
differences between financial reporting and tax bases of assets and liabilities
and are measured using the enacted income tax rates that will be in effect when
the differences are expected to reverse. An allowance is recorded when it is
more likely than not that any or all of a deferred tax asset will not be
realized. The provision for income taxes includes taxes currently payable plus
the net change during the year in deferred tax assets and liabilities recorded
by the Company.
(H) Capital
The Company effected a 1-for-3 reverse stock split in December 1993. All
share amounts referred to in these financial statements and notes have been
adjusted for the stock split.
(I) Revenue recognition
Sales are recorded at the time goods are shipped.
(J) Research and development costs
All research and development costs are expensed as incurred.
(K) Loss per share
Loss per share amounts are computed by dividing net losses by the weighted
average number of shares of common stock outstanding during each of the periods.
Warrants, options and other common stock equivalents have not been included in
the calculation of loss per share because their effect would be antidilutive.
(L) Reclassifications
Beginning in 1995, volume rebates awarded to customers have been recorded
in net sales. Prior to 1995, such rebates were recorded in selling expenses.
Prior year financial statements have been reclassified to reflect this change.
The effect of this reclassification was to decrease net sales and selling,
general and administrative expenses by $380,000 and $91,000 for the years ended
December 31, 1994 and 1993, respectively.
In addition, certain other amounts in the 1993 and 1994 financial
statements have been reclassified to conform to the 1995 presentation.
(M) Stock based compensation
In October 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Account Standards No. 123, Accounting For Stock Based
Compensation ("SFAS 123"). SFAS 123, the disclosure provisions of which must be
implemented for fiscal years beginning subsequent to December 15, 1995,
establishes a fair value based method of accounting for stock based compensation
plans, the effect of which can either be disclosed or recorded. The Company will
adopt the provisions of SFAS 123 in 1996. Upon adoption, the Company intends to
retain the intrinsic value method of accounting for stock based compensation,
which it currently uses.
F-8
<PAGE> 130
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(N) Management estimates
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
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. The most significant estimates made by management in the
accompanying financial statements relate to accounts receivable allowances.
Actual results could differ from those estimates.
NOTE 2. INVENTORIES
Inventories consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1995 1994
------ ------
<S> <C> <C>
Raw materials............................................... $2,439 $1,426
Work-in-process............................................. 783 284
Finished goods.............................................. 990 339
------ ------
$4,212 $2,049
====== ======
</TABLE>
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, ESTIMATED
----------------- USEFUL LIVES
1995 1994 (YEARS)
------- ------ ------------
<S> <C> <C> <C>
Leasehold improvements................................. $ 529 $ 216 5 - 10
Machinery and equipment................................ 1,948 1,501 3 - 7
Transportation equipment............................... 17 13 3
Furniture and equipment................................ 435 146 3 - 7
------- ------
2,929 1,876
Less accumulated depreciation and amortization......... (1,197) (896)
------- ------
$ 1,732 $ 980
======= ======
</TABLE>
F-9
<PAGE> 131
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4. LONG-TERM DEBT
Long-term debt consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------
1995 1994
----- -----
<S> <C> <C>
Notes payable to banks, payable in monthly installments,
including interest at rates ranging from 9.6% to 10.5% per
annum for terms expiring at various dates through March
2000, secured by furniture and equipment.................. $186 $ 58
Capital lease obligations, net of imputed interest of $16,
payable in monthly installments including interest at
imputed rates ranging from 10.8% to 13.0% per annum for
terms expiring at various dates through May 1999, secured
by equipment.............................................. 85 --
---- ----
271 58
Less current maturities..................................... (90) (25)
---- ----
$181 $ 33
==== ====
</TABLE>
Annual maturities of long-term debt including capital lease obligations at
December 31, 1995 were as follows:
<TABLE>
<S> <C>
1996........................................................ $ 90
1997........................................................ 81
1998........................................................ 59
1999........................................................ 32
2000........................................................ 9
----
$271
====
</TABLE>
NOTE 5. MAJOR CUSTOMERS
The table below reflects the percentage of total net sales that major
customers (i.e., customers who accounted for more than 10% of the Company's
total net sales in any year) accounted for:
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
------------------
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
Customer A.................................................. 13% 14% 15%
Customer B.................................................. -- 10% --
Customer C.................................................. 12% -- 12%
</TABLE>
NOTE 6. INCOME TAXES
At December 31, 1995 and 1994, the Company had a deferred tax asset of
approximately $6.0 million and $5.4 million, respectively, attributable
primarily to net operating loss carryforwards. The Company has established a
valuation allowance for 100% of the deferred tax asset due to the uncertainties
related to its eventual realizability. The change in the Company's net deferred
tax asset and the related valuation allowance in 1995 was due to losses incurred
for income tax purposes during the year. The Company has net operating loss
carryforwards of approximately $16.0 million for tax purposes which expire
between the years 2000 and 2010.
As a result of certain changes in the Company's ownership during 1991, the
utilization of net operating loss carryforwards has been limited to
approximately $350,000 per year for losses incurred prior to 1991.
F-10
<PAGE> 132
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Future changes in the Company's ownership, if any, may have the effect of
further limiting the annual utilization of loss carryforwards.
NOTE 7. OTHER MATTERS
I. CLASS ACTION SETTLEMENT
In April 1992, several class action lawsuits were filed against the Company
and certain of its officers and directors (the "Defendants"). The complaints
alleged that the Defendants had misrepresented the Company's prospects for
obtaining final approval from the Food and Drug Administration ("FDA") to
manufacture and market Piroxicam. On September 28, 1993, the U.S. District Court
approved a settlement of the class action lawsuits. Pursuant to the settlement
agreement, the Company agreed to (i) pay $850,000 which was funded by the
Company's Directors and Officers liability insurance; (ii) issue 250,000 shares
of free trading common stock; and (iii) issue five year warrants (See Note
8(III)(E)), to purchase 658,333 shares of free trading common stock at $15.00
per share. All such shares and warrants were distributed in early 1995. In 1993,
the Company recorded a charge to earnings of $1,336,000 related to this
settlement. Such charge represented the market value of the 250,000 shares on
the settlement date.
II. WRITE OFF OF INVENTORY AND RECEIVABLES
As a result of the Company's withdrawal of its abbreviated new drug
applications for Minoxidil, Haloperidol and Piroxicam, the Company wrote off
inventory and issued credits to customers in the amounts of $792,000 in 1993.
NOTE 8. CAPITAL STOCK
I. CAPITAL STOCK -- AUTHORIZED AND ISSUED
At December 31, 1995, the Company had authorized 200,000 shares of
preferred stock, $.005 par value (the "Preferred Stock"), none of which was
issued and outstanding.
In addition to its 12,838,466 common shares issued, the Company had a total
of 3,047,143 warrants and options outstanding at December 31, 1995.
II. STOCK OFFERINGS
(A) 1995 Private Placement
During July 1995, the Company completed a $5 million private placement
("1995 Private Placement") of 833,333 units at a price of $6.00 per unit. Each
unit consisted of one share of common stock, $.005 par value, and a twelve month
warrant (the "Private Warrants") to purchase one share of common stock at an
exercise price of $6.50 per share. The price of the shares was determined in
arms-length negotiations between the Company and the placement agent, Gruntal &
Co., Incorporated ("Gruntal"). The Company received aggregate net proceeds of
approximately $4.4 million from this offering. In addition to fees for serving
as the placement agent, Gruntal received three-year warrants (See Note
8(III)(C)) to purchase 83,333 shares of common stock at an exercise price of
$6.00 per share.
In August 1995, the Company filed a registration statement relating to the
shares of common stock sold in the 1995 Private Placement and the shares of
common stock underlying the warrants sold in the private placement. Such
registration statement was declared effective under the Securities Act of 1933,
as amended, during October 1995. The Company has also agreed to use its best
efforts to maintain the effectiveness of the registration statement until July
1997.
On December 12, 1995, the Company reduced the exercise price of the Private
Warrants from $6.50 to $6.00 for a 60 day period as an incentive for warrant
holders to exercise. Subsequent to December 31, 1995,
F-11
<PAGE> 133
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Company issued 581,333 shares of its common stock as a result of the
exercise of 581,333 Private Warrants. Net proceeds from the exercise of these
warrants amounted to approximately $3.4 million.
(B) 1994 Private Placement
During September 1994, the Company completed a private placement ("1994
Private Placement") in which the Company sold an aggregate of 2,000,000 shares
of its common stock at a price of $2.50 per share. The price of the shares was
determined in arms-length negotiations between the Company and Gruntal, which
acted as the placement agent of this offering. In addition to fees for serving
as the placement agent, Gruntal also received 200,000 warrants (See Note
8(III)(D)). The Company received aggregate net proceeds of approximately $4.1
million from this offering. A registration statement relating to the shares sold
in the 1994 Private Placement is effective as of the date of these financial
statements.
III. STOCK OPTIONS, WARRANTS AND RIGHTS
(A) Employee and director stock option plans
(1) Description
In 1992, the Company established a stock option plan which provides for the
granting at the fair market value of the underlying shares at the date of grant,
of incentive options for its employees, officers and directors (the "1992
Plan"). The 1992 Plan provides for the grant of up to 333,333 shares of common
stock to officers, directors and other key employees. The 1992 Plan provides for
mandatory grants to directors for serving on the Board of Directors, committees
of the Board of Directors, as chairman of committees and as Chairman of the
Board of Directors. Options granted pursuant to the 1992 Plan expire five years
from the date they become vested, which is, in most cases, over a three year
period beginning with the grant date. The 1992 Plan is administered by the
Compensation Committee of the Board of Directors.
At the Company's annual meeting of shareholders on July 25, 1995, the
shareholders approved the Board of Directors's adoption of a new stock option
plan (the "1995 Plan"). Under the 1995 Plan, the Board is authorized to issue
options to purchase up to 550,000 shares of common stock to officers, directors,
and other key employees. The 1995 Plan provides for mandatory grants to
directors for serving on the Board of Directors, committees of the Board of
Directors, as chairman of committees and as Chairman of the Board of Directors,
which mandatory grants of options superceded the options grants provided for in
the 1992 Plan. The exercise price of options granted under the 1995 Plan must
equal or exceed the fair market value of the common stock on the date such
options are granted. No options issued under the 1995 Plan may be exercised more
than ten years from the date of grant. The Compensation Committee of the Board
of Directors is responsible for administering the 1995 Plan.
All employee and director options expire at various times between 1996 and
2005.
(2) Employee and director stock option activity in 1995
In 1995, the Board of Directors granted a total of 35,828 stock options
under its 1995 Plan to the President and the outside directors for their
services on the Board and its committees. These options are exercisable at $8.44
per share and expire in April 2000. During 1995, the Company also granted
110,000 stock options to certain employees of the Company. These options vest
generally over three years, are exercisable at prices between $5.91 and $9.00
per share and expire five years from their vesting dates. All of the above
options were issued at or above the fair market value of the Company's common
stock at the date of grant.
F-12
<PAGE> 134
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Below is a table summarizing transactions and other relevant data
pertaining to employee and director stock options:
<TABLE>
<CAPTION>
NUMBER OF PRICE PER
OPTIONS SHARE
--------- ---------------
<S> <C> <C>
1992 PLAN
Options outstanding at December 31, 1992................... 97,494 $9.56 - $25.41
Options granted............................................ 113,329 $4.50 - $ 7.69
--------
Options outstanding at December 31, 1993................... 210,823 $4.50 - $25.41
Options granted............................................ 85,829 $4.63 - $ 5.75
--------
Options outstanding at December 31, 1994................... 296,652 $4.50 - $25.41
Options granted............................................ 103,761 $5.91 - $ 9.00
Options exercised.......................................... (9,166) $5.75 - $ 6.63
Options canceled........................................... (67,080) $19.50 - $25.41
--------
Options outstanding at December 31, 1995................... 324,167 $4.50 - $25.41
========
1995 PLAN
Options outstanding at December 31, 1994................... -- --
Options granted............................................ 42,067 $8.44 - $ 9.00
--------
Options outstanding at December 31, 1995................... 42,067 $8.44 - $ 9.00
========
NON-PLAN STOCK OPTIONS
Options outstanding at December 31, 1992................... 446,137 $.75 - $25.41
Options granted............................................ 9,999 $ 6.56
Options exercised.......................................... (137,560) $ .75
--------
Options outstanding at December 31, 1993................... 318,576 $.75 - $25.41
Options granted............................................ 462,500 $3.00 - $ 6.75
Options exercised.......................................... (105,665) $ .75
Options canceled........................................... (3,334) $ .75
--------
Options outstanding at December 31, 1994................... 672,077 $.75 - $25.41
Options exercised.......................................... (29,499) $.75 - $ 6.56
--------
Options outstanding at December 31, 1995................... 642,578 $.75 - $25.41
========
</TABLE>
At December 31, 1995, 623,809 of the previously described options were
vested.
(B) 1995 private placement warrants
As part of the Company's 1995 Private Placement, the Company issued 833,333
Private Warrants.
Each Private Warrant entitles the holder to purchase one share of common
stock at an exercise price of $6.50 per share. The exercise price is subject to
increase or decrease upon the happening of certain corporate events including,
but not limited to the payment of any stock dividend, stock split, stock
combination or similar transaction. The Private Warrants may be exercised at any
time through July 20, 1996, unless such period is extended by the Company.
On December 12, 1995, the Company reduced the exercise price of the Private
Warrants from $6.50 to $6.00 for a 60 day period as an incentive for warrant
holders to exercise their Private Warrants. Subsequent to December 31, 1995, the
Company issued 581,333 shares of its common stock as a result of the exercise of
581,333 Private Warrants. Net proceeds from the exercise of these warrants
amounted to approximately $3.4 million.
F-13
<PAGE> 135
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(C) 1995 Gruntal warrant
As part of its compensation for acting as the placement agent in connection
with the 1995 Private Placement, Gruntal received the 1995 Gruntal warrant which
allows them to purchase 83,333 shares of common stock at an exercise price equal
to $6.00 per share, exercisable until July 21, 1998. The holder of the 1995
Gruntal warrant may pay the exercise price in cash or use a cashless exercise.
In a cashless exercise, the holder of the 1995 Gruntal warrant has the right at
any time to exercise the warrant in whole or in part by surrendering the warrant
certificate in exchange for the number of shares of common stock equal to (x)
the number of shares as to which the 1995 Gruntal warrant is being exercised
multiplied by (y) a fraction, the numerator of which is the market price (as
defined in the 1995 Gruntal warrant) of the common stock at the date of exercise
less the exercise price and the denominator of which is such market price. The
1995 Gruntal warrant provides for an adjustment of the exercise price and the
number and type of securities issuable upon the exercise thereof upon the
occurrence of certain events, including the payment of any stock dividend stock
split, stock combination or similar transaction.
(D) 1994 Gruntal warrant
As part of its compensation for acting as the placement agent in connection
with the 1994 Private Placement, Gruntal received warrants which allow them to
purchase 200,000 shares of common stock at an exercise price equal to $3.50 per
share, exercisable until August 12, 1999. The holder of the 1994 Gruntal warrant
may pay the exercise price in cash or use a cashless exercise. The provisions
for a cashless exercise and adjustments to the exercise price are similar to
those described above for the 1995 Gruntal warrant.
(E) Class action settlement warrants
In accordance with the settlement in 1993 of the class action lawsuit,
during the first quarter of 1995, the Company issued warrants to purchase
658,333 shares of common stock (See Note 7(I)). Each of these warrants (the
"Series F Warrants") entitles the holder to purchase one share of common stock
at an exercise price of $15.00 per share. The Series F Warrants are exercisable
through December 1999, unless such period is extended by the Company. The
exercise price and the number of shares of common stock to be purchased upon the
exercise of each Series F Warrant are subject to increase or decrease upon the
happening of certain corporate events, including but not limited to the payment
of any stock dividend, stock split, stock combination or similar transactions.
The Series F Warrants may be called at the sole option of the Company upon
thirty days prior written notice to the registered holders thereof so long as
the common stock trades above $18.00 per share for 20 consecutive trading days
ending not more than 10 days prior to the date that the notice of redemption is
given. Any such redemption shall be for all outstanding Series F Warrants. If
the Company elects to redeem the Series F Warrants, then the Warrant holders
shall have the rights to exercise their Series F Warrants until the redemption
date, and thereafter, the holder shall only be entitled to receive the
redemption price therefor.
(F) 1992 public offering warrants
As part of the Company's 1992 public offering, 1,150,000 warrants (the
"Public Warrants") were issued. Each Public Warrant entitled the holder to
purchase one sixth ( 1/6) of a share of common stock (six Public Warrants were
required to purchase one share of common stock) at an exercise price of $30 per
Share. On July 8, 1995, all such warrants expired unexercised.
(G) 1992 underwriters warrants
The Company has outstanding underwriters' warrants relating to its 1992
public offering ("the 1992 Underwriters Warrants"). Paradise Valley Securities,
Inc. ("PVS"), the managing underwriter of the
F-14
<PAGE> 136
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company's January 1992 public offering and designees of Chatfield Dean and Co.,
Inc., one of the underwriters of such offering, own an aggregate of 33,333 1992
Underwriters Warrants to purchase units of the Company's securities at an
exercise price of $21.60 per unit. Each unit consists of 2 shares of common
stock and a warrant to purchase 1/2 of a share of common stock at an exercise
price of $30 per share. The exercise price and the number of shares of common
stock and warrants which can be purchased upon the exercise of the 1992
Underwriters' Warrants are subject to increase of decrease upon the happening of
certain events, and in the event that the Company issues shares of common stock
at less than $9.00 per share. The issuance of the shares of common stock and, if
issued, the warrants, will cause a reduction in the exercise price of and an
increase in the number of shares of common stock issuable upon the exercise of
this warrant. Issuances of securities subsequent to the date of issuance of the
1992 Underwriters Warrants have reduced the exercise price of the units to
approximately $17.25 per unit and increased the number of units available for
purchase to approximately 40,000 units. The warrants are exercisable through
January 9, 1997.
(H) 1991 public offering warrants
In August 1993, PVS exercised an "Underwriter's Warrant" issued in
connection with the Company's February 1991 public offering. The Underwriter's
warrant entitled PVS to purchase 15,300 Units of the Company's securities. Each
unit consisted of eight shares of common stock, $.005 par value, and two common
stock purchase warrants, at an exercise price of $7.68 per Unit. In connection
with the exercise of this Underwriter's Warrant, the Company issued 122,400
shares of its common stock and a warrant to purchase 30,600 shares and received
$117,504 from the Underwriter.
On May 2, 1994, PVS exercised their warrant to purchase 30,600 shares of
the Company's common stock. The exercise price of the warrant was $3.00 per
share, representing an aggregate exercise price of $91,800. PVS paid the Company
$45,225, which represents the difference between the aggregate exercise price
and a credit of $46,575, which the Company granted to PVS in return for PVS
agreeing to waive its right of first refusal contained in the underwriting
agreement relating to the Company's 1992 public offering. In connection with
this agreement, the Company and PVS executed mutual releases with respect to all
matters arising under the 1992 underwriting agreement and with respect to the
class action litigation.
(I) Customer options
In June 1991, the Company entered into an option agreement with a customer,
which agreement was subsequently assigned to the customer's parent. Under the
agreement, the customer was granted a five-year option to purchase shares of the
Company's common stock at $1.875 per share, upon the satisfaction of certain
purchase targets. Options earned are determined as of June 30 of each year based
on the previous 12 months' purchases by the customer. As of December 31, 1995,
the maximum number of options the customer could earn through the end of this
agreement in June 1996 is 106,666 options. If the customer earns options for the
contract year ended June 30, 1996 and at that date a spread exists whereby the
fair market value per share exceeds the option price (the "Spread"), the Company
will record a charge to earnings equal to the Spread times the number of options
earned.
In February 1995, the Company entered into an agreement with another
customer whereby the customer agreed to engage the Company as its sole supplier
of the Company's present and future products for a five year period subject to
certain exceptions. In return, the Company granted the customer stock options to
purchase up to 50,000 shares of common stock at $6.00 per share, the market
price on the date of grant. Such options vest at the rate of 9,000 per year,
with 5,000 options vesting upon entering into this agreement. In connection with
this agreement, the Company has recorded a charge to earnings of approximately
$66,000 in 1995.
F-15
<PAGE> 137
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(J) Anti-takeover right
Certain provisions of the Articles and Bylaws of the Company may be deemed
to have an anti-takeover effect and may delay, defer or prevent a tender offer
or takeover attempt, including an attempt that might result in a premium being
bid over the market price for the shares held by shareholders. Several
provisions may not be amended in the Company's Articles and Bylaws without the
affirmative vote of the shareholder of 80% of the outstanding shares of common
stock.
A supermajority (80%) vote of the shareholders is required to approve
certain transactions with an entity of which 10% or more is beneficially owned
by a 10% or more shareholder of the company, unless such transaction is approved
by a majority of the continuing directors.
The Company has a classified Board of Directors divided into three classes
serving staggered terms. At each annual meeting, approximately one-third of the
director's terms of office expire for which elections are held. Directors may be
removed from office only for cause and only by supermajority vote of the
shareholders.
In addition, shareholder action must be effected at a duly called annual or
special meeting of the shareholders and may not be effected by written consent.
Special meetings are called by the Board of Directors pursuant to a resolution
approved by a majority of the entire Board of Directors.
NOTE 9. R &D LIMITED PARTNERSHIP
In 1991, the Company, through its subsidiary RRGI, completed the funding of
a research and development limited partnership (the "Partnership"). The
Partnership received net proceeds of $1,035,000 from its partners to develop
five generic prescription drugs ("Licensed Drugs"). The Partnership's funds were
paid, in part, to the Company for its services in developing the Licensed Drugs
and to obtain a one-percent royalty interest in the gross revenue derived from
the commercial sale of Piroxicam for a three-year period, with the remainder
paid to third party vendors used in the development of the products. As
remuneration for developing the Licensed Drugs, the Company received $40,000 and
$52,000 in 1994 and 1993, respectively, from the Partnership. In return for
funding the development of the Licensed Drugs, the Partnership will receive a
royalty of 10 percent of the net revenues generated by sales of the Licensed
Drugs over a five-year period.
As of March 1, 1996, the Company had received FDA approvals for three of
the Licensed Drugs and Piroxicam. Applications are pending for the other two
Licensed Drugs. The Company incurred royalty expenses of $69,000 in 1995 related
to the sales of the Licensed Drugs and Piroxicam.
NOTE 10. COMMITMENTS AND CONTINGENCIES
I. OPERATING LEASES
The Company leases its 25,000 square foot production facility under an
operating lease that expires on July 31, 2000 and provides for two five-year
renewal options. The Company has also agreed to lease an additional 10,228
square foot space contiguous to its existing space when it becomes available,
but no later than November 1996. Pursuant to the lease agreement, the Company
also has an option throughout the term of the lease, including renewal periods,
to purchase the entire building and an adjacent building at a specified price.
Annual rent under the lease is approximately $137,000, subject to annual cost of
living increases.
The Company also leases another nearby 40,000 square foot facility which
houses its executive offices, warehouse and in the future and, will house its
research and development laboratory. The lease is for a 10 1/2 year term, with
two five-year renewal options. The lease requires the Company to make annual
lease payments of approximately $195,000. The Company also has an option to
purchase the leased facility during the first twelve-months of the lease and
during the sixth year of the lease at a specified price.
F-16
<PAGE> 138
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Total rental expense for operating leases was $324,000, $178,000 and
$167,000 for 1995, 1994 and 1993, respectively. The terms of the operating
leases for the Company's facilities require the Company to maintain minimum
insurance coverage and to pay property taxes and repair and maintenance
expenses.
At December 31, 1995, future minimum lease payments under all
non-cancelable operating leases are as follows (in thousands):
<TABLE>
<S> <C>
1996........................................................ $ 256
1997........................................................ 260
1998........................................................ 265
1999........................................................ 269
2000........................................................ 216
Thereafter.................................................. 750
------
Total minimum lease payments...................... $2,016
======
</TABLE>
II. OTHER COMMITMENTS
(A) Purchase commitments
The Company has entered into a development agreement with a raw material
supplier to develop two products and to purchase its raw material requirements
for these products from the supplier. So long as the Company files ANDAs,
obtains approval of same within a specified time period and thereafter satisfies
certain purchase requirements, the supplier has agreed that the Company shall be
its only customer for this raw material in the United States, Canada and Mexico.
The Company currently has ANDAs pending for both products.
(B) Product license agreement
In August 1993, the Company entered into a perpetual license agreement with
the formulator of a drug whereby the Company has agreed to pay the formulator a
sliding royalty with a maximum of 10 percent of net sales of this product for a
ten-year period. In 1994, the Company paid the formulator certain fees ($70,000
in cash) when the Company received an acceptable bioequivalency study for this
drug and charged such fees to expense. In 1995, the Company issued the
formulator 10,695 shares in unregistered common stock upon the filing of an ANDA
for this drug and accordingly charged $24,000 to expense. In 1995, the royalty
expense incurred for this product was $38,000.
(C) Foreign distribution agreements
On July 31, 1994 the Company entered into a license agreement with an
Australian pharmaceutical manufacturer with respect to the licensing of one or
more products developed by the Company. The license permits the Australian
manufacturer to develop, manufacture and market the licensed products in the
Pacific Rim markets, including Australia, New Zealand, Japan, Taiwan and Hong
Kong (the "Territory").
Although the Company and the Australian manufacturer have agreed on the
first product to be licensed under the agreement, there can be no assurance that
any other products will be licensed under such agreement. The Company is not
obligated under such agreement to license any products to the Australian
manufacturer other than the first product, and the Australian manufacturer is
not obligated to accept and license any additional product from the Company.
Under the agreement, the Company will receive a royalty from the Australian
manufacturer with respect to any sales of the licensed products by such
manufacturer in the Territory. In November 1994, the Company entered into a
license agreement with a Canadian pharmaceutical company. Pursuant to the
agreement, the Canadian company licensed the right to manufacture or purchase
from the company at normal selling prices and distribute eight of the Company's
products
F-17
<PAGE> 139
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
under its private label. Under the agreement, the Company will receive a royalty
on the Canadian company's sales of the licensed products in Canada.
III. EMPLOYMENT CONTRACTS
In 1994, the Company entered into employment contracts with certain
officers, the most significant of which is with the Company's President. The
President's contract provides for an annual base salary, plus cost of living
increases, plus a bonus equal to three percent of pre-tax income, the total not
to exceed three times the President's base salary. Additionally, the President
was granted options to purchase up to 250,000 shares of common stock at a price
of $6.75 per share. Such options become exercisable at the rate of 50,000 each
January 1st, beginning January 1, 1994. The agreement and these options expire
December 31, 1998. The President has agreed not to compete with the Company for
a period of eighteen months after termination of his employment.
Each contract with the Company's other officers provides for a minimum base
salary, bonuses and stock options, which generally vest over a three-year
period. These contracts expire at various dates between 1995 and 1997.
IV. CONTINGENCIES
(A) Litigation
In February 1993, the Securities and Exchange Commission initiated a formal
investigation into possible violations of the federal securities laws by the
Company and certain of its officers and directors. The SEC's examination is
focusing on the Company's public disclosure during the period between July 1991
and April 1992 regarding the status of the Company's ANDAs for Piroxicam and
Minoxidil and on sales of securities during this period by certain persons,
including Company executive officers and/or directors. The Company believes that
the SEC's investigation is ongoing. While no assurances can be given as to the
outcome of the SEC's investigation, the Company does not believe such outcome
will have a material adverse effect on the Company's financial condition or
results of operations.
On January 12, 1994, the Company was served with a suit brought by one of
its shareholders who opted out of the Company's settlement of the class action
litigation settled during 1993. The suit, Dinesh Shah v. Royce Laboratories,
Inc. and Chatfield Dean & Co., Inc., 94 CIV 0061 (S.D. N.Y.) which has also been
brought against one of the underwriters of the Company's January 1992 public
offering, alleges that the Company's January 9, 1992 prospectus was false and
misleading. The suit seeks rescissory damages for violations of Section 11 of
the Securities Act of 1933 in the amount of approximately $40,000 plus interest.
The Company is vigorously defending this suit and believes it has a meritorious
defense. No assurances can be given as to the outcome of this matter.
On August 4, 1995, the Company was sued by Bristol-Myers Squibb Company,
Inc. and E.R. Squibb & Sons, Inc. (collectively, "Bristol-Myers") in the
Southern District of Florida with respect to Captopril (Case No.
95-1682-CIV-Davis).
In March 1995, the Company received a tentative approval of its ANDA for
Captopril, the Company's generic equivalent to Bristol-Myers' anti-hypertensive
drug Capoten(R). Under the General Agreement on Tariffs and Trade ("GATT")
treaty implementing legislation, patent protection for Capoten(R) was extended
from August 8, 1995 until February 13, 1996. The Company asserted, in a
certification (the "Certification") filed with the FDA, that under GATT, the
Company should have the right to market Captopril after August 8, 1995, subject
to the Company's possible obligation to pay "equitable remuneration" to
Bristol-Myers on the Company's sales of Captopril during the period between
August 8, 1995 and February 13, 1996 (the "Delta Period"). Bristol-Myers suit
against the Company was filed based upon the Company's filing of the
Certification.
F-18
<PAGE> 140
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On August 25, 1995, the District Court determined that under the GATT
treaty, the Company's manufacture, use or sale of Captopril during the Delta
Period would not infringe upon Bristol-Myers' patent for Capoten(R). Based upon
this determination, the District Court granted the Company's Emergency Motion to
set aside the statutory injunction which arises automatically upon the filing of
an infringement action. The District Court further dismissed Bristol-Myers'
complaint for patent infringement. However, the District Court denied the
Company's request that the District Court order an immediate effective date of
the Company's ANDA for Captopril.
Bristol-Myers appealed the decision of the District Court and on November
1, 1995, the United States Court of Appeals for the Federal Circuit (the
"Circuit Court") reversed and remanded, with instructions, the decision of the
District Court. The Circuit Court, in its ruling, determined that as a matter of
law, the safe harbor provisions of GATT do not permit the Company to make, use
or sell Captopril prior to February 13, 1996. The Circuit Court further
concluded that as a result of its finding, the statutory bar against FDA
approval of the Company's ANDA for Captopril prior to February 13, 1996 remained
in effect. The Company appealed the Circuit Court's decision to the U.S. Supreme
Court however, the Supreme Court did not grant certiorari and the matter has now
been remanded to the District Court.
While there can be no assurance, the Company does not believe that this
litigation will have a material adverse impact on its financial position or
results of operations.
In the ordinary course of business, the Company is at times involved in
other legal actions and proceedings. Presently, there are no such actions which
are expected to have a significant effect on the Company's operations.
F-19
<PAGE> 141
ROYCE LABORATORIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARES)
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 3,950 $ 2,291
Accounts receivable, net of allowances of $1,740 and $909,
respectively........................................... 3,780 3,466
Inventories............................................... 5,858 4,212
Prepaid expenses and other current assets................. 582 315
-------- --------
Total current assets.............................. 14,170 10,284
Property and equipment, net................................. 3,359 1,732
Other assets................................................ 59 77
-------- --------
$ 17,588 $ 12,093
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,746 $ 2,521
Accrued liabilities....................................... 649 628
Current maturities of long-term debt...................... 386 90
-------- --------
Total current liabilities......................... 2,781 3,239
Long term debt.............................................. 1,053 181
-------- --------
Total liabilities................................. 3,834 3,420
-------- --------
Commitments and contingencies............................... -- --
-------- --------
Stockholders' equity:
Common stock, $.005 par value, 35,000,000 shares
authorized; 13,519,213 and 12,838,466 shares issued,
respectively........................................... 67 64
Additional paid-in capital................................ 30,335 26,471
Accumulated deficit....................................... (16,637) (17,851)
Treasury stock (2,500 shares at cost)..................... (11) (11)
-------- --------
Total stockholders' equity........................ 13,754 8,673
-------- --------
$ 17,588 $ 12,093
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-20
<PAGE> 142
ROYCE LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
1996 1995
---------- -------------
<S> <C> <C>
Net sales................................................... $17,216 $6,522
Cost of goods sold.......................................... 11,200 4,784
---------- ----------
Gross profit................................................ 6,016 1,738
Operating Expenses:
Research and development.................................. 1,252 1,235
Selling, general and administrative....................... 3,633 2,122
---------- ----------
Operating income (loss)..................................... 1,131 (1,619)
---------- ----------
Other income (expense):
Other income.............................................. 162 123
Interest expense.......................................... (47) (17)
---------- ----------
115 106
---------- ----------
Income (loss) before income taxes........................... 1,246 (1,513)
Income taxes................................................ 32 --
---------- ----------
Net income (loss)........................................... $ 1,214 $(1,513)
========== ==========
Per share data:
Earnings (loss) per common and common equivalent share.... $ .09 $ (.12)
========== ==========
Weighted average number of common and common equivalent
shares outstanding........................................ 14,013,366 12,189,873
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-21
<PAGE> 143
ROYCE LABORATORIES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
(IN THOUSANDS EXCEPT SHARES)
(UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
------------------- PAID-IN ACCUMULATED TREASURY STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT STOCK EQUITY
---------- ------ ---------- ----------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995...... 12,838,466 $64 $26,471 $(17,851) $(11) $ 8,673
Issuance of stock -- exercise of
warrants and options............ 680,747 3 3,766 -- -- 3,769
Stock options..................... -- -- 98 -- -- 98
Net income........................ -- -- -- 1,214 -- 1,214
---------- --- ------- -------- ---- -------
Balance at September 30, 1996..... 13,519,213 $67 $30,335 $(16,637) $(11) $13,754
========== === ======= ======== ==== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-22
<PAGE> 144
ROYCE LABORATORIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS EXCEPT IN SUPPLEMENTAL DISCLOSURES)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1996 1995
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................... $ 1,214 $(1,513)
Adjustments to reconcile net income (loss) to net cash
used in operating activities;
Depreciation........................................... 396 207
Option grant to customer............................... 32 --
Changes in operating assets and liabilities:
Increase in accounts receivable........................ (314) (758)
Increase in inventories................................ (1,646) (1,434)
Increase in other current assets....................... (267) (190)
(Increase) decrease in other assets.................... 18 (4)
Decrease in accounts payable........................... (775) (213)
Increase in accrued liabilities........................ 87 76
------- -------
Net cash used in operating activities............. (1,255) (3,829)
------- -------
Cash flows from investing activities:
Acquisition of property and equipment..................... (1,464) (652)
------- -------
Net cash used in investing activities............. (1,464) (652)
------- -------
Cash flows from financing activities:
Proceeds from issuance of long-term debt.................. 743 138
Repayment of long-term debt............................... (134) (39)
Net proceeds from issuance of stock....................... 3,769 4,485
Collection of loans receivable............................ -- 27
------- -------
Net cash provided by financing activities......... 4,378 4,611
------- -------
Net increase in cash and cash equivalents................... 1,659 130
Cash and cash equivalents, beginning of period.............. 2,291 3,323
------- -------
Cash and cash equivalents, end of period.................... $ 3,950 $ 3,453
======= =======
</TABLE>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
During the nine months ended September 30, 1996 and 1995, the Company made
cash payments for interest totaling approximately $50,000 and $16,000,
respectively.
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
During the nine months ended September 30, 1996 and 1995, the Company
incurred $546,000 and $101,000, respectively, in capital lease obligations
for new equipment.
During the nine months ended September 30, 1995, the Company issued 12,017
shares of unregistered common stock in satisfaction of contract
obligations.
The accompanying notes are an integral part of these financial statements.
F-23
<PAGE> 145
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
(UNAUDITED)
NOTE 1. OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
I. INTERIM FINANCIAL STATEMENTS
The unaudited financial statements presented herein have been prepared in
accordance with the instructions to Form 10-Q and do not include all of the
information and note disclosures required by generally accepted accounting
principles. These statements should be read in conjunction with the financial
statements and notes thereto included in the Company's Form 10-K for the year
ended December 31, 1995. The accompanying unaudited financial statements have
not been examined by independent certified public accountants in accordance with
generally accepted auditing standards, but in the opinion of management such
financial statements include all adjustments, consisting only of normal
recurring adjustments, that are necessary to present fairly the Company's
financial position and results of operations for the interim periods. The
results of operations for the nine months ended September 30, 1996 may not be
indicative of the results that may be expected for the year ending December 31,
1996.
II. SIGNIFICANT ACCOUNTING POLICIES
(A) Earnings (loss) per common and common equivalent share
Earnings (loss) per common and common equivalent share amounts are computed
by dividing net income (loss) by the weighted average number of shares of common
stock and common stock equivalents outstanding during each of the periods.
Warrants, options and other common stock equivalents have not been included in
the calculation of loss per share for the nine months ended September 30, 1995
because their effect would be anti-dilutive. Primary and fully diluted earnings
per share were the same for the nine months ended September 30, 1996.
(B) Reclassification
Certain amounts in the 1995 financial statements have been reclassified to
conform to the 1996 presentation.
NOTE 2. INVENTORIES
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(UNAUDITED)
<S> <C> <C>
Raw materials............................................... $2,276 $2,439
Work-in-progress............................................ 1,585 783
Finished goods.............................................. 1,997 990
------ ------
$5,858 $4,212
====== ======
</TABLE>
NOTE 3. LONG-TERM DEBT
On August 5, 1996, the Company received $742,500 in net proceeds under a
bank term loan related to purchases of equipment. The term loan is payable in 48
monthly installments of $19,022, consisting of principal and interest, and is
collateralized by a first priority security interest in all of the equipment and
fixtures owned by the Company, except equipment financed under capital leases.
The effective interest rate on the term loan is 10.5%. In connection with this
loan, the Company is required to comply with various covenants, including debt
to equity and interest coverage ratios.
On August 27, 1996, the Company entered into a $546,000 non-cancelable
three-year capital lease agreement for furniture and equipment. The obligation
is payable in monthly installments, consisting of
F-24
<PAGE> 146
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
principal and interest at 10.4% per annum, and is secured by the furniture and
equipment leased. At the end of the original lease term, the Company has the
option to purchase the equipment for 25% of its total cost.
NOTE 4. INCOME TAXES
The Company used approximately $1.5 million of its net operating loss
carryforwards to offset 90% of its taxable income for the nine months ended
September 30, 1996. Accordingly, the Company's net deferred tax asset and its
valuation allowance for such asset were reduced by approximately $550,000 in the
nine months ended September 30, 1996. The provision for income taxes for the
nine months ended September 30, 1996 consists of the Company's estimate of
alternative minimum taxes incurred during the periods.
NOTE 5. CAPITAL STOCK
1995 PRIVATE PLACEMENT WARRANTS
As part of the Company's 1995 private placement, the Company issued 833,333
twelve-month warrants (the "Private Warrants") to purchase one share of common
stock at an exercise price of $6.50 per share until July 20, 1996. The exercise
price of these warrants was reduced from $6.50 to $6.00 during the 60 day period
beginning December 12, 1995. During the nine months ended September 30, 1996,
the Company issued 581,333 shares of its common stock as a result of the
exercise of 581,333 Private Warrants. Net proceeds from the exercise of these
warrants amounted to approximately $3.4 million. The remaining 252,000 Private
Warrants expired on July 20, 1996. The shares of common stock underlying the
Private Warrants were registered for sale by the holders thereof under the
Securities Act of 1933, as amended.
NOTE 6. COMMITMENTS AND CONTINGENCIES
In February 1993, the Securities and Exchange Commission (the "SEC")
initiated a formal investigation into possible violations of the federal
securities laws by the Company and certain of its officers and directors. The
SEC's examination focused on the Company's public disclosure during the period
between July 1991 and April 1992 regarding the status of the Company's
abbreviated new drug applications ("ANDAs") for Piroxicam and Minoxidil and on
sales of securities during this period by certain persons, including certain
Company executive officers and/or directors.
On May 2, 1996, the Company and Patrick J. McEnany, the Company's Chairman
and Chief Executive Officer, entered into a settlement (the "Settlement") with
the SEC resolving the SEC's formal investigation with respect to the Company and
Mr. McEnany, without admitting or denying that a violation of the securities
laws had occurred. As part of the Settlement, the Company and Mr. McEnany
consented to the granting of a civil injunction requiring them to comply with
the federal securities laws in the future. Further, in connection with the
Settlement, Mr. McEnany paid a $25,000 administrative fine, which amount was
reimbursed to Mr. McEnany by the Company under the indemnification provisions of
the Company's Articles of Incorporation and By-Laws. The Company believes that
the Settlement brings to a close the SEC's investigation of the Company and Mr.
McEnany.
In January 1994, the Company was served with a suit brought by one of its
shareholders who opted out of the Company's settlement of the class action
litigation settled during 1993. The suit, Dinesh Shah v. Royce Laboratories,
Inc. and Chatfield Dean & Co., Inc., 94 CIV 0061 (S.D. N.Y.) which was also
brought against one of the underwriters of the Company's January 1992 public
offering, alleged that the Company's January 9, 1992 prospectus was false and
misleading. In August 1996, the Company settled this matter for $25,000 in cash.
On August 4, 1995, the Company was sued by Bristol-Myers Squibb Company,
Inc. and E.R. Squibb & Sons, Inc. (collectively, "Bristol-Myers") in the
Southern District of Florida with respect to Captopril (Case No.
95-1682-CIV-Davis). For information regarding this suit, see Note 10 (IV) (A) of
the Notes to
F-25
<PAGE> 147
ROYCE LABORATORIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Consolidated Financial Statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 1995. In July 1996, this suit was
dismissed without any further liability to the Company.
An agreement in which one of the Company's customers could earn options to
purchase shares of the Company's common stock by meeting certain purchase
targets expired during the second quarter of 1996. The Company believes, and has
been so advised by its legal counsel, that based upon the terms and its
interpretation of the written agreement, the customer did not satisfy the
purchase requirement under the agreement and thus, did not earn the options.
Accordingly, the Company has not recorded any sales allowance relating to these
options. Notwithstanding, the customer may disagree with this interpretation and
no assurance can be given as to the ultimate outcome of any dispute with respect
to this issue. The future resolution of this matter in a manner inconsistent
with the Company's interpretation would result in a charge to earnings at the
time of any such resolution.
In the ordinary course of business, the Company is at times involved in
other legal actions and proceedings. Presently, there are no such actions which
are expected to have a significant effect on the Company's operations.
F-26
<PAGE> 148
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 accompanying consolidated balance sheets and the related consolidated
statements of income, stockholders' equity and of cash flows 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 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.
As described in Notes 1 and 2, on February 27, 1997, the Company merged
with Oclassen Pharmaceuticals, Inc. (Oclassen) in a transaction accounted for as
a pooling of interests. The accompanying supplementary consolidated financial
statements give retroactive effect to the merger of Watson Pharmaceuticals Inc.
with Oclassen.
In our opinion, based upon our audits and the reports of other auditors,
the accompanying supplementary consolidated balance sheets and the related
supplementary consolidated statements of income, stockholders' equity and of
cash flows 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, 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. We did not audit the financial
statements of 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. In addition, we
did not audit the financial statements of Oclassen which statements reflect
total assets of $30,021,000 and $28,041,000 at December 31, 1995 and 1994,
respectively, and total revenues of
F-27
<PAGE> 149
$29,247,000, $28,557,000 and $25,148,000 for the years ended December 31, 1995,
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,
Circa and Oclassen, is based solely on the reports of each of the respective
other auditors. We conducted our audits of the supplementary 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 the other auditors provide a reasonable
basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Costa Mesa, California
February 5, 1996, except as to
Note 13, which is as of
March 4, 1996 and except as to
the pooling of interests with Oclassen
which is as of February 27, 1997
F-28
<PAGE> 150
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 (incorporated
herein and not included separately). 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.
DELOITTE & TOUCHE LLP
/s/ Deloitte & Touche LLP
Pittsburgh, Pennsylvania
February 2, 1996
F-29
<PAGE> 151
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Circa Pharmaceuticals, Inc.
We have audited the accompanying consolidated balance sheet of Circa
Pharmaceuticals, Inc. and Subsidiaries (the "Company") as of December 31, 1994,
and the related consolidated statements of operations, shareholders' equity and
cash flows for each of the two years in the period ended December 31, 1994.
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 constitutes 22% of consolidated total
assets in 1994. In 1994 and 1993, the Company has recorded income from Somerset
of $25,089,000 and $23,787,000, respectively. Those statements were audited by
other auditors whose report has been furnished to us, and our opinion, insofar
as it relates to the amounts included for Somerset, is based solely on the
report of other auditors.
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, based on our audits and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Circa Pharmaceuticals,
Inc. and Subsidiaries as of December 31, 1994 and the consolidated results of
their operations and their cash flows for each of the two years in the period
ended December 31, 1994, in conformity with generally accepted accounting
principles.
As discussed in Notes 1 and 2, the Company changed its method of accounting
for investments in marketable securities effective January 1, 1994.
COOPERS & LYBRAND L.L.P.
/s/ Coopers & Lybrand L.L.P.
Melville, New York
February 7, 1995.
F-30
<PAGE> 152
[LETTERHEAD OF ARTHUR ANDERSEN LLP]
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Oclassen Pharmaceuticals, Inc.:
We have audited the balance sheets of Oclassen Pharmaceuticals, Inc. (a
Delaware corporation) as of December 31, 1994 and 1995, and the related
statements of income, stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1995 (not presented herein). 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, the financial statements referred to above present fairly,
in all material respects, the financial position of Oclassen Pharmaceuticals,
Inc. as of December 31, 1994 and 1995, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1995 in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Oakland, California
February 8, 1996
F-31
<PAGE> 153
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARES)
<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-32
<PAGE> 154
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
Merger expenses (Note 2).................................. 13,939
-------- ------- --------
Total operating expenses.......................... 114,538 81,294 69,974
-------- ------- --------
Operating income............................................ 38,397 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
Gain from (provision for) legal settlements............... 2,299 (6,297)
Partnership loss.......................................... (7,644)
-------- ------- --------
Total other income, net........................... 34,360 33,809 27,626
-------- ------- --------
Income before provision 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-33
<PAGE> 155
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
UNREALIZED
NOTES HOLDING GAIN
COMMON STOCK ADDITIONAL RECEIVABLE (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-34
<PAGE> 156
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)
--------- -------- --------
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-35
<PAGE> 157
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).
Investments are accounted for under the equity method of accounting where the
Company can exert significant influence and ownership does not exceed 50%. All
investments in which the Company holds less than a 20% interest and does not
exert significant influence are accounted for under the cost method of
accounting. Intercompany accounts and transactions have been eliminated.
The Company's wholly-owned subsidiaries include Watson Laboratories, Inc.
("Watson Labs"), Circa, Watson Pharmaceuticals (Asia), Ltd. ("Watson (Asia)"),
and Corona Pharmaceuticals, Inc. (currently inactive). Watson (Asia) was formed
in 1995 to expand the Company's operations into the Asian and Pacific Rim
markets. 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. The Company's investments accounted for under the equity
method include Somerset Pharmaceuticals, Inc. and ANCIRC. The investment in
Andrx Corporation is accounted for under the cost method of accounting. See Note
4 for further discussion of these investments.
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-36
<PAGE> 158
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-37
<PAGE> 159
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 21% of product sales, 10% and 11%
individually. In 1994, one customer accounted for 10% of product sales. 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 9.
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-38
<PAGE> 160
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.
RECENT PRONOUNCEMENTS
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for
Stock-Based Compensation," which established a fair-value-based method of
accounting for stock-based compensation plans and requires additional
disclosures for those companies who elect not to adopt the new method of
accounting. The Company will be required to adopt SFAS 123 in 1996. The
Company's intention is to continue to account for employee stock awards in
accordance with APB Opinion No. 25 and to adopt the disclosure only alternative
as described in SFAS 123. Accordingly, it is expected that this adoption will
not have a material impact on the Company's consolidated financial statements or
results of operations.
In March 1995, the Financial Accounting Standards Board issued SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," (SFAS 121) which requires the Company to review for impairment
of long-lived assets, certain identifiable intangibles and goodwill related to
those assets whenever events or changes in circumstances indicate that the
carrying amount of an asset might not be recoverable. In certain situations, an
impairment loss would be recognized. SFAS 121 will become effective in 1996. The
company has studied the implications of SFAS 121 and, based on its initial
evaluation, does not expect its adoption to have a material impact on the
Company's financial condition or results of operations.
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.
F-39
<PAGE> 161
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. These deferred tax assets resulted
principally from net operating loss carryforwards and tax credit carryforwards
generated by Circa prior to its acquisition by the Company. 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-40
<PAGE> 162
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-41
<PAGE> 163
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-42
<PAGE> 164
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>
American Triumvirate Insurance Company ("ATIC")
Prior to December 21, 1994, the Company had a 50% ownership interest with
another pharmaceutical company in ATIC, a captive insurance company, which
underwrote product liability insurance for Circa, Somerset and the joint venture
partner. The investment was accounted for under the equity method of accounting.
The Company recognized $759,000 and $901,000 as its equity in ATIC's earnings
for the years ended December 31, 1994 and 1993, respectively. On December 21,
1994, the Company sold its 50% interest in ATIC to the other joint venture
partner. The selling price was $8.2 million, which was equal to 50% of ATIC's
shareholders' equity at December 31, 1994. The Company received approximately
$8.0 million in cash and established a receivable for the balance. For financial
reporting purposes, the sale of ATIC did not result in a gain or loss to the
Company.
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.
F-43
<PAGE> 165
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
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.
F-44
<PAGE> 166
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
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>
F-45
<PAGE> 167
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
The NOL carryforwards discussed above were generated by Circa prior to its
acquisition by the Company. Prior to the acquisition, Circa's net deferred tax
assets were fully reserved due to uncertainty of future realization. As a result
of the acquisition of Circa by Watson, the Company determined that such net
deferred tax assets were likely to be realized. See Note 2 for related
discussion.
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.
F-46
<PAGE> 168
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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.
F-47
<PAGE> 169
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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
March 1996 Settlement of United States Department of Justice Inquiry
In July 1995, Circa initiated discussions with the United States Department
of Justice as to the possible resolution of a long-standing 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.
F-48
<PAGE> 170
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1993 and 1994 Legal Settlements and Legal Provisions
In November 1994, Circa settled its litigation with a former president, who
resigned in 1990. Under the terms of the agreement, the former president,
through an escrow agent, sold all of the 528,108 shares of Circa's common stock
owned by him. The proceeds from the sale of a substantial portion of such
shares, after payment of expenses and various taxes, were utilized to settle
Circa's claim that his conduct damaged Circa and also to reimburse Circa for
legal expenses paid on his behalf in past years. Circa recognized a gain on
settlement of $2.3 million.
In 1994, Circa made cash settlement payments aggregating $8.9 million,
which amounts had been provided for in prior years. Such payments related to
civil anti-trust claims settled in 1994 and other claims settled in prior years.
In 1993, Circa settled anti-trust and other matters requiring payments of
$4.8 million. In addition, Circa recorded a gain of $2.5 million related to a
settlement of an action against a former officer and received a refund of $1.1
million from a settlement fund established in 1991. Income from these events was
offset by an increase in the liability for future legal settlements.
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. The Company will consolidate
Joint Venture A and will account for Joint Venture B under the equity method of
accounting.
F-49
<PAGE> 171
SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS
WATSON PHARMACEUTICALS, INC., AND OCLASSEN PHARMACEUTICALS, INC.
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTARY CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1994
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents (Note 1)........................ $ 95,216 $ 74,618
Marketable securities (Note 1)............................ 41,761 50,476
Accounts receivable, net of allowances for doubtful
accounts of $2,135 and $1,346.......................... 28,126 18,970
Royalty receivable (Note 6)............................... 8,205
Inventories (Note 3)...................................... 25,886 20,134
Prepaid expenses and other current assets................. 4,161 4,573
Deferred tax assets (Note 7).............................. 21,115 30,995
-------- --------
Total current assets.............................. 224,470 199,766
Property and equipment, net (Note 3)........................ 71,045 55,302
Investments in joint ventures and other long-term
investments (Note 4)...................................... 49,355 31,824
Other assets................................................ 7,272 3,465
-------- --------
Total assets................................................ $352,142 $290,357
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses (Note 3)............ $ 32,817 $ 25,971
Income taxes payable (Note 7)............................. 2,985
Current portion of long-term debt (Note 5)................ 622 641
-------- --------
Total current liabilities......................... 36,424 26,612
Long-term debt (Note 5)..................................... 3,577 5,058
Deferred partnership liability (Note 6)..................... -- 14,033
Other liabilities........................................... 726 1,679
-------- --------
Total liabilities................................. 40,727 47,382
-------- --------
Mandatorily Redeemable Preferred Stock (Note 8)............. 36,650 33,933
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred stock; no par; 2,500,000 shares authorized; none
outstanding (Note 9)
Preferred Stock, Series A, $0.001 par value; 1,000,000
shares authorized, 500,000 shares issued and
outstanding............................................ 1,000 1,000
Common stock; par value of $.0033; 100,000,000 shares
authorized; 37,016,662 and 36,417,234 shares issued and
outstanding, respectively (Note 9)..................... 123 121
Additional paid-in capital................................ 147,662 133,199
Retained earnings......................................... 126,859 79,059
Unrealized holding gain (loss)............................ 621 (870)
Notes receivable -- common stock.......................... (644) (653)
Unearned compensation -- stock awards (Note 1)............ (856) (2,814)
-------- --------
Total stockholders' equity........................ 274,765 209,042
-------- --------
Total liabilities and stockholders' equity........ $352,142 $290,357
======== ========
</TABLE>
See accompanying Notes to Supplementary Consolidated Financial Statements.
F-50
<PAGE> 172
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTARY CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
1995 1994 1993
--------- --------- ---------
<S> <C> <C> <C>
Revenues:
Product sales............................................. $159,724 $121,703 $ 95,503
Royalty income (Note 6)................................... 22,247 1,209
-------- -------- --------
Total revenues.................................... 181,971 122,912 95,503
-------- -------- --------
Operating expenses:
Cost of revenues (Note 10)................................ 74,274 57,957 47,400
Research and development (Note 10)........................ 22,350 22,565 18,316
Selling, general and administrative (Note 10)............. 31,545 28,070 28,752
Merger expenses (Note 2).................................. 13,939
-------- -------- --------
Total operating expenses.......................... 142,108 108,592 94,468
-------- -------- --------
Operating income............................................ 39,863 14,320 1,035
Other income (expense):
Equity in earnings of joint ventures (Note 4)............. 22,766 24,968 24,688
Investment and other income............................... 12,755 7,768 17,904
Gain from (provision for) legal settlements............... 2,299 (6,297)
Partnership loss.......................................... (7,644)
-------- -------- --------
Total other income, net........................... 35,521 35,035 28,651
-------- -------- --------
Income before provision for income taxes.................... 75,384 49,355 29,686
Provision (benefit) for income taxes (Note 7)............... 24,867 10,853 (21,917)
-------- -------- --------
Net income.................................................. $ 50,517 $ 38,502 $ 51,603
======== ======== ========
Net income available to common stockholders................. $ 47,800 $ 36,585 $ 51,494
======== ======== ========
Per share data:
Earnings per share
-- Primary............................................. $ 1.27 $ 0.98 $ 1.42
======== ======== ========
-- Fully diluted....................................... $ 1.33
========
Weighted average number of common and common equivalent
shares outstanding:
-- Primary............................................. 37,778 37,144 36,132
======== ======== ========
-- Fully diluted....................................... 38,748
========
</TABLE>
See accompanying Notes to Supplementary Consolidated Financial Statements.
F-51
<PAGE> 173
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
SERIES A
CONVERTIBLE UNREALIZED
PREFERRED HOLDING
STOCK COMMON STOCK ADDITIONAL RETAINED RECEIVABLE GAIN (LOSS) ON
--------------- --------------- PAID-IN EARNINGS FROM AVAILABLE-FOR-SALE
SHARES AMOUNT SHARES AMOUNT CAPITAL (DEFICIT) STOCKHOLDERS SECURITIES
------ ------ ------ ------ ---------- --------- ------------ ------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1992......................... 500 1,000 32,333 $ 107 $ 72,935 ($9,020) ($783) $ --
Net proceeds from initial
public offering............ 2,443 8 25,975
Net proceeds from second
public offering............ 1,065 4 28,920
Exercise of
options/warrants........... 410 1 2,098
Net collection of note
receivable from
stockholders............... 2
Tax benefit related to stock
option plan................ 2,285
Common stock issued to
employees.................. 344 1 2,862
Cancellation of common stock
issued to employees........ (411) (1) (2,960)
Amortization of unearned
compensation...............
Repurchases of common stock,
net of issuances........... (10) (107) 113
Elimination of unamortized
deferred compensation...... (246)
Accretion of issuance cost of
mandatorily redeemable
preferred stock............ (109)
Net income................... -- -- 51,603
--- ----- ------ ----- -------- -------- ----- -----
BALANCE AT DECEMBER 31,
1993......................... 500 1,000 36,174 120 131,762 42,474 (668) --
Exercise of
options/warrants........... 224 1 515
Collection of note receivable
from stockholders.......... 40
Tax benefit related to stock
option plan................ 659
Common stock issued to
employees.................. 26 326
Cancellation of common stock
issued to employees........ (6) (100)
Amortization of unearned
compensation...............
Adjustment for unrealized
holding loss on
investment................. (870)
Repurchases of common stock,
net of issuances........... (1) 37 (25)
Accretion of issuance cost of
mandatorily redeemable
preferred stock............ (109)
Cumulative dividends on
mandatorily redeemable
preferred stock............ (1,808)
Net income................... -- -- 38,502
--- ----- ------ ----- -------- -------- ----- -----
<CAPTION>
UNEARNED TOTAL
DEFERRED COMPENSATION STOCKHOLDERS'
COMPENSATION STOCK AWARDS EQUITY
------------ ------------ -------------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31,
1992......................... $(246) $(4,850) $ 59,143
Net proceeds from initial
public offering............ 25,983
Net proceeds from second
public offering............ 28,924
Exercise of
options/warrants........... 2,099
Net collection of note
receivable from
stockholders............... 2
Tax benefit related to stock
option plan................ 2,285
Common stock issued to
employees.................. (2,863) --
Cancellation of common stock
issued to employees........ 2,163 (798)
Amortization of unearned
compensation............... 1,471 1,471
Repurchases of common stock,
net of issuances........... 6
Elimination of unamortized
deferred compensation...... 246 --
Accretion of issuance cost of
mandatorily redeemable
preferred stock............ (109)
Net income................... 51,603
----- ------- --------
BALANCE AT DECEMBER 31,
1993......................... -- (4,079) 170,609
Exercise of
options/warrants........... 516
Collection of note receivable
from stockholders.......... 40
Tax benefit related to stock
option plan................ 659
Common stock issued to
employees.................. 326
Cancellation of common stock
issued to employees........ 80 (20)
Amortization of unearned
compensation............... 1,185 1,185
Adjustment for unrealized
holding loss on
investment................. (870)
Repurchases of common stock,
net of issuances........... 12
Accretion of issuance cost of
mandatorily redeemable
preferred stock............ (109)
Cumulative dividends on
mandatorily redeemable
preferred stock............ (1,808)
Net income................... 38,502
----- ------- --------
</TABLE>
F-52
<PAGE> 174
<TABLE>
<CAPTION>
SERIES A
CONVERTIBLE UNREALIZED
PREFERRED HOLDING
STOCK COMMON STOCK ADDITIONAL RETAINED RECEIVABLE GAIN (LOSS) ON
--------------- --------------- PAID-IN EARNINGS FROM AVAILABLE-FOR-SALE
SHARES AMOUNT SHARES AMOUNT CAPITAL (DEFICIT) STOCKHOLDERS SECURITIES
------ ------ ------ ------ ---------- --------- ------------ ------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1994......................... 500 1,000 36,417 $ 121 $133,199 $79,059 $(653) $ (870)
Exercise of
options/warrants........... 600 2 7,628
Tax benefit related to stock
option plan................ 6,808
Amortization of unearned
compensation...............
Adjustment for unrealized
holding gain on
investment................. 1,491
Repurchases of common stock,
net of issuances........... 27 9
Accretion of issuance cost of
mandatorily redeemable
preferred stock............ (109)
Cumulative dividends on
mandatorily redeemable
preferred stock............ (2,608)
Net income................... -- -- 50,517
--- ----- ------ ----- -------- -------- ----- -----
Balance at December 31,
1995......................... 500 1,000 37,017 $ 123 $147,662 $126,859 $(644) $ 621
=== ===== ====== ===== ======== ======== ===== =====
<CAPTION>
UNEARNED TOTAL
DEFERRED COMPENSATION STOCKHOLDERS'
COMPENSATION STOCK AWARDS EQUITY
------------ ------------ -------------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31,
1994......................... $ -- $(2,814) $209,042
Exercise of
options/warrants........... 7,630
Tax benefit related to stock
option plan................ 6,808
Amortization of unearned
compensation............... 1,958 1,958
Adjustment for unrealized
holding gain on
investment................. 1,491
Repurchases of common stock,
net of issuances........... 36
Accretion of issuance cost of
mandatorily redeemable
preferred stock............ (109)
Cumulative dividends on
mandatorily redeemable
preferred stock............ (2,608)
Net income................... 50,517
----- ------- --------
Balance at December 31,
1995......................... $ -- $ (856) $274,765
===== ======= ========
</TABLE>
See Accompanying Notes to the Supplementary Consolidated Financial Statements
F-53
<PAGE> 175
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTARY 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................................................ $ 50,517 $ 38,502 $ 51,603
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 6,024 4,880 4,008
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 settlement 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...................... (9,574) (7,988) (2,720)
Increase in royalty receivable....................... (8,205) --
Increase in inventories.............................. (6,196) (3,903) (6,798)
(Increase) decrease in prepaid expenses and other
current assets...................................... 47 (152) 983
(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.... 6,810 1,863 11,433
Increase (decrease) in income taxes payable.......... 3,263 -- (360)
Decrease in accrual for legal settlements............ -- (10,881) (5,256)
--------- -------- --------
Total adjustments................................. (12,611) (24,239) (38,774)
--------- -------- --------
Net cash provided by operating activities......... 37,906 14,263 12,829
--------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment....................... (22,922) (21,707) (14,354)
Disposals of property and equipment....................... 1,463 104 4
Purchases of marketable securities........................ (387,280) (19,164) (23,475)
Proceeds from maturities of marketable securities......... 396,725 47,471
Loan to officer........................................... (700)
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)
Purchase of other assets.................................. (2,000) --
Investment (increase) decrease in other joint ventures.... (818) (1,518) 676
Payment to partnership.................................... (8,000)
--------- -------- --------
Net cash provided by (used in) investing
activities...................................... (23,472) 10,347 (28,721)
--------- -------- --------
</TABLE>
See accompanying Notes to Supplementary Consolidated Financial Statements.
F-54
<PAGE> 176
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTARY 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 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................... 7,666 528 2,105
Net collections of notes receivable from stockholders..... 40 2
------- ------- -------
Net cash provided by financing activities......... 6,164 3,630 53,524
------- ------- -------
Net increase in cash and cash equivalents................... 20,598 28,240 37,632
Cash and cash equivalents at beginning of year.............. 74,618 46,378 8,746
------- ------- -------
Cash and cash equivalents at end of year.................... $95,216 $74,618 $46,378
======= ======= =======
Supplemental disclosures of cash flow information:
Cash paid during the periods for:
Interest............................................... $ 446 $ 901 $ 778
Income taxes........................................... $ 6,765 $10,082 $ 6,387
Additional disclosures of non-cash items:
Issuance of common stock for note receivable........... $ 27 $ 37 $ 107
Exchange of inventory for rights to license new
product............................................... $ 445
</TABLE>
See accompanying Notes to Supplementary Consolidated Financial Statements
F-55
<PAGE> 177
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY 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 supplementary consolidated financial statements include
the accounts of the Company and its wholly owned subsidiaries, and have been
retroactively restated to include the accounts of Circa Pharmaceuticals, Inc.
("Circa") that merged with the Company on July 17, 1995 and Oclassen
Pharmaceuticals, Inc. ("Oclassen") that merged with the Company on February 27,
1997 (Note 2).
The supplementary consolidated financial statements will become the
historical consolidated financial statements of the Company and subsidiaries
after consolidated financial statements covering the date of consummation of the
merger are issued.
Investments are accounted for under the equity method of accounting where
the Company can exert significant influence and ownership does not exceed 50%.
All investments in which the Company holds less than 20% interest and does not
exert significant influence are accounted for under the cost method of
accounting. Intercompany accounts and transactions have been eliminated.
The Company's wholly owned subsidiaries include Watson Laboratories, Inc.
("Watson Labs"), Circa, Watson Pharmaceuticals (Asia) Ltd. (Note 13), Corona
Pharmaceuticals, Inc. (currently inactive) and Oclassen. Watson (Asia) was
formed in 1995 to expand the Company's operations into the Asian and Pacific Rim
markets. 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. The Company's investments accounted for under the equity
method include Somerset Pharmaceuticals, Inc. and ANCIRC. The investment in
Andrx Corporation is accounted for under the cost method of accounting. See Note
4 for further discussion of these investments.
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-56
<PAGE> 178
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY 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.................... $ 50,054 $463 $ (54) $ 50,463
State-issued securities..................... 4,400 4,400
Corporate bonds............................. 11,854 232 12,086
Commercial paper............................ 46,197 (48) 46,149
Equity securities............................. 6,624 28 6,652
Money market funds............................ 17,227 17,227
-------- ---- ----- --------
$136,356 $723 $(102) $136,977
======== ==== ===== ========
</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.................... $ 66,471 $(2,610) $ 63,861
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............................ 28,422 28,422
-------- ------ ------- --------
$125,964 $2,573 $(3,443) $125,094
======== ====== ======= ========
</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 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-57
<PAGE> 179
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY 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 December 1996.
REVENUE RECOGNITION
Revenues from product sales are recognized upon shipment and are net of
returns and adjustments. 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 21% of product sales, 10% and 11%
individually. In 1994, one customer accounted for 10% of product sales. 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 primary earnings per share is based on the weighted
average number of common and common equivalent shares outstanding. Common
equivalent shares include the dilutive effect of the assumed exercise of all
outstanding stock options and warrants, described in Note 9, using the treasury
stock method. Fully diluted earnings per share assumes the conversion of
convertible preferred stock (Notes 8 and 9), if dilutive, as well as the
dilutive effects of stock options and warrants using the treasury stock method.
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.
F-58
<PAGE> 180
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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.
RECENT PRONOUNCEMENTS
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for
Stock-Based Compensation," which established a fair value-based method of
accounting for stock-based compensation plans and requires additional
disclosures for those companies who elect not to adopt the new method of
accounting. The Company will be required to adopt SFAS 123 in 1996. The
Company's intention is to continue to account for employee stock awards in
accordance with APB Opinion No. 25 and to adopt the disclosure only alternative
as described in SFAS 123. Accordingly, it is expected that this adoption will
not have a material impact on the Company's consolidated financial statements or
results of operations.
In March 1995, the Financial Accounting Standards Board issued SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," which requires the Company to review for impairment of
long-lived assets, certain identifiable intangibles and goodwill related to
those assets whenever events or changes in circumstances indicate that the
carrying amount of an asset might not be recoverable. In certain situations, an
impairment loss would be recognized. SFAS 121 will become effective in 1996. The
company has studied the implications of SFAS 121 and, based on its initial
evaluation, does not expect its adoption to have a material impact on the
Company's financial condition or results of operations.
2. MERGERS
MERGER WITH CIRCA
On July 17, 1995, the stockholders of the Company and Circa approved a
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.
F-59
<PAGE> 181
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. These deferred tax assets resulted
principally from net operating loss carryforwards and tax credit carryforwards
generated by Circa prior to its acquisition by the Company. 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.
MERGER WITH OCLASSEN
Effective February 27, 1997, the Company completed a merger with Oclassen,
which resulted in Oclassen becoming a wholly owned subsidiary of the Company.
Oclassen, founded in 1985, develops and markets specialty pharmaceuticals for
the prevention, diagnosis and treatment of skin diseases. Immediately prior to
the completion of the merger, each holder of Oclassen Preferred Stock, Series A,
B, C, D and E voluntarily converted each share of Oclassen Preferred Stock into
one share of Oclassen common stock. Subsequent to the conversion of preferred
shares to common shares, under the terms of the merger agreement, the holders of
Oclassen common stock received 0.37 of a share of the Company's common stock for
each share of Oclassen common stock. Accordingly, to effectuate the merger, the
Company issued approximately 3.3 million shares of the Company's common stock
for all of the outstanding common shares of Oclassen.
The merger qualifies as a tax free reorganization and was accounted for as
a pooling-of-interests. These supplementary consolidated financial statements
have been retroactively restated to include the results of Oclassen for all
periods presented.
F-60
<PAGE> 182
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the combined and separate results of Watson
and Oclassen for the three years in the period ended December 31, 1995. For
purposes of the following table, the results for Watson include the accounts of
Circa.
<TABLE>
<CAPTION>
WATSON OCLASSEN COMBINED
-------- -------- --------
<S> <C> <C> <C>
Year ended December 31, 1995
Total revenues............................................ $152,935 $29,036 $181,971
Equity in earnings of joint ventures...................... $ 22,766 $ 22,766
Net income................................................ $ 47,890 $ 2,627 $ 50,517
Year ended December 31, 1994
Total revenues............................................ $ 94,858 $28,054 $122,912
Equity in earnings of joint ventures...................... $ 24,968 $ 24,968
Net income................................................ $ 36,545 $ 1,957 $ 38,502
Year ended December 31, 1993
Total revenues............................................ $ 70,838 $24,665 $ 95,503
Equity in earnings of joint ventures...................... $ 24,688 $ 24,688
Net income................................................ $ 50,417 $ 1,186 $ 51,603
</TABLE>
The combined financial results of the Company and Oclassen presented above
include reclassifications made to conform accounting policies and financial
statement presentation of the two companies. There were no adjustments that
affected net income of the combined company. There were no intercompany
transactions between the two companies.
In connection with the merger, the Company will record a one-time charge of
approximately $8.0 million for merger-related expenses during the quarter ending
March 31, 1997. These expenses include investment banking fees and other costs
related to the consolidation of operations between the two companies.
F-61
<PAGE> 183
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. BALANCE SHEET COMPONENTS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1995 1994
------- -------
(IN THOUSANDS)
<S> <C> <C>
Inventories:
Raw materials............................................. $11,837 $ 8,140
Work-in-process........................................... 5,112 3,264
Finished goods............................................ 8,937 8,730
------- -------
$25,886 $20,134
======= =======
Property and equipment:
Buildings and improvements................................ $22,457 $23,392
Leaseholds improvements................................... 8,340 8,117
Land and land improvements................................ 4,937 5,058
Machinery and equipment................................... 42,658 32,526
Research and laboratory equipment......................... 9,020 7,753
Furniture and fixtures.................................... 3,114 2,801
------- -------
90,526 79,647
Less accumulated depreciation and amortization............ (34,247) (29,432)
------- -------
56,279 50,215
Construction in progress.................................. 14,766 5,087
------- -------
$71,045 $55,302
======= =======
Accounts payable and accrued expenses:
Trade accounts payable.................................... $19,224 $12,310
Reserve for litigation settlement......................... 2,839 3,119
Accrued payroll and benefits.............................. 3,573 2,761
Reserve for sales coupons................................. 1,783
Contract obligations...................................... 2,708 2,919
Other accrued expenses.................................... 2,690.. 4,862
------- -------
$32,817 $25,971
======= =======
</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 its 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-62
<PAGE> 184
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY 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.
F-63
<PAGE> 185
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1994
-------- --------
(IN THOUSANDS)
<S> <C> <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............................................ 363 292
Stockholders' equity......................................... 32,420 25,496
-------- --------
Total liabilities and stockholders' equity......... $ 51,205 $ 55,989
======== ========
</TABLE>
American Triumvirate Insurance Company ('ATIC')
Prior to December 21, 1994, the Company had a 50% ownership interest with
another pharmaceutical company in ATIC, a captive insurance company, which
underwrote product liability insurance for Circa, Somerset and the joint venture
partner. The investment was accounted for under the equity method of accounting.
The Company recognized $759,000 and $901,000 as its equity in ATIC's earnings
for the years ended December 31, 1994 and 1993, respectively. On December 21,
1994, the Company sold its 50% interest in ATIC to the other joint venture
partner. The selling price was $8.2 million, which was equal to 50% of ATIC's
shareholders' equity at December 31, 1994. The company received approximately
$8.0 million in cash and established a receivable for the balance. For financial
reporting purposes, the sale of ATIC did not result in a gain or loss to the
Company.
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.
F-64
<PAGE> 186
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
In addition effective June 6, 1995, Oclassen renewed a secured, $5,000,000
line of credit agreement with a bank. Proceeds from this line of credit may be
used for general working capital purposes and financing product acquisitions.
Borrowings are available on a short-term basis under various market-based
interest rate options. Additionally, the line of credit may be converted to a
three year term loan. Pursuant to the terms of the line of credit, the Company
must comply with certain covenants. As of December 31, 1995, Oclassen was in
compliance with these covenants. The line is renewable on an annual basis. There
were no borrowings during 1995 under the line.
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>
At December 31, 1995, annual maturities of long-term debt consisted 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,
F-65
<PAGE> 187
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. 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. The costs
and profits from the sale of the generic product are to be shared equally by the
partners.
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 $ 4,660
State.................................................. 3,336 2,397 1,020
------- ------- --------
9,959 10,797 5,680
------- ------- --------
Deferred tax provision (benefit):
Federal................................................ 7,622 (592) (25,446)
State.................................................. 478 (11) (4,436)
------- ------- --------
8,100 (603) (29,882)
Exercise of stock options not treated as a reduction of
income tax expense..................................... 6,808 659 2,285
------- ------- --------
$24,867 $10,853 $(21,917)
======= ======= ========
</TABLE>
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.
F-66
<PAGE> 188
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The income tax provision differs from the amount computed by applying the
federal income tax rate to income as follows:
<TABLE>
<CAPTION>
FOR THE 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) (2) (95)
-- --- ---
33% 22% (74)%
== === ===
</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.............. $19,630 $28,301
Difference in accounting for inventory and receivables...... 4,019 2,045
Benefits from tax credits and carryforward credits.......... 4,077 3,968
Difference in depreciation for book and tax purposes........ (4,998) (3,394)
Difference in investment basis for book and tax............. (116) 502
Contract revenue and expense recognition.................... 1,087 1,168
Other....................................................... 3,823 4,171
------- -------
Gross deferred tax assets......................... 27,522 36,761
Deferred tax asset valuation allowance...................... (4,742) (5,766)
------- -------
Net deferred tax assets........................... $22,780 $30,995
======= =======
</TABLE>
Watson had net operating loss ("NOL") carryforwards at December 31, 1995 of
approximately $51.0 million for both federal and New York state income tax
purposes. In the year ended December 31, 1995, Watson 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 Watson'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 NOL
carryforwards were generated by Circa prior to its acquisition by Watson. Prior
to the acquisition, Circa's net deferred tax assets were fully reserved due to
uncertainty of future realization. As a result of the acquisition of Circa by
Watson, Watson determined that such net deferred tax assets were likely to be
realized. See Note 2 for related discussion.
At December 31, 1995, Oclassen had federal and state income tax NOL
carryforwards totaling approximately $3.8 million and $2.3 million,
respectively, which are available to offset future taxable income related to
Oclassen, if any, through 2010 and 2000, respectfully. As a result of the
acquisition of Oclassen in 1997, the amount of NOL carryforward available to
offset taxable income will also be subject to annual limitation.
The Company's NOL carryforwards will begin to expire in 2000. The Company
has approximately $3.0 million in federal qualified research credits which
expire beginning in 2000 and approximately $1.7 million in
F-67
<PAGE> 189
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
federal alternative minimum tax credits which have no expiration date. These
credits are available to directly offset future federal income taxes.
8. MANDATORILY REDEEMABLE PREFERRED STOCK
As discussed in Note 2, in connection with the Company's merger with
Oclassen, the holders of Oclassen's Mandatorily Redeemable Preferred Stock
Series B, C, D and E voluntarily converted each share of preferred stock into
one share of Oclassen common stock and immediately exchanged each outstanding
common share of Oclassen for 0.37 shares of the Company's common stock. As a
condition of the merger and the voluntary conversion of Oclassen Preferred
Stock, referred to above, all accrued and unpaid dividends on shares of Oclassen
Preferred Stock will be forfeited and all preference payments that holders of
Oclassen Preferred Stock would have received upon consummation of the merger
will be forfeited. Undeclared cumulative accrued dividends, inclusive of those
dividends associated with Series A Preferred Stock (Note 9), through December
31, 1995 totaled approximately $4.4 million. The following describes each class
of mandatorily redeemable preferred stock including amounts outstanding as of
December 31, 1995.
SERIES B
Oclassen is authorized to issue 2,889,403 shares, and had issued 1,418,184
shares of Series B Preferred Stock at a price of $2.30 per share before
reduction for issuance costs.
SERIES C
Oclassen is authorized to issue 3,024,748 shares, and had issued 1,422,906
shares of Series C Preferred Stock at a price of $4.36 per share before
reduction for issuance costs.
SERIES D
Oclassen is authorized to issue 7,000,000 shares, and had issued 3,105,888
shares of Series D Preferred Stock at a price of $5.00 per share before
reduction for issuance costs.
SERIES E
Oclassen is authorized to issue, and had issued 625,000 shares of Series E
Preferred Stock at a price of $12.00 per share before reduction for issuance
costs.
The rights of the preferred stockholders as to dividends, redemption,
liquidation and conversion are defined by Oclassen's Certificate of
Incorporation and are summarized as follows:
The shares of Series B, C, D and E Preferred Stock had liquidation
preferences which equal the sum of the original issue price plus any unpaid
cumulative dividends, whether or not declared. The priority of liquidation and
dividend preferences is first Series E, Series D, Series C and Series B
Preferred Stock as a group, then Series A Preferred Stock and then Common Stock
to the extent of book value per share, after which preferred and common
stockholders share ratably. The priority of liquidation in a merger, acquisition
or sale of substantially all of the Company's assets is as above except that
after the Series A preference, common stockholders share equally with preferred
stockholders on an "as if converted to common" basis. Dividends of $0.96, $0.40,
$0.35, $0.18 and $0.20 per share are payable to Series E, Series D, Series C,
Series B and Series A Preferred Stockholders, respectively, in preference to any
dividend distributions to common stockholders. The Series E, Series D, Series C
and Series B preferred stock dividends are noncumulative through April 22, 1994,
and are cumulative thereafter. These amounts through December 31, 1995 totaled
$4.4 million and are included in the accompanying balance sheets in mandatorily
redeemable preferred stock. No dividends have been declared through December 31,
1995.
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS
Net income available to common stockholders represents net income as
adjusted to reflect accrued dividends and the accretion of issuance costs
related to mandatorily redeemable Preferred Stock.
F-68
<PAGE> 190
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. 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.
Oclassen is authorized to issue 1 million shares and has issued 500,000
shares of Series A Preferred Stock at a price of $2.00 per share. As discussed
in Note 2, in connection with Watson's acquisition of Oclassen, these shares
were voluntarily converted into Oclassen common stock and immediately thereafter
exchanged, pursuant to the exchange ratio defined in the merger agreement, for
184,850 shares of Watson Common Stock. In addition, Oclassen is authorized to
issue 1 million shares of preferred stock, which is undesignated as to series.
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> <C> <C>
Outstanding at December 31, 1992............................ 1,810,567 $ 0.30 - $40.57
Granted................................................... 508,658 $ 6.69 - $25.00
Exercised................................................. (358,184) $ 0.30 - $11.05
Canceled.................................................. (254,209) $ 5.38 - $40.57
--------- ---------------------
Outstanding at December 31, 1993............................ 1,706,832 $ 2.00 - $30.52
Granted................................................... 910,257 $12.65 - $33.00
Exercised................................................. (41,565) $ 3.67 - $16.50
Canceled.................................................. (185,349) $ 6.69 - $30.52
--------- ---------------------
Outstanding at December 31, 1994............................ 2,390,175 $ 2.00 - $33.00
Granted................................................... 1,776,230 $18.75 - $47.00
Exercised................................................. (581,001) $ 2.00 - $49.05
Canceled.................................................. (99,615) $14.39 - $37.25
--------- ---------------------
Outstanding at December 31, 1995............................ 3,485,789 $ 3.67 - $47.00
Exercisable at December 31, 1995............................ 1,335,199 $ 3.67 - $36.63
========= =====================
</TABLE>
F-69
<PAGE> 191
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
STOCK PURCHASE PLAN
During 1987, Oclassen adopted the 1987 Stock Purchase Plan (the "1987
Purchase Plan") under which it has reserved 469,069 shares, as converted
pursuant to the exchange ratio defined in the merger agreement with Oclassen, of
Watson's Common Stock for sale to employees, directors and consultants. The
terms of the 1987 Purchase Plan provide that the price of the shares to be
purchased under the 1987 Purchase plan shall be determined by the Company's
Board of Directors, provided that such price shall not be less than fair market
value of the common stock at the date of grant. In the event of voluntary or
involuntary termination of employment, the Company retains the right to
repurchase, for a period of 60 days after such termination, the invested shares
purchased under the 1987 Purchase Plan at the original purchase price. Initial
grants under the 1987 Purchase Plan generally vest at the rate of 25% at the end
of the 12 month period following commencement of employment, with the remaining
balance vesting ratably over the next 36 months. Subsequent grants under the
1987 Purchase Plan generally vest ratably over 48 months following the date of
the grant. At December 31, 1995, there were no remaining shares of common stock
available for issuance under the 1987 Purchase Plan.
NOTES RECEIVABLE FROM STOCKHOLDERS
Notes receivable from stockholders relate to shares issued under the 1987
Purchase Plan, bear interest at rates ranging from 6.25% to 9.0% per annum, and
are generally due the earlier of four years from the date of issuance or the
date of the employee's termination.
10. LICENSE, ROYALTY AND CO-PROMOTION ARRANGEMENTS
The Company has entered into various license and royalty agreements which
provide the Company with certain rights to develop and market products using
certain technological and patent rights covered under the agreements. In
addition, such agreements require the Company to pay royalties on sales and
certain agreements contain requirements for development funding and/or minimum
marketing efforts to maintain exclusivity.
Beginning in 1996, the Company became obligated for minimum purchase
commitments of raw materials for one of its product lines. The commitment is for
approximately $690,000 annually through 2001.
In August, 1993, the Company terminated an agreement for the co-promotion
of one of its products. The termination agreement provided for a termination
payment of $1.2 million to be paid by the Company in eight equal quarterly
installments of $150,000 through July 1, 1995. The termination payment was
charged to expense upon signing of the termination agreement. The termination
agreement also includes a noncompete provision which expired July 1, 1995.
During August 1992, the Company entered into development and marketing
agreements with another company (the "Licensee") concerning the use of an oral
formulation of FIAU for the treatment of hepatitis-B infections. Under terms of
the agreements, all funding for the worldwide development of oral FIAU for the
treatment of hepatitis-B, would be paid by the Licensee. Additionally, the
Licensee would market any resulting products outside the United States, would
pay development milestone payments to the Company and would pay royalties to the
Company based on sales outside the United States. In connection with the matter
discussed further in Note 12, all activity related to these agreements has
ceased. Contract obligations and reserves of approximately $2.7 million, net of
any contractual and legal obligations, will be relieved upon the resolution of
any uncertainties related to the agreements or their termination.
F-70
<PAGE> 192
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During February 1995, the Company in connection with renegotiating one of
its license and supply agreements, acquired the Monodox(R) New Drug Application
("NDA") for $2.0 million and recorded the purchase as an intangible asset. The
Monodox(R) NDA is being amortized over a six-year period. In addition to the
NDA, the Company received various product cost reductions. The term of the new
supply agreement is through February 1, 2000, and shall be automatically renewed
in one-year increments thereafter unless terminated by one of the parties to the
agreement.
11. 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.
In March 1994, Oclassen made a $700,000 loan to its President and Chief
Executive Officer. The loan bears interest at 3.94% per annum, payable monthly,
and is secured by real property and 18,485 shares of the Company's common stock.
The principal is due the earlier of April 1997 or within 180 days of the sale of
the real property securing the loan. Principal and interest receivable are
$702,000 at December 31, 1995, and are recorded in prepaid expenses and other
current assets in the accompanying balance sheets.
Rent paid to related parties is summarized as follows:
<TABLE>
<CAPTION>
YEAR 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>
F-71
<PAGE> 193
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. 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 $1.5 million, $1.9 million and $1.9 million for the years
ended December 31, 1995, 1994 and 1993, respectively.
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........................................................ $1,400
1997........................................................ 1,108
1998........................................................ 905
1999........................................................ 716
2000........................................................ 692
------
Total minimum lease payments...................... $4,821
======
</TABLE>
LEGAL MATTERS
In July 1995, Circa initiated discussions with the United States Department
of Justice as to the possible resolution of a long-standing 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.
In November 1994, Circa settled its litigation with a former president, who
resigned in 1990. Under the terms of the agreement, the former president,
through an escrow agent, sold all of the 528,108 shares of Circa's common stock
owned by him. The proceeds from the sale of a substantial portion of such
shares, after payment of expenses and various taxes, were utilized to settle
Circa's claim that his conduct damaged Circa and also to reimburse Circa for
legal expenses paid on his behalf in past years. Circa recognized a gain on
settlement of $2.3 million. In 1994, Circa made cash settlement payments
aggregating $8.9 million, which amounts had been provided for in prior years.
Such payments related to civil anti-trust claims settled in 1994 and other
claims settled in prior years.
In 1993, Circa settled anti-trust and other matters requiring payments of
$4.8 million. In addition, Circa recorded a gain of $2.5 million related to a
settlement of an action against a former officer and received a refund of $1.1
million from a settlement fund established in 1991. Income from these events was
offset by an increase in the liability for future legal settlements.
During 1993, clinical trials involving a compound that was licensed to
another company in 1992 were halted as a result of serious adverse events. The
potential exists for product liability claims against Oclassen, and several
claims have been filed through December 31, 1995. At this time, the financial
obligation related to this matter remains uncertain. However, the Company
believes, based on the opinion of outside counsel, that the outcome of this
matter will not have a material adverse effect on the Company's financial
position or results of operations.
F-72
<PAGE> 194
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
13. 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. The Company will consolidate
Joint Venture A and will account for Joint Venture B under the equity method of
accounting.
F-73
<PAGE> 195
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $112,111 $ 92,214
Marketable securities..................................... 71,308 26,038
Accounts receivable, net of allowances for doubtful
accounts of $1,856 and $1,320.......................... 25,721 25,081
Royalty receivable........................................ 7,255 8,205
Inventories:
Raw materials.......................................... 11,780 11,483
Work-in-process........................................ 6,413 5,112
Finished goods......................................... 8,110 6,042
Prepaid expenses and other current assets................. 2,805 2,344
Current deferred tax assets............................... 11,106 21,115
-------- --------
Total current assets.............................. 256,609 197,634
Property and equipment, net................................. 73,010 69,999
Investments in joint ventures and other long-term
investments............................................... 60,148 49,355
Other assets................................................ 5,427 5,133
-------- --------
Total assets...................................... $395,194 $322,121
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses..................... $ 24,320 $ 25,215
Income taxes payable...................................... 9,984 2,985
Current portion of long-term debt......................... 621 622
-------- --------
Total current liabilities......................... 34,925 28,822
Long-term debt.............................................. 3,116 3,577
Other liabilities........................................... 687
-------- --------
Total liabilities................................. 38,041 33,086
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock; no par; 2,500,000 shares authorized; none
outstanding Common stock; par value of $.0033;
500,000,000 shares authorized; 36,804,371 and
36,368,725 shares issued and outstanding............... 121 120
Additional paid-in capital................................ 155,031 146,439
Retained earnings......................................... 196,328 142,711
Unrealized holding gain on marketable securities.......... 5,813 621
Unearned compensation-stock awards........................ (140) (856)
-------- --------
Total stockholders' equity........................ 357,153 289,035
-------- --------
Total liabilities and stockholders' equity........ $395,194 $322,121
======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-74
<PAGE> 196
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1996 1995
-------- --------
<S> <C> <C>
Revenues:
Product sales............................................. $122,155 $ 93,626
Royalty income............................................ 19,862 16,013
-------- --------
Total revenues.................................... 142,017 109,639
-------- --------
Operating expenses:
Cost of revenues.......................................... 56,842 47,005
Research and development.................................. 12,467 13,922
Selling, general and administrative....................... 13,371 12,528
Merger expenses........................................... -- 13,939
-------- --------
Total operating expenses.......................... 82,680 87,394
-------- --------
Operating income (loss)..................................... 59,337 22,245
Other income (expense):
Equity in earnings of joint ventures...................... 14,156 15,857
Investment and other income............................... 5,844 4,067
Gain on sale of Marsam stock.............................. -- 6,126
-------- --------
Other income, net................................. 20,000 26,050
-------- --------
Income before provision for income taxes.................... 79,337 48,295
Provision for income taxes.................................. 25,720 17,284
-------- --------
Net income.................................................. $ 53,617 $ 31,011
======== ========
Per share data:
Earnings per share........................................ $ 1.43 $ 0.84
======== ========
Weighted average number of common and common equivalent
shares outstanding..................................... 37,624 36,987
======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-75
<PAGE> 197
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1996 1995
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 53,617 $ 31,011
--------- ---------
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 4,514 3,892
Provision for doubtful accounts........................... 536 152
Amortization of unearned compensation-stock awards........ 716 1,214
Amortization of deferred income........................... (687) (687)
Equity in earnings of joint ventures...................... (11,415) (14,112)
Dividends received from Somerset.......................... 10,500 13,500
Decrease in deferred partnership liability................ (14,033)
Gain on sale of Marsam stock.............................. (6,126)
Increase in deferred tax liabilities...................... 2,173
Tax benefit related to stock option plan.................. 3,764 1,981
Changes in assets and liabilities:
(Increase) in accounts receivable......................... (1,176) (5,752)
(Increase) decrease in royalty receivable................. 950 (1,976)
(Increase) in inventories................................. (3,666) (3,699)
(Increase) decrease in other current assets............... (461) 286
Decrease in deferred tax assets........................... 10,009 5,939
(Increase) in other assets................................ (294) (2,510)
Increase (decrease) in accounts payable and accrued
expenses............................................... (895) 7,639
Increase in income taxes payable.......................... 6,999 805
--------- ---------
Total adjustments...................................... 19,394 (11,314)
--------- ---------
Net cash provided by operating activities......... 73,011 19,697
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................... (7,526) (14,913)
Purchase of marketable securities......................... (574,661) (254,595)
Proceeds from sale of marketable securities............... 528,561 265,455
Investment in joint ventures.............................. (3,857) (1,000)
Proceeds from sale of Marsam Stock........................ 7,005
--------- ---------
Net cash (used) provided in investing
activities...................................... (57,483) 1,952
--------- ---------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-76
<PAGE> 198
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
1996 1995
-------- -------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options................... 4,830 2,788
Principal payments on long-term debt...................... (461) (533)
-------- -------
Net cash provided by financing activities......... 4,369 2,255
-------- -------
NET INCREASE IN CASH AND CASH EQUIVALENTS................... 19,897 23,904
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............ 92,214 71,165
-------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $112,111 $95,069
======== =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the periods for:
Interest............................................... $ 243 $ 279
Income taxes........................................... $ 4,882 $ 5,673
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-77
<PAGE> 199
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
(UNAUDITED)
NOTE A -- GENERAL
The unaudited, consolidated financial statements as of September 30, 1996
and for the nine months ended September 30, 1996 and 1995, as well as related
notes, should be read in conjunction with the Company's Annual Report on Form
10-K for the year ended December 31, 1995.
In the opinion of management, the accompanying consolidated financial
statements contain all adjustments (consisting of only normal recurring
adjustments), necessary to present fairly the Company's financial position as of
September 30, 1996, and the results of operations for the nine months ended
September 30, 1996 and 1995 and cash flows for the nine months ended September
30, 1996 and 1995. The results of operations and cash flows for the nine months
ended September 30, 1996 are not necessarily indicative of the results of
operations or cash flows which may be reported for the remainder of 1996. The
accounting policies followed during the nine months ended September 30, 1996
were the same as those disclosed in the Company's Annual Report on Form 10-K for
the year ended December 31, 1995.
NOTE B -- MERGER AGREEMENT
On September 25, 1996, the Company entered into a definitive merger
agreement with Oclassen Pharmaceuticals, Inc. ("Oclassen"). The merger is a
stock-for-stock transaction, expected to be accounted for as a "pooling of
interests" in which Oclassen will become a wholly-owned subsidiary of the
Company. Oclassen is a privately held company which primarily markets
dermatology related pharmaceutical products.
Under the terms of the merger agreement signed by both companies, Oclassen
stockholders will receive common shares of Watson valued at approximately $135.0
million. The actual number of Watson common shares to be issued will be based on
the average of the Watson closing price for the 10 days prior to the Oclassen
stockholder meeting, subject to a "collar" of $27.00 to $35.00 per share. Under
the proposed agreement, the maximum number of Watson shares to be issued would
be 5.00 million (based on an average closing price of $27.00 per share). The
minimum number of Watson shares to be issued would be 3.86 million (based on an
average closing price of $35.00 per share). The ultimate completion of this
proposed transaction is subject to a number of conditions, including, but not
limited to, the approval of the merger by the stockholders of Oclassen and
receipt of regulatory approvals. It is anticipated that this transaction will
close in early 1997.
NOTE C -- JOINT VENTURES
Somerset Pharmaceuticals, Inc. ("Somerset"). The Company maintains a 50%
interest in the outstanding common stock of Somerset and utilizes the equity
interest 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 $15.7 million for the nine months ended September
30, 1996. Income includes 50% of Somerset's earnings, ongoing management fees
and amortization of deferred income, offset by goodwill. The excess cost of this
investment over the Company's proportionate share of Somerset's net assets was
$8.7 million at September 30, 1996 and $9.4 million at December 31, 1995 and is
being amortized on a straight-line basis over 15 years.
F-78
<PAGE> 200
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Condensed balance sheets and income statements of Somerset are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Current assets.............................................. $47,274 $43,993
Other assets................................................ 18,583 7,127
------- -------
Total assets...................................... $65,857 $51,120
======= =======
Current liabilities......................................... $25,457 $17,057
Other liabilities........................................... 0 63
Stockholders' equity........................................ 40,400 34,000
------- -------
Total liabilities and stockholders' equity........ $65,857 $51,120
======= =======
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
1996 1995
------- -------
<S> <C> <C>
Net revenues................................................ $81,826 $75,450
Costs and expenses.......................................... 39,516 30,582
Income taxes................................................ 14,911 14,500
------- -------
Net income................................................ $27,399 $30,368
======= =======
</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 joint
venture were amended whereby the Company and Andrx became equal partners in
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 $1.4 million for the nine months ended
September 30, 1996.
Condensed balance sheets and income statements of ANCIRC are as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Cash........................................................ $518 $ 85
Other assets................................................ 26 0
---- -------
Total assets...................................... $544 $ 85
==== =======
Current liabilities......................................... $612 $ 1,285
Partners' deficit........................................... (68) (1,200)
---- -------
Total liabilities and partners' deficit........... $544 $ 85
==== =======
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
1996 1995
------- -------
<S> <C> <C>
Research & development expenses............................. $ 2,776 $ 2,172
------- -------
Net loss.................................................... $(2,768) $(2,163)
======= =======
</TABLE>
F-79
<PAGE> 201
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTARY CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $117,492 $ 95,216
Marketable securities..................................... 86,299 41,761
Accounts receivable, net of allowance for doubtful
accounts of $3,002 and $2,135.......................... 28,854 28,126
Royalty receivable........................................ 7,255 8,205
Inventories:
Raw materials.......................................... 12,335 11,837
Work-in-process........................................ 6,413 5,112
Finished goods......................................... 11,472 8,937
Prepaid expenses and other current assets................. 5,381 4,161
Current deferred tax assets............................... 11,106 21,115
-------- --------
Total current assets.............................. 286,607 224,470
Property and equipment, net................................. 74,170 71,045
Investments in joint ventures and other long-term
investments............................................... 60,148 49,355
Other assets................................................ 7,279 7,272
-------- --------
Total assets...................................... $428,204 $352,142
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses..................... $ 32,024 $ 32,817
Income taxes payable...................................... 9,984 2,985
Current portion of long-term debt......................... 621 622
-------- --------
Total current liabilities......................... 42,629 36,424
Long-term debt.............................................. 3,116 3,577
Other liabilities........................................... 12 726
-------- --------
Total liabilities................................. 45,757 40,727
-------- --------
Mandatorily Redeemable Preferred Stock...................... 38,688 36,650
Commitments and contingencies
Stockholders' equity:
Preferred Stock; no par; 2,500,000 shares authorized; none
outstanding............................................
Preferred Stock; Series A; $0.001 par value; 1,000,000
shares authorized, 500,000 shares issued and
outstanding............................................ 1,000 1,000
Common stock; par value of $.0033; 500,000,000 shares
authorized; 37,489,508 and 37,016,662 shares issued and
outstanding............................................ 125 123
Additional paid-in capital................................ 156,469 147,662
Retained earnings......................................... 181,198 126,859
Unrealized holding gain on marketable securities.......... 5,813 621
Notes receivable -- common stock.......................... (706) (644)
Unearned compensation -- stock awards..................... (140) (856)
-------- --------
Total stockholders' equity........................ 343,759 274,765
-------- --------
Total liabilities and stockholders' equity........ $428,204 $352,142
======== ========
</TABLE>
See accompanying Notes to Supplementary Consolidated Financial Statements.
F-80
<PAGE> 202
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTARY CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1996 1995
-------- --------
<S> <C> <C>
Revenues:
Product sales............................................. $146,431 $114,821
Royalty income............................................ 19,862 16,013
-------- --------
Total revenues.................................... 166,293 130,834
-------- --------
Operating expenses:
Cost of revenues.......................................... 63,941 53,836
Research and development.................................. 16,021 16,926
Selling, general and administrative....................... 25,037 22,963
Merger expenses........................................... 13,939
-------- --------
Total operating expenses.......................... 104,999 107,664
-------- --------
Operating income............................................ 61,294 23,170
Other income:
Equity in earnings of joint ventures...................... 14,156 15,857
Investment and other income............................... 6,707 4,942
Gain on sale of Marsam stock.............................. 6,126
-------- --------
Other income, net................................. 20,863 26,925
-------- --------
Income before provision for income taxes.................... 82,157 50,095
Provision for income taxes.................................. 25,780 17,284
-------- --------
Net income.................................................. $ 56,377 $ 32,811
======== ========
Net income available to common stockholders................. $ 54,339 $ 30,773
======== ========
Per share data:
Earnings per share
-- Primary............................................. $ 1.41 $ 0.82
======== ========
-- Fully diluted....................................... $ 1.36
========
Weighted average number of common and common equivalent
shares outstanding
-- Primary............................................. 38,519 37,621
======== ========
-- Fully diluted....................................... 41,339
========
</TABLE>
See accompanying Notes to Supplementary Consolidated Financial Statements.
F-81
<PAGE> 203
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTARY CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1996 1995
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 56,377 $ 32,811
--------- ---------
Adjustments to reconcile net income to net cash provided by
operating activities
Depreciation and amortization............................. 5,198 4,464
Amortization of unearned compensation-stock awards........ 716 1,214
Amortization of deferred income and bond premium.......... (687) (687)
Decrease in deferred partnership liability................ (14,033)
Dividends received from Somerset.......................... 10,500 13,500
Equity in earnings of joint ventures...................... (11,415) (14,112)
Gain on sale of Marsam stock.............................. (6,126)
Provision for doubtful accounts........................... 536 152
Tax benefit related to stock option plan.................. 3,764 1,981
Changes in assets and liabilities:
Increase in accounts receivable........................... (1,264) (5,905)
(Increase) decrease in royalty receivable................. 950 (1,976)
Increase in inventories................................... (4,334) (3,336)
Increase in prepaid expenses & other current assets....... (1,420) (201)
Decrease in deferred tax assets........................... 10,009 8,112
Increase in other assets.................................. (294) (2,510)
Increase (decrease) in accounts payable and accrued
expenses............................................... (820) 6,164
Increase in income taxes payable.......................... 6,999 805
--------- ---------
Total adjustments...................................... 18,438 (12,494)
--------- ---------
Net cash provided by operating activities......... 74,815 20,317
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment....................... (8,037) (15,213)
Purchase of marketable securities......................... (574,661) (253,966)
Proceeds from maturities of marketable securities......... 529,293 265,455
Proceeds from sale of Marsam stock........................ 7,005
Repayment of loan to officer.............................. 200
Investment in Andrx....................................... (1,000)
Purchase of other assets.................................. (2,000)
Increase in investment in other joint ventures............ (3,857)
--------- ---------
Net cash (used) provided in investing
activities...................................... (57,062) 281
--------- ---------
</TABLE>
See accompanying Notes to Supplementary Consolidated Financial Statements.
F-82
<PAGE> 204
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTARY CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1996 1995
-------- -------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on long-term debt...................... $ (461) $ (533)
Proceeds from exercise of stock options................... 4,984 2,907
-------- -------
Net cash provided by financing activities......... 4,523 2,374
-------- -------
Net increase in cash and cash equivalents................... 22,276 22,972
Cash and cash equivalents at beginning of period............ 95,216 74,618
-------- -------
Cash and cash equivalents at end of year.................... $117,492 $97,590
======== =======
Supplemental disclosures of cash flow information:
Cash paid during the periods for:
Interest............................................... 243 279
Income taxes........................................... 4,890 5,676
Additional disclosure of non-cash item:
Issuance of common stock for note receivable........... 28 27
</TABLE>
See accompanying Notes to Supplementary Consolidated Financial Statements.
F-83
<PAGE> 205
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
(UNAUDITED)
NOTE A -- GENERAL
The unaudited supplementary consolidated financial statements as of
September 30, 1996 and for the nine months ended September 30, 1996 and 1995, as
well as related notes, should be read in conjunction with the Company's
Supplementary Consolidated Financial Statements as of December 31, 1995 and for
each of the three years in the period ended December 31, 1995 included elsewhere
herein.
In the opinion of management, the accompanying supplementary consolidated
financial statements contain all adjustments (consisting of only normal
recurring adjustments), necessary to present fairly the Company's financial
position as of September 30, 1996, and the results of operations for the nine
months ended September 30, 1996 and 1995 and cash flows for the nine months
ended September 30, 1996 and 1995. The results of operations and cash flows for
the nine months ended September 30, 1996 are not necessarily indicative of the
results of operations or cash flows which may be reported for the remainder of
1996. The accounting policies followed during the nine months ended September
30, 1996 were the same as those disclosed in the Company's supplementary
consolidated financial statements as of December 31, 1995 and for each of the
three years in the period ended December 31, 1995.
NOTE B -- MERGER AGREEMENT
On September 25, 1996, the Company entered into a definitive merger
agreement with Oclassen Pharmaceuticals, Inc. ("Oclassen"). Oclassen is a
privately held company which primarily markets dermatology related
pharmaceutical products. On February 26, 1997, the stockholders of Oclassen
approved the merger which resulted in Oclassen becoming a wholly owned
subsidiary of the Company. The merger became effective on February 27, 1997.
Under the terms of the Oclassen merger agreement, Oclassen stockholders received
0.37 of a share of the Company's common stock for each Oclassen common share.
Accordingly, the Company issued approximately 3.3 million shares of its common
stock for all of the outstanding common shares of Oclassen. The merger qualifies
as a tax-free reorganization and was accounted for as a pooling of interests.
NOTE C -- 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 producer Eldepryl(R), which is used in the treatment of Parkinson's
disease. Income recognized from Somerset was $15.7 million and $17.0 million for
the nine months ended September 30, 1996 and 1995, respectively. Income includes
50% of Somerset's earnings, ongoing management fees and amortization of deferred
income, offset by goodwill. The excess cost of this investment over the
Company's proportionate share of Somerset's net assets was $8.7 million at
September 30, 1996 and $9.4 million at December 31, 1995 and is being amortized
on a straight-line basis over 15 years.
F-84
<PAGE> 206
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Condensed balance sheets and income statements of Somerset are as follows
(in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Current assets............................................ $47,274 $43,993
Other assets.............................................. 18,583 7,127
------- -------
Total assets.................................... $65,857 $51,120
======= =======
Current liabilities....................................... $25,457 $17,057
Other liabilities......................................... -- 63
Stockholders' equity...................................... 40,400 34,000
------- -------
Total liabilities and stockholders' equity...... $65,857 $51,120
======= =======
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1996 1995
------- -------
<S> <C> <C>
Net revenues................................................ $81,826 $75,450
Costs and expenses.......................................... 39,516 30,582
Income taxes................................................ 14,911 14,500
------- -------
Net income.................................................. $27,399 $30,368
======= =======
</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 joint venture were
amended whereby the Company and Andrx became equal partners in 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 $1.4 million and $0.9 million for the nine months ended September
30, 1996 and 1995, respectively.
Condensed balance sheets and income statements of ANCIRC are as follows (in
thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Cash...................................................... $518 $ 85
Other assets.............................................. 26
---- -------
Total assets.................................... $544 $ 85
==== =======
Current liabilities....................................... $612 $ 1,285
Partners' deficit......................................... (68) (1,200)
---- -------
Total liabilities and stockholders' equity...... $544 $ 85
==== =======
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1996 1995
------- -------
<S> <C> <C>
Research & development expenses............................. $ 2,776 $ 2,172
------- -------
Net loss.................................................... $(2,768) $(2,163)
======= =======
</TABLE>
F-85
<PAGE> 207
UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL STATEMENTS
WATSON PHARMACEUTICALS, INC., OCLASSEN PHARMACEUTICALS, INC.,
AND ROYCE LABORATORIES, INC.
The following Unaudited Pro Forma Condensed Combined Financial Statements
include the accounts of Watson, Oclassen and Royce. On February 27, 1997, Watson
completed its merger with Oclassen in a transaction accounted for as a pooling
of interests. Watson's transaction with Royce is planned to be accounted for
under the pooling of interests method of accounting. Accordingly, Watson's
consolidated financial statements have been retroactively adjusted as if Watson,
Royce and Oclassen had operated as one entity since inception.
The following Unaudited Pro Forma Condensed Combined Balance Sheet presents
the pro forma combined financial position of Watson as of September 30, 1996 as
if the pending acquisition of Royce and the merger with Oclassen had been
consummated as of September 30, 1996.
The following Unaudited Pro Forma Condensed Combined Statements of
Operations for the nine months ended September 30, 1996 and the years ended
December 31, 1995, 1994 and 1993 present the pro forma results of the combined
company as if Watson's acquisition of Oclassen and pending acquisition of Royce
had been consummated as of January 1, 1993.
The unaudited pro forma earnings per common and common equivalent share
include the weighted average number of common shares and common share
equivalents outstanding of Watson and Royce and Oclassen (based on the
respective merger share exchange ratios). Common share equivalents include,
where appropriate, the assumed exercise of conversion of warrants and options.
In computing the unaudited pro forma earnings per common and common equivalent
share, Watson utilizes the treasury stock method.
These Unaudited Pro Forma Condensed Combined Financial Statements and notes
thereto should be read in conjunction with the respective historical
consolidated financial statements and notes thereto of each Watson, Royce and
Oclassen and the Supplementary Consolidated Financial Statements of Watson which
are included elsewhere herein. The supplementary financial information of
Watson, which retroactively reflects Watson's acquisition of Oclassen, has been
derived from Watson's Supplementary Consolidated Financial Statements, and notes
thereto, included elsewhere herein and should be read in conjunction with the
Watson/Oclassen S-4, the historical audited financial statements of Oclassen,
the Risk Factors associated with the Merger of Watson and Oclassen, and
Oclassen's Management's Discussion included in the Watson/Oclassen S-4. The pro
forma condensed combined results of operations do not necessarily reflect actual
results which would have occurred if the acquisitions had taken place on the
assumed dates, nor are they necessarily indicative of the results of future
combined operations.
F-86
<PAGE> 208
WATSON/OCLASSEN/ROYCE
UNAUDITED PRO FORMA
CONDENSED COMBINED STATEMENT OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA COMBINED
SUPPLEMENTARY WATSON/
WATSON/ OCLASSEN/
WATSON OCLASSEN OCLASSEN ROYCE ROYCE
-------- -------- ------------- ------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
Product sales, net........................................ $122,155 $24,276 $146,431 $17,216 $163,647
Royalty income............................................ 19,862 -- 19,862 -- 19,862
-------- ------- -------- ------- --------
Total revenues...................................... 142,017 24,276 166,293 17,216 183,509
-------- ------- -------- ------- --------
Operating expenses:
Cost of revenues.......................................... 56,842 7,099 63,941 11,200 75,141
Research and development.................................. 12,467 3,554 16,021 1,252 17,273
Selling, general and administrative....................... 13,371 11,666 25,037 3,633 28,670
-------- ------- -------- ------- --------
Total operating expenses............................ 82,680 22,319 104,999 16,085 121,084
-------- ------- -------- ------- --------
Operating income............................................ 59,337 1,957 61,294 1,131 62,425
-------- ------- -------- ------- --------
Other income:
Equity in earnings of joint ventures...................... 14,156 -- 14,156 -- 14,156
Investment and other income............................... 5,844 863 6,707 115 6,822
-------- ------- -------- ------- --------
Total other income.................................. 20,000 863 20,863 115 20,978
-------- ------- -------- ------- --------
Income before provision for income taxes.................... 79,337 2,820 82,157 1,246 83,403
Provision for income taxes.................................. 25,720 60 25,780 32 25,812
-------- ------- -------- ------- --------
Net income.......................................... $ 53,617 $ 2,760 $ 56,377 $ 1,214 $ 57,591
======== ======= ======== ======= ========
Per share data:
Earnings per share:
Primary................................................. $ 1.43 $ 0.30 $ 1.41 $ 0.09 $ 1.36
======== ======= ======== ======= ========
Fully diluted $ 0.27 $ 1.36 $ 1.32
======= ======== ========
Weighted average number of common and common equivalent
shares outstanding:
Primary................................................. 37,624 2,424 38,519 14,013 40,931
======== ======= ======== ======= ========
Fully diluted 10,063 41,339 43,751
======= ======== ========
</TABLE>
See accompanying notes
to the unaudited pro forma condensed combined financial statements.
F-87
<PAGE> 209
WATSON/OCLASSEN/ROYCE
UNAUDITED PRO FORMA
CONDENSED COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1995
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA COMBINED
SUPPLEMENTARY WATSON/
WATSON/ OCLASSEN/
WATSON OCLASSEN OCLASSEN ROYCE ROYCE
-------- -------- ------------- ------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
Product sales, net........................................ $130,688 $29,036 $159,724 $10,503 $170,227
Royalty income............................................ 22,247 -- 22,247 -- 22,247
-------- ------- -------- ------- --------
Total revenues...................................... 152,935 29,036 181,971 10,503 192,474
-------- ------- -------- ------- --------
Operating expenses:
Cost of revenues.......................................... 64,996 9,278 74,274 7,143 81,417
Research and development.................................. 18,573 3,777 22,350 2,212 24,562
Selling, general and administrative....................... 17,030 14,515 31,545 3,634 35,179
Merger expenses........................................... 13,939 -- 13,939 -- 13,939
-------- ------- -------- ------- --------
Total operating expenses............................ 114,538 27,570 142,108 12,989 155,097
-------- ------- -------- ------- --------
Operating income (loss)..................................... 38,397 1,466 39,863 (2,486) 37,377
-------- ------- -------- ------- --------
Other income:
Equity in earnings of joint ventures...................... 22,766 -- 22,766 -- 22,766
Investment and other income............................... 11,594 1,161 12,755 150 12,905
-------- ------- -------- ------- --------
Total other income.................................. 34,360 1,161 35,521 150 35,671
-------- ------- -------- ------- --------
Income (loss) before provision for income taxes............. 72,757 2,627 75,384 (2,336) 73,048
Provision for income taxes.................................. 24,867 -- 24,867 -- 24,867
-------- ------- -------- ------- --------
Net income (loss)................................... $ 47,890 $ 2,627 $ 50,517 $(2,336) $ 48,181
======== ======= ======== ======= ========
Per share data:
Earnings (loss) per share................................. $ 1.29 $ (0.05) $ 1.27 $ (0.19) $ 1.14
======== ======= ======== ======= ========
Weighted average number of common and common equivalent
shares outstanding...................................... 37,143 1,719 37,778 12,352 39,910
======== ======= ======== ======= ========
</TABLE>
See accompanying notes
to the unaudited pro forma condensed combined financial statements.
F-88
<PAGE> 210
WATSON/OCLASSEN/ROYCE
UNAUDITED PRO FORMA
CONDENSED COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1994
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA COMBINED
SUPPLEMENTARY WATSON/
WATSON/ OCLASSEN/
WATSON OCLASSEN OCLASSEN ROYCE ROYCE
------- -------- ------------- ------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
Product sales, net........................................ $93,649 $28,054 $121,703 $ 6,191 $127,894
Royalty income............................................ 1,209 -- 1,209 -- 1,209
------- ------- -------- ------- --------
Total revenues...................................... 94,858 28,054 122,912 6,191 129,103
Operating expenses:
Cost of revenues.......................................... 48,972 8,985 57,957 4,538 62,495
Research and development.................................. 18,980 3,585 22,565 960 23,525
Selling, general and administrative....................... 13,342 14,728 28,070 2,298 30,368
------- ------- -------- ------- --------
Total operating expenses............................ 81,294 27,298 108,592 7,796 116,388
------- ------- -------- ------- --------
Operating income (loss)..................................... 13,564 756 14,320 (1,605) 12,715
------- ------- -------- ------- --------
Other Income:
Equity in earnings of joint ventures...................... 24,968 -- 24,968 -- 24,968
Investment and other income............................... 6,542 1,226 7,768 128 7,896
Gain from legal settlements............................... 2,299 -- 2,299 -- 2,299
------- ------- -------- ------- --------
Total other income.................................. 33,809 1,226 35,035 128 35,163
------- ------- -------- ------- --------
Income (loss) before provision for income taxes............. 47,373 1,982 49,355 (1,477) 47,878
Provision for income taxes.................................. 10,828 25 10,853 -- 10,853
------- ------- -------- ------- --------
Net income (loss)................................... $36,545 $ 1,957 $ 38,502 $(1,477) $ 37,025
======= ======= ======== ======= ========
Per share data:
Earnings (loss) per share................................. $ 1.00 $ 0.02 $ 0.98 $ (0.14) $ 0.90
======= ======= ======== ======= ========
Weighted average number of common and common equivalent
shares outstanding...................................... 36,515 1,705 37,144 10,554 38,966
======= ======= ======== ======= ========
</TABLE>
See accompanying notes
to the unaudited pro forma condensed combined financial statements.
F-89
<PAGE> 211
WATSON/OCLASSEN/ROYCE
UNAUDITED PRO FORMA
CONDENSED COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1993
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA COMBINED
SUPPLEMENTARY WATSON/
WATSON/ OCLASSEN/
WATSON OCLASSEN OCLASSEN ROYCE ROYCE
-------- -------- ------------- ------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
Product sales, net........................................ $ 70,838 $24,665 $ 95,503 $ 3,519 $ 99,022
Royalty income............................................ -- -- -- -- --
-------- ------- -------- ------- --------
Total revenues...................................... 70,838 24,665 95,503 3,519 99,022
-------- ------- -------- ------- --------
Operating expenses:
Cost of revenues.......................................... 39,207 8,193 47,400 3,017 50,417
Write-off of inventory.................................... -- -- -- 768 768
Research and development.................................. 15,085 3,231 18,316 305 18,621
Selling, general and administrative....................... 15,682 12,537 28,219 2,084 30,303
Other..................................................... -- 533 533 -- 533
-------- ------- -------- ------- --------
Total operating expenses............................ 69,974 24,494 94,468 6,174 100,642
-------- ------- -------- ------- --------
Operating income (loss)..................................... 864 171 1,035 (2,655) (1,620)
-------- ------- -------- ------- --------
Other income (expense):
Equity in earnings of joint ventures...................... 24,688 -- 24,688 -- 24,688
Investment and other income............................... 16,879 1,025 17,904 58 17,962
Provision for legal settlements........................... (6,297) -- (6,297) (1,336) (7,633)
Partnership loss.......................................... (7,644) -- (7,644) -- (7,644)
-------- ------- -------- ------- --------
Total other income (expense)........................ 27,626 1,025 28,651 (1,278) 27,373
-------- ------- -------- ------- --------
Income (loss) before provision for income taxes............. 28,490 1,196 29,686 (3,933) 25,753
Provision (benefit) for income taxes........................ (21,927) 10 (21,917) -- (21,917)
-------- ------- -------- ------- --------
Net income (loss)................................... $ 50,417 $ 1,186 $ 51,603 $(3,933) $ 47,670
======== ======= ======== ======= ========
Per share data:
Earnings (loss) per share:
Primary................................................. $ 1.42 $ 0.63 $ 1.42 $ (0.41) $ 1.26
======== ======= ======== ======= ========
Fully diluted........................................... $ 0.13 $ 1.33 $ 1.18
======= ======== ========
Weighted average number of common and common equivalent
shares outstanding:
Primary................................................. 35,504 1,702 36,132 9,493 37,770
======== ======= ======== ======= ========
Fully diluted........................................... 8,787 38,748 40,386
======= ======== ========
</TABLE>
See accompanying notes
to the unaudited pro forma condensed combined financial statements.
F-90
<PAGE> 212
WATSON/OCLASSEN/ROYCE
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
SEPTEMBER 30, 1996
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA COMBINED
SUPPLEMENTARY WATSON/
WATSON/ OCLASSEN/
WATSON OCLASSEN ADJUSTMENTS OCLASSEN ROYCE ADJUSTMENTS ROYCE
-------- -------- ----------- ------------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents.......... $112,111 $ 5,381 $ (8,000) $109,492 $ 3,950 $ (6,500) $106,942
Marketable securities.............. 71,308 14,991 86,299 -- 86,299
Accounts receivable, net........... 25,721 3,133 28,854 3,780 32,634
Royalty receivable................. 7,255 -- 7,255 -- 7,255
Inventories........................ 26,303 3,917 30,220 5,858 36,078
Deferred tax assets................ 11,106 -- 11,106 -- 11,106
Other current assets............... 2,805 2,576 5,381 582 5,963
-------- -------- -------- -------- --------
Total current assets....... 256,609 29,998 278,607 14,170 286,277
Property and equipment, net........ 73,010 1,160 74,170 3,359 77,529
Investments in joint ventures and
other long-term investments...... 60,148 -- 60,148 -- 60,148
Other assets....................... 5,427 1,852 7,279 59 7,338
-------- -------- -------- -------- -------- -------- --------
$395,194 $33,010 $ (8,000) $420,204 $ 17,588 $ (6,500) $431,292
======== ======== ======== ======== ======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accruals...... $ 24,320 $ 5,045 $ 29,365 $ 2,395 $ 31,760
Current portion of long-term
debt............................. 621 -- 621 386 1,007
Contract obligations and reserve... -- 2,659 2,659 -- 2,659
Income taxes payable............... 9,984 -- 9,984 -- 9,984
-------- -------- -------- -------- --------
Total current
liabilities.............. 34,925 7,704 42,629 2,781 45,410
Long-term debt..................... 3,116 -- 3,116 1,053 4,169
Other liabilities.................. -- 12 12 -- 12
-------- -------- -------- -------- --------
Total liabilities.......... 38,041 7,716 45,757 3,834 49,591
-------- -------- -------- -------- --------
Mandatorily redeemable preferred
stock............................ -- 38,688 $(38,688) -- -- --
-------- -------- -------- -------- --------
Preferred stock.................... -- 1,000 (1,000) -- -- --
Common stock....................... 121 1,442 (1,429) 134 67 $ (59) 142
Additional paid-in capital......... 155,031 -- 41,117 196,148 30,335 59 226,542
Retained earnings (deficit)........ 196,328 (15,130) (8,000) 173,198 (16,637) (6,500) 150,061
Treasury stock (2,500 shares, at
cost)............................ -- -- (11) (11)
Unrealized holding gain............ 5,813 -- 5,813 -- 5,813
Notes receivable -- common stock... -- (706) (706) -- (706)
Unearned compensation -- stock
awards........................... (140) -- (140) -- (140)
-------- -------- -------- -------- --------
Total stockholders' equity
(deficit)................ 357,153 (13,394) 374,447 13,754 381,701
-------- -------- -------- -------- -------- -------- --------
$395,194 $33,010 $ (8,000) $420,204 $ 17,588 $ (6,500) $431,292
======== ======== ======== ======== ======== ======== ========
</TABLE>
See accompanying notes
to the unaudited pro forma condensed combined financial statements.
F-91
<PAGE> 213
WATSON/OCLASSEN/ROYCE
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
DECEMBER 31, 1995
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA COMBINED
SUPPLEMENTARY WATSON/
WATSON/ OCLASSEN/
WATSON OCLASSEN ADJUSTMENTS OCLASSEN ROYCE ADJUSTMENTS ROYCE
-------- -------- ----------- ------------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents.......... $ 92,214 $ 3,002 $ 95,216 $ 2,291 $ 97,507
Marketable securities.............. 26,038 15,723 41,761 -- 41,761
Accounts receivable, net........... 25,081 3,045 28,126 3,466 31,592
Royalty receivable................. 8,205 -- 8,205 -- 8,205
Inventories........................ 22,637 3,249 25,886 4,212 30,098
Deferred tax assets................ 21,115 -- 21,115 -- 21,115
Other current assets............... 2,344 1,817 4,161 315 4,476
-------- -------- -------- -------- --------
Total current assets....... 197,634 26,836 224,470 10,284 234,754
Property and equipment, net........ 69,999 1,046 71,045 1,732 72,777
Investments in joint ventures and
other long-term investments...... 49,355 -- 49,355 -- 49,355
Other assets....................... 5,133 2,139 7,272 77 7,349
-------- -------- -------- -------- -------- -------- --------
$322,121 $30,021 $ -- $352,142 $ 12,093 $ -- $364,235
======== ======== ======== ======== ======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accruals...... $ 25,215 $ 4,894 $ 30,109 $ 3,149 $ 33,258
Current portion of long-term
debt............................. 622 -- 622 90 712
Contract obligations and reserve... -- 2,708 2,708 -- 2,708
Income taxes payable............... 2,985 -- 2,985 -- 2,985
-------- -------- -------- -------- --------
Total current
liabilities.............. 28,822 7,602 36,424 3,239 39,663
Long-term debt..................... 3,577 -- 3,577 181 3,758
Other liabilities.................. 687 39 726 -- 726
-------- -------- -------- -------- --------
Total liabilities.......... 33,086 7,641 40,727 3,420 44,147
-------- -------- -------- -------- --------
Mandatorily redeemable preferred
stock............................ -- 36,650 $(36,650) -- -- --
-------- -------- -------- -------- --------
Preferred stock.................... -- 1,000 (1,000) -- -- --
Common stock....................... 120 1,226 (1,213) 133 64 $ (56) 141
Additional paid-in capital......... 146,439 -- 38,863 185,302 26,471 56 211,829
Retained earnings (deficit)........ 142,711 (15,852) 126,859 (17,851) 109,008
Treasury stock (2,500 shares, at
cost)............................ -- -- -- (11) (11)
Unrealized holding gain............ 621 -- 621 -- 621
Notes receivable -- common stock... -- (644) (644) -- (644)
Unearned compensation -- stock
awards........................... (856) -- (856) -- (856)
-------- -------- -------- -------- --------
Total stockholders' equity
(deficit)................ 289,035 (14,270) 311,415 8,673 320,088
-------- -------- -------- -------- -------- -------- --------
$322,121 $30,021 $ -- $352,142 $ 12,093 $ -- $364,235
======== ======== ======== ======== ======== ======== ========
</TABLE>
See accompanying notes
to the unaudited pro forma condensed combined financial statements.
F-92
<PAGE> 214
WATSON/OCLASSEN/ROYCE
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
DECEMBER 31, 1994
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA COMBINED
SUPPLEMENTARY WATSON/
WATSON/ OCLASSEN/
WATSON OCLASSEN ADJUSTMENTS OCLASSEN ROYCE ADJUSTMENTS ROYCE
-------- -------- ----------- ------------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents.......... $ 71,165 $ 3,453 $ 74,618 $ 3,323 $ 77,941
Marketable securities.............. 35,531 14,945 50,476 -- 50,476
Accounts receivable, net........... 16,128 2,842 18,970 1,453 20,423
Inventories........................ 16,361 3,773 20,134 2,049 22,183
Deferred tax assets................ 30,995 -- 30,995 -- 30,995
Other current assets............... 2,732 1,841 4,573 223 4,796
-------- -------- -------- -------- --------
Total current assets....... 172,912 26,854 199,766 7,048 206,814
Property and equipment, net........ 54,115 1,187 55,302 980 56,282
Investments in joint ventures and
other long-term investments...... 31,824 -- 31,824 -- 31,824
Other assets....................... 3,465 -- 3,465 83 3,548
-------- -------- -------- -------- -------- ---- --------
$262,316 $28,041 $ -- $290,357 $ 8,111 $ -- $298,468
======== ======== ======== ======== ======== ==== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accruals...... $ 17,610 $ 5,442 $ 23,052 $ 1,698 $ 24,750
Current portion of long-term
debt............................. 641 -- 641 25 666
Contract obligations and reserve... -- 2,919 2,919 -- 2,919
Income taxes payable............... -- -- -- -- --
-------- -------- -------- -------- --------
Total current
liabilities.............. 18,251 8,361 26,612 1,723 28,335
Long-term debt..................... 5,058 -- 5,058 33 5,091
Deferred partnership liability..... 14,033 -- 14,033 -- 14,033
Other liabilities.................. 1,604 75 1,679 -- 1,679
-------- -------- -------- -------- --------
Total liabilities.......... 38,946 8,436 47,382 1,756 49,138
-------- -------- -------- -------- --------
Mandatorily redeemable preferred
stock............................ -- 33,933 $(33,933) -- -- --
-------- -------- -------- -------- -------- ---- --------
Preferred stock.................... -- 1,000 (1,000) -- -- --
Common stock....................... 118 1,087 (1,074) 131 60 $(52) 139
Additional paid-in capital......... 132,115 -- 36,007 168,122 21,821 52 189,995
Retained earnings (deficit)........ 94,821 (15,762) 79,059 (15,515) 63,544
Treasury stock (2,500 shares, at
cost)............................ -- -- -- (11) (11)
Unrealized holding (loss).......... (870) -- (870) -- (870)
Notes receivable -- common stock... -- (653) (653) -- (653)
Unearned compensation -- stock
awards........................... (2,814) -- (2,814) -- (2,814)
-------- -------- -------- -------- --------
Total stockholders' equity
(deficit)................ 223,370 (14,328) 242,975 6,355 249,330
-------- -------- -------- -------- -------- ---- --------
$262,316 $28,041 $ -- $290,357 $ 8,111 $ -- $298,468
======== ======== ======== ======== ======== ==== ========
</TABLE>
See accompanying notes
to the unaudited pro forma condensed combined financial statements.
F-93
<PAGE> 215
WATSON/OCLASSEN/ROYCE
NOTES TO UNAUDITED PRO FORMA
CONDENSED COMBINED FINANCIAL STATEMENTS
(1) Historical Presentation. The foregoing unaudited pro forma condensed
combined financial statements are derived from and should be read in conjunction
with the audited consolidated financial statements, including the notes thereto,
of Watson, Oclassen and Royce included or incorporated by reference elsewhere in
this Proxy Statement/Prospectus and Watson's Supplementary Consolidated
Financial Statements and notes thereto included elsewhere in this Proxy
Statement/Prospectus. The fiscal years of Watson, Royce and Oclassen end on
December 31, and, as such, the historical audited consolidated statements of
income have been reported on such fiscal year bases. No adjustments have been
made to the Unaudited Pro Forma Condensed Combined Financial Statements for
differences in the application of generally accepted accounting principles
between Watson and Royce, as the impact of such adjustments would not be
material. The unaudited pro forma condensed combined financial information gives
effect to Watson's mergers with Oclassen and Royce under the pooling of
interests accounting method as if the mergers had occurred at the beginning of
each period presented for the statements of income and on the date of each
balance sheet presented.
Certain amounts in the consolidated historical financial statements of
Watson, Oclassen and Royce have been reclassified to conform with the Unaudited
Pro Forma Condensed Combined Financial Statement presentation.
No adjustments are necessary to eliminate intercompany transactions and
balances in the Unaudited Pro Forma Condensed Combined Financial Statements as
there were no intercompany transactions or balances.
The pro forma statements are presented for illustrative purposes only and
are not necessarily indicative of the operating results or financial position
that would have occurred if the mergers had been consummated in accordance with
the assumptions set forth in these notes, nor is it necessarily indicative of
future operating results or financial position.
(2) Watson and Royce Merger. The following pro forma adjustments were made
to arrive at the pro forma combined adjustments:
(a) Under the terms of the Royce Merger Agreement, Royce will become a
wholly owned subsidiary of Watson, and stockholders of Royce will receive
common shares of Watson valued at approximately $98 million. The Royce
Merger Agreement provides that Watson will issue at the closing of the
Merger to the holders of each share of Royce Common Stock the number of
shares of Watson Common Stock equal to $7.25 divided by the Average Closing
Price of Watson's Common Stock for the ten consecutive trading days ending
on the trading day immediately preceding the effective date of the Merger,
subject to a $38.00 to $47.00 collar.
For purposes of these Unaudited Pro Forma Condensed Combined Financial
Statements, it was assumed that the Average Closing Price will be $42.00
and, accordingly, approximately 2.33 million shares of Watson Common Stock
were assumed to have been issued to consummate the merger. See Exhibit 11.1
for a computation of pro forma earnings per share.
(b) The Unaudited Pro Forma Condensed Combined Balance Sheet at
September 30, 1996 has been adjusted to reflect estimated nonrecurring
merger costs of $6.5 million. The adjustment gives effect to these merger
costs as if they had been paid on September 30, 1996. The estimated merger
costs are expected to include costs associated with investment banking
fees, legal, accounting, printing and other costs with respect to the
Merger. These costs have been excluded from the Unaudited Pro Forma
Condensed Combined Statement of Income for the nine months ended September
30, 1996 due to their nonrecurring nature.
F-94
<PAGE> 216
WATSON/OCLASSEN/ROYCE
NOTES TO UNAUDITED PRO FORMA
CONDENSED COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(c) Royce's Options. As of February 27, 1997, there were outstanding
the following options and warrants:
<TABLE>
<S> <C>
1992 Stock Option Plan...................................... 285,168
1995 Stock Option Plan...................................... 207,643
Options granted outside of Company Plan..................... 625,081
Warrants.................................................... 941,666
---------
2,059,558
=========
</TABLE>
Under the Merger Agreement, each of the options and warrants will
become an option or warrant to purchase a number of whole shares of Watson
Common Stock equal to the number of shares of Royce Common Stock into which
such Royce option or warrant is exercisable immediately prior to the
effective date of the Merger multiplied by the Exchange Ratio at an option
or warrant exercise price determined by dividing the exercise price of such
option or warrant immediately prior to the effective date of the Merger by
the Exchange Ratio.
(3) Watson and Oclassen Merger. On February 27, 1997, Watson completed its
merger with Oclassen in a transaction accounted for as a pooling of interests.
The following adjustments were made to arrive at the pro forma supplementary
Watson/Oclassen financial statements:
(a) Under the terms of the Oclassen Merger Agreement, Oclassen became a
wholly owned subsidiary of Watson. Immediately prior to completion of the
Merger, each holder of Oclassen Preferred Stock, Series A, B, C, D, and E,
converted each share of the Oclassen Preferred Stock into one share of Oclassen
Common Stock. The following table summarizes the number of shares of Oclassen
Preferred Stock outstanding at September 30, 1996:
<TABLE>
<CAPTION>
FOLLOWING CONVERSION
NUMBER OF FROM PREFERRED, THE
OCLASSEN NUMBER OF OCLASSEN
PREFERRED SHARES COMMON SHARES
---------------- --------------------
<S> <C> <C>
Preferred Stock, Series A............................ 500,000 500,000
Preferred Stock, Series B............................ 1,418,184 1,418,184
Preferred Stock, Series C............................ 1,442,906 1,442,906
Preferred Stock, Series D............................ 3,105,888 3,105,888
Preferred Stock, Series E............................ 625,000 625,000
--------- ---------
7,091,978 7,091,978
</TABLE>
(b) Pursuant to the Oclassen Merger Agreement, shares of Oclassen Common
Stock were exchanged for shares of Watson Common Stock. The average closing
price, as defined in the Oclassen merger agreement, used in the merger was
$35.00, which resulted in an exchange ratio of 0.369. Accordingly, approximately
3.30 million shares of Watson Common Stock were issued to consummate the merger.
(c) The Unaudited Pro Forma Condensed Combined Balance Sheet at September
30, 1996 has been adjusted to reflect estimated nonrecurring merger costs of
$8.0 million. The adjustment gives effect to these merger costs as if they had
been paid on September 30, 1996. The estimated merger costs are expected to
include costs associated with investment banking fees, legal, accounting,
printing and other costs with respect to the Merger. These costs have been
excluded from the Unaudited Pro Forma Condensed Combined Statement of Income for
the nine months ended September 30, 1996 due to their nonrecurring nature.
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ANNEX A
AGREEMENT AND PLAN OF MERGER
THIS AGREEMENT AND PLAN OF MERGER is dated as of December 24, 1996 (the
"Agreement") by and among Watson Pharmaceuticals, Inc., a Nevada corporation
("Watson"), Dolphins Acquisition Corp., a Florida corporation and the
wholly-owned subsidiary of Watson ("Watson Sub"), and Royce Laboratories, Inc.,
a Florida corporation (the "Company").
WHEREAS, the Board of Directors of each of Watson and the Company have
determined that a business combination between Watson and the Company merging
their respective pharmaceutical businesses is in the best interests of their
respective companies and stockholders and accordingly have agreed to effect the
merger provided for herein upon the terms and subject to the conditions set
forth herein; and
WHEREAS, it is the intention of the parties to this Agreement that (a) for
federal income tax purposes, the merger provided for herein shall qualify as a
"reorganization" within the meaning of Section 368 of the Internal Revenue Code
of 1986, as amended (the "Code"); and (b) for accounting purposes, the merger
provided for herein shall qualify as a "pooling of interests"; and
NOW, THEREFORE, in consideration of the premises and of the
representations, warranties, covenants and agreements set forth herein, the
parties hereto hereby agree as follows:
ARTICLE I
THE MERGER
1.1. The Merger. Upon the terms and subject to the conditions of this
Agreement, at the Effective Time (as defined in Section 1.3 of this Agreement),
Watson Sub shall be merged with and into the Company in accordance with the laws
of the State of Florida and the terms of this Agreement (the "Merger"),
whereupon the separate corporate existence of Watson Sub shall cease, and the
Company shall be the surviving corporation of the Merger (the Company, as the
surviving corporation after the Merger is sometimes referred to herein as the
"Surviving Corporation").
1.2. Closing. Subject to the terms and conditions of this Agreement, the
closing of the Merger (the "Closing") shall take place (a) at the offices of
D'Ancona & Pflaum, 30 North LaSalle Street, Chicago, Illinois 60602 at 10:00
a.m. three business days after all the conditions set forth in Article VI of
this Agreement (other than those that are waived by the party or parties for
whose benefit such conditions exist) are satisfied; or (b) at such other place,
time, and/or date as the parties hereto may otherwise agree. The date upon which
the Closing shall occur is referred to herein as the "Closing Date."
1.3. Effective Time. If all the conditions to the Merger set forth in
Article VI of this Agreement have been fulfilled or waived and this Agreement
shall not have been terminated as provided in Article VII hereof, the parties
hereto shall cause a certificate of merger (the "Certificate of Merger") to be
properly executed and filed in accordance with the laws of the State of Florida
and the terms of this Agreement on or before the Closing Date. The parties
hereto shall also take such further actions as may be required under the laws of
the State of Florida in connection with the consummation of the Merger. The
Merger shall become effective at such time as the Certificate of Merger is duly
filed with the Secretary of State of Florida or at such later time as is
specified in the Certificate of Merger (the "Effective Time"). From and after
the Effective Time, the Surviving Corporation shall possess all the rights,
privileges, powers and franchises and be subject to all of the restrictions,
disabilities and duties of the Company and Watson Sub, all as provided under
applicable law.
1.4. Conversion of Shares.
(a) At the Effective Time:
(i) each share of Common Stock, par value $0.01 per share, of Watson
Sub outstanding at the Effective Time, by virtue of the Merger and without
any action on the part of the holders thereof, shall be converted into and
exchanged for one share of Common Stock, par value $0.01 per share, of the
Surviving Corporation; and
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(ii) each share of Common Stock, $0.005 par value per share, of the
Company (the "Company Common Stock") outstanding at the Effective Time, by
virtue of the Merger and without any action on the part of the holders
thereof, except as otherwise provided in Sections 1.4(c) and 1.4(e) hereof,
shall be converted into the right to receive the number of shares of Watson
Common Stock equal to the following: $7.25 divided by the Average Closing
Price (as defined herein) (the "Exchange Ratio").
(b) As a result of the Merger and without any action on the part of the
holder thereof, at the Effective Time, all shares of Company Common Stock shall
cease to be outstanding and shall be canceled and retired and shall cease to
exist, and each holder of shares of Company Common Stock shall thereafter cease
to have any rights with respect to such shares of Company Common Stock, except
for the right to receive, without interest, the consideration set forth in this
Section 1.4 and cash for fractional shares of Watson Common Stock in accordance
with Section 1.6 of this Agreement upon the surrender of a certificate (each, a
"Certificate") representing such shares of Company Common Stock in accordance
with the provisions of this Article I.
(c) Each share of Company Common Stock and each share of Series A, B, C, D
or E Preferred Stock of the Company (collectively, the "Preferred Stock") held
by the Company as treasury stock or owned by Watson or any Subsidiary (as
defined in Section 1.4(d) of this Agreement) of Watson at the Effective Time
shall be canceled, and no payment shall be made with respect thereto.
(d) For purposes of this Agreement, (i) the term "Average Closing Price"
shall mean the average of the per share last daily closing price of Watson
Common Stock as quoted on the Nasdaq National Market ("Nasdaq") (and as reported
by The Wall Street Journal or, if not reported thereby, by another authoritative
source) during the ten (10) consecutive trading days ending on the trading day
immediately preceding the Closing Date; provided, however, that (A) if the
Average Closing Price is greater than $47, for purposes of this Agreement, the
Average Closing Price shall be deemed to be equal to $47; and (B) if the Average
Closing Price is less than $38, for purposes of this Agreement, the Average
Closing Price shall be deemed to be equal to $38; (ii) the word "Subsidiary"
when used with respect to any Person means any corporation or other
organization, whether incorporated or unincorporated, of which (A) at least
fifty percent (50%) of the securities or other interests having by their terms
ordinary voting power to elect a majority of the board of directors or others
performing similar functions with respect to such corporation or other
organization is directly or indirectly owned or controlled by such Person or by
any one or more of its Subsidiaries; or (B) such Person or any other Subsidiary
of such Person is a general partner, it being understood that representations
and warranties of a Person concerning any former Subsidiary of such Person shall
be deemed to relate only to the periods during which such former Subsidiary was
a Subsidiary of such Person; and (iii) the word "Person" means an individual, a
corporation, a limited liability company, a partnership, an association, a trust
or any other entity or organization, including a government or political
subdivision or any agency or instrumentality thereof, or any affiliate (as that
term is defined in the Securities Exchange Act of 1934, as amended, and the
rules and regulations promulgated thereunder (the "Exchange Act")) of any of the
foregoing.
(e) As soon as practicable after the date hereof, the parties hereto will
negotiate in good faith to enter into an agreement to allow Watson to pay cash
to certain holders of small numbers of shares of Company Common Stock in lieu of
the consideration to be received by such holders of Company Common Stock
pursuant to Section 1.4(a) hereof; provided, however, that the aggregate cash
consideration to be paid to such holders may not exceed 9.9% of the aggregate
consideration to be paid to all holders of Company Common Stock upon
consummation of the transactions contemplated hereby.
1.5. Stock Options. All options and warrants to acquire Company Common
Stock (individually, a "Company Option" and collectively, the "Company Options")
outstanding at the Effective Time under the Company's 1992 Stock Option Plan,
the Company's 1995 Stock Option Plan or otherwise (the "Company Stock Option
Plans") shall remain outstanding following the Effective Time. At the Effective
Time, such Company Options, by virtue of the Merger and without any further
action on the part of the Company or the holder of such Company Options, shall
be assumed by Watson in such manner that Watson (a) is a corporation (or a
parent or a subsidiary corporation of such corporation) "assuming a stock option
in a transaction to which Section 424(a) applied" within the meaning of Section
424 of the Code; or (b) to the extent that Section 424 of the Code does not
apply to any such Company Options, would be such a
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corporation (or a parent or a subsidiary corporation of such corporation) were
Section 424 applicable to such option. Each Company Option assumed by Watson
shall be exercisable upon the same terms and conditions as under the applicable
Company Stock Option Plan and the applicable option agreement issued thereunder,
except that (x) the unexercised portion of each such Company Option shall be
exercisable for that whole number of shares of Watson Common Stock (rounded to
the nearest whole share, with 0.5 rounded upward) equal to the number of shares
of Company Common Stock subject to the unexercised portion of such Company
Option multiplied by the Exchange Ratio; and (y) the option exercise price per
share of Watson Common Stock shall be an amount equal to the option exercise
price per share of Company Common Stock subject to such Company Option in effect
at the Effective Time divided by the Exchange Ratio (the option price per share,
as so determined, being rounded to the nearest full cent, with $0.005 rounded
upward). No payment shall be made for fractional interests. The term,
exercisability, vesting schedule, status as an "incentive stock option" under
Section 422 of the Code, if applicable, and all of the other terms of the
Company Options shall otherwise remain unchanged unless modified by or as a
result of the transaction contemplated by this Agreement. As soon as practicable
after the Effective Time, Watson shall deliver to the holders of Company Options
appropriate notices setting forth such holders' rights pursuant to such Company
Options, as amended by this Section 1.5 as well as notice of Watson's assumption
of the Company's obligations with respect thereto (which occurs by virtue of
this Agreement). Watson shall take all corporate actions necessary to reserve
for issuance such number of shares of Watson Common Stock as will be necessary
to satisfy exercises in full of all Company Options after the Effective Time.
1.6. Exchange of Certificates Representing Company Common Stock.
(a) American Stock Transfer & Trust Company shall act as exchange agent
(the "Exchange Agent") in the Merger.
(b) As of the Effective Time and in any event, no later than five (5)
business days after the Effective Time, Watson shall deposit or cause to be
deposited with the Exchange Agent for exchange in accordance with this Article
I, the shares of Watson Common Stock issuable pursuant to Section 1.4 in
exchange for shares of Company Common Stock outstanding at the Effective Time
and a sufficient amount of cash to satisfy the cash payments to be made by
Watson to certain holders of Company Common Stock pursuant to Sections 1.4(e)
and 1.6(f) hereof.
(c) On or promptly after the Effective Time, Watson shall cause the
Exchange Agent to mail to each holder of record of shares of Company Common
Stock (i) a letter of transmittal which shall specify that delivery shall be
effected, and risk of loss and title to such shares of Company Common Stock
shall pass, only upon delivery of the Certificates representing such shares to
Watson; and (ii) instructions for use in effecting the surrender of such
Certificates in exchange for the consideration to be received by such holder
pursuant to Sections 1.4 and 1.6 hereof. Upon surrender of a Certificate
representing shares of Company Common Stock for cancellation to Watson, together
with such letter of transmittal, duly executed and completed in accordance with
the instructions thereto, the holder of the shares represented by such
Certificate shall be entitled to receive in exchange therefor either (i) cash in
accordance with Section 1.4(e) hereof; or (ii)(A) a certificate representing
that number of whole shares of Watson Common Stock; and (B) a check representing
the amount of cash in lieu of fractional shares, if any, and unpaid dividends
and distributions, if any, which such holder has the right to receive in respect
of the Certificate surrendered pursuant to the provisions of this Section 1.6,
in each case, after giving effect to any required withholding tax, and the
shares represented by the Certificate so surrendered shall forthwith be
canceled. No interest will be paid or accrued on the cash payable pursuant to
Section 1.4(e) hereof, the cash in lieu of fractional shares and unpaid
dividends and distributions, if any, payable to holders of shares of Company
Common Stock who receive shares of Watson Common Stock pursuant to Section 1.4
hereof. In the event of a transfer of ownership of Company Common Stock which is
not registered in the transfer records of the Company, the consideration to be
paid to such holder of Company Common Stock pursuant to Sections 1.4 and 1.6
hereof may be issued to such a transferee if the Certificate representing such
Company Common Stock is presented to Watson, accompanied by all documents
required to evidence and effect such transfer and to evidence that any
applicable stock transfer taxes have been paid or, alternatively, payments of
such transfer tax to the Exchange Agent. Until so surrendered, each Certificate
that, at the Effective Time, represented shares of Company Common Stock will be
deemed from and after the
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Effective Time, for all corporate purposes other than the payment of dividends
(except to the extent provided in Section 1.6(d) below), to evidence the
consideration to be received by the holders of Company Common Stock pursuant to
Sections 1.4 and 1.6 hereof.
(d) Notwithstanding anything to the contrary contained herein, no dividends
or other distributions declared after the Effective Time on Watson Common Stock
shall be paid with respect to any shares of Company Common Stock entitled to be
converted into shares of Watson Common Stock represented by a Certificate until
such Certificate is surrendered for exchange as provided herein. Subject to the
effect of applicable laws, following surrender of any such Certificate, there
shall be paid to the holder of the certificates representing whole shares of
Watson Common Stock issued in exchange therefor, without interest, (i) at the
time of such surrender, the amount of dividends or other distributions with a
record date after the Effective Time theretofore payable with respect to such
whole shares of Watson Common Stock and not paid, less the amount of any
withholding taxes which may be required thereon; and (ii) at the appropriate
payment date, the amount of dividends or other distributions with a record date
after the Effective Time but prior to surrender and a payment date subsequent to
surrender payable with respect to such whole shares of Watson Common Stock, less
the amount of any withholding taxes which may be required thereon.
(e) At or after the Effective Time, there shall be no transfers on the
stock transfer books of the Company of the shares of Company Common Stock which
were outstanding at the Effective Time. If, after the Effective Time,
Certificates are presented to the Surviving Corporation, they shall be canceled
and exchanged for the consideration set forth in this Article I deliverable in
respect thereof pursuant to this Agreement in accordance with the procedures set
forth in this Section 1.6. Certificates surrendered for exchange by any person
constituting an "affiliate" of the Company for purposes of Rule 145(c) under the
Securities Act of 1933, as amended (the "Securities Act") shall not be exchanged
until Watson has received an Affiliate Letter (as defined herein) from such
person as provided in Section 5.9.
(f) No fractional shares of Watson Common Stock shall be issued pursuant
hereto. In lieu of the issuance of any fractional share of Watson Common Stock
pursuant to Section 1.4, cash adjustments will be paid to holders in respect of
any fractional share of Watson Common Stock that would otherwise be issuable,
and the amount of such cash adjustment shall be equal to such fractional
proportion of the Average Closing Price of a share of Watson Common Stock.
(g) All former stockholders of the Company (each, a "Stockholder" and
collectively the "Stockholders") shall look only to Watson for payment of cash
(if a Stockholder is to receive cash pursuant to Section 1.4(e) hereof), shares
of Watson Common Stock, cash in lieu of fractional shares and unpaid dividends
and distributions on the Watson Common Stock, as the case may be, deliverable in
respect of each share of Company Common Stock such stockholder holds as
determined pursuant to this Agreement, in each case, without any interest
thereon.
(h) None of Watson, Watson Sub, the Company, the Surviving Corporation or
any other person shall be liable to any former holder of shares of Company
Common Stock for any amount properly delivered to a public official pursuant to
applicable abandoned property, escheat or similar laws.
(i) In the event any Certificate shall have been lost, stolen or destroyed,
upon the making of an affidavit of that fact by the person claiming such
Certificate to be lost, stolen or destroyed and, if required by the Surviving
Corporation, the posting by such person of a bond in such reasonable amount as
the Surviving Corporation may direct as indemnity against any claim that may be
made against it with respect to such Certificate, Watson will issue in exchange
for such lost, stolen or destroyed Certificate, the consideration to be received
by the holder of such Certificate pursuant to Sections 1.4 and 1.6 hereof.
(j) Any portion of the property delivered to the Exchange Agent in
accordance with this Section 1.6 that remains unclaimed by the Stockholders one
year after the Effective Time shall be delivered to Watson. Any Stockholders who
have not theretofore complied with this Section 1.6 shall thereafter look only
to Watson for payment of their consideration to be received by such Stockholder
pursuant to Sections 1.4 and 1.6 hereof deliverable in respect of each share of
the Company Common Stock such Stockholder holds as determined pursuant to this
Agreement, in each case, without any interest thereon.
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1.7. Adjustment of Exchange Ratio. In the event that, subsequent to the
date of this Agreement but prior to the Effective Time, the outstanding shares
of Watson Common Stock or Company Common Stock shall have been changed into a
different number of shares or a different class as a result of a stock split,
reverse stock split, stock dividend, subdivision, reclassification, split,
combination, exchange, recapitalization or other similar transaction, the
Exchange Ratio and the Average Closing Price shall be appropriately adjusted.
1.8. Tax Consequences and Accounting Treatment. It is intended by the
parties hereto that the Merger shall constitute a reorganization within the
meaning of Section 368 of the Code and that the transaction be accounted for as
a pooling of interests.
1.9. Taking of Necessary Action; Further Action. If, at any time after the
Effective Time, any further action is necessary or desirable to carry out the
purposes of this Agreement and to vest the Surviving Corporation with full
right, title and possession to all assets, property, rights, privileges, powers
and franchises of the Company and Watson Sub, the officers and directors of the
Company and Watson Sub are fully authorized in the name of their respective
corporations or otherwise to take, and will take, all such lawful and necessary
action, so long as such action is consistent with this Agreement.
ARTICLE II
CERTAIN MATTERS RELATING TO
THE SURVIVING CORPORATION
2.1. Certificate of Incorporation of the Surviving Corporation. The
certificate of incorporation of Watson Sub in effect at the Effective Time shall
be the certificate of incorporation of the Surviving Corporation until amended
in accordance with its terms and pursuant to applicable law; provided however,
that Article I of the Certificate of Incorporation of the Surviving Corporation
shall be amended to read as follows: "The name of the corporation is Royce
Laboratories, Inc.".
2.2. By-Laws of the Surviving Corporation. The By-Laws of Watson Sub in
effect at the Effective Time shall be the By-Laws of the Surviving Corporation
until amended in accordance with the terms of such By-Laws and pursuant to
applicable law and the Certificate of Incorporation of the Surviving
Corporation.
2.3. Directors of the Surviving Corporation. The directors of the
Surviving Corporation immediately after the Effective Time shall consist of the
persons listed on Exhibit A attached hereto, to hold office until their
successors are duly appointed or elected in accordance with applicable law.
2.4. Officers of the Surviving Corporation. The officers of the Surviving
Corporation immediately after the Effective Time shall consist of the persons
listed on Exhibit B attached hereto who shall hold the offices listed opposite
their respective names until their successors are duly appointed or elected in
accordance with applicable law.
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF
WATSON AND WATSON SUB
Watson and Watson Sub represent and warrant to the Company that the
statements contained in this Article III are true and correct, except as set
forth in the disclosure statement delivered by Watson and Watson Sub to the
Company concurrently herewith and identified as the "Watson Disclosure
Statement." All exceptions noted in the Watson Disclosure Statement shall be
numbered to correspond to the applicable sections to which such exception
refers; provided, however that any disclosure set forth on any particular
schedule shall be deemed disclosed in reference to all applicable schedules.
3.1 Existence, Good Standing, Corporate Authority. Each of Watson and
Watson Sub (i) is a corporation duly incorporated, validly existing and in good
standing under the laws of its respective jurisdiction of incorporation; (ii)
has all requisite power and authority to own or lease, and operate its
properties and assets, and to carry on its business as now conducted and as
currently proposed to be conducted, except where the failure to have such power
and authority would not have a Watson Material Adverse Effect (as defined
herein) and to consummate the transactions contemplated hereby; (iii) is duly
qualified or licensed to do
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business and is in good standing in all jurisdictions in which it owns or leases
property or in which the conduct of its business requires it to so qualify or be
licensed, except where the failure to so qualify, individually or in the
aggregate, would not have a Watson Material Adverse Effect; and (iv) has
obtained all licenses, permits, franchises and other governmental authorizations
necessary to the ownership or operation of its properties or the conduct of its
business, except where the failure to have obtained such licenses, permits,
franchises or authorizations would not have a Watson Material Adverse Effect.
The copies of Watson's and Watson Sub's Articles or Certificate of Incorporation
and By-Laws as in effect on the date hereof have been previously delivered to
the Company or have been made available for the Company's review and are true
and correct. For purposes of this Agreement, a "Material Adverse Effect" when
used with respect to any entity means (a) a material adverse effect on the
business, results of operations, financial condition or prospects of such entity
and its subsidiaries, taken as a whole, or (b) a material impairment in the
ability of such entity or its subsidiaries to perform any of their obligations
under this Agreement or to consummate the Merger.
3.2 Authorization of Agreement and Other Documents. The execution and
delivery of this Agreement and the other documents executed or to be executed in
connection herewith to which Watson or Watson Sub is a party (collectively, the
"Watson Ancillary Documents"), have been duly authorized by the Board of
Directors of Watson and Watson Sub and no other proceedings on the part of
Watson or Watson Sub or their stockholders are necessary to authorize the
execution, delivery or performance of this Agreement or any Watson Ancillary
Document. This Agreement is, and, as of the Closing Date, each of the Watson
Ancillary Documents will be, a valid and binding obligation of Watson and/or
Watson Sub, as the case may be, enforceable against Watson and/or Watson Sub, as
the case may be, in accordance with its terms, except to the extent that
enforcement thereof may be limited by bankruptcy, insolvency; reorganization,
moratorium, fraudulent conveyance or other similar laws affecting enforcement of
creditors' rights generally, and by general principles of equity (regardless of
whether enforcement is considered in a proceeding at law or in equity).
3.3 No Violation. Neither the execution and delivery by Watson and Watson
Sub of this Agreement or the Watson Ancillary Agreements, nor the consummation
by Watson and Watson Sub of the transactions contemplated hereby and thereby in
accordance with their respective terms, will (a) conflict with or result in a
breach of any provisions of the Articles or Certificate of Incorporation or
By-Laws of Watson or Watson Sub; (b) result in a breach or violation of, a
default under, or the triggering of any payment or other material obligations
pursuant to, or accelerate vesting under, any of the Watson stock option plans,
or any grant or award made under any of the foregoing; (c) violate, conflict
with, result in a breach of any provision of, constitute a default (or an event
which, with notice or lapse of time or both, would constitute a default) under,
result in the termination, or in a right of termination or cancellation of,
accelerate the performance required by, result in the triggering of any payment
or other material obligations pursuant to, result in the creation of any lien,
security interest, charge or encumbrance upon any of the material properties of
Watson or Watson Sub under, or result in being declared void, voidable, or
without further binding effect, any of the terms, conditions or provisions of
any note, bond, mortgage, indenture, deed of trust or any material license,
franchise, permit, lease, contract, agreement or other instrument, commitment or
obligation to which Watson or Watson Sub is a party, or by which Watson or
Watson Sub or any of their respective properties is bound or affected, except
for any of the foregoing matters which would not have a Watson Material Adverse
Effect; (d) contravene or conflict with or constitute a violation of any
provision of any law, regulation, judgement, injunction, order or decree binding
upon or applicable to Watson or Watson Sub, except for any of the foregoing
matters which would not have a Watson Material Adverse Effect; or (e) other than
the filings provided for in Sections 1.3 and 5.7, filings required under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act"), the
Exchange Act, the Securities Act, or applicable state securities and "Blue Sky"
laws or filings in connection with the maintenance of qualification to do
business in other jurisdictions (collectively, the "Regulatory Filings"),
require any material consent, approval or authorization of, or declaration of,
or filing or registration with, any domestic governmental or regulatory
authority, the failure to obtain or make which would have a Watson Material
Adverse Effect.
3.4 SEC Documents. Watson has delivered or made available to the Company
each registration statement, report, proxy statement or information statement
(as defined in Regulation 14C under the Exchange Act) prepared by it since
January 1, 1994, which reports constitute all of the documents required to
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be filed by Watson with the Securities and Exchange Commission ("SEC") since
such date, each in the form (including exhibits and any amendments thereto)
filed with the SEC (collectively, the "Watson Reports"). As of their respective
dates, the Watson Reports and any Watson Reports filed after the date hereof and
prior to the Effective Time (a) complied as to form in all material respects
with the applicable requirements of the Securities Act or the Exchange Act, as
the case may be, and the rules and regulations thereunder; and (b) did not
contain any untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements made therein,
in the light of the circumstances under which they were made, not misleading.
Watson has timely filed with the SEC all reports required to be filed under
Sections 13, 14 and 15(d) of the Exchange Act since January 1, 1994. Each of the
consolidated balance sheets of Watson included in or incorporated by reference
into the Watson Reports (including the related notes and schedules) fairly
present in all material respects the consolidated financial position of Watson
and the Watson Subsidiaries as of its date (subject, in the case of unaudited
statements, to normal year-end audit adjustments which would not be material in
amount or effect), and each of the consolidated statements of income, retained
earnings and cash flows of Watson included in or incorporated by reference into
the Watson Reports (including any related notes and schedules) fairly present in
all material respects the results of operations, retained earnings or cash
flows, as the case may be, of Watson and the Watson Subsidiaries for the periods
set forth therein (subject, in the case of unaudited statements, to normal
year-end audit adjustments which would not be material in amount or effect). The
financial statements of Watson, including the notes thereto, included in or
incorporated by reference into the Watson Reports comply as to form in all
material respects with applicable accounting requirements and with the published
rules and regulations of the SEC with respect thereto, and have been prepared in
accordance with generally accepted accounting principles consistently applied
("GAAP") (except as may be indicated in the notes thereto). Since January 1,
1994, there has been no material change in Watson's accounting methods or
principles except as described in the notes to such Watson financial statements.
All transactions entered into by Watson or its Subsidiaries with Related Parties
(as defined herein) that are required to be disclosed in the Watson Reports have
been properly disclosed, in all material respects.
3.5 No Brokers. Watson has not entered into any contract, arrangement or
understanding with any person or firm which may result in the obligation of the
Company or Watson, Watson Sub or their respective Subsidiaries to pay any
finder's fee, brokerage or agent's commissions or other like payments in
connection with the negotiations leading to this Agreement or the consummation
of the transactions contemplated hereby, except that Watson has retained Bear
Stearns & Co. Inc. as its financial advisor, the arrangements with which have
been disclosed in writing to the Company prior to the date hereof.
3.6 Opinion of Financial Advisor. Watson has received the opinion of Bear
Stearns & Co. Inc., to the effect that, as of the date of such opinion, the
consideration to be paid by Watson pursuant to the Merger is fair to Watson from
a financial point of view.
3.7 Watson Common Stock. The issuance and delivery by Watson of shares of
Watson Common Stock in connection with the Merger and this Agreement have been
duly and validly authorized by all necessary corporate action on the part of
Watson. The shares of Watson Common Stock to be issued in connection with the
Merger and this Agreement, when issued in accordance with the terms of this
Agreement, will be validly issued, fully paid and nonassessable and free of
preemptive rights.
3.8 Capitalization
(a) The total authorized capital stock of Watson consists of (i)
500,000,000 shares of Watson Common Stock, 36,818,957 shares of which are issued
and outstanding as of December 1, 1996 and (ii) 2,500,000 shares of Preferred
Stock, none of which are issued and outstanding as of the date of this
Agreement. The authorized capital stock of Watson Sub consists of 1,000 shares
of Common Stock, $0.01 par value per share, 100 shares of which, as of the date
hereof, are issued and outstanding and are held by Watson. There are no shares
of capital stock of Watson or Watson Sub of any other class authorized, issued
or outstanding. Except as set forth in the Watson Disclosure Statement, Watson
has not issued any shares of Watson Common Stock or Preferred Stock since
December 1, 1996. All of such outstanding shares of Watson Common Stock have
been validly issued, are fully paid and nonassessable and were issued in
compliance with all preemptive rights.
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(b) Except as set forth in the Watson Disclosure Statement, there are
currently no outstanding, and as of the Closing; there will be no outstanding
(i) securities convertible into or exchangeable for any capital stock of Watson
or any of the Watson Significant Subsidiaries (as defined below), (ii) options,
warrants or other rights to purchase or subscribe to capital stock of Watson or
any of the Watson Significant Subsidiaries or securities convertible into or
exchangeable for capital stock of Watson or any of the Watson Significant
Subsidiaries, or (iii) contracts, commitments, agreements, understandings,
arrangements, calls or claims of any kind relating to the issuance of any
capital stock of Watson or any of the Watson Significant Subsidiaries. For
purposes of this Agreement, a "Watson Significant Subsidiary" shall mean each
Subsidiary of Watson which has total assets or total revenues for the previous
fiscal year in excess of $10,000,000.
3.9 Material Adverse Change. Since September 30, 1996 to the date of this
Agreement, Watson, Watson Sub and their Subsidiaries, taken as a whole, have not
suffered any change in their businesses, operations, assets, liabilities,
financial condition or prospects which would reasonably have a Watson Material
Adverse Effect; provided, that a Watson Material Adverse Effect will not be
deemed to have occurred solely as a result of fluctuations in the value of
Watson Common Stock due to or arising from any public disclosures by Watson
(including its 50% Subsidiary, Somerset Pharmaceuticals, Inc.), including,
without limitation, disclosures relating to Watson's entering into any other
transactions (including, without limitation, transactions relating to the
acquisition of assets, stock or merger transactions). Since September 30, 1996
to the date of this Agreement, (a) Watson, Watson Sub and their Subsidiaries
have not entered into any transaction outside the ordinary course of business
which will be required to be disclosed in Watson's Form 10-K for the year ended
December 31, 1996; (b) Watson has not (i) declared, set aside or paid any
dividend or made any other distribution or payment with respect to any shares of
its capital stock or other ownership interests; or (ii) directly or indirectly,
redeemed, purchased or otherwise acquired any shares of its capital stock, or
made any commitment for any such action; or (c) neither Watson nor any Watson
Significant Subsidiary has voluntarily elected to alter the manner of keeping
its books, accounts or records, or changed in any manner the accounting
practices therein reflected, except for (i) changes that would not have a Watson
Material Adverse Effect; or (ii) changes in accounting laws which effect all
pharmaceutical companies generally.
3.10 Litigation. There is no litigation or proceeding, in law or in
equity, and there are no proceedings or governmental investigations before any
commission or other administrative authority, pending or, to Watson's knowledge,
threatened against Watson, any of the Watson Significant Subsidiaries or any of
Watson's or the Watson Significant Subsidiaries' respective officers, directors
or affiliates, with respect to or affecting Watson's or any of the Watson
Significant Subsidiaries' operations, business, products, sales practices or
financial condition, or related to the consummation of the transactions
contemplated hereby, or by the Watson Ancillary Documents or the Ancillary
Documents which, in each case, if conducted with results unfavorable to Watson
or any of the Watson Significant Subsidiaries, would have a Watson Material
Adverse Effect. There are no facts known to Watson which, if known by a
potential claimant or governmental authority, would reasonably give rise to a
claim or proceeding which, if asserted or conducted with results unfavorable to
Watson or any of the Watson Significant Subsidiaries, would have a Watson
Material Adverse Effect.
3.11 Disclosure Documents. The Proxy Statement/Prospectus to be delivered
to the Stockholders in connection with the approval of the transactions
contemplated by this Agreement, or any amendment or supplement thereto (the
"Proxy Statement") at the time of mailing thereof and at the time of the meeting
of Stockholders, or, in the case of the Form S4 (as defined in Section 5.7 of
this Agreement) and each amendment or supplement thereto, at the time it is
filed or becomes effective under the Securities Act, will not contain any untrue
statement of a material fact or omit to state any material fact required to be
stated therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading; provided, however,
that the foregoing shall not apply to the extent that any such untrue statement
of a material fact or omission to state a material fact was made by Watson in
reliance upon and in conformity with written information concerning the Company
furnished to Watson by the Company specifically for use in the Proxy Statement.
3.12 Tax Reorganization; Accounting Matters. Neither Watson nor any of its
Subsidiaries has taken or failed to take any action which would prevent the
Merger from (a) constituting a reorganization within the meaning of section
368(a) of the Code; or (b) being treated as a "pooling or interests" in
accordance with
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Accounting Principles Board Opinion No. 16, the interpretative releases issued
pursuant thereto, and the pronouncements of the SEC.
3.13 Compliance with Laws -- General. Watson and each of the Watson
Significant Subsidiaries are in substantial compliance with all foreign,
federal, state or local laws, ordinances or regulations of any court, arbitral,
tribunal, administrative agency or commissioner or other governmental or other
regulatory authority or agency ("Governmental Entities") (including, but not
limited to, those related to occupational health and safety, controlled
substances, Environmental Laws (as defined herein), Tax (as defined herein)
laws, labor, ERISA (as defined herein), the Foreign Corrupt Practices Act,
employment and employment practices or EEOC matters) that are applicable to
Watson and each Watson Significant Subsidiary or affect or relate to this
Agreement or the transactions contemplated hereby, except for any such
noncompliance that would not, individually or in the aggregate, have a Watson
Material Adverse Effect. To Watson's knowledge, there has been no storage,
treatment, generation, transportation or Release (as defined herein) of any
Materials of Environmental Concern (as defined herein) by Watson, any Watson
Significant Subsidiary or by any other person or entity for which Watson or any
Watson Significant Subsidiary is or may be held responsible, at any Facility (as
herein defined) or any Offsite Facility (as herein defined) in violation of, or
which could give rise to any material obligation under, Environmental Laws,
where such liability or obligation would be reasonably likely to have a Watson
Material Averse Effect.
3.14 Compliance with Laws -- FDA.
(a) Watson and each Watson Significant Subsidiary are in substantial
compliance with all Federal and state laws applicable to the manufacture,
processing, packing, testing and sale of pharmaceutical products to the extent
such laws are applicable to them, all rules and regulations of the Food and Drug
Administration ("FDA") and the U.S. Drug Enforcement Agency (the "DEA"), to the
extent such rules and regulations are applicable to them, each new drug
application ("NDA") and abbreviated new drug application ("ANDA") and each of
its establishment license applications ("ELA") and/or product license
applications ("PLA") in which Watson or any of the Watson Significant
Subsidiaries have sold any product on or after July 17, 1995, except where the
failure to be in such compliance would not have a Watson Material Adverse
Effect.
(b) At any time after July 17, 1995, neither Watson, the Watson Significant
Subsidiaries nor, to the knowledge of Watson, their respective officers,
employees, or agents have made an untrue statement of material fact or
fraudulent statement to the FDA or the DEA, failed to disclose a material fact
required to be disclosed to the FDA or the DEA, or committed an act, made a
statement, or failed to make a statement that could reasonably be expected to
provide a basis for the FDA to invoke its policy respecting "Fraud, Untrue
Statements of Material Facts, Bribery, and Illegal Gratuities," set forth in 56
Fed. Reg 46191 (September 10, 1991).
(c) At any time after July 17, 1995, neither Watson nor any of the Watson
Significant Subsidiaries have received any written notice that the FDA or the
DEA has commenced, or threatened to initiate, any judicial action against or to
withdraw its approval or request the recall of any product of Watson or any of
the Watson Significant Subsidiaries, where such product withdrawal or recall
would have a Watson Material Adverse Effect, or commenced or threatened to
initiate, any action to enjoin production at any facility owned or used by
Watson or any of the Watson Significant Subsidiaries or any other facility at
which any of Watson's or any of the Watson Significant Subsidiaries' products
are manufactured, processed, packaged, labeled, stored, distributed, tested or
otherwise handled (the "Manufacturing Locations"), where such action would have
a Watson Material Adverse Effect.
(d) Watson has made available to the Company copies of any and all material
reports of inspection observations, establishment inspection reports, warning
letters and any other material documents received from or issued by the FDA or
the DEA since January 1, 1995 that indicate or suggest a lack of material
compliance with the FDA or the DEA regulatory requirements by Watson or by any
Watson Significant Subsidiary.
3.15 Books and Records. Watson's and each Watson Significant Subsidiary's
books, accounts and records are, in all material respects, maintained in
Watson's and such Watson Significant Subsidiary's usual,
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regular and ordinary manner, in accordance with GAAP and with respect to Watson
and the Watson Significant Subsidiaries other than Circa Pharmaceuticals, Inc.
("Circa"), since January 1, 1995, and, with respect to Circa, since July 18,
1995, all material transactions to which Watson or any Watson Significant
Subsidiary is or has been a party, taken as a whole, are properly reflected
therein.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF THE COMPANY
The Company represents and warrants to Watson and Watson Sub that the
statements contained in this Article IV are true and correct, except as set
forth in the disclosure statement delivered by the Company to Watson and Watson
Sub concurrently herewith and identified as the "Disclosure Statement." All
exceptions noted in the Disclosure Statement shall be numbered to correspond to
the applicable sections to which such exception refers; provided, however that
any disclosure set forth on any particular schedule shall be deemed disclosed in
reference to all applicable schedules.
4.1. Organization, Standing and Qualification. The Company and each of its
Subsidiaries (i) is a corporation duly organized, validly existing and in good
standing under the laws of its respective jurisdiction of incorporation; (ii)
has all requisite power and authority to own or lease, and operate their
respective properties and assets, and to carry on their respective businesses as
now conducted and as currently proposed to be conducted except where the failure
to have such power and authority would not have a Company Material Adverse
Effect and to consummate the transactions contemplated hereby; (iii) is duly
qualified or licensed to do business and is in good standing in all
jurisdictions in which they own or lease property or in which the conduct of
their respective businesses requires them to so qualify or be licensed except
where the failure to so qualify, individually or in the aggregate, would not
have a Company Material Adverse Effect; and (iv) has obtained all licenses,
permits, franchises and other governmental authorizations necessary to the
ownership or operation of their respective properties or the conduct of their
respective businesses except where the failure to have obtained such licenses,
permits, franchises or authorizations would not have a Company Material Adverse
Effect.
4.2. Capitalization.
(a) The total authorized capital stock of the Company consists of (i)
35,000,000 shares of common stock, par value $0.005 per share, 13,519,213 shares
of which are issued and outstanding as of the date of this Agreement; (ii)
38,500 shares of Series A Preferred Stock, par value $0.005 per share, none of
which are issued and outstanding as of the date of this Agreement; (iii) 10,000
shares of Series B Preferred Stock, par value $0.005 per share, none of which
are issued and outstanding as of the date of this Agreement; (iv) 35,000 shares
of Series C Preferred Stock, par value $0.005 per share, none of which are
issued and outstanding as of the date of this Agreement; (v) 10,000 shares of
Series D Preferred Stock, par value $0.005 per share, none of which are issued
and outstanding as of the date of this Agreement; (vi) 27,000 shares of Series E
Preferred Stock, par value $10 per share, none of which are issued and
outstanding as of the date of this Agreement; and (iii) 128,000 shares of
preferred stock, none of which are issued and outstanding as of the date of this
Agreement. There are no shares of capital stock of the Company of any other
class authorized, issued or outstanding.
(b) Except as set forth in the Disclosure Statement, each share of the
outstanding Company Common Stock is (i) duly authorized and validly issued; (ii)
fully paid and nonassessable and free of preemptive and similar rights; and
(iii) to the knowledge of the Company, with respect to the shares of Company
Common Stock owned by the directors and officers of the Company, free and clear
of all liens, pledges, security interests, claims or other encumbrances and
restrictions on voting and transfer other than restrictions on transfer imposed
by Federal and state securities laws.
(c) Except as set forth in the Disclosure Statement, there are currently no
outstanding, and, except as permitted pursuant to Section 5.2 or the exercise or
cancellation of outstanding options in accordance with their terms, as of the
Closing, there will be no outstanding (i) securities convertible into or
exchangeable for any capital stock of the Company or any of its Subsidiaries,
(ii) options, warrants or other rights to purchase
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or subscribe to capital stock of the Company or any of its Subsidiaries or
securities convertible into or exchangeable for capital stock of the Company or
any of its Subsidiaries, or (iii) contracts, commitments, agreements,
understandings, arrangements, calls or claims of any kind to which the Company
or any of its Subsidiaries is a party or is bound relating to the issuance of
any capital stock of the Company or any of its Subsidiaries. The Disclosure
Statement identifies, as of the date hereof, the option holder, the number of
shares subject to each option, the exercise price, the vesting schedule and the
expiration date of each outstanding option or warrant to purchase capital stock
of the Company or any of its Subsidiaries.
4.3. Subsidiaries. The Company owns directly or indirectly each of the
outstanding shares of capital stock (or other ownership interests having by
their terms ordinary voting power to elect a majority of directors or others
performing similar functions with respect to such Subsidiary) of each of the
Company's Subsidiaries indicated in the Disclosure Schedule as being owned by
the Company. Each of the outstanding shares of capital stock owned by the
Company of each of the Company's Subsidiaries is duly authorized, validly
issued, fully paid and nonassessable, and is owned, directly or indirectly, by
the Company free and clear of all liens, pledges, security interests, claims or
other encumbrances other than liens imposed by local law which are not material.
The following information for each Subsidiary of the Company is listed in the
Disclosure Schedule, if applicable: (a) its name and jurisdiction of
incorporation or organization; (b) the location of its chief executive office;
(c) a summary of its lines of business and products; (d) its authorized capital
stock or share capital; and (e) the number of issued and outstanding shares of
capital stock or share capital.
4.4. Ownership Interests. Except for the interests in the Company's
Subsidiaries and the interests disclosed in the Disclosure Schedule, neither the
Company nor any of its Subsidiaries owns any direct or indirect interest in any
corporation, joint venture, limited liability company, partnership, association
or other entity. Since January 1, 1992, the Company has not (i) disposed of the
capital stock (other than Company Common Stock) or all or substantially all of
the assets of any ongoing business, or (ii) purchased the business and/or all or
substantially all of the assets of another person, firm or corporation (whether
by purchase of stock, assets, merger or otherwise).
4.5. Constituent Documents. True and complete copies of the Certificate of
Incorporation and all amendments thereto, the By-Laws as amended and currently
in force, all stock records, and all corporate minute books and records of the
Company and each of its Subsidiaries have been furnished or made available by
the Company to Watson for inspection to the extent requested by Watson. Said
stock records accurately reflect all stock transactions and the current stock
ownership of the Company and its Subsidiaries. Since April 1, 1990, the
corporate minute books and records of the Company and its Subsidiaries contain
true and complete copies of all resolutions adopted by the stockholders or the
board of directors of the Company and its Subsidiaries and any other action
formally taken by them respectively as such.
4.6. Authorization of Agreement and Other Documents. The execution and
delivery of this Agreement and the other documents executed or to be executed in
connection herewith to which the Company is a party (collectively, the
"Ancillary Documents"), have been duly authorized by the Board of Directors of
the Company and no other proceedings on the part of the Company are necessary to
authorize the execution, delivery or performance of this Agreement or any
Ancillary Document, except the approval of the Merger by the Stockholders. This
Agreement is, and, as of the Closing Date, each of the Ancillary Documents will
be, a valid and binding obligation of the Company, enforceable against the
Company in accordance with its terms, except to the extent that enforcement
thereof may be limited by bankruptcy, insolvency, reorganization, moratorium,
fraudulent conveyance or other similar laws affecting enforcement of creditors'
rights generally, and by general principles of equity (regardless of whether
enforcement is considered in a proceeding at law or in equity) and subject to
the receipt of Stockholder approval of the Merger.
4.7. No Violation. Neither the execution and delivery of this Agreement
nor the Ancillary Documents by the Company nor the consummation by the Company
of the transactions contemplated hereby and thereby in accordance with their
respective terms, will (a) conflict with or result in a breach of any provisions
of the Certificate of Incorporation or By-Laws of the Company or any of its
Subsidiaries; (b) result in a breach or violation of, a default under, or the
triggering of any payment or other material obligations pursuant to, or
accelerate vesting under, any of the Company Stock Option Plans, or any grant or
award made under any of
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the foregoing; (c) violate, conflict with, result in a breach of any provision
of, constitute a default (or an event which, with notice or lapse of time or
both, would constitute a default) under, result in the termination, or in a
right of termination or cancellation of, accelerate the performance required by,
result in the triggering of any payment or other material obligations pursuant
to, result in the creation of any lien, security interest, charge or encumbrance
upon any of the material properties of the Company or any of its Subsidiaries
under, or result in being declared void, voidable, or without further binding
effect, any of the terms, conditions or provisions of any note, bond, mortgage,
indenture, deed of trust or any material license, franchise, permit, lease,
contract, agreement or other instrument, commitment or obligation to which the
Company or any of its Subsidiaries is a party, or by which the Company or any of
its Subsidiaries or any of their respective properties is bound or affected; (d)
contravene or conflict with or constitute a violation of any provision of any
law, regulation, judgment, injunction, order or decree binding upon or
applicable to the Company or any of its Subsidiaries, except for any of the
foregoing matters which would not have a Company Material Adverse Effect; or (e)
other than the Regulatory Filings, require any material consent, approval or
authorization of, or declaration of, or filing or registration with, any
domestic governmental or regulatory authority, the failure to obtain or make
which would have a Company Material Adverse Effect.
4.8. Compliance with Laws -- General.
(a) The Company and each of its Subsidiaries hold all permits, licenses,
variances, exemptions, orders and approvals of any Governmental Entities
necessary for the lawful conduct of its business (the "Permits"), except where
the failure to hold such permits would not have a Company Material Adverse
Effect.
(b) The Company and its Subsidiaries are in substantial compliance with the
terms of its Permits.
(c) The Company and its Subsidiaries are in substantial compliance with all
laws, ordinances or regulations of all Governmental Entities (including, but not
limited to, those related to occupational health and safety, controlled
substances or employment and employment practices) that are applicable to the
Company or any of its Subsidiaries or affect or relate to this Agreement or the
transactions contemplated hereby, except for any noncompliance that would not
have a Company Material Adverse Effect.
(d) As of the date of this Agreement, and as of the Closing, no
investigation, review, inquiry or proceeding by any Governmental Entity with
respect to the Company or any of its Subsidiaries is to the knowledge of the
Company, pending or threatened.
(e) Neither the Company nor any of its Subsidiaries are subject to any
agreement, contract or decree with any Governmental Entities arising out of any
current or previously existing violations of any laws, ordinances or regulations
applicable to the Company or any of its Subsidiaries.
4.9. Compliance with Laws -- FDA.
(a) As to each drug of the Company for which a new drug application or
abbreviated new drug application has been approved by the FDA, which drug is
described in the Disclosure Statement, the applicant and all persons performing
operations covered by the application are in substantial compliance with 21
U.S.C. sec.sec. 355 or 357, 21 C.F.R. Parts 314 or 430 et. seq., respectively,
and all terms and conditions of the application.
(b) As to each biologic product of the Company or its Subsidiaries for
which an ELA and/or PLA has been filed, which products are described in the
Disclosure Statement, the applicant and all persons performing operations
covered by the application are in substantial compliance with 42 U.S.C.
sec. 262, 21 C.F.R. Part 601 et. seq., and all terms and conditions of the ELA
and/or PLA.
(c) The Company and each of its Subsidiaries are in substantial compliance
with all applicable registration and listing requirements set forth in 21 U.S.C.
sec. 360 and 21 C.F.R. Part 207. To the extent required, the Company and each of
its Subsidiaries have obtained licenses from the DEA and are in substantial
compliance with all such licenses and all applicable regulations promulgated by
the DEA.
(d) All manufacturing operations conducted by or, to the knowledge of the
Company, for the benefit of the Company and its Subsidiaries have been and are
being conducted in substantial compliance with the good manufacturing practice
regulations set forth in 21 C.F.R. Parts 210 and 211.
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(e) Neither the Company, its Subsidiaries nor, to the knowledge of the
Company, their respective officers, employees, or agents have made an untrue
statement of material fact or fraudulent statement to the FDA or the DEA, failed
to disclose a material fact required to be disclosed to the FDA or the DEA, or
committed an act, made a statement, or failed to make a statement that could
reasonably be expected to provide a basis for the FDA to invoke its policy
respecting "Fraud, Untrue Statements of Material Facts, Bribery, and Illegal
Gratuities," set forth in 56 Fed. Reg 46191 (September 10, 1991).
(f) The Company has made available to Watson copies of any and all reports
of inspection observations, establishment inspection reports, warning letters
and any other documents received from or issued by the FDA or the DEA within the
last three years that indicate or suggest lack of compliance with the FDA or the
DEA regulatory requirements by the Company, its Subsidiaries or persons covered
by product applications or otherwise performing services for the benefit of the
Company or its Subsidiaries.
(g) Neither the Company nor its Subsidiaries have received any written
notice that the FDA or the DEA has commenced, or threatened to initiate, any
action to withdraw its approval or request the recall of any product of the
Company or its Subsidiaries or commenced or threatened to initiate, any action
to enjoin production at any facility owned or used by the Company or its
Subsidiaries or any of the Company's or its Subsidiaries' Manufacturing
Locations.
(h) As to each article of drug or consumer product currently manufactured
and/or distributed by the Company or its Subsidiaries, which products are
described in the Disclosure Statement, such article is not adulterated or
misbranded within the meaning of the FDCA, 21 U.S.C. sec.sec. 301c et. seq.
(i) As to each drug referred to in (a), the Company, and its officers,
employees, agents and affiliates have included or caused to be included in the
application for such drug, where required, the certification described in 21
U.S.C. sec. 335a(k)(l) and the list described in 21 U.S.C. sec. 335a(k)(2), and
such certification and such list was in each case true and accurate when made
and remained true and accurate thereafter.
(j) Neither the Company, its Subsidiaries, nor, to the knowledge of the
Company, their respective officers, employees, agents or affiliates, has been
convicted of any crime or engaged in any conduct for which debarment is mandated
by 21 U.S.C. sec. 335a(a) or authorized by 21 U.S.C. sec. 335a(b).
(k) As to each application or abbreviated application submitted to, but not
approved by, the FDA, and not withdrawn by the Company or its Subsidiaries, or
applicants acting on its behalf as of the date of this Agreement, the Company
and its Subsidiaries have complied in all material respects with the
requirements of 21 U.S.C. sec.sec. 355 and 357 and 21 C.F.R. Parts 312, 314 and
430 et. seq. and has provided, or will provide, all additional information and
taken, or will take, all additional action requested by the FDA in connection
with the application.
4.10. Books and Records. The Company's and its Subsidiaries' books,
accounts and records are, and have been, in all material respects, maintained in
the Company's and its Subsidiaries usual, regular and ordinary manner, in
accordance with GAAP, and since July 1, 1990, all material transactions to which
the Company or any of its Subsidiaries is or has been a party are properly
reflected therein.
4.11. SEC Documents. The Company has delivered or made available to Watson
each registration statement, report, proxy statement or information statement
(as defined in Regulation 14C under the Exchange Act) prepared by it since
January 1, 1993, which reports constitute all of the documents required to be
filed by the Company with the SEC since such date, each in the form (including
exhibits and any amendments thereto) filed with the SEC (collectively, the
"Company Reports"). As of their respective dates, the Company Reports and any
Company Reports filed after the date hereof and prior to the Effective Time (a)
complied as to form in all material respects with the applicable requirements of
the Securities Act or the Exchange Act, as the case may be, and the rules and
regulations thereunder; and (b) did not contain any untrue statement of a
material fact or omit to state a material fact required to be stated therein or
necessary to make the statements made therein, in the light of the circumstances
under which they were made, not misleading. The Company has timely filed with
the SEC all reports required to be filed under Section 13, 14 and 15(d) of the
Exchange Act since January 1, 1993. Each of the consolidated balance sheets of
the Company included in or incorporated by reference into the Company Reports
(including the related notes and
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schedules) fairly present in all material respects the consolidated financial
position of the Company and its Subsidiaries as of its date (subject, in the
case of unaudited statements, to normal year-end audit adjustments which would
not be material in amount or effect, and each of the consolidated statements of
income, retained earnings and cash flows of the Company included in or
incorporated by reference into the Company Reports (including any related notes
and schedules) fairly present in all material respects the results of
operations, retained earnings or cash flows, as the case may be, of the Company
and its Subsidiaries for the periods set forth therein (subject, in the case of
unaudited statements, to normal year-end audit adjustments which would not be
material in amount or effect). The financial statements of the Company,
including the notes thereto, included in or incorporated by reference into the
Company Reports comply as to form in all material respects with applicable
accounting requirements and with the published rules and regulations of the SEC
with respect thereto, and have been prepared in accordance with GAAP (except as
may be indicated in the notes thereto). Since January 1, 1993, there has been no
material change in the Company's accounting methods or principles except as
described in the notes to such Company financial statements.
4.12. Accounts Receivables. To the knowledge of the Company, none of the
trade receivables and notes receivable which are reflected in the financial
statements contained in the Company Reports or which arose subsequent to
September 30, 1996, is or was subject to any counterclaim or set off. All of
such trade receivables arose out of bona fide, arms-length transactions for the
sale of goods or performance of services, and to the Company's knowledge, all
such trade receivables and notes receivable are good and collectible (or have
been collected) in the ordinary course of business using normal collection
practices at the aggregate recorded amounts thereof, less the amount of
applicable reserves for doubtful accounts and for allowances and discounts. All
such reserves, allowances and discounts, were and are adequate and materially
consistent in extent with reserves, allowances and discounts previously
maintained by the Company in the ordinary course of its business, subject to
industry changes due to shelf restocking or customer rebates. Since September
30, 1996, there has not been a material write-down or write-off of the Company's
aggregate trade receivables or a material adverse change in the aging thereof.
The Company does not have, to a material extent, any outstanding sales on
consignment, sales on approval, sales on return or guaranteed sales.
4.13. Inventory. All inventory of the Company or any of its Subsidiaries
which is held for sale or resale, including raw materials, work in process and
finished goods (collectively, "Inventory"), consists of items of a quantity and
quality historically useable and/or saleable in the normal course of business,
except for items of obsolete and slow-moving material and materials which are
below standard quality, all of which have been written down to estimated net
realizable value on an item by item basis. None of such write-downs have had a
Company Material Adverse Effect since September 30, 1996. With the exception of
items of below standard quality which have been written down to their estimated
net realizable value, no material portion of the materials and/or workmanship
comprising the Inventory is defective. All Inventory reflected in the Company
Reports is valued at the lower of cost or market with cost determined by the
first in first out accounting method. Since September 30, 1996, there has not
been a material change in the level of the Inventory. All Inventory is, and, to
the knowledge of the Company, all tools, dies, jigs, patterns, molds, equipment,
supplies and other materials used in the production of Inventory are, located at
the Real Estate (as defined herein), the Leased Premises (as defined herein) or
the Company's or its Subsidiaries' Manufacturing Locations.
4.14. Bank Accounts. The Disclosure Statement contains a list showing: (a)
the name of each bank, safe deposit company or other financial institution in
which the Company or any of its Subsidiaries has an account, lock box or safe
deposit box; (b) the names of all persons authorized to draw thereon or to have
access thereto and the names of all persons and entities, if any, holding powers
of attorney from the Company or any of its Subsidiaries; and (c) all instruments
or agreements to which the Company or any of its Subsidiaries is a party as an
endorser, surety or guarantor, other than checks or other instruments endorsed
for collection or deposit.
4.15. Intellectual Property.
(a) The Disclosure Statement identifies all of the following which are used
in the Company's or any of its Subsidiaries' businesses and in which the Company
or any of its Subsidiaries claims any ownership rights: (i) all registered
trademarks, service marks, slogans, trade names, trade dress and the like
(collectively with
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the associated goodwill of each, "Trademarks"), together with information
regarding all registrations and pending applications to register any such
rights; (ii) all common law Trademarks; (iii) all patents on and pending
applications to patent any technology or design; (iv) all registrations of and
applications to register copyrights; and (v) all licenses or rights in computer
software, Trademarks, patents, copyrights, unpatented formulations,
manufacturing methods and other know-how, whether to or by the Company or any of
its Subsidiaries, other than licenses to commercially available computer
software and other know-how acquired or entered into by the Company or any of
its Subsidiaries in the ordinary course of business. The rights required to be
so identified, together with all proprietary formulation, manufacturing methods,
know-how and trade secrets that are material to the Company's or any of its
Subsidiaries' businesses, are referred to herein collectively as the
"Intellectual Property".
(b)(i) The Company or its Subsidiaries is the owner of or duly licensed to
use each Trademark and its associated goodwill; (ii) each of the Trademark
registrations exists and has been maintained in good standing; (iii) each patent
and application included in the Intellectual Property exists, is owned by or
licensed to the Company or its Subsidiaries and, to the Company's knowledge, has
been maintained in good standing; (iv) each copyright registration exists and is
owned by the Company or its Subsidiaries; (v) to the Company's knowledge, no
other firm, corporation, association or person claims the right to use in
connection with similar or closely related goods and in the same geographic
area, any mark which is identical or confusingly similar to any of the
Trademarks; (vi) the Company has no knowledge of any claim that any third party
asserts ownership rights in any of the Intellectual Property; (vii) the Company
has no knowledge of any claim or knowledge of any facts that would give the
Company any reason to reasonably believe that the Company's or its Subsidiaries'
use of any Intellectual Property infringes any right of any third party; (viii)
the Company has no knowledge and there are no facts known to the Company that
would give the Company any reasonable basis to believe that any third party is
infringing on any of the Company's or its Subsidiaries' rights in any of the
Intellectual Property; (ix) the Company has no knowledge and there are no facts
known to the Company that would give the Company any reasonable basis to believe
that any of its actions or the actions of its Subsidiaries has infringed or is
infringing on any third party's Intellectual Property rights; (x) to the
Company's knowledge, there are no undisclosed government restrictions, domestic
or foreign, which specifically limit the manner in which any of the Intellectual
Property may be used or licensed; and (xi) to the Company's knowledge, neither
the Company, its Subsidiaries nor any of their respective officers or directors
has disclosed any confidential information of the Company or any of its
Subsidiaries which would constitute trade secrets under Florida law, except in
the ordinary course of business of the Company and its Subsidiaries or with the
authority of the Company or its Subsidiaries.
(c) Watson understands and acknowledges that the Surviving Corporation must
continue to assert control over the quality of the goods or services offered in
connection with the Company's Trademarks or its Subsidiaries in order to
maintain its claim of ownership in the Trademarks after the Closing.
4.16. Title to Properties. Attached to the Disclosure Statement is a list
and description of each item of real or tangible personal property owned by the
Company or any of its Subsidiaries which has a net book value in excess of
$50,000. The Company or its Subsidiaries (i) has good, marketable, legal and
valid title to such property free and clear of all liens, claims, encumbrances
or security interests (collectively, "Liens"), except for (A) Liens set forth on
the Disclosure Statement and (B) (x) mechanic's, materialmen's, and similar
liens, (y) liens arising under worker's compensation, unemployment insurance,
social security, retirement, and similar legislation and (z) liens on goods in
transit incurred pursuant to documentary letters of credit; and (ii) enjoys
peaceful and undisturbed possession under all leases to which it is a party as
lessee. All of the leases to which the Company or any of its Subsidiaries is a
party (other than leases for Leased Premises) are legal, valid and binding
obligations of the Company or its Subsidiaries and in full force and effect, and
no default by the Company or its Subsidiaries, or, to the knowledge of the
Company, any other party thereto has occurred or is continuing thereunder. The
Disclosure Schedule lists all properties and assets used by the Company or any
of its Subsidiaries in connection with the operation of their respective
businesses which are held under any lease or under any conditional sale or other
title retention agreement to the extent the Company or its Subsidiaries
remaining obligations under any such lease or agreement exceeds $50,000. Except
for such assets and facilities as are immaterial to the business of the Company
or its Subsidiaries, all
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tangible assets and facilities of the Company and its Subsidiaries are in good
operating condition and repair (ordinary wear and tear excepted) and, in the
aggregate with the intangible assets of the Company, are sufficient to conduct
the business of the Company and its Subsidiaries as previously conducted prior
to the date hereof.
4.17. Real Estate.
(a) Neither the Company nor any of its Subsidiaries owns any real estate,
or has the option to acquire any real estate, other than the premises identified
in the Disclosure Statement (the "Real Estate"). The Disclosure Statement
accurately sets forth the street addresses of the Real Estate. The Real Estate
is not subject to any leases or tenancies. None of the improvements comprising
the Real Estate or the businesses conducted or proposed to be conducted by the
Company or its Subsidiaries thereon, are, to the Company's knowledge, in
violation of any material use or occupancy restriction, limitation, condition or
covenant of record or any zoning or building law, code, ordinance or public
utility easement or any other applicable law. No material expenditures are
required to be made for the repair or maintenance of any improvements on the
Real Estate or for the Real Estate to be used for its intended purpose.
(b) Neither the Company nor any of its Subsidiaries leases any real estate
other than the premises identified in the Disclosure Statement as being so
leased (the "Leased Premises"). The Leased Premises are leased to the Company or
its Subsidiaries, pursuant to written leases, true, correct and complete copies
of which have been provided to Watson or its counsel. None of the improvements
comprising the Leased Premises, or the businesses conducted or proposed to be
conducted by the Company or its Subsidiaries thereon, are, to the Company's
knowledge, in violation of any building line or use or occupancy restriction,
limitation, condition or covenant of record or any zoning or building law, code
or ordinance, public utility or other easements or other applicable law, except
for violations which do not have a Company Material Adverse Effect or materially
interfere with the conduct of the business of the Company or its Subsidiaries.
No material expenditures are required to be made for the repair or maintenance
of any improvements on the Leased Premises or for the Leased Premises to be used
for its intended purpose. Neither the Company nor its Subsidiaries are in
default under any agreement relating to the Leased Premises nor, to the
knowledge of the Company, is any other party thereto in default thereunder. All
options in favor of the Company or its Subsidiaries to purchase any of the
Leased Premises, if any, are in full force and effect.
(c) The Real Estate, the Leased Premises, each facility located on the Real
Estate and the Leased Premises and, to the Company's knowledge, each of the
Company's or its Subsidiaries' Manufacturing Locations are currently served by
gas, electricity, water, sewage and waste disposal and other utilities adequate
to operate such Real Estate, Leased Premises, Manufacturing Locations and/or
facility at its current rate of production, and none of the utility companies
serving any such Real Estate, Leased Premises, any facility and, to the
Company's knowledge, each of such Manufacturing Locations has threatened the
Company or its Subsidiaries with any reduction in service.
(d) There are no challenges or appeals pending regarding the amount of the
taxes on, or the assessed valuation of, the Real Estate or the Leased Premises,
and no special arrangements or agreements exist with any governmental authority
with respect thereto (the representations and warranties contained in this
Section 4.17(d) shall not be deemed to be breached by any prospective general
increase in real estate tax rates).
(e) There are no condemnation proceedings pending against the Company or,
to the Company's knowledge, threatened with respect to any portion of the Real
Estate or the Leased Premises.
(f) There is no tax assessment (in addition to the normal, annual general
real estate tax assessment) pending against the Company or, to the Company's
knowledge, threatened with respect to any portion of the Real Estate or, to the
extent the Company or its Subsidiaries is liable for payment therefor, the
Leased Premises.
(g) The buildings and other facilities located on the Real Estate and the
Leased Premises are free of any material latent structural or engineering
defects known to the Company or any material patent structural or engineering
defects.
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4.18. Contracts.
(a) Neither the Company nor any of its Subsidiaries is a party to, or bound
by, or the issuer or beneficiary of, any undischarged written or oral: (i)
agreement or arrangement obligating the Company or its Subsidiaries to pay or
receive, or pursuant to which the Company or its Subsidiaries has previously
paid or received, an amount in excess of $50,000 (excluding purchase and sale
orders entered into by the Company or its Subsidiaries in the ordinary course of
business consistent with past practices); (ii) employment or consulting
agreement or arrangement; (iii) collective bargaining agreement; (iv) plan or
contract or arrangement providing for bonuses, severance, options, deferred
compensation, retirement payments, profit sharing, medical and dental benefits
or the like covering employees of the Company, other than Plans, Welfare Plans
and Employee Benefit Plans (in each case as defined herein) described in the
Disclosure Statement; (v) agreement restricting in any manner the Company's
right to compete with any other person or entity, the Company's right to sell to
or purchase from any other person or entity, the right of any other party to
compete with the Company, or the ability of such person or entity to employ any
of the Company's employees; (vi) secrecy or confidentiality agreements; (vii)
any distributorship, non-employee commission or marketing agent, representative
or franchise agreement providing for the marketing and/or sale of the products
or services of the Company or any of its Subsidiaries; (viii) agreement between
the Company and any of its affiliates or other Related Parties (as herein
defined); (ix) guaranty, performance, bid or completion bond, or surety or
indemnification agreement; (x) requirements contract; (xi) loan or credit
agreement, pledge agreement, note, security agreement, mortgage, debenture,
indenture, factoring agreement or letter of credit; (xii) agreement for the
treatment or disposal of Materials of Environmental Concern (as defined herein);
(xiii) power of attorney; (xiv) any agreement relating to the ownership or
control of any interest in a partnership, corporation, limited liability
company, joint venture or other entity or similar arrangement; (xvi) any
contract, agreement or arrangement containing change of control provisions; or
(xvii) any other agreement not entered into in the ordinary course of business.
Neither the Company nor any of its Subsidiaries are currently negotiating (and
have not entered into preliminary discussions with respect to) any transaction
involving an aggregate payment by the Company or its Subsidiaries and/or
receipts to the Company or its Subsidiaries in excess of $150,000 excluding
purchase and sale orders entered into by the Company or its Subsidiaries in the
ordinary course of business consistent with past practices.
(b) All agreements, leases, subleases and other instruments referred to in
this Section 4.18, are, pursuant to their terms, in full force and binding upon
the Company or its Subsidiaries, and, to the knowledge of the Company, the other
parties thereto. Neither the Company nor any of its Subsidiaries is and, to the
Company's knowledge, none of the other parties thereto are in default of a
material provision under any such agreement, lease, sublease or other
instrument. No event, occurrence or condition exists which, with the lapse of
time, the giving of notice, or both, or the happening of any further event or
condition, would become a default of a material provision under any such
agreement, lease, sublease or other instrument by the Company or its
Subsidiaries, or, to the knowledge of the Company, the other contracting party.
Neither the Company nor any of its Subsidiaries has released or waived any
material right under any such agreement, lease, sublease or other instrument
other than in the ordinary course of business consistent with past practices.
(c) Immediately after the Closing, except as contemplated by this
Agreement, neither the Company nor any of its Subsidiaries will be bound by the
terms of any stock option agreement, registration rights agreement, stockholders
agreement, management agreement, consulting agreement or any other agreement
relating to the equity or management of the Company or its Subsidiaries.
(d) Neither the Company nor any of its Subsidiaries is a party to, or bound
by, any unexpired, undischarged or unsatisfied written or oral contract,
agreement, indenture, mortgage, debenture, note or other instrument under the
terms of which performance by the Company or its Subsidiaries according to the
terms of this Agreement will be a default of a material provision under or an
event of acceleration, or grounds for termination, or whereby timely performance
by the Company of this Agreement may be prohibited, prevented or delayed.
4.19. Insurance. The Disclosure Statement contains a true and correct list
of all insurance policies which are owned by the Company or its Subsidiaries or
which name the Company or any of its Subsidiaries as
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an insured (or loss payee), including without limitation those which pertain to
the Company's or its Subsidiaries' assets, employees or operations. All such
insurance policies are in full force and effect and neither the Company nor any
of its Subsidiaries have received notice of cancellation of any such insurance
policies. In the two (2) year period ending on the date hereof, neither the
Company nor any of its Subsidiaries have received any written notice from, or on
behalf of, any insurance carrier relating to or involving an annual increase by
over 10% in insurance rates (except to the extent that insurance risks may be
increased for all similarly situated risks) or non-renewal of a policy, or
requiring or suggesting material alteration of any of the Company's or its
Subsidiaries' assets, purchase of additional equipment, or material modification
of any of the Company's or its Subsidiaries' methods of doing business. Neither
the Company nor any of its Subsidiaries made any claim for reimbursement from
its insurance carriers since June 30, 1993.
4.20. Litigation. Except as set forth in the Disclosure Schedule or
matters which are immaterial to the Company or its Subsidiaries, there is no
litigation or proceeding, in law or in equity, and there are no proceedings or
governmental investigations before any commission or other administrative
authority, pending or, to the Company's knowledge, threatened against the
Company or any of its Subsidiaries, or any of the Company's or its Subsidiaries'
respective officers, directors or affiliates, with respect to or affecting the
Company's or its Subsidiaries' respective operations, businesses, products,
sales practices or financial condition, or related to the consummation of the
transactions contemplated hereby or by the Watson Ancillary Documents or the
Ancillary Documents. There are no facts known to the Company which, if known by
a potential claimant or governmental authority, would reasonably give rise to a
claim or proceeding which, if asserted or conducted with results unfavorable to
the Company or its Subsidiaries, would have a Company Material Adverse Effect.
4.21. Warranties. To the Company's knowledge, neither the Company nor any
of its Subsidiaries has made any oral or written warranties with respect to the
quality or absence of defects of its products or services which they have sold
or performed which are in force as of the date hereof except as are described in
the Disclosure Statement. There are no material claims pending or, to the
knowledge of the Company, threatened against the Company or any of its
Subsidiaries with respect to the quality of or absence of defects in such
products or services nor are there any facts known to the Company relating to
the quality of or absence of defects in such products or services which, if
known by a potential claimant or governmental authority, would reasonably give
rise to a material claim or proceeding. The Disclosure Statement sets forth a
summary, which is accurate in all material respects, of all returns of products
during the period beginning January 1, 1995 and ending on the date hereof, and
all credits and allowances for returned products given to customers during said
period to the extent that such returns, credits and allowances with respect to
any one product exceeds $50,000 in the aggregate, and said summary contains a
description of any reoccurring product defects (other than returns due to date
expirations). The Company has no knowledge of or reason to believe that the
percentage of warranty claims or product returns for products sold by the
Company and its Subsidiaries prior to the Closing Date will exceed historical
levels.
4.22. Products Liability. Neither the Company nor any of its Subsidiaries
have received any written notice relating to, nor does the Company have
knowledge of any facts or circumstances which could reasonably give rise to, any
claim involving any product manufactured, produced, distributed or sold by or on
behalf of the Company or its Subsidiaries resulting from an alleged defect in
design, manufacture, materials or workmanship, or any alleged failure to warn,
or from any breach of implied warranties or representations, other than notices
or claims that have been settled or resolved by the Company or its Subsidiaries
prior to the date of this Agreement.
4.23. Arbitration. Neither the Company nor any of its Subsidiaries is a
party to, or bound by, any decree, order or arbitration award (or agreement
entered into in any administrative, judicial or arbitration proceeding with any
governmental authority) with respect to or affecting the properties, assets,
personnel or business activities of the Company or its Subsidiaries.
4.24. Taxes.
(a) As used in this Agreement, (i) the term "Taxes" means all federal,
state, local, foreign and other net income, gross income, gross receipts, sales,
use, ad valorem, transfer, franchise, profits, license, lease, service,
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service use, withholding, payroll, employment, excise, severance, stamp,
occupation, premium, property, windfall profits, customs, duties or other taxes,
fees, assessments or charges of any kind whatever of a nature similar to taxes,
together with any interest and any penalties, additions to tax or additional
amounts with respect thereto, and the term "Tax" means any one of the foregoing
Taxes; and (ii) the term "Returns" means all returns, declarations, reports,
statements and other documents required to be filed in respect of Taxes, and the
term "Return" means any one of the foregoing Returns.
(b) There have been properly completed and filed on a timely basis and in
correct form all material Returns required to be filed by the Company or any of
its Subsidiaries. As of the time of filing, the foregoing Returns were correct
and complete in all material respects. An extension of time within which to file
any Return which has not been filed has not been requested or granted.
(c) With respect to all amounts in respect of Taxes imposed upon the
Company or any of its Subsidiaries, or for which the Company or any of its
Subsidiaries is or could be liable, whether to taxing authorities (as, for
example, under law) or to other persons or entities (as, for example, under tax
allocation agreements), with respect to all taxable periods or portions of
periods ending on or before September 30, 1996, (i) all applicable tax laws and
agreements have been complied with in all material respects, and (ii) all
amounts required to be paid by the Company or its Subsidiaries, to taxing
authorities or others, on or before the date hereof have been paid or adequately
reserved for on the financial statements contained in the Company Reports, and
any Taxes accrued but not due and payable as of September 30, 1996 have been
accrued or otherwise reserved for in financial statements contained in the most
recent Company Report. No Taxes have been (or will prior to the Closing Date be)
recorded by the Company or any of its Subsidiaries other than in the ordinary
course of business. There are no Liens filed against any asset of the Company or
any of its Subsidiaries resulting from the failure to pay any Tax when due.
(d) To the Company's knowledge, no issues have been raised (and are
currently pending) by any taxing authority in connection with any of the
Returns. No waivers of statutes of limitation with respect to the Returns have
been given by the Company or any of its Subsidiaries (or with respect to any
Return which a taxing authority has asserted should have been filed by the
Company or any of its Subsidiaries) which waivers are still in effect. The
Disclosure Statement sets forth those years for which examinations have been
completed, those years for which examinations are presently being conducted, and
those years for which Returns will be required but are not yet due to be filed
and have not yet been filed. All deficiencies asserted or assessments made as a
result of any examinations have been fully paid, or are fully reflected as a
liability in the financial statements contained in the Company Report, or are
being contested and an adequate reserve therefor has been established and is
fully reflected as a liability in the financial statements contained in the most
recent Company Report.
(e) The unpaid Taxes of the Company or any of its Subsidiaries do not
materially exceed the reserve for tax liability (excluding any reserve for
deferred Taxes established to reflect timing differences between book and tax
income) set forth or included in the financial statements included in the most
recent Company Report, as adjusted for the passage of time through the Closing.
(f) Neither the Company nor any of its Subsidiaries is or at any time has
been a party to or bound by (nor will the Company or any of its Subsidiaries
become a party to or bound by) any tax indemnity, tax sharing or tax allocation
agreement.
(g) Neither the Company nor any of its Subsidiaries has ever been a member
of an affiliated group of corporations, within the meaning of section 1504 of
the Code.
(h) All material elections with respect to Taxes affecting the Company or
any of its Subsidiaries that are currently effective as of the date hereof that
are not reflected in the Company's Returns are set forth in the Disclosure
Statement.
4.25. ERISA. The Disclosure Schedule contains a list and brief description
of all "employee pension benefit plans" (as defined in Section 3(2) of the
Employee Retirement Income Security Act of 1974, as amended ("ERISA"))
(sometimes referred to herein as "Pension Plans"), "employee welfare benefit
plans" (as defined in Section 3(1) of ERISA and referred to herein as a "Welfare
Plan") and all other Benefit Plans
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(defined herein as any Pension Plan, Welfare Plan and any other plan, fund,
program, arrangement or agreement to provide employees, directors, independent
contractors, officers or agents of any Commonly Controlled Entity with medical,
health, life, bonus, stock (option, ownership or purchase), deferred
compensation, severance, salary continuation, vacation, sick leave, fringe,
incentive insurance or other benefits) maintained, or contributed to, or
required to be contributed to, by the Company or any of its subsidiaries or any
other Person that, together with the Company at any time during the last six
years, is or was treated as a single employer under Section 414(b), (c), (m) or
(o) of the Code (the Company and each such other Person, a "Commonly Controlled
Entity") for the benefit of any current or former employees, officers or
directors of any Commonly Controlled Entity. The Company has delivered or made
available to Watson true, complete and correct copies of (i) each Benefit Plan
(or, in the case of any unwritten Benefit Plans, descriptions thereof), (ii) the
most recent annual report on Forms 5500 and 990, if any, filed with the Internal
Revenue Service with respect to each Benefit Plan (if any such report was
required), (iii) the most recent summary plan description for each Benefit Plan
for which such summary plan description is required, (iv) each trust agreement
and group annuity contract relating to any Benefit Plan; and (v) a list of all
assets and liabilities of, allocated to or accounted for separately with respect
to every Benefit Plan (including insurance contracts associated with every
Benefit Plan regardless of whether any current cash value exists). Each Benefit
Plan has been established, funded, maintained and administered in all material
respects in accordance with its terms and is in compliance with the applicable
provisions of ERISA, the Code, all other applicable laws and all applicable
collective bargaining agreements except where the failure to comply would not be
reasonably expected to result in a Company Material Adverse Effect.
(b) All Pension Plans have been the subject of favorable and up-to-date
(through any applicable remedial amendment period) determination letters from
the Internal Revenue Service, or have filed a timely application therefor, to
the effect that such Pension Plans are qualified and exempt from federal income
taxes under Section 401(a) and 501(a), respectively, of the Code, and no such
determination letter has been revoked nor has any such Pension Plan been amended
since the date of its most recent determination letter or application therefor
in any respect that would adversely affect its qualification or materially
increase its costs.
(c) No Commonly Controlled Entity has adopted or been obligated to
contribute to any "defined benefit pension plan" as defined in Section 3(35) of
ERISA subject to Title IV of ERISA in the five years preceding the date hereof.
(d) No Commonly Controlled Entity has been required at any time within the
five calendar years preceding the date hereof or is required currently to
contribute to any "multiemployer plan" (as defined in Section 4001(a)(3) of
ERISA ) or has withdrawn from any multiemployer plan where such withdrawal has
either: (i) resulted or would result in any "withdrawal liability" (within the
meaning of Section 4201 of ERISA) that has not been fully paid; or (ii) engaged
in a transaction that might have resulted in withdrawal liability but for the
application of Section 4204 of ERISA.
(e) With respect to any Welfare Plan, (i) no such Welfare Plan is funded
through a "welfare benefits fund", as such term is defined in Section 419(e) of
the Code, (ii) no such Welfare Plan is self-insured, and (iii) each such Welfare
Plan that is a "group health plan", as such term is defined in Section
5000(b)(1) of the Code, complies with the applicable requirements of Section
4980B(f) of the Code.
(f) Except as set forth in the Disclosure Schedule, neither the Company or
any Commonly Controlled Entity nor any Person acting on behalf of the Company or
any Commonly Controlled Entity has, in contemplation of any corporate
transaction involving Watson, issued any written communication to, or otherwise
made or entered into any legally binding commitment with, any employees of the
Company or of any Commonly Controlled Entity to the effect that, following the
date hereof, (i) any benefits or compensation provided to such employees under
existing Benefit Plans or under any other plan or arrangement will be enhanced,
(ii) any new plans or arrangements providing benefits or compensation will be
adopted, (iii) any Benefit Plans will be continued for any period of time or
cannot be amended or terminated at any time or for any reason, or (iv) any plans
or arrangements provided by Watson will be made available to such employees.
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(g) No Commonly Controlled Entity has ever promised or been obligated to
provide former employees with coverage or benefits under Benefit Plans, other
than as required by Section 4980B of the Code.
(h) All contributions or premiums owed by Commonly Controlled Entities with
respect to Benefit Plans under law, contract or otherwise have been made in full
and on a timely basis and Commonly Controlled Entities are not obligated to
contribute with respect to any Benefit Plan that involves a retroactive
contribution, assessment or funding waiver arrangement. All administrative costs
attributable to Benefit Plans have been paid when due.
(i) To the Company's knowledge, no Pension Plan or Welfare Plan or any
"fiduciary" or "party-in-interest" (as such terms are respectively defined by
Sections 3(21) and 3(14) of ERISA) thereto has engaged in a transaction
prohibited by Section 406 of ERISA or 4975 of the Code for which a valid
exception is not available.
(j) There are no pending or, to the Company's knowledge, threatened likely
claims, lawsuits, arbitrations or audits asserted or instituted against any
Benefit Plan, any fiduciary (as defined by Section 3(21) of ERISA thereto, any
Commonly Controlled Entity or any employee or administrator thereof in
connection with the existence, operation or administration of a Benefit Plan,
other than routine claims for benefits.
(k) Nothing in this Agreement or the transaction contemplated hereunder
will: (i) cause the termination or repricing of any insurance contract to which
a Commonly Controlled Entity or Benefit Plan is a party to the purposes of
providing employee benefits; (ii) trigger a right of any employee of any
Commonly Controlled Entity to severance, deferred compensation or retirement
benefits; or (iii) cause any early withdrawal or premature termination penalty
with respect to any asset held in connection with any Benefit Plan.
(l) No Commonly Controlled Entity maintains any unfunded plan of deferred
compensation.
4.26. Labor Matters. Except as set forth in the Disclosure Statement or
for events that occur after the date hereof which are disclosed in writing by
the Company to Watson, (a) there is no labor strike, dispute, slowdown, work
stoppage or lockout pending or, to the knowledge of the Company, threatened
against or affecting the Company or any of its Subsidiaries and during the past
three years, there has not been any such action; (b) there are no union claims
to represent the employees of the Company or any of its Subsidiaries, (c)
neither the Company nor any of its Subsidiaries is a party to or bound by any
collective bargaining or similar agreement with any labor organization, or work
rules or practices agreed to with any labor organization or employee association
applicable to employees of the Company or any of its Subsidiaries; (d) none of
the employees of the Company or any of its Subsidiaries are represented by any
labor organization and the Company does not have any knowledge of any current
union organizing activities among the employees of the Company or any of its
Subsidiaries, nor to the knowledge of the Company does any question concerning
representation exist with respect to such employees; (e) to the knowledge of the
Company, the Company and its Subsidiaries are, and has at all times been, in
material compliance with all applicable employment laws and practices,
including, without limitation, any such laws relating to employment
discrimination, occupational safety and health and unfair labor practices; (f)
there is no unfair labor practice charge or complaint against the Company or any
of its Subsidiaries pending or, to the knowledge of the Company, threatened
before the National Labor Relations Board or, to the knowledge of the Company,
any charges or complaints, or facts which could reasonably give rise to a charge
or complaint, pending or threatened with any Governmental Entity who has
jurisdiction over unlawful employment practices; (g) there is no grievance or
arbitration proceeding arising out of any collective bargaining agreement or
other grievance procedure pending relating to the Company or any of its
Subsidiaries; (h) neither the Company nor any of its Subsidiaries is delinquent
in payments to any of its employees for any wages, salaries, commissions,
bonuses or other direct compensation for any services performed by them to the
date of this Agreement or amounts required to be reimbursed to such employees;
(i) upon termination of the employment of any of the employees of the Company or
any of its Subsidiaries after the Closing, neither the Company nor any of its
Subsidiaries will be liable to any of its employees for severance pay, except as
otherwise required by federal law; (j) the employment of each of the Company's
or its Subsidiaries' employees is terminable at will without cost to the Company
or any of its Subsidiaries except for payments disclosed on the Disclosure
Statement or required under the Plans, Welfare Plans and Employee Benefit Plans
and payment of accrued salaries or wages and vacation pay; (k) no
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employee or former employee of the Company or any of its Subsidiaries has any
right to be rehired by the Company or its Subsidiaries prior to the Company's or
its Subsidiaries' hiring a person not previously employed by the Company or its
Subsidiaries; and (l) the Disclosure Statement contains a true and complete list
of all employees who are employed by the Company or any of its Subsidiaries as
of December 1, 1996, and said list correctly reflects their salaries, wages,
other compensation (other than benefits under the Plans, Welfare Plans and
Employee Benefit Plans), dates of employment and positions. Neither the Company
nor any of its Subsidiaries owes any past or present employee any sum in excess
of $25,000 individually or $50,000 in the aggregate other than for accrued wages
or salaries for the current payroll period, and amounts payable under Plans,
Welfare Plans or Employee Benefit Plans. No employee owes any sum to the Company
or any of its Subsidiaries in excess of $25,000, and all employees together do
not owe the Company or any of its Subsidiaries in excess of $50,000.
4.27. Environmental Matters.
(a) The Company, its Subsidiaries and their respective assets and
businesses are in substantial compliance with all Environmental Laws and
Environmental Permits (as herein defined) applicable to them. A copy of any
notice, citation, inquiry or complaint which the Company or any of its
Subsidiaries has received in the past three years of any alleged violation of
any Environmental Law or Environmental Permit is contained in the Disclosure
Schedule, and all violations alleged in said notices have been or are being
corrected. A description of all such violations currently being corrected is
contained in the Disclosure Statement. The Company and its Subsidiaries possess
all Environmental Permits which are required for the operation of their
respective businesses, and are in substantial compliance with the provisions of
all such Environmental Permits. Copies of all Environmental Permits issued to
the Company or any of its Subsidiaries have been provided or made available to
Watson or its counsel. The Company has delivered to Watson copies of all
environmental reports with respect to the Real Estate and the Leased Premises in
its possession (other than reports prepared by or on behalf of Watson) which
were conducted during the last five years.
(b) The Disclosure Statement sets forth a complete list of all Materials of
Environmental Concern stored, treated, generated, used, transported or Released
(as herein defined) in connection with the operation of the Company's business.
There has been no storage, treatment, generation, transportation or Release of
any Materials of Environmental Concern by the Company or any of its
Subsidiaries, or, to the knowledge of the Company, by any other person or entity
for which the Company or any of its Subsidiaries is or may be held responsible,
at any Facility (as herein defined) or any Offsite Facility (as herein defined)
in violation of, or which could give rise to any material obligation under,
Environmental Laws.
(c) The Disclosure Statement sets forth a complete list of all Containers
(as herein defined) that are now present at, or have heretofore been removed
during the last two years from, the Real Estate or the Leased Premises. All
Containers which have been heretofore removed from the Real Estate or the Leased
Premises have been removed substantially in accordance with all applicable
Environmental Laws.
(d) For the purposes of this Agreement: (i) "Environmental Laws" means all
federal, state and local statutes, regulations, ordinances, rules, regulations
and policies, all court orders and decrees and arbitration awards, and the
common law, which pertain to environmental matters or contamination of any type
whatsoever. Environmental Laws include, without limitation, those relating to:
manufacture, processing, use, distribution, treatment, storage, disposal,
generation or transportation of Materials of Environmental Concern; air, surface
or ground water or noise pollution; Releases; protection of wildlife, endangered
species, wetlands or natural resources; Containers; health and safety of
employees and other persons; and notification requirements relating to the
foregoing; (ii) "Environmental Permits" means licenses, permits, registrations,
governmental approvals, agreements and consents which are required under or are
issued pursuant to Environmental Laws; (iii) "Materials of Environmental
Concern" means (A) pollutants, contaminants, pesticides, radioactive substances,
solid wastes or hazardous or extremely hazardous, special, dangerous or toxic
wastes, substances, chemicals or materials within the meaning of any
Environmental Law, including without limitation any (i) "hazardous substance" as
defined in CERCLA, and (ii) any "hazardous waste" as defined in the Resource
Conservation and Recovery Act ("RCRA"), 42 U.S.C., Sec. 6902 et. seq., and all
amendments thereto and reauthorizations thereof; and (B) even if not prohibited,
limited or regulated by Environmental
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Laws, all pollutants, contaminants, hazardous, dangerous or toxic chemical
materials, wastes or any other substances, including without limitation, any
industrial process or pollution control waste (whether or not hazardous within
the meaning of RCRA) which could pose a hazard to the environment or the health
and safety of any person, or impair the use or value of any portion of the Real
Estate or the Leased Premises; (iv) "Release" means any spill, discharge, leak,
emission, escape, injection, dumping, or other release or threatened release of
any Materials of Environmental Concern into the environment, whether or not
notification or reporting to any governmental agency was or is, required,
including without limitation any Release which is subject to CERCLA; (v)
"Facility" means any facility as defined in the Comprehensive Environmental
Response, Compensation and Liability Act, 42 U.S.C. 9601, et. seq., as amended
and reauthorized ("CERCLA"); (vi) "Offsite Facility" means any Facility which is
not presently, and has not heretofore been, owned, leased or occupied by the
Company; and (vii) "Containers" means above-ground and under-ground storage
tanks, vessels and related equipment and containers.
4.28. Interim Conduct of Business. Except as otherwise contemplated by
this Agreement, since September 30, 1996, neither the Company nor any of its
Subsidiaries has:
(a) sold, assigned, leased, exchanged, transferred or otherwise disposed of
any material portion of its assets or property, except for sales of Inventory
and cash applied in the payment of the Company's or its Subsidiaries'
liabilities in the usual and ordinary course of business in accordance with the
Company's or its Subsidiaries' past practices;
(b) written off any asset which has a net book value which exceeds $25,000
individually or $50,000 in the aggregate in value, or suffered any casualty,
damage, destruction or loss, or interruption in use, of any material asset,
property or portion of Inventory (whether or not covered by insurance), on
account of fire, flood, riot, strike or other hazard or Act of God;
(c) waived any material right arising out of the conduct of, or with
respect to, its business;
(d) made (or committed to make) capital expenditures in an amount which
exceeds $25,000 for any item or $100,000 in the aggregate;
(e) made any change in accounting methods or principles;
(f) borrowed any money or issued any bonds, debentures, notes or other
corporate securities (other than equity securities), including without
limitation, those evidencing borrowed money;
(g) entered into any transaction with, or made any payment to, or incurred
any liability to, any Related Party (as defined herein) in an amount which
exceeds $15,000 or $50,000 in the aggregate (except for payment of salary and
other customary expense reimbursements made in the ordinary course of business
to Related Parties who are employees of the Company or its Subsidiaries);
(h) increased the compensation payable to any employee, except for normal
pay increases in the ordinary course of business consistent with past practices;
(i) made any payments or distributions to its employees, officers or
directors except such amounts as constitute currently effective compensation for
services rendered, or reimbursement for reasonable ordinary and necessary
out-of-pocket business expenses;
(j) paid or incurred any management or consulting fees, or engaged any
consultants, except in the ordinary course of business;
(k) hired any employee who has an annual salary in excess of $35,000, or
employees with aggregate annual salaries or wages in excess of $70,000;
(l) terminated any employee having an annual salary or wages in excess of
$35,000 or employees with aggregate annual salaries or wages in excess of
$70,000;
(m) adopted any new Plan, Welfare Plan or Employee Benefit Plan;
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(n) issued or sold any securities of any class, except for the grant or
exercise of options to purchase Company Common Stock under the Company Option
Plans;
(o) paid, declared or set aside any dividend or other distribution on its
securities of any class, or purchased, exchanged or redeemed any of its
securities of any class; or
(p) without limitation by the enumeration of any of the foregoing, entered
into any transaction other than in the usual and ordinary course of business in
accordance with past practices.
Notwithstanding the foregoing, the Company shall not be deemed to have breached
the terms of this Section 4.28 by entering into this Agreement or by
consummating the transactions contemplated hereby.
4.29. Affiliated Transactions. Since January 1, 1995, neither the Company
nor any of its Subsidiaries has been a party to any transactions (other than
employee compensation and other ordinary incidents of employment) in excess of
$15,000 individually or $50,000 in the aggregate with a "Related Party" other
than loans to Company employees made in connection with the exercise of Company
stock options, all of which have been paid in full as of the date hereof. For
purposes of this Agreement, the term "Related Party" shall mean: any present or
former officer or director, 10% stockholder or present affiliate of the Company
or any of its Subsidiaries, any present or former known spouse, ancestor or
descendant of any of the aforementioned persons or any trust or other similar
entity for the benefit of any of the foregoing persons. No property or interest
in any property (including, without limitation, designs and drawings concerning
machinery) which relates to and is or will be necessary or useful in the present
or currently contemplated future operation of the Company's or its Subsidiaries'
respective businesses, is presently owned by or leased or licensed by or to any
Related Party. Prior to the Closing, all amounts due and owing to or from the
Company or its Subsidiaries by or to any of the Related Parties (excluding
employee compensation and other incidents of employment) shall be paid in full.
Except for the ownership of securities representing less than a 2% equity
interest in various publicly traded companies, neither the Company, its
Subsidiaries, nor to the Company's knowledge, any Related Party has an interest,
directly or indirectly, in any business, corporate or otherwise, which is in
competition with the Company's or its Subsidiaries' respective businesses.
4.30. Significant Customers, Suppliers and Employees. The Disclosure
Statement sets forth an accurate list of the Company's and its Subsidiaries'
Significant Customers (as defined herein), Significant Suppliers (as defined
herein) and Significant Employees (as defined herein). The Company has no
knowledge of any intention or indication of intention by a (a) Significant
Customer to terminate its business relationship with the Company or its
Subsidiaries or to limit or alter its business relationship with the Company or
its Subsidiaries in any material respect; (b) Significant Supplier to terminate
its business relationship with the Company or its Subsidiaries or to limit or
alter its business relationship with the Company or its Subsidiaries in any
material respect; or (c) Significant Employee intends to terminate his
employment with the Company or its Subsidiaries. Notwithstanding the foregoing,
nothing contained herein shall be deemed to be a covenant or guaranty by the
Company that any particular Significant Customer, Significant Supplier or
Significant Employee will continue to conduct business with the Company and its
Subsidiaries after the date hereof. As used herein, (w) "Significant Customer"
means the 10 largest customers of the Company and its Subsidiaries, taken as a
whole, including distributors of the Company's products, measured in terms of
sales volume in dollars for the year ended December 31, 1995 and for the eleven
month period ending November 30, 1996, (x) "Significant Supplier" means any
supplier of the Company and its Subsidiaries from whom the Company or its
Subsidiaries has purchased $250,000 or more of goods during the year ended
December 31, 1995 or $229,000 or more goods during the eleven month period
ending November 30, 1996, for use in the Company's or its Subsidiaries'
respective businesses; and (y) "Significant Employee" means the Chief Executive
Officer, the President, the Senior Director of Research and Development, any
Vice President, the Director of Field Sales or any regional sales manager of the
Company or its Subsidiaries.
4.31. Material Adverse Change. Since September 30, 1996 to the date of
this Agreement, neither the Company nor its Subsidiaries has suffered any
material adverse change in the business, operations, assets, liabilities,
financial condition or prospects of the Company or its Subsidiaries, taken as a
whole.
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4.32. Bribes. Since April 1, 1990, neither the Company, its Subsidiaries
nor, to the Company's knowledge, any of their respective officers, directors,
employees, agents or representatives has made, directly or indirectly, with
respect to the Company, its Subsidiaries or their respective business
activities, any bribes or kickbacks, illegal political contributions, payments
from corporate funds not recorded on the books and records of the Company or its
Subsidiaries, payments from corporate funds to governmental officials, in their
individual capacities, for the purpose of affecting their action or the action
of the government they represent, to obtain favorable treatment in securing
business or licenses or to obtain special concessions, or illegal payments from
corporate funds to obtain or retain business.
4.33. Absence of Indemnifiable Claims, etc. There are no pending claims
and, to the knowledge of the Company, no facts that would reasonably entitle any
director, officer or employee of the Company or its Subsidiaries to
indemnification by the Company or its Subsidiaries under applicable law, the
Certificate of Incorporation or By-laws of the Company or its Subsidiaries or
any insurance policy maintained by the Company or its Subsidiaries.
4.34. No Undisclosed Liabilities. There are no liabilities or obligations
of any nature (whether accrued, absolute, contingent or otherwise) of the
Company or its Subsidiaries other than (i) liabilities disclosed or provided for
in the most recent financial statements contained in the Company Reports; (ii)
liabilities which, individually or in the aggregate, are not material to the
Company or its Subsidiaries; (iii) liabilities under this Agreement (or
contemplated hereby) or disclosed in the Disclosure Statement and (iv)
liabilities incurred since September 30, 1996 in the ordinary course of business
and consistent with past practices.
4.35. No Brokers. Neither the Company nor any of its Subsidiaries has
entered into any contract, arrangement or understanding with any person or firm
which may result in the obligation of the Company or Watson, Watson Sub or their
respective Subsidiaries to pay any finder's fee, brokerage or agent's
commissions or other like payments in connection with negotiations leading to
this Agreement or the consummation of the transactions contemplated hereby,
except that the Company has retained Gruntal & Co., Incorporated as its
financial advisor, the arrangements with which have been disclosed in writing to
Watson prior to the date hereof.
4.36. Tax Reorganization. Neither the Company nor any of its Subsidiaries
has taken or failed to take any action which would prevent the Merger from (a)
constituting a reorganization within the meaning of section 368(a) of the Code
or (b) being treated as a "pooling or interests" in accordance with Accounting
Principles Board Opinion No. 16, the interpretative releases issued pursuant
thereto, and the pronouncements of the SEC.
4.37. Opinion of Financial Advisor. The Company has received the opinion
of Gruntal & Co., Incorporated to the effect that, as of the date hereof, the
consideration to be received by the Stockholders pursuant to the Merger is fair
to such Stockholders from a financial point of view.
4.38. Information Supplied. The information supplied or to be supplied in
writing by the Company, its Subsidiaries, or any of their respective officers,
directors, representatives, agents or employees, for inclusion or incorporation
by reference in (a) the Proxy Statement will not, at the time the Proxy
Statement is first mailed to the Stockholders, at the time such Stockholders
vote on adoption of this Agreement, contain any untrue statement of a material
fact or omit to state any material fact necessary in order to make the
statements made therein, in light of the circumstances under which they were
made, not misleading and (b) the Form S-4, together with all amendments and
supplements thereto, will not, at the time the Form S-4 is filed or becomes
effective under the Securities Act and at the Effective Time, contain any untrue
statement of a material fact or omit to state a material fact necessary in order
to make the statements made therein, in light of the circumstances under which
they were made, not misleading. No representation is made by the Company with
respect to statements made or incorporated by reference therein based on
information supplied by Watson or any of Watson's Subsidiaries specifically for
inclusion or incorporation by reference in the Proxy Statement or the Form S-4.
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4.39. Takeover Statutes. No "fair price", "moratorium", "control share
acquisition" or other similar antitakeover statute or regulation enacted under
state or federal laws in the United States, applicable to the Company or any of
its Subsidiaries is applicable to the Merger or the other transactions
contemplated hereby.
ARTICLE V
COVENANTS
5.1 Alternative Proposals. Prior to the Effective Time, the Company agrees
(a) that neither it nor any of its Subsidiaries shall, and it shall direct and
cause its officers, directors, employees, agents and representatives (including,
without limitation, any investment banker, attorney or accountant retained by it
or any of its Subsidiaries) not to, initiate or solicit, directly or indirectly,
any inquiries or the making or implementation of any proposal or offer
(including, without limitation, any proposal or offer to its Stockholders) with
respect to a merger, acquisition, consolidation or similar transaction
involving, or any purchase of all or any significant portion of the assets or
any equity securities of, the Company or its Subsidiaries (any such proposal or
offer being hereinafter referred to as an "Alternative Proposal") or engage in
any negotiations concerning, or provide any confidential information or data to,
or have any discussions with, any person relating to an Alternative Proposal, or
otherwise facilitate any effort or attempt to make or implement an Alternative
Proposal; (b) that it will immediately cease and cause to be terminated any
existing activities, discussions or negotiations with any parties conducted
heretofore with respect to any of the foregoing, and it will take the necessary
steps to inform the individuals or entities referred to above of the obligations
undertaken in this Section 5.1; and (c) that it will notify the other
immediately if any such inquiries or proposals are received by, any such
information is requested from, or any such negotiations or discussions are
sought to be initiated or continued with, it; provided, however, that nothing
contained in this Section 5.1 shall prohibit the Board of Directors of the
Company from (A) furnishing information to or entering into discussions or
negotiations with, any person or entity that makes an unsolicited bona fide
proposal to acquire the Company pursuant to a merger, consolidation, share
exchange, purchase of a substantial portion of assets, business combination or
other similar transaction, if, and only to the extent that, (i) the Board of
Directors of the Company determines in good faith that such action is required
for the Board of Directors to comply with its fiduciary duties to stockholders
imposed by law; (ii) prior to furnishing such information to, or entering into
discussions or negotiations with, such person or entity, the Company provides
written notice to Watson to the effect that it is furnishing information to, or
entering into discussions or negotiations with, such person or entity; and (iii)
subject to any confidentiality agreement with such person or entity (which the
Company determined in good faith was required to be executed in order for its
Board of Directors to comply with its fiduciary duties to stockholders imposed
by law), the Company keeps Watson informed of the status of any such discussions
or negotiations; and (B) to the extent applicable, complying with Rule 14e-2
promulgated under the Exchange Act with regard to an Alternative Proposal.
Nothing in this Section 5.1 shall (x) permit the Company to terminate this
Agreement (except as specifically provided in Article 7 hereof); (y) permit the
Company to enter into any agreement with respect to an Alternative Proposal
during the term of this Agreement (it being agreed that during the term of this
Agreement, the Company shall not enter into any agreement with any person that
provides for, or in any way facilitates, an Alternative Proposal (other than a
confidentiality agreement in customary form)); or (z) affect any other
obligation of the Company under this Agreement.
5.2 Interim Operations.
(a) During the period from the date of this Agreement and continuing until
the earlier of the termination of this Agreement or the Effective Time, except
as set forth in the Disclosure Statement, unless Watson has consented in writing
thereto (which consent shall not be unreasonably withheld), the Company shall,
and shall cause each of its Subsidiaries to,:
(i) conduct their respective operations according to their usual,
regular and ordinary course in substantially the same manner as heretofore
conducted;
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(ii) to the extent consistent with their respective businesses, use
commercially reasonable efforts to preserve intact their respective
business organizations and goodwill, keep available the services of their
respective officers and employees and maintain satisfactory relationships
with those persons having business relationships with them;
(iii) not amend their respective Certificates of Incorporation or
By-Laws or comparable governing instruments;
(iv) promptly notify Watson of any material emergency or other Company
Material Adverse Effect, any material litigation or material governmental
complaints, investigations or hearings (or communications indicating that
the same may be contemplated), or the material breach of any representation
or warranty contained herein;
(v) promptly deliver to Watson true and correct copies of any report,
statement or schedule filed with the SEC subsequent to the date of this
Agreement;
(vi) not (A) except pursuant to the exercise of options, warrants,
conversion rights and other contractual rights existing on the date hereof
and disclosed pursuant to this Agreement, issue any shares of its capital
stock, effect any stock split or otherwise change its capitalization as it
existed on the date hereof; (B) grant, confer or award any option, warrant,
conversion right or other right not existing on the date hereof to acquire
any shares of its capital stock; (C) increase any compensation or enter
into or amend any employment agreement with any of its present or future
officers, directors or employees, except for normal increases consistent
with past practice; (D) grant any severance or termination package to any
employee or consultant, except to the extent consistent with past
practices; (E) hire any new employee who shall have, or terminate the
employment of any employee who has, an annual salary in excess of $80,000;
or (F) adopt any new employee benefit plan (including any stock option,
stock benefit or stock purchase plan) or amend any existing employee
benefit plan in any material respect, except for changes which are less
favorable to participants in such plans;
(vii) not (A) declare, set aside or pay any dividend or make any other
distribution or payment with respect to any shares of its capital stock or
other ownership interests; or (B) directly or indirectly, redeem, purchase
or otherwise acquire any shares of its capital stock, or make any
commitment for any such action;
(viii) not enter into any agreement or transaction, or agree to enter
into any agreement or transaction, outside the ordinary course of business,
including, without limitation, any transaction involving a merger,
consolidation, joint venture, license agreement partial or complete
liquidation or dissolution, reorganization, recapitalization, restructuring
or a purchase, sale, lease or other disposition of a material portion of
assets or capital stock;
(ix) not enter into any additional research and development contracts
which call for the payment or receipt of funds in excess of $10,000
individually or $50,000 in the aggregate, other than the contracts
contemplated by the Company's research and development plan which has been
disclosed by the Company to Watson prior to the date hereof;
(x) not incur any indebtedness for borrowed money or guarantee any
such indebtedness or issue or sell any debt securities or warrants or
rights to acquire any debt securities of others other than in the ordinary
course of its business, but in no event in an amount exceeding $2,500,000
in the aggregate (other than normal expenditures for the purchase of raw
materials or other supplies);
(xi) not make any loans, advances or capital contributions to, or
investments in, any other Person;
(xii) Except as described in the Disclosure Statement, not make or
commit to made any capital expenditures in excess of $25,000 individually
or $50,000 in the aggregate;
(xiii) not apply any of its assets to the direct or indirect payment,
discharge, satisfaction or reduction of any amount payable directly or
indirectly to or for the benefit of any affiliate or Related Party of the
Company or any of its Subsidiaries or enter into any transaction with any
affiliate or Related Party
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of the Company or its Subsidiaries (except for payment of salary and other
customary expense reimbursements made in the ordinary course of business to
Related Parties who are employees of the Company or its Subsidiaries);
(xiv) not voluntarily elect to alter the manner of keeping its books,
accounts or records, or change in any manner the accounting practices
therein reflected, except for changes in accounting laws which effect all
pharmaceutical companies generally;
(xv) not grant or make any mortgage or pledge or subject itself or any
of its material properties or assets to any lien, charge or encumbrance of
any kind, except Liens for taxes not currently due and liens granted to
incur the indebtedness contemplated by Section 5.2(a)(x) hereof; and
(xvi) maintain insurance on its tangible assets and its businesses in
such amounts and against such risks and losses as are currently in effect.
(b) During the period from the date of this Agreement and continuing until
the earlier of the termination of this Agreement or the Effective Time, except
as set forth in the Disclosure Statement, unless the Company has consented in
writing thereto (which consent shall not be unreasonably withheld), Watson
shall, and shall cause each of its Subsidiaries to,:
(i) conduct their respective operations according to their usual,
regular and ordinary course in substantially the same manner as heretofore
conducted (except for entering into transactions described in 5.2(b)(v)
below);
(ii) promptly deliver to the Company true and correct copies of any
report, statement or schedule filed with the SEC subsequent to the date of
this Agreement;
(iii) promptly notify the Company of any material emergency or other
Watson Material Adverse Effect, any material litigation or material
governmental complaints, investigations or hearings (or communications
indicating that the same may be contemplated), or the material breach of
any representation or warranty contained herein;
(iv) not amend their respective Certificates of Incorporation or
By-laws or comparable governing instruments;
(v) promptly notify the Company of its entering into any agreement
with respect to any material transaction involving a merger, consolidation,
joint venture, partial or complete liquidation or dissolution,
reorganization or recapitalization, restructuring or a purchase, sale,
lease or other disposition of a material portion of assets or capital
stock;
(vi) not take any action that would result in a failure to maintain
the trading of Watson Common Stock on the Nasdaq National Market;
(vii) with respect to Watson only (and not its Subsidiaries), not (A)
declare, set aside or pay any dividend or make any other distribution or
payment with respect to any shares of its capital stock or other ownership
interests; or (B) directly or indirectly, redeem, purchase or otherwise
acquire any shares of its capital stock, or make any commitment for any
such action; and
(viii) not voluntarily elect to alter the manner of keeping its books,
accounts or records, or change in any manner the accounting practices
therein reflected, except for (A) changes that would not have a Watson
Material Adverse Effect; or (B) changes in accounting laws which effect all
pharmaceutical companies generally.
5.3 Meetings of Stockholders. The Company will take all action necessary
in accordance with applicable law and its Certificate of Incorporation and
Bylaws to convene a meeting of the Stockholders as promptly as practicable to
consider and vote upon the approval of the Merger, this Agreement and the
transactions contemplated hereby. The Board of Directors of the Company shall
recommend such approval and the Company shall take all lawful action to solicit
such approval, including, without limitation, timely mailing the Proxy Statement
to the Stockholders; provided, however, that such recommendation or
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solicitation is subject to any action (including any withdrawal or change of its
recommendation) taken by, or upon authority of, the Board of Directors of the
Company in the exercise of its good faith judgment as to its fiduciary duties to
the Stockholders imposed by law.
5.4 Filings; Other Action. Subject to the terms and conditions herein
provided, the Company and Watson shall: (a) promptly make their respective
filings and thereafter make any other required submissions under the HSR Act
with respect to the Merger; (b) use all reasonable efforts to cooperate with one
another in (i) determining which filings are required to be made prior to the
Effective Time with, and which consents, approvals, permits or authorizations
are required to be obtained prior to the Effective Time from, governmental or
regulatory authorities of the United States, the several states and foreign
jurisdictions in connection with the execution and delivery of this Agreement
and the consummation of the transactions contemplated hereby; and (ii) timely
making all such filings and timely seeking all such consents, approvals, permits
or authorizations; (c) use commercially reasonable efforts to obtain all
consents under or with respect to, any contract, lease, agreement, purchase
order, sales order or other instrument, Permit or Environmental Permit, where
the consummation of the transactions contemplated hereby would be prohibited or
constitute an event of default, or grounds for acceleration or termination, in
the absence of such consent; and (d) take, or cause to be taken, all other
commercially reasonable actions as are reasonably necessary, proper or
appropriate to consummate and make effective the transactions contemplated by
this Agreement. If, at any time after the Effective Time, any further
commercially reasonable action is necessary or desirable to carry out the
purpose of this Agreement, the proper officers and directors of Watson and the
Surviving Corporation shall take all such necessary action.
5.5 Inspection of Records. From the date hereof to the Effective Time, the
Company shall (a) allow all designated officers, attorneys, accountants and
other representatives of Watson reasonable access at all reasonable times to the
offices, records and files, correspondence, audits and properties, as well as to
all information relating to commitments, contracts, titles and financial
position, or otherwise pertaining to the business and affairs of the Company and
its Subsidiaries; (b) furnish to Watson, its counsel, financial advisors,
auditors and other authorized representatives such financial and operating data
and other information as such persons may reasonably request; and (c) instruct
the employees, counsel and financial advisors of the Company and its
Subsidiaries to cooperate with Watson and its investigation of the business of
the Company and its Subsidiaries. From the date hereof to the Effective Time,
Watson shall (a) furnish to the Company, its counsel, financial advisors,
auditors and other authorized representatives such financial and operating data
and other information as such persons may reasonably request, and (b) instruct
the officers, counsel and financial advisors of Watson to cooperate with the
Company in its investigation of the business of Watson or its Subsidiaries. All
information disclosed by the Company to Watson and its representatives or by
Watson to the Company and its representatives shall be subject to the terms of
that certain Non-Disclosure Agreement (the "Confidentiality Agreement") dated as
of December 13, 1995 between Watson and the Company.
5.6 Publicity. Neither party hereto shall make any press release or public
announcement with respect to this Agreement, the Merger or the transactions
contemplated hereby without the prior written consent of the other party hereto
(which consent shall not be unreasonably withheld); provided, however, that each
party hereto may make any disclosure or announcement which such party, in the
opinion of its legal counsel, is obligated to make pursuant to applicable law or
regulation of any national securities exchange, in which case, the party
desiring to make the disclosure shall consult with the other party hereto prior
to making such disclosure or announcement.
5.7 Registration Statement. Watson and the Company shall cooperate and
promptly prepare and Watson shall file with the SEC as soon as practicable a
Registration Statement on Form S-4 (the "Form S-4") under the Securities Act,
with respect to the Watson Common Stock issuable in the Merger, a portion of
which Registration Statement shall also serve as the Proxy Statement. The
respective parties will cause the Proxy Statement and the Form S-4 to comply as
to form in all material respects with the applicable provisions of the
Securities Act, the Exchange Act and the rules and regulations promulgated
thereunder. Watson shall use all reasonable efforts, and the Company will
cooperate with Watson, to have the Form S-4 declared effective by the SEC as
promptly as practicable. Watson shall use its best efforts to obtain, prior to
the effective date of the Form S-4, all necessary state securities law or "Blue
Sky" permits or approvals
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required to carry out the transactions contemplated by this Agreement and will
pay all expenses incident thereto. No amendment or supplement to the Proxy
Statement will be made by Watson or the Company without the approval of the
other party, which approval shall not be unreasonably withheld. Watson will
advise the Company, promptly after it receives notice thereof, of the time when
the Form S-4 has become effective or any supplement or amendment has been filed,
the issuance of any stop order, the suspension of the qualification of the
Watson Common Stock issuable in connection with the Merger for offering or sale
in any jurisdiction, or any request by the SEC for amendment of the Proxy
Statement or the Form S-4 or comments thereon and responses thereto or requests
by the SEC for additional information and Watson shall use its best efforts to
promptly resolve any such stop order, suspension or qualification.
5.8 Further Action. Each party hereto shall, subject to the fulfillment at
or before the Effective Time of each of the conditions of performance set forth
herein or the waiver thereof, perform such further acts and execute such
documents as may be reasonably required to effect the Merger.
5.9 Affiliate Letters. At least 30 days prior to the Closing Date, the
Company shall deliver to Watson a list of names and addresses of those persons
who were or will be, in the Company's reasonable judgment, at the record date
for its Stockholders' meeting to approve the Merger, "affiliates" (each such
person, an "Affiliate") of the Company within the meaning of Rule 145 of the
rules and regulations promulgated under the Securities Act. The Company shall
provide Watson such information and documents as Watson shall reasonably request
for purposes of reviewing such list. The Company shall deliver or cause to be
delivered to Watson, prior to the Closing Date, from each of the Affiliates of
the Company identified in the foregoing list, an Affiliate Letter in
substantially the form attached hereto as Exhibit C. Watson shall be entitled to
place legends as specified in such Affiliate Letters on the certificates
evidencing any Watson Common Stock to be received by such Affiliates pursuant to
the terms of this Agreement, and to issue appropriate stop transfer instructions
to the transfer agent for the Watson Common Stock, consistent with the terms of
such Affiliate Letters.
5.10 Expenses. Whether or not the Merger is consummated, all costs and
expenses incurred in connection with this Agreement and the transactions
contemplated hereby shall be paid by the party incurring such expenses, except
(a) as otherwise expressly provided for herein; and (b) the expenses incurred in
connection with printing and mailing the Form S-4 and the Proxy Statement shall
be shared equally by the Company and Watson.
5.11 Tax Treatment of Merger. From and after the date hereof and until the
Effective Time, neither Watson nor the Company nor any of their respective
Subsidiaries or other affiliates shall (a) knowingly take any action, or
knowingly fail to take any action, that would jeopardize qualification of the
Merger as (i) a reorganization within the meaning of Section 368(a) of the Code;
or (ii) a "pooling of interests" for accounting purposes; or (b) enter into any
contract, agreement, commitment or arrangement with respect to the foregoing.
After the Effective Time, Watson shall not take or fail to take (and shall cause
the Surviving Corporation not to take or fail to take) any action that is
reasonably likely to jeopardize qualification of the Merger as a reorganization
within the meaning of Section 368(a) of the Code.
5.12 Employee Benefit Plans. Watson covenants and agrees that it will
continue the Company's existing benefit plans and arrangements for a period of
at least six months following the Effective Date. Thereafter, to the extent the
existing benefit plans and arrangements provided by the Company to its employees
are terminated, such employees who remain employees of the Surviving Corporation
shall be entitled to participate in all benefit plans and arrangements that are
available and subsequently become available to Watson's employees on the same
basis as Watson's employees in similar positions are eligible to participate.
For purposes of satisfying the terms and conditions of such plans, Watson shall
give full credit for eligibility, vesting or benefit accrual for each
participant's period of service with the Company prior to the Effective Time. To
the extent Watson's benefit plans provide medical or dental welfare benefits
after the Closing Date, Watson shall cause all pre-existing condition exclusions
and actively at work requirements to be waived and Watson shall provide that any
expenses incurred on or before the Closing Date shall be taken into account
under Watson's benefit plans for purposes of satisfying the applicable
deductible, coinsurance and maximum out-of-pocket provisions for such employees
and their covered dependents.
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5.13 Company Options. Immediately after the Effective Time, but in any
event, no later than three business days after the Closing Date, Watson shall
register the shares of Watson Common Stock issuable upon exercise of such
Company Options with the SEC on Form S-8, to the extent that such Company
Options may be registered on such form. To the extent that all or any portion of
the Company Options may not be registered on Form S-8 (the "Non-Employee
Options"), Watson and the Company shall cooperate and promptly prepare and
Watson shall file with the SEC as soon as practicable a Registration Statement
on Form S-3 (the "Form S-3") under the Securities Act, with respect to the
Watson Common Stock issuable upon exercise of the Non-Employee Options. Watson
shall use all reasonable efforts, and the Company will cooperate with Watson, to
have the Form S-3 declared effective by the SEC on or prior to the Effective
Date. Watson will advise holders of such Non-Employee Options, promptly after it
receives notice thereof, of the time when the Form S-3 has become effective, the
issuance of any stop order or the suspension of the qualification of the Watson
Common Stock issuable in connection with the exercise of the Non-Employee
Options for offering or sale in any jurisdiction and Watson shall use its best
efforts to promptly resolve any such stop order, suspension or qualification.
5.14 Indemnification of Directors and Officers of the Company
(a) From and after the Effective Time of the Merger, Watson agrees to
indemnify and hold harmless, and to cause the Surviving Corporation to honor its
separate indemnification to, each person who is an officer or director of the
Company or its Subsidiaries on the date of this Agreement (an "Indemnified
Person") from and against all damages, liabilities, judgments and claims (and
related expenses including, but not limited to, attorney's fees and amounts paid
in settlement) based upon or arising from his or her capacity as an officer or
director of the Company or its Subsidiaries, to the same extent he or she would
have been indemnified under the Articles of Incorporation or By-laws of Watson
as such documents were in effect on the date of this Agreement and to the extent
permitted under applicable law. Subject to an Indemnified Person's obligation to
refund any advances in accordance with the Florida Business Corporation Act,
Watson shall advance all litigation costs reasonably incurred by such
Indemnified Person in accordance with applicable law.
(b) The rights granted to the Indemnified Persons hereby shall be
contractual rights inuring to the benefit of all Indemnified Persons and shall
survive this Agreement and any merger consolidation or reorganization of Watson.
(c) The rights to indemnification granted by this Section 5.14 are subject
to the following limitations: (i) amounts otherwise required to be paid by
Watson to an Indemnified Person pursuant to this Section 5.14 shall be reduced
by any amounts that such Indemnified Person has recovered by virtue of the claim
for which indemnification is sought and Watson shall be reimbursed for any
amounts paid by Watson that such Indemnified Person subsequently recovers by
virtue of such claim; (ii) any claim for indemnification pursuant to this
Section 5.14 must be submitted in writing to the Chief Executive Officer or
Chairman of Watson promptly upon such Indemnified Person becoming aware of such
claim, provided that any such failure to advise promptly will not cause a loss
of indemnity unless it has a prejudicial effect on Watson; and (iii) an
Indemnified Person shall not settle any claim for which indemnification is
provided herein without the prior written consent of Watson, which consent shall
not be unreasonably withheld.
5.15 Publication of Post-Merger Results. Watson shall use its reasonable
best efforts to cause financial results covering at least thirty days of
post-Merger combined operations to be published in its first report of quarterly
financial statements as soon as practicable after such information is required
to be filed with the SEC.
5.16 Agreement with respect to Products under Development. As soon as
practicable after the date hereof, but in any event within ten (10) business
days after the date hereof, Watson and the Company shall negotiate in good faith
and shall use their best efforts to enter into an agreement with respect to the
development and sale of all of the Company's products under development.
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ARTICLE VI
CONDITIONS
6.1 Conditions to Each Party's Obligation to Effect the Merger. The
respective obligations of each party to effect the Merger shall be subject to
the fulfillment at or prior to the Closing Date of each of the following
conditions (unless waived by each of the parties hereto in accordance with the
provisions of Section 7.6 hereof):
(a) This Agreement and the Merger and other transactions contemplated
hereby shall have been approved and adopted by the requisite vote of the
Stockholders.
(b) The waiting period applicable to the consummation of the Merger
under the HSR Act shall have expired or been terminated.
(c) No preliminary or permanent injunction or other order or decree by
any federal or state court which prevents the consummation of the Merger or
materially changes the terms or conditions of this Agreement shall have
been issued and remain in effect. In the event any such order or injunction
shall have been issued, each party agrees to use its reasonable efforts to
have any such injunction lifted.
(d) The Form S-4 and Form S-3 shall have been declared effective by
the SEC and shall be effective at the Effective Time, and no stop order
suspending the effectiveness of the Form S-4 or the Form S-3 shall have
been issued, no action, suit, proceeding or investigation by the SEC to
suspend the effectiveness thereof shall have been initiated and be
continuing, and all necessary approvals under state securities laws
relating to the issuance or trading of the Watson Common Stock to be issued
to the Stockholders in connection with the Merger shall have been received.
(e) All material consents, authorizations, orders and approvals of (or
filings or registrations with) any governmental commission, board or other
regulatory body required in connection with the execution, delivery and
performance of this Agreement shall have been obtained or made, except for
filings in connection with the Merger and any other documents required to
be filed after the Effective Time.
(f) The Watson Common Stock to be issued to the Stockholders in
connection with the Merger shall have been authorized for trading on the
Nasdaq National Market subject only to official notice of issuance.
(g) Watson shall have received the opinion of D'Ancona & Pflaum,
counsel to Watson, dated the Closing Date, to the effect that the Merger
will be treated for federal income tax purposes as a reorganization within
the meaning of Section 368(a) of the Code, and that the Company and Watson
will each be a party to that reorganization within the meaning of Section
368(b) of the Code. In rendering such opinion, counsel shall be entitled to
rely upon, among other things, reasonable assumptions as well as
representations and covenants of Watson, Watson Sub and the Company.
(h) The Company shall have received the opinion of Akerman, Senterfitt
& Eidson P.A., counsel to the Company, dated the Closing Date, to the
effect that the Merger will be treated for federal income tax purposes as a
reorganization within the meaning of Section 368(a) of the Code, and that
the Company and Watson will each be a party to that reorganization within
the meaning of Section 368(b) of the Code. In rendering such opinion,
counsel shall be entitled to rely upon, among other things, reasonable
assumptions as well as representations and covenants of Watson, Watson Sub
and the Company.
(i) Watson shall have received the opinion of Price Waterhouse LLP,
dated the Closing Date, to the effect that the Merger will be treated as a
"pooling of interests" for accounting purposes.
(j) The Company shall have received from Price Waterhouse LLP a
letter, dated the Closing Date, indicating that the Company has not taken
any action that would preclude it from entering into a transaction that
would be treated as a "pooling of interests" for accounting purposes.
(k) Patrick J. McEnany shall have entered into an Employment Agreement
in substantially the form attached hereto as Exhibit D.
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6.2 Conditions to Obligation of the Company to Effect the Merger. The
obligation of the Company to effect the Merger shall be subject to the
fulfillment at or prior to the Closing Date of the following conditions (unless
waived by the Company in accordance with the provisions of Section 7.6 hereof):
(a) Watson shall have performed, in all material respects, all of its
agreements contained herein that are required to be performed by Watson on
or prior to the Closing Date, and the Company shall have received a
certificate of the Chairman or President of Watson, dated the Closing Date,
certifying to such effect.
(b) The representations and warranties of Watson and Watson Sub
contained in this Agreement and in any document delivered in connection
herewith shall be true and correct as of the Closing in all material
respects, and the Company shall have received a certificate of the Chairman
or President of Watson, dated the Closing Date, certifying to such effect.
(c) The Company shall have received from Watson certified copies of
the resolutions of Watson's and Watson Sub's Boards of Directors approving
and adopting this Agreement, the Watson Ancillary Documents and the
transactions contemplated hereby and thereby.
(d) The Company shall have received the opinion of D'Ancona & Pflaum
to such matters as the Company or the Company's counsel shall reasonably
request.
(e) From the date of this Agreement through the Effective Time, there
shall not have occurred any event that has had, would have or would be
reasonably likely to have a material adverse effect in the financial
condition, business, operations or prospects of Watson and its
Subsidiaries, taken as a whole; provided, that such an event will not be
deemed to have occurred solely as a result of fluctuations in the value of
Watson Common Stock due to or arising from any public disclosures by Watson
(including its 50% subsidiary, Somerset Pharmaceuticals, Inc.), including,
without limitation, disclosures relating to Watson's entering into any
other transactions (including, without limitation, transactions relating to
the acquisition of assets, stock or merger transactions).
(f) The Company shall have received the updated opinion of Gruntal &
Co., Incorporated dated the Closing Date, to the effect that the Merger or
the Exchange Ratio, as the case may be, continues to be fair to the
Stockholders from a financial point of view.
(g) Watson and Watson Sub shall have executed and delivered such other
documents and taken such other actions as the Company shall reasonably
request.
6.3 Conditions to Obligation of Watson and Watson Sub to Effect the
Merger. The obligations of Watson and Watson Sub to effect the Merger shall be
subject to the fulfillment at or prior to the Closing Date of the following
conditions (unless waived by the Company in accordance with the provisions of
Section 7.6 hereof):
(a) The Company shall have performed, in all material respects, all of
its agreements contained herein that are required to be performed by the
Company on or prior to the Closing Date, and Watson shall have received a
certificate of the Chairman or President of the Company, dated the Closing
Date, certifying to such effect.
(b) The representations and warranties of the Company contained in
this Agreement and in any document delivered in connection herewith shall
be true and correct as of the Closing in all material respects, and Watson
shall have received a certificate of the Chairman or President of the
Company, dated the Closing Date, certifying to such effect.
(c) Watson shall have received from the Company certified copies of
the resolutions of the Company's Board of Directors and Stockholders
approving and adopting this Agreement, the Ancillary Documents and the
transactions contemplated hereby and thereby.
(d) Watson shall have received the opinion of Akerman, Senterfitt &
Eidson P.A. to such matters as Watson or Watson's counsel shall reasonably
request.
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(e) From the date of this Agreement through the Effective Time, there
shall not have occurred any event that has had, would have or would be
reasonably likely to have a material adverse effect in the financial
condition, business, operations or prospects of the Company.
(f) The Company shall have received all necessary consents with
respect to any contract, lease, purchase order, sales order, license
agreement, Permit, Environmental Permit and license which are required as a
result of a change of control of the Company except in those instances
where failure to receive any such consent would not have a Company Material
Adverse Effect.
(g) The Company shall have executed and delivered such other documents
and taken such other actions as Watson shall reasonably request.
ARTICLE VII
TERMINATION
7.1 Termination by Mutual Consent. This Agreement may be terminated and
the Merger may be abandoned at any time prior to the Effective Time, before or
after the approval of this Agreement by the Stockholders, by the mutual consent
of Watson and the Company.
7.2 Termination by Either Watson or the Company. This Agreement may be
terminated and the Merger may be abandoned by action of the Board of Directors
of either Watson or the Company if (a) the Merger shall not have been
consummated by March 31, 1997; provided, however, that the right to terminate
this Agreement under this Section 7.2(a) will not be available to any party
whose failure to fulfill any obligation under this Agreement has been the cause
of, or resulted in, the failure of the Merger to occur on or before such date;
(b) the approval of the Stockholders required by Section 6.1(a) shall not have
been obtained at a meeting duly convened therefor or at any adjournment thereof;
provided, however, that the Company shall not have the right to terminate this
Agreement under this Section 7.2(b) if the Company caused (directly or
indirectly) or aided in the failure to obtain such approval; or (c) a court of
competent jurisdiction or a governmental, regulatory or administrative agency or
commission shall have issued an order, decree or ruling or taken any other
action either (i) permanently restraining, enjoining or otherwise prohibiting
the transactions contemplated by this Agreement; or (ii) compelling Watson,
Watson Sub or the Surviving Corporation to dispose of or hold separate all or a
material portion of the respective businesses or assets of Watson and the
Company, or sell or license any material product of Watson or the Company, and
such order, decree, ruling or other action shall have become final and
non-appealable.
7.3 Termination by the Company. This Agreement may be terminated and the
Merger may be abandoned at any time prior to the Effective Time, before or after
the adoption and approval by the Stockholders, by action of the Board of
Directors of the Company, if (a) the Company receives an Alternative Proposal
and the Board of Directors of the Company determines in good faith and pursuant
to the exercise of its fiduciary duties to its Stockholders, to accept such
Alternative Proposal, and the Board of Directors of the Company recommends or
resolves to accept or recommend to the Stockholders such Alternative Proposal;
(b) the Board of Directors of the Company determines in good faith and pursuant
to the exercise of its fiduciary duties, to withdraw its recommendation of this
Agreement and/or the Merger; (c) the Board of Directors of Watson shall have
withdrawn or modified in a manner materially adverse to the Company, its
approval or recommendation of this Agreement and/or the Merger (other than upon
the happening of an event described in Sections 7.4(b) or 7.4(c)); (d) there has
been a breach by Watson or Watson Sub of any representation or warranty
contained in this Agreement which would have a Watson Material Adverse Effect;
(e) there has been a material breach of any of the material covenants or
agreements set forth in this Agreement on the part of Watson, which breach is
not curable or, if curable, is not cured within 30 days after written notice of
such breach is given by the Company to Watson; or (f) Watson enters into any
transaction, or series of related transactions, or enters into any agreement
relating to any of the foregoing, where Watson would (i) require the approval of
its shareholders pursuant to Nevada General Corporate Law; or (ii) issue or
propose to issue in excess of twenty-percent (20%) of the outstanding Watson
Common Stock in connection with such transaction, or series of related
transactions, calculated on a fully diluted basis after giving effect to
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the consummation of the contemplated transaction between Watson and Oclassen
Pharmaceuticals, Inc. and the consummation of such new transaction or series of
related new transactions.
7.4 Termination by Watson. This Agreement may be terminated and the Merger
may be abandoned at any time prior to the Effective Time, before or after the
approval by the Stockholders, by action of the Board of Directors of Watson, if
(a) the Board of Directors of the Company shall have (i) recommended an
Alternative Proposal to the Stockholders or (ii) withdrawn or modified in a
manner materially adverse to Watson, its approval or recommendation of this
Agreement or the Merger (other than upon the happening of an event described in
Sections 7.3(d) or 7.3(e)); (b) there has been a breach by the Company of any
representation or warranty contained in this Agreement which would have a
Company Material Adverse Effect; or (c) there has been a material breach of any
of the material covenants or agreements set forth in this Agreement on the part
of the Company, which breach is not curable or, if curable, is not cured within
30 days after written notice of such breach is given by Watson to the Company.
7.5 Effect of Termination and Abandonment.
(a) In the event that this Agreement is terminated by the Company pursuant
to Sections 7.3(a) or 7.3(b) or by Watson pursuant to Section 7.4(a) and the
Company enters into an agreement or an understanding with respect to an
Alternative Proposal within nine (9) months of the date of such termination and
thereafter, consummates such transaction, then the Company shall promptly pay
Watson a fee in an amount equal to $3,000,000. If (x) the Company terminates
this Agreement pursuant to Section 7.3(a) or Watson terminates this Agreement
pursuant to Section 7.4(a)(i); and (y) the Company does not enter into an
agreement or an understanding with respect to an Alternative Proposal within
nine (9) months after the termination of this Agreement or does not consummate
such transaction within eighteen (18) months after the termination of this
Agreement, the Company shall reimburse Watson for all actual out-of-pocket costs
and expenses incurred by Watson in connection with this Agreement and the
consummation and negotiation of the transactions contemplated hereby, including,
without limitation, legal, professional and service fees and expenses, which
amount shall be payable by wire transfer of same day funds within twelve months
from the date of termination of this Agreement. The Company acknowledges that
the agreements contained in this Section 7.5(a) are an integral part of the
transactions contemplated by this Agreement, and that, without these agreements,
Watson and Watson Sub would not enter into this Agreement. Accordingly, if the
Company fails to promptly pay the amount due pursuant to this Section 7.5(a),
and, in order to obtain such payment, Watson or Watson Sub commences a suit
which results in a final, non-appealable judgment against the Company for the
fee set forth in this Section 7.5(a), the Company shall pay to Watson its costs
and expenses (including attorneys' fees) incurred by Watson in connection with
such suit, together with interest on the amount of the fee at the rate of 12%
per annum.
(b) In the event of termination of this Agreement and the abandonment of
the Merger pursuant to this Article 7, all obligations of the parties hereto
shall terminate, except the obligations of the parties pursuant to this Section
7.5 and the provisions of Sections 5.6 and 5.10, which obligations shall survive
the termination of this Agreement.
7.6 Extension; Waiver. At any time prior to the Effective Time, any party
hereto, by action taken by its Board of Directors, may, to the extent legally
allowed, (a) extend the time for the performance of any of the obligations or
other acts of the other parties hereto; (b) waive any inaccuracies in the
representations and warranties made to such party contained herein or in any
document delivered pursuant hereto; and (c) waive compliance with any of the
agreements or conditions for the benefit of such party contained herein. Any
agreement on the part of a party hereto to any such extension or waiver shall be
valid only if set forth in an instrument in writing signed on behalf of such
party.
ARTICLE VIII
GENERAL PROVISIONS
8.1 Nonsurvival of Representations, Warranties and Agreements. All
representations, warranties and agreements in this Agreement or in any
instrument delivered pursuant to this Agreement shall be deemed to
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the extent expressly provided herein to be conditions to the Merger and, shall
not survive the Merger, provided, however, that the agreements contained in
Sections 1.4, 1.5, 1.6, 1.7, 1.9, 5.10, 5.11, 5.12, 5.13, 5.14 and 5.15 and
Articles 2 and 8 and the agreements delivered pursuant to this Agreement shall
survive the Merger.
8.2 Notices. All notices required or permitted to be given hereunder shall
be in writing and may be delivered by hand, by facsimile, by nationally
recognized private courier, or by United States mail. Notices delivered by mail
shall be deemed given three (3) business days after being deposited in the
United States mail, postage prepaid, registered or certified mail. Notices
delivered by hand by facsimile, or by nationally recognized private carrier
shall be deemed given on the day following receipt; provided, however, that a
notice delivered by facsimile shall only be effective if such notice is also
delivered by hand, or deposited in the United States mail, postage prepaid,
registered or certified mail, on or before two (2) business days after its
delivery by facsimile. All notices shall be addressed as follows:
<TABLE>
<S> <C>
If to Watson or Watson Sub: If to the Company:
Watson Pharmaceuticals, Inc. Royce Laboratories, Inc.
311 Bonnie Circle 5350 N.W. 165th Street
Corona, California 91720 Miami, Florida 33014
Fax: (909) 270-1096 Fax:
Attn: Dr. Allen Chao, Attn: Patrick J. McEnany, Chairman,
Chairman & CEO President and CEO
With copies to: With copies to:
D'Ancona & Pflaum Akerman, Senterfitt & Eidson P.A.
30 North LaSalle, Suite 2900 One S.E. 3rd Avenue
Chicago, Illinois 60602 Miami, Florida 33131
Fax: (312) 580-0923 Fax: (305) 374-5095
Attn: Michel J. Feldman Attn: Philip B. Schwartz
</TABLE>
or to such other address as any party shall specify by written notice so given,
and such notice shall be deemed to have been delivered as of the date so
telecommunicated, personally delivered or mailed.
8.3 Assignment, Binding Effect. Neither this Agreement nor any of the
rights, interests or obligations hereunder shall be assigned by any of the
parties hereto (whether by operation of law or otherwise) without the prior
written consent of the other parties. Subject to the preceding sentence, this
Agreement shall be binding upon and shall inure to the benefit of the parties
hereto and their respective permitted successors and assigns. Notwithstanding
anything contained in this Agreement to the contrary, except for the provisions
of Sections 1.4, 1.5, 1.6, 1.7, 2.3, and 2.4, nothing in this Agreement,
expressed or implied, is intended to confer on any person other than the parties
hereto or their respective heirs, successors, executors, administrators and
assigns any rights, remedies, obligations or liabilities under or by reason of
this Agreement.
8.4 Entire Agreement. This Agreement, the Exhibits, the Disclosure
Statement, the Watson Disclosure Statement, the Confidentiality Agreement, the
Ancillary Documents, the Watson Ancillary Agreements, and any other documents
delivered by the parties in connection herewith constitute the entire agreement
among the parties with respect to the subject matter hereof and supersede all
prior agreements and understandings among the parties with respect thereto. No
addition to or modification of any provision of this Agreement shall be binding
upon any party hereto unless made in writing and signed by all parties hereto.
8.5 Amendment. This Agreement may be amended by the parties hereto, by
action taken by their respective Boards of Directors, at any time before or
after approval of matters presented in connection with the Merger by the
Stockholders, but after any such Stockholder approval, no amendment shall be
made which by law requires the further approval of Stockholders without
obtaining such further approval. This Agreement may not be amended except by an
instrument in writing signed on behalf of each of the parties hereto.
8.6 Governing Law. This Agreement shall be governed by and construed in
accordance with the laws of the State of Florida without regard to its rules of
conflict of laws.
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8.7 Counterparts. This Agreement may be executed by the parties hereto in
separate counterparts, each of which when so executed and delivered shall be an
original, but all such counterparts shall together constitute one and the same
instrument.
8.8 Headings. Headings of the Articles and Sections of this Agreement are
for the convenience of the parties only and shall be given no substantive or
interpretive effect whatsoever.
8.9 Interpretation. In this Agreement, unless the context otherwise
requires, words describing the singular number shall include the plural and vice
versa, and words denoting any gender shall include all genders and words
denoting natural persons shall include corporations and partnerships and vice
versa.
8.10 Waivers. Except as provided in this Agreement, no action taken
pursuant to this Agreement, including, without limitation, any investigation by
or on behalf of any party, shall be deemed to constitute a waiver by the party
taking such action of compliance with any representations, warranties, covenants
or agreements contained in this Agreement. The waiver by any party hereto of a
breach of any provision hereunder shall not operate or be construed as a waiver
of any prior or subsequent breach of the same or any other provision hereunder.
8.11 Incorporation of Exhibits. The Disclosure Statement, the Watson
Disclosure Statement and all Exhibits attached hereto and referred to herein are
hereby incorporated herein and made a part hereof for all purposes as if fully
set forth herein.
8.12 Severability. Any term or provision of this Agreement which is
invalid or unenforceable in any jurisdiction shall, as to that jurisdiction, be
ineffective to the extent of such invalidity or unenforceability without
rendering invalid or unenforceable the remaining terms and provisions of this
Agreement or affecting the validity or enforceability of any of the terms or
provisions of this Agreement in any other jurisdiction. If any provision of this
Agreement is so broad as to be unenforceable, the provision shall be interpreted
to be only so broad as is enforceable.
8.13 Enforcement of Agreement. The parties hereto agree that irreparable
damage would occur in the event that any of the provisions of this Agreement was
not performed in accordance with its specific terms or was otherwise breached.
It is accordingly agreed that the parties shall be entitled to an injunction or
injunctions to prevent breaches of this Agreement and to enforce specifically
the terms and provisions hereof in any court of competent jurisdiction, this
being in addition to any other remedy to which they are entitled at law or in
equity.
A-37
<PAGE> 254
IN WITNESS WHEREOF, the parties have executed this Agreement and caused the
same to be duly delivered on their behalf on the day and year first written
above.
WATSON PHARMACEUTICALS, INC.
By: /s/ Allen Chao
------------------------------------
Title: Chairman and CEO
-----------------------------------
DOLPHINS ACQUISITION CORP.
By: /s/ Allen Chao
------------------------------------
Title: President
-----------------------------------
ROYCE LABORATORIES, INC.
By: /s/ Patrick J. McEnany
------------------------------------
Title: Chairman, President and CEO
-----------------------------------
A-38
<PAGE> 255
EXHIBIT A
DIRECTORS
Dr. Allen Chao
Patrick McEnany
Fred Wilkinson
<PAGE> 256
EXHIBIT B
OFFICERS
Dr. Allen Chao
Chairman
Patrick McEnany
President
Michel Feldman
Secretary
<PAGE> 257
FORM OF AMENDMENT
TO
AGREEMENT AND PLAN OF MERGER
This Amendment (the "Amendment") dated as of March 4, 1997 to the Agreement
and Plan of Merger (the "Merger Agreement") dated as of December 24, 1996 among
Watson Pharmaceuticals, Inc., a Nevada corporation ("Watson"), Dolphins
Acquisition Corp., a Florida corporation and the wholly-owned subsidiary of
Watson ("Watson Sub"), and Royce Laboratories, Inc., a Florida corporation (the
"Company"), is entered into by and among Watson, Watson Sub and the Company.
RECITALS
A. Watson, Watson Sub and the Company have heretofore entered into the
Merger Agreement providing for the merger of Watson Sub with and into the
Company, with the Company surviving the Merger. All capitalized terms used
herein and not otherwise defined herein shall have the meanings ascribed to them
in the Merger Agreement.
B. The Merger Agreement contemplates that it may be terminated and the
Merger may be abandoned by action of the Board of Directors of either Watson or
the Company if the Merger shall not have been consummated on or prior to March
31, 1997.
AGREEMENTS
NOW, THEREFORE, in consideration of the premises and mutual agreements
herein contained, and for other good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged, the parties hereto agree as
follows:
1. Status of the Merger Agreement. Except as specifically set forth
herein, the Merger Agreement shall remain in full force and effect and
shall not be waived, modified, superseded or otherwise affected by this
Amendment. This Amendment is not to be construed as a release, waiver or
modification of any of the terms, conditions, representations, warranties,
covenants, rights or remedies set forth in the Merger Agreement, except as
specifically set forth herein.
2. Amendment to the Merger Agreement. Section 7.2(a) of the Merger
Agreement is hereby deleted in its entirety and replaced by the following:
"(a) The Merger shall not have been consummated by April 30, 1997;
provided, however, that the right to terminate this Agreement under this
Section 7.2(a) will not be available to any party whose failure to
fulfill any obligation under this Agreement has been the cause of, or
resulted in, the failure of the Merger to occur on or before such date;"
3. Representations and Warranties of Entities. Each of the Company,
Watson and Watson Sub represents and warrants that its execution, delivery
and performance of this Amendment has been duly authorized by all necessary
corporate action and this Amendment is a legal, valid and binding
obligation of such entity in accordance with its terms.
4. Counterparts. This Amendment may be executed in any number of
counterparts, each of which shall be deemed an original and all of which
together shall constitute one and the same instrument.
5. Governing Law. This Amendment shall be a contract made under and
governed by the laws of the State of Florida, without regard to conflict of
laws principles.
<PAGE> 258
IN WITNESS WHEREOF, the parties have executed this Amendment and caused the
same to be duly delivered on their behalf on the day and year first written
above.
WATSON PHARMACEUTICALS, INC.
By: /s/ Allen Chao
------------------------------------
Title: Chairman and CEO
-----------------------------------
DOLPHINS ACQUISITION CORP.
By: /s/ Allen Chao
------------------------------------
Title: President
-----------------------------------
ROYCE LABORATORIES, INC.
By: /s/ Patrick J. McEnany
------------------------------------
Title: Chairman, President and CEO
-----------------------------------
2
<PAGE> 259
[GRUNTAL LETTERHEAD]
ANNEX B
February 27, 1997
Board of Directors
Royce Laboratories, Inc.
5350 Northwest 165th Street
Miami, Florida 33014
Dear Sirs:
We understand that Royce Laboratories, Inc. ("Royce"), Watson
Pharmaceuticals, Inc. ("Watson") and a wholly-owned subsidiary of Watson
("Watson-Sub") have entered into an Agreement and Plan of Merger (the
"Agreement"), pursuant to which Watson-Sub will be merged with and into Royce
(the "Merger"). We understand that, pursuant to the Agreement, among other
things, (i) each share of common stock of Royce ("Royce common stock")
outstanding at the Effective Time (as defined in the Agreement) shall be
converted into the right to receive the number of shares of Watson common stock
("Watson common stock") equal $7.25 divided by the Average Closing Price (as
defined in the Agreement); (ii) the number of shares of Watson common stock to
be issued is subject to a collar of $38.00 to $47.00 per share and (iii) the
outstanding stock options and warrants to purchase Royce common stock, whether
or not exercisable, will be automatically converted into options and warrants to
purchase Watson common stock. (The transaction contemplated by the Agreement is
referred to herein as the "Transaction"). The terms and conditions of the
Transaction are set forth in more detail in the Agreement.
You have requested our opinion as to the fairness to the shareholders of
Royce from a financial point of view of the terms of the Merger.
In arriving at our opinion, we have reviewed the Agreement and certain
publicly available business and financial information relating to Royce and
Watson. We have also reviewed certain other information, including financial
forecasts and related information, provided to us by Royce and Watson and we
have met with Royce's and Watson's managements to discuss the business and
prospects of Royce and Watson. We have also considered certain financial and
stock market data of Royce and Watson, and we have compared that data with
similar data for other publicly held companies in businesses similar to those of
Royce and Watson, and we have considered the financial terms of certain other
business combinations and other transactions which have been effected. We also
considered such other information, financial studies, analyses and
investigations and financial, economic and market criteria which we deem
relevant.
In connection with our review, we have not assumed any responsibility for
independent verification of any of the foregoing information and have relied on
its being complete and accurate in all material respects. With respect to the
financial forecasts, we have assumed that they have been reasonably prepared on
bases reflecting the best currently available estimates and judgments of Royce's
and Watson's managements as to the future financial performance of Royce and
Watson. In addition, we have not made an independent evaluation or appraisal of
the assets or liabilities (contingent or otherwise) of Royce or Watson, nor have
we been furnished with any such evaluations or appraisals.
We have relied as to all legal matters on advice of counsel to Royce. Our
opinion is necessarily based upon financial, economic, market and other
conditions as they exist on, and the information made available to us as of, the
date hereof. We are not expressing any opinion as to what the value of the
Watson common stock actually will be when issued to Royce shareholders in the
Merger or the prices at which such common stock will trade subsequent to the
Merger. We have not been requested to solicit or entertain any other offers for
the acquisition of Royce as a whole or any other transaction involving Royce. We
have not been requested to opine, and our opinion does not in any manner
address, the Company's underlying business decision to proceed with the
Transaction.
B-1
<PAGE> 260
We have assumed, with the consent of Royce and Watson, that the Transaction
will comply with applicable federal and state laws, including, without
limitation, laws relating to bankruptcy, insolvency, reorganization, fraudulent
conveyance, fraudulent transfer or other similar laws now or hereafter in effect
affecting creditors' rights generally. We have assumed, with the consent of
Royce and Watson, that receipt of Watson common stock will be tax-free for
federal income tax purposes to the shareholders of Royce and that neither Royce
nor Watson will recognize income, gain or loss as a result of the Transaction.
We have acted as financial advisor to Royce in connection with the
Transaction and will receive a fee for our services, a substantial portion of
which is contingent upon the consummation of the Transaction. In addition, Royce
has agreed to indemnify us for certain liabilities arising out of our engagement
as financial advisor, including the rendering of this opinion.
As part of our investment banking services, we are regularly engaged in the
valuation of businesses and securities in connection with mergers, acquisitions,
underwritings, sales and distributions of listed and unlisted securities,
private placements and valuations for estate, corporate and other purposes. As
you know, we have previously acted as a financial advisor for Royce and have
rendered services to Royce in connection with two private placements of
securities and a warrant call for which we received compensation, including
warrants to purchase an aggregate of 283,333 shares of Royce common stock.
Certain of our executives and employees own Royce common stock and/or warrants
to purchase Royce common stock.
In the ordinary course of our business, we and our affiliates may actively
trade the equity securities of both Royce and Watson for our own account and for
the accounts of customers and, accordingly, may at any time hold a long or short
position in such securities. As you are aware, we also regularly publish
research reports regarding the businesses and securities of publicly-owned
companies in the pharmaceutical industry, including Royce and Watson, and are a
market maker for Royce common stock and Watson common stock.
It is understood that this letter is for information of the Board of
Directors of the Company in connection with its consideration of the
Transaction. Our opinion does not constitute a recommendation to any member of
the Board of Directors or any shareholder as to how such member or shareholder
should vote on the proposed Transaction and is not to be quoted or referred to,
in whole or in part, in any registration statement, prospectus or proxy
statement, or in any other document used in connection with the offering or sale
of securities, nor shall this letter be used for other purposes, without our
prior written consent. We understand that this opinion will be filed with the
Securities and Exchange Commission and distributed to Royce's shareholders as
part of the Proxy Statement related to the proposed Merger. We hereby consent to
the foregoing use of the opinion.
Based upon and subject to the foregoing, it is our opinion that, as of the
date hereof, the terms of the Merger are fair, from a financial point of view,
to the holders of Royce common stock.
Respectfully submitted,
By: /s/ GRUNTAL & CO., INC.
------------------------------------
Gruntal & Co., Inc.
B-2
<PAGE> 261
ANNEX C
[BEAR STEARNS LETTERHEAD]
December 19, 1996
Board of Directors
Watson Pharmaceuticals, Inc.
311 Bonnie Circle
Corona, CA 91720
Attention: Dr. Allen Chao, Chief Executive Officer
Dear Sirs:
We understand that Watson Pharmaceuticals, Inc. ("Watson") and Royce
Laboratories, Inc. ("Royce") are considering a transaction in which Dolphin
Acquisition Corp. ("Dolphin"), a newly-formed wholly-owned subsidiary of Watson,
would be merged with and into Royce in a stock-for-stock exchange (the
"Merger"). Pursuant to the Merger each outstanding share of common stock of
Royce would be converted into the right to receive a number of shares of Watson
common stock equal to the result obtained by dividing $7.25 by the average per
share closing price of Watson's common stock as quoted on the NASDAQ National
Market during the ten consecutive trading days ending on the trading day
immediately preceding the closing date; provided, however, that in no event will
the Exchange Ratio be greater than 0.19079 or less than 0.15426. We understand
that the Merger will be accounted for as a pooling of interests.
You have asked us to render our opinion as to whether the Transaction is
fair, from a financial point of view, to the shareholders of Watson.
In the course of analyses for rendering this opinion, we have:
1. reviewed a draft of the Merger Agreement dated December 19, 1996;
2. reviewed Royce's Annual Reports to Shareholders and Annual Reports
on Form 10-K for the fiscal years ended December 31, 1993 through 1995, and
its Quarterly Report on Form 10-Q for the period ended September 30, 1996;
3. reviewed certain operating and financial information, including
projections, provided to us by Royce's management relating to its business
and prospects;
4. met with certain members of Royce's senior management to discuss
its operations, historical financial statements and future prospects;
5. reviewed Watson's Annual Reports to Shareholders and Annual
Reports on Form 10-K for the fiscal years ended December 31, 1993 through
1995, and its Quarterly Report on Form 10-Q for the period ended September
30, 1996;
6. reviewed certain operating and financial information, including
projections, provided to us by Watson's management relating to its business
and prospects;
7. reviewed analyses provided to us by Watson's management relating
to the anticipated pro forma financial impact on Watson of the merger;
8. met with certain members of Watson's senior management to discuss
its operations, historical financial statements and future prospects;
9. reviewed the historical prices and trading volumes of the common
shares of Royce and Watson;
10. reviewed publicly available financial data and stock market
performance data of companies which we deemed generally comparable to
Royce;
C-1
<PAGE> 262
11. reviewed the terms of recent acquisitions of companies which we
deemed generally comparable to Royce; and
12. conducted such other studies, analyses, inquiries and
investigations as we deemed appropriate.
In the course of our review, we have relied upon and assumed, without
independent verification, the accuracy and completeness of the financial and
other information provided to us by Royce and Watson. With respect to Royce's
and Watson's projected financial results and potential synergies that could be
achieved upon consummation of the Transaction, we have assumed that they have
been reasonably prepared on bases reflecting the best currently available
estimates and judgments of the respective managements as to their respective
expected future performance. We have not assumed any responsibility for the
independent verification of any of such information or of the projections
provided to us and we have further relied upon the assurances of the managements
of Royce and Watson that they are unaware of any facts that would make the
information or projections provided to us incomplete or misleading. In arriving
at our opinion, we have not performed or obtained any independent appraisal of
the assets or liabilities of Royce or Watson. Our opinion is necessarily based
on economic, market and other conditions, and the information made available to
us, as of the date hereof.
Based on the foregoing, it is our opinion that the Transaction is fair,
from a financial point of view, to the shareholders of Watson.
We have acted as financial advisor to Watson in connection with the
Transaction and will receive a fee for such services, payment of a significant
portion of which is contingent upon the consummation of the Transaction.
It is understood that this letter is intended for the benefit and use of
the Board of Directors of Watson in its evaluation of the Merger. We understand
that this opinion will be filed with the Securities and Exchange Commission and
distributed to Royce's shareholders as part of the Proxy Statement relating to
the proposed Merger. We hereby consent to the foregoing use of the opinion.
Otherwise our opinion may not be published or otherwise used or referred to
without our written consent, which shall not be unreasonably withheld.
Very truly yours,
BEAR, STEARNS & CO. INC.
By: /s/ KEVIN CLARKE
------------------------------------
Managing Director
C-2
<PAGE> 263
PART II
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 78.751 of the Nevada Revised Statutes authorizes a corporation,
under certain circumstances, to indemnify its directors and officers (including
reimbursement for expenses incurred). The Registrant has provided for
indemnification to the fullest extent permitted by the provisions of the Nevada
statute in its Articles of Incorporation and Bylaws.
The Registrant maintains a directors' and officers' liability insurance
policy that, subject to the terms and conditions of the policy, $20,000,000 in
the aggregate (subject to a $250,000 retention per loss) arising from any
wrongful act (as defined by the policy) in his or her capacity as a director or
officer. The policy reimburses the Registrant for amounts which lawfully
indemnifies the Registrant or as required or permitted by law to indemnify its
directors and officers.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
a. Exhibits
<TABLE>
<S> <C> <C>
2.1 -- Agreement and Plan of Merger among the Registrant, Dolphins
Acquisition Corp. and Royce Laboratories, Inc. dated as of
December 24, 1996 (incorporated by reference to Annex A to
the Proxy Statement/Prospectus which is part of this
Registration Statement)
3(i) -- Articles of Incorporation of the Registrant, as amended
(incorporated by reference to Exhibit 3.1 to 33-46229)
3(ii) -- Bylaws of the Registrant, as amended (incorporated by
reference to Exhibit 3.2 to 33-46229)
4.1 -- Articles of Incorporation and Bylaws as amended, of the
Registrant (included in Exhibits 3(i) and 3(ii)
4.2 -- Specimen Warrant Certificate for the Series F Warrants
(incorporated by reference to Exhibit 4.2 to Amendment No. 1
to Royce's Registration Statement on Form S-2 dated January
27, 1994, registration number 33-72276).
4.3 -- Form of Warrant Agreement for the Series F Warrants
(incorporated by reference to Exhibit 4.3 to Amendment No. 1
to Royce's Registration Statement on Form S-2 dated January
27, 1994, registration number 33-72276).
*5.1 -- Opinion of D'Ancona & Pflaum as to the legality of the
securities being registered
*5.2 -- Opinion of Kummer Kaempfer Bonner & Renshaw
*8.1 -- Form of Opinion of D'Ancona & Pflaum regarding certain tax
matters related to the transaction
*8.2 -- Form of Opinion of Akerman, Senterfitt & Eidson, P.A.
regarding certain tax matters related to the transaction
10.1 -- Form of Employment Agreement between Oclassen
Pharmaceuticals, Inc., the Registrant and Glenn A. Oclassen
(incorporated by reference to Exhibit 10.1 to 333-16275)
10.2 -- Form of Employment Agreement between Oclassen
Pharmaceuticals, Inc., the Registrant and Terry L. Johnson
(incorporated by reference to Exhibit 10.2 to 333-16275)
10.3 -- Form of Employment Agreement between Oclassen
Pharmaceuticals, Inc., the Registrant and Anthony A. DiTonno
(incorporated by reference to Exhibit 10.3 to 333-16275)
10.4 -- Form of Employment Agreement between Royce Laboratories,
Inc. and Patrick J. McEnany (incorporated by reference to
Exhibit 10.1 of Royce Laboratories, Inc.'s Current Report on
Form 8-K dated January 8, 1997)
10.5 -- Placement Agreement Warrant issued to Gruntal & Co.,
Incorporated in connection with 1995 private placement
(incorporated by reference to Exhibit 10.13 to Royce's
Registration Statement on Form S-3 dated August 18, 1995,
registration number 33-61917)
10.6 -- Warrant issued to Gruntal & Co. Incorporated (incorporated
by reference to Exhibit 10.12 to Royce's Registration
Statement on Form S-3 dated December 9, 1994, registration
number 33-84260)
*10.7 -- Stock Option Agreement made as of February 25, 1995 between
Royce and Major Pharmaceuticals, Inc.
*10.8 -- Non-Incentive Stock Option Agreement made as of February 1,
1996 between Royce and Physician and Pharmaceutical
Services, Inc.
*11.1 -- Historical and Pro Forma Earnings Per Share
</TABLE>
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<PAGE> 264
23.1 -- Consent of Price Waterhouse LLP (Costa Mesa)
23.2 -- Consent of Price Waterhouse LLP (Miami)
23.3 -- Consent of Coopers & Lybrand L.L.P.
23.4 -- Consent of Deloitte & Touche LLP
23.5 -- Consent of Akerman, Senterfitt & Eidson, P.A. (contained in
Exhibit 8.2)
23.6 -- Consent of D'Ancona & Pflaum (contained in Exhibits 5.1 and
8.1)
23.7 -- Consent of Bear, Stearns & Co. Inc. (contained in Annex C to
the Proxy Statement/Prospectus which is part of this
Registration Statement)
23.8 -- Consent of Gruntal & Co., Inc. (contained in Exhibit 99.2)
*23.9 -- Consent of Kummer Kaempfer Bonner & Renshaw
23.10 -- Consent of Arthur Andersen LLP
*24.1 -- Powers of attorney
*99.1 -- Royce Laboratories, Inc. Proxy Card
*99.2 -- Opinion of Gruntal & Co., Incorporated (contained in Annex B
to the Proxy Statement/ Prospectus included in this
registration statement)
*99.3 -- Opinion of Bear Stearns & Co. Inc. (contained in Annex C to
the Proxy Statement/Prospectus included in this registration
statement)
- ---------------
* Previously filed
b. Financial Statement Schedules
Valuation and Qualifying Accounts.
Supplementary Valuation and Qualifying Accounts.
ITEM 22. UNDERTAKINGS
a. (1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement;
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than a 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective registration statement;
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement;
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
b. The undersigned registrant hereby undertakes to deliver or to cause to
be delivered with the prospectus, to each person to whom the prospectus is sent
or given, the latest annual report to security holders that is incorporated by
reference in the prospectus and furnished pursuant to and meeting the
requirements of Rule 14a-3 or Rule 14c-3 under the Securities Exchange Act of
1934; and, where interim financial information required to be presented by
Article 3 of Regulation S-X are not set forth in the prospectus, to
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<PAGE> 265
deliver, or cause to be delivered to each person to whom the prospectus is sent
or given, the latest quarterly report that is specifically incorporated by
reference in the prospectus to provide such interim financial information.
c. (1) The undersigned registrant hereby undertakes as follows: that prior
to any public reoffering of the securities registered hereunder through use of a
prospectus which is a part of this registration statement, by any person or
party who is deemed to be an underwriter within the meaning of Rule 145(c), the
issuer undertakes that such reoffering prospectus will contain the information
called for by the applicable registration form with respect to reofferings by
persons who may be deemed underwriters, in addition to the information called
for by the other items of the applicable form.
(2) The registrant undertakes that every prospectus (i) that is filed
pursuant to paragraph (1) immediately preceding, or (ii) that purports to meet
the requirements of Section 10(a)(3) of the Act and is used in connection with
an offering of securities subject to Rule 415, will be filed as a part of an
amendment to the registration statement and will not be used until such
amendment is effective and that, for purposes of determining any liability under
the Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered therein
and the offering of such securities at the time shall be deemed to be the
initial bona fide offering thereof.
d. The undersigned registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the prospectus pursuant to
Items 4, 10(b), 11 or 13 of this Form, within one business day of receipt of
such request and to send the incorporated documents by first class mail or other
equally prompt means. This includes information contained in documents filed
subsequent to the effective date of the registration statement through the date
of responding to the request.
e. The undersigned registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction and the
company being acquired involved therein, that was not the subject of and
included in the registration statement when it became effective.
f. The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 that is incorporated by reference in the registration
statement shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
g. Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission,
such indemnification is against public policy as expressed in the Securities Act
and is therefore unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person thereof in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.
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<PAGE> 266
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Corona, State of
California, on the day of March 13, 1997.
WATSON PHARMACEUTICALS, INC.
(Registrant)
By: /s/ Allen Chao
------------------------------------
Allen Chao, Ph.D.
Chairman and Chief Executive Officer
(Principal Executive and Financial
Officer)
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been duly signed on March 13, 1997 by the following
persons in the capacities indicated:
<TABLE>
<CAPTION>
SIGNATURES TITLES DATE
---------- ------ ----
<C> <S> <C>
/s/ Allen Chao Chairman and Chief Executive March 13, 1997
- ----------------------------------------------------- Officer (Principal Executive
Allen Chao, Ph.D. and Financial Officer)
* President and Director March 13, 1997
- -----------------------------------------------------
Melvin Sharoky, M.D.
* Vice President Corporate March 13, 1997
- ----------------------------------------------------- Controller (Principal
Chato Abad Accounting Officer)
* Secretary and Director March 13, 1997
- -----------------------------------------------------
Michel J. Feldman
* Director March 13, 1997
- -----------------------------------------------------
Alec D. Keith, Ph.D.
* Director March 13, 1997
- -----------------------------------------------------
Albert F. Hummel
* Director March 13, 1997
- -----------------------------------------------------
Michel Fedida
* Director March 13, 1997
- -----------------------------------------------------
Ronald R. Taylor
By: /s/ Allen Chao
--------------------------------------------------
Attorney in fact
</TABLE>
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<PAGE> 267
WATSON PHARMACEUTICALS, INC.
SCHEDULE II -- VALUATION & QUALIFYING ACCOUNTS
(IN THOUSANDS)
<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>
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<PAGE> 268
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTARY CONSOLIDATED FINANCIAL STATEMENTS
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COSTS AND DEDUCTIONS/ END OF
PERIOD EXPENSES OTHER PERIOD
------------ ---------- ----------- ----------
<S> <C> <C> <C> <C>
YEAR END 1995:
Allowance for doubtful accounts.......... $1,083 $ 400 $ (133) $1,350
Product return allowance................. $ 189 $2,397 $(1,878) $ 708
YEAR END 1994:
Allowance for doubtful accounts.......... $ 574 $ 759 $ (250) $1,083
Product return allowance................. $ 109 $1,088 $(1,008) $ 189
YEAR END 1993:
Allowance for doubtful accounts.......... $ 121 $ 453 $ -- $ 574
Product return allowance................. $ 164 $ 266 $ (321) $ 109
</TABLE>
II-6
<PAGE> 269
EXHIBIT INDEX
<TABLE>
<S> <C> <C>
2.1 -- Agreement and Plan of Merger among the Registrant, Dolphins
Acquisition Corp. and Royce Laboratories, Inc. dated as of
December 24, 1996 (incorporated by reference to Annex A to
the Proxy Statement/Prospectus which is part of this
Registration Statement)
3(i) -- Articles of Incorporation of the Registrant, as amended
(incorporated by reference to Exhibit 3.1 to 33-46229)
3(ii) -- Bylaws of the Registrant, as amended (incorporated by
reference to Exhibit 3.2 to 33-46229)
4.1 -- Articles of Incorporation and Bylaws as amended, of the
Registrant (included in Exhibits 3(i) and 3(ii)
4.2 -- Specimen Warrant Certificate for the Series F Warrants
(incorporated by reference to Exhibit 4.2 to Amendment No. 1
to Royce's Registration Statement on Form S-2 dated January
27, 1994, registration number 33-72276).
4.3 -- Form of Warrant Agreement for the Series F Warrants
(incorporated by reference to Exhibit 4.3 to Amendment No. 1
to Royce's Registration Statement on Form S-2 dated January
27, 1994, registration number 33-72276).
*5.1 -- Opinion of D'Ancona & Pflaum as to the legality of the
securities being registered
*5.2 -- Opinion of Kummer Kaempfer Bonner & Renshaw
*8.1 -- Form of Opinion of D'Ancona & Pflaum regarding certain tax
matters related to the transaction
*8.2 -- Form of Opinion of Akerman, Senterfitt & Eidson, P.A.
regarding certain tax matters related to the transaction
10.1 -- Form of Employment Agreement between Oclassen
Pharmaceuticals, Inc., the Registrant and Glenn A. Oclassen
(incorporated by reference to Exhibit 10.1 to 333-16275)
10.2 -- Form of Employment Agreement between Oclassen
Pharmaceuticals, Inc., the Registrant and Terry L. Johnson
(incorporated by reference to Exhibit 10.2 to 333-16275)
10.3 -- Form of Employment Agreement between Oclassen
Pharmaceuticals, Inc., the Registrant and Anthony A. DiTonno
(incorporated by reference to Exhibit 10.3 to 333-16275)
10.4 -- Form of Employment Agreement between Royce Laboratories,
Inc. and Patrick J. McEnany (incorporated by reference to
Exhibit 10.1 of Royce Laboratories, Inc.'s Current Report on
Form 8-K dated January 8, 1997)
10.5 -- Placement Agreement Warrant issued to Gruntal & Co.,
Incorporated in connection with 1995 private placement
(incorporated by reference to Exhibit 10.13 to Royce's
Registration Statement on Form S-3 dated August 18, 1995,
registration number 33-61917)
10.6 -- Warrant issued to Gruntal & Co. Incorporated (incorporated
by reference to Exhibit 10.12 to Royce's Registration
Statement on Form S-3 dated December 9, 1994, registration
number 33-84260)
*10.7 -- Stock Option Agreement made as of February 25, 1995 between
Royce and Major Pharmaceuticals, Inc.
*10.8 -- Non-Incentive Stock Option Agreement made as of February 1,
1996 between Royce and Physician and Pharmaceutical
Services, Inc.
*11.1 -- Historical and Pro Forma Earnings Per Share
23.1 -- Consent of Price Waterhouse LLP (Costa Mesa)
23.2 -- Consent of Price Waterhouse LLP (Miami)
23.3 -- Consent of Coopers & Lybrand L.L.P.
23.4 -- Consent of Deloitte & Touche LLP
23.5 -- Consent of Akerman, Senterfitt & Eidson, P.A. (contained in
Exhibit 8.2)
23.6 -- Consent of D'Ancona & Pflaum (contained in Exhibits 5.1 and
8.1)
23.7 -- Consent of Bear, Stearns & Co. Inc. (contained in Annex C to
the Proxy Statement/Prospectus which is part of this
Registration Statement)
23.8 -- Consent of Gruntal & Co., Inc. (contained in Exhibit 99.2)
*23.9 -- Consent of Kummer Kaempfer Bonner & Renshaw
23.10 -- Consent of Arthur Andersen LLP
*24.1 -- Powers of attorney
*99.1 -- Royce Laboratories, Inc. Proxy Card
*99.2 -- Opinion of Gruntal & Co., Incorporated (contained in Annex B
to the Proxy Statement/ Prospectus included in this
registration statement)
*99.3 -- Opinion of Bear Stearns & Co. Inc. (contained in Annex C to
the Proxy Statement/Prospectus included in this registration
statement)
</TABLE>
- ---------------
* Previously filed
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Prospectus (the "Prospectus") constituting
part of this Registration Statement on Form S-4 of Watson Pharmaceuticals,
Inc. (the "Company") of our report dated February 5, 1996, except as to Note
13, which is as of March 4, 1996 and except as to the pooling of interests with
Oclassen Pharmaceuticals, Inc., which is as of February 27, 1997, relating
to the financial statements of Watson Pharmaceuticals, Inc. which appear in
the Prospectus, and we consent to the incorporation by reference in the
Prospectus of such report appearing on page F-2 of the Company's Annual Report
on Form 10-K for the year ended December 31, 1995. We also consent to the
reference to us under the heading "Experts" in such Prospectus.
Price Waterhouse LLP
Costa Mesa, California
March 13, 1997
<PAGE> 1
Exhibit 23.2
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
---------------------------------------------------
We hereby consent to the use in the Prospectus constituting part of
this Registration Statement on Form S-4 of Watson Pharmaceuticals, Inc. of our
report dated February 28, 1996, relating to the financial statements of Royce
Laboratories, Inc., which appears in such Prospectus. We also consent to the
reference to us under the headings "Experts" in such Prospectus.
Price Waterhouse LLP
Miami, Florida
March 12, 1997
<PAGE> 1
Exhibit 23.3
CONSENT OF COOPERS & LYBRAND L.L.P.
We consent to the incorporation by reference in the registration statement of
Watson Pharmaceuticals, Inc. on Form S-4 (File No. 333-20029), of our report
dated February 7, 1995, on our audits of the consolidated financial statements
and financial statement schedule of Circa Pharmaceuticals, Inc. as of December
31, 1994, and for the years ended December 31, 1994 and 1993. We also consent
to the reference to our Firm under the caption "Experts."
COOPERS & LYBRAND L.L.P.
/s/ Coopers & Lybrand L.L.P.
Melville, New York
March 12, 1997.
<PAGE> 1
Exhibit 23.4
INDEPENDENT AUDITORS'
CONSENT
We consent to the inclusion and incorporation by reference in this Amendment No.
4 to Registration Statement No. 333-20029 of Watson Pharmaceuticals, Inc. on
Form S-4 of our report dated February 2, 1996, relating to the consolidated
financial statements of Somerset Pharmaceuticals, Inc. and subsidiaries as of
December 31, 1995 and 1994 and for each of the three years in the period then
ended, included herein and appearing in the Annual Report on Form 10-K/A of
Watson Pharmaceuticals, Inc. for the year ended December 31, 1995 and to the
reference to us under the heading "Experts" in the Prospectus, which is part of
such Registration Statement.
/s/ Deloitte & Touche LLP
Pittsburgh, Pennsylvania
March 13, 1997
<PAGE> 1
Exhibit 23.10
CONSENT OF ARTHUR ANDERSEN LLP
As independent public accountants, we hereby consent to the use of our
report dated February 8, 1996 included herein and to all references to our Firm
included in this Registration Statement.
/s/ Arthur Andersen LLP
-----------------------
ARTHUR ANDERSEN LLP
Oakland, California,
March 12, 1997
