SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
COMMISSION FILE NUMBER 0-20045
WATSON PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
NEVADA 95-3872914
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
311 BONNIE CIRCLE
CORONA, CA 91720
(Address of principal executive offices) (Zip Code)
909-270-1400
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:
YES [X] NO [ ]
The number of shares outstanding of the Registrant's only class of common stock
as of November 4, 1997 was 87,840,934 shares.
<PAGE>
WATSON PHARMACEUTICALS, INC.
INDEX TO THE FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
PART I FINANCIAL INFORMATION PAGE NUMBER
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets
as of September 30, 1997 and
December 31, 1996 3
Consolidated Statements of
Income for the Three and Nine Months
Ended September 30, 1997 and 1996 5
Consolidated Statements of Cash
Flows for the Nine Months Ended
September 30, 1997 and 1996 6
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and
Analysis of Financial Condition
and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosure
About Market Risk 18
PART II OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $100,673 $158,221
Marketable securities 82,013 80,966
Accounts receivable, net of allowances for
doubtful accounts of $2,130 and $2,206 64,809 32,845
Royalty receivable 5,554
Inventories:
Raw materials 17,705 12,801
Work-in-process 9,684 7,150
Finished goods 17,310 12,478
Prepaid expenses and other current assets 1,024 6,381
Deferred tax assets 9,146 9,807
-------- --------
Total current assets 302,364 326,203
Property and equipment, net 81,821 78,429
Investments and other assets 160,447 66,051
Product rights, net 197,369 2,171
-------- --------
$742,001 $472,854
======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE>
<TABLE>
<CAPTION>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(unaudited)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 39,770 $ 31,758
Income taxes payable 6,671 472
Current portion of long-term debt 812 1,025
Current liability from acquisition of product rights 45,000
--------- ---------
Total current liabilities 92,253 33,255
Long-term debt 2,648 3,864
Long-term liability from acquisition of product rights 50,000
Deferred tax liabilities 43,730 12,226
--------- ---------
Total liabilities 188,631 49,345
--------- ---------
Commitments and contingencies
Minority interest 767 401
--------- ---------
Stockholders' equity:
Preferred stock; no par; 2,500 shares
authorized; none outstanding
Common stock; par value of $.0033; 500,000
shares authorized; 87,764 and 85,439
shares issued and outstanding, respectively 290 282
Additional paid-in capital 255,451 231,512
Retained earnings 245,613 184,852
Unrealized holding gain on available-for-sale securities 51,321 7,189
Notes receivable from stockholders (72) (727)
--------- ---------
Total stockholders' equity 552,603 423,108
--------- ---------
$ 742,001 $ 472,854
========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE>
<TABLE>
<CAPTION>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Earnings Per Share)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Revenues:
Product sales $ 91,817 $ 55,074 $ 214,251 $ 163,648
Royalty income 7,260 14,249 19,862
----------- ---------- ----------- ----------
Total revenues 91,817 62,334 228,500 183,510
----------- ---------- ----------- ----------
Operating expenses:
Cost of revenues 34,525 25,457 87,025 75,141
Research and development 4,201 5,706 13,041 17,274
Selling, general and administrative 11,606 9,752 31,825 28,731
Amortization of intangibles 3,280 3,280
Merger expenses 14,718
----------- ---------- ----------- ----------
Total operating expenses 53,612 40,915 149,889 121,146
----------- ---------- ----------- ----------
Operating income 38,205 21,419 78,611 62,364
Other income:
Equity in earnings of joint ventures 1,818 4,803 9,713 14,156
Investment and other income, net 2,412 2,582 9,543 6,822
----------- ---------- ----------- ----------
Total other income 4,230 7,385 19,256 20,978
----------- ---------- ----------- ----------
Income before provision
for income taxes 42,435 28,804 97,867 83,342
Provision for income taxes 14,837 9,609 37,106 25,752
----------- ---------- ----------- ----------
Net income $ 27,598 $ 19,195 $ 60,761 $ 57,590
=========== ========== =========== ==========
Earnings per share $ 0.31 $ 0.22 $ 0.68 $ 0.65
=========== ========== =========== ==========
Weighted average
shares outstanding 90,013 87,790 89,037 88,036
=========== ========== =========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
5
<PAGE>
<TABLE>
<CAPTION>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
1997 1996
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 60,761 $ 57,590
--------- ---------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 9,265 5,298
Amortization of unearned compensation-stock awards 716
Dividends received from Somerset 8,000 10,500
Equity in earnings of joint ventures (8,832) (11,415)
Provision for doubtful accounts (76) 918
Deferred income tax provision 2,775 10,009
Tax benefit related to stock option plan 10,993 3,765
Changes in assets and liabilities:
Accounts receivable (31,888) (1,960)
Royalty receivable 5,554 950
Inventories (12,270) (5,980)
Prepaid expenses and other current assets 5,357 (1,486)
Other assets (2,355) 12
Accounts payable and accrued expenses 8,012 (1,548)
Income taxes payable 6,199 6,999
Other liabilities (714)
--------- ---------
Total adjustments 734 16,064
--------- ---------
Net cash provided by operating activities 61,495 73,654
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (8,880) (9,491)
Purchases of marketable securities (101,825) (84,885)
Proceeds from maturities of marketable securities 100,857 39,516
Acquisition of product rights (48,478)
Investment in Andrx (15,307)
Investments in joint ventures (2,590) (3,857)
--------- ---------
Net cash used in investing activities (76,223) (58,717)
--------- ---------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
6
<PAGE>
<TABLE>
<CAPTION>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
1997 1996
----------- --------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payment on liability from
acquisition of product rights $ (55,000)
Proceeds from long-term debt $ 743
Long-term debt paid in advance (752)
Principal payments on long-term debt (677) (597)
Proceeds from exercise of stock options 13,609 8,851
----------- --------
Net cash (used) provided by financing activities (42,820) 8,997
----------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (57,548) 23,934
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 158,221 97,507
----------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 100,673 $121,441
=========== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the periods for:
Interest $ 264 $ 293
Income taxes $ 17,484 $ 4,962
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Acquisition of product rights:
Fair value of assets acquired $ (198,478)
Fair value of liabilities assumed $ 150,000
-----------
$ (48,478)
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
7
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(UNAUDITED)
NOTE A - GENERAL
The unaudited consolidated financial statements as of September 30, 1997 and for
the three and nine months ended September 30, 1997 and 1996, 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, 1996. As discussed in Note B to the
Consolidated Financial Statements, in 1997 the Company entered into two mergers
that were accounted for as poolings of interests. These financial statements
have been restated to include the results of operations of the pooled companies
for all periods presented.
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,
1997, and the results of operations for the three and nine months ended
September 30, 1997 and 1996 and cash flows for the nine months ended September
30, 1997 and 1996. The results of operations and cash flows for the three and
nine months ended September 30, 1997 are not necessarily indicative of the
results of operations or cash flows which may be reported for the remainder of
1997. The accounting policies followed during the three and nine months ended
September 30, 1997 were the same as those disclosed in the Company's Annual
Report on Form 10-K for the year ended December 31, 1996.
NOTE B - ACQUISITIONS
In 1997, the Company entered into several acquisitions which will require the
payment of future scheduled amounts and the possible payment of certain
contingent amounts. In addition, the Company continues to review additional
acquisition and investment opportunities. The Company expects to use a
combination of available cash, future debt or equity financing and future
operating cash flows to fund its future acquisition costs and contingent
payments. Please refer to the Liquidity and Capital Resources section of this
Form 10-Q for further discussion of financing alternatives under consideration.
8
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
SUBSEQUENT EVENT - ACQUISITION OF PRODUCTS FROM G. D. SEARLE & CO. ("SEARLE")
In October 1997, the Company acquired the U.S. rights to three Searle branded
off-patent oral contraceptive products: Genora, Levora and Nor QD. Cash of $80.0
million was paid at closing from available cash on hand. This amount includes a
$5.0 million payment related to the achievement of certain events between the
signing and the closing of the transaction. The Company also agreed to acquire
the U.S. rights to certain additional generic oral contraceptive products from
Searle (the "Future Products"), upon achievement of certain events, which
include in certain instances, approval by the U.S. Food and Drug Administration.
If the Future Products are acquired before July 1, 1999, the aggregate
acquisition cost for the Future Products will be $93.5 million. In addition to
the acquisition cost of the Future Products, Watson also agreed to make
contingent payments to Searle based on the achievement of certain events,
including but not limited to, future net sales of certain products during the
period from January 1, 2000 to December 31, 2004.
SUBSEQUENT EVENT - ACQUISITION OF CERTAIN ASSETS FROM COCENSYS, INC.
("COCENSYS")
In October 1997, the Company acquired the Pharmaceutical Sales and Marketing
Division, two products and two co-promotion agreements from CoCensys. A total of
$8.0 million was paid. A contingent payment of $1.0 million may be required,
based upon the achievement of certain future events. The Company used available
cash to fund this acquisition.
AGREEMENT TO ACQUIRE THE RUGBY GROUP, INC. ("RUGBY")
During the third quarter, the Company entered into an agreement with Hoechst
Marion Roussel, Inc., to acquire all of the ouststanding stock of Rugby for
$70.0 million in cash and contingent payments based on future sales and future
operating results. Rugby develops, manufactures and markets a wide array of
generic pharmaceutical products. The acquisition is expected to be completed
upon receipt of federal regulatory approval. Under the terms of the agreement,
the Company will acquire Rugby and its abbreviated new drug applications which
include several licensed products, plus Rugby's sales and marketing capabilities
for U.S. generic pharmaceuticals. Watson will also acquire Rugby's product
development group and product pipeline.
ACQUISITION OF PRODUCT RIGHTS TO DILACOR XR/Registered trademark/
On June 30, 1997, in connection with the termination of a partnership agreement
with Rhone-Poulenc Rorer, Inc. ("RPR"), the Company obtained the exclusive U.S.
and certain worldwide marketing, sales and distribution rights to Dilacor
XR/Registered trademark/ for $190.0 million in cash (payable as set forth
below), future royalties and an inventory supply agreement. RPR agreed to
transfer the new drug application for Dilacor XR/Registered trademark/ to the
Company no later than December 31, 1997. In addition, Watson acquired the
customer list for Dilacor XR/Registered trademark/ and the exclusive license to
use the Dilacor XR/Registered trademark/ trademark. These product rights are
being amortized on a straight-line basis over 17 years. Prior to the termination
of the partnership agreement, the Company earned royalties on RPR's sales of
Dilacor XR/Registered trademark/. The Company earned royalties from such RPR
sales in the amount of $27.2 million and $14.2 million for the year ended
December 31, 1996 and nine months ended September 30, 1997, respectively. RPR's
sales of Dilacor XR/Registered trademark/ in 1996 were approximately $140.0
million.
Dilacor XR/Registered trademark/ (diltiazem hydrochloride) has been available in
the United States for the treatment of hypertension since June 1992 and was
approved for the treatment of chronic stable angina in March 1995. The Company
obtained all worldwide rights with the exception of New Zealand, The Republic of
Korea and North Korea. The Company is responsible for obtaining all regulatory
approvals required to market Dilacor XR/Registered trademark/ outside of the
United States.
9
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
To date, the Company has made scheduled payments to RPR of $95.0 million from
its available cash on hand. The remaining scheduled payments are due as follows:
DUE DATE AMOUNT
-------- ------
January 1, 1998 $ 45.0 million
January 1, 1999 30.0 million
January 1, 2000 15.0 million
January 1, 2001 5.0 million
------------
Total $ 95.0 million
============
In October 1997, Andrx Corporation received regulatory approval and began to
market a generic form of Dilacor XR/Registered trademark/. In response, the
Company has introduced its own off-patent alternative. Due to this recent
generic competition, the Company's product sales and gross profits from Dilacor
XR/Registered trademark/ are likely to decline in future periods.
MERGER WITH ROYCE LABORATORIES, INC. ("ROYCE")
On April 16, 1997, the stockholders of Royce approved the merger which resulted
in Royce becoming a wholly owned subsidiary of the Company. Under the terms of
the Royce merger agreement, Royce stockholders received approximately 0.19 of a
share of the Company's common stock for each Royce share. In the merger, Watson
issued approximately 2.6 million shares of common stock for all of the
outstanding common shares of Royce.
Royce develops, manufactures and markets off-patent prescription drugs in solid
dosage forms (tablets and capsules). The merger qualified as a tax-free
reorganization for federal income tax purposes and was accounted for as a
pooling of interests. During the second quarter of 1997, the Company recorded a
one-time charge of $5.8 million for investment banking fees and other merger
related expenses incurred in connection with the Royce acquisition. The
Company's financial statements have been restated to include the results of
Royce for all periods presented.
MERGER WITH OCLASSEN PHARMACEUTICALS, INC. ("OCLASSEN")
On February 26, 1997, the stockholders of Oclassen approved the merger which
resulted in Oclassen becoming a wholly owned subsidiary of the Company. Under
the terms of the Oclassen merger agreement, Oclassen stockholders received
approximately 0.37 of a share of the Company's common stock for each Oclassen
share. In the merger, Watson issued approximately 3.3 million shares of common
stock for all of the outstanding common shares of Oclassen.
10
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Oclassen develops specialty prescription pharmaceuticals to prevent and treat
skin diseases and markets these products to dermatologists. The merger qualified
as a tax-free reorganization for federal income tax purposes and was accounted
for as a pooling of interests. During the first quarter of 1997, the Company
recorded a one-time charge of $8.9 million for investment banking fees and other
merger related expenses incurred in connection with the Oclassen acquisition.
The Company's financial statements have been restated to include the results of
Oclassen for all periods presented.
NOTE C - STOCK SPLIT
On October 13, 1997, the Company announced that its board of directors approved
a two-for-one stock split in the form of a 100% stock dividend to all
stockholders who owned shares on October 22, 1997. The par value of the
Company's common stock will remain at $0.0033 per share. The Company issued the
additional shares effective October 29, 1997. All share and per share amounts
reflect the stock split.
NOTE D - INCREASE IN INVESTMENT IN ANDRX CORPORATION ("ANDRX")
On June 16, 1997, the Company purchased a total of 600,000 shares of Andrx
common stock from Andrx and its founders. The stock was purchased at $25.50 per
share. The total purchase price of $15.3 million was paid from available cash.
The Company now owns 2.7 million common shares of Andrx, which represents
approximately 18.5% of the total Andrx common shares outstanding. Watson
continues to account for this investment using the cost method, which requires
that the investment be adjusted to fair value. The fair value of the Andrx
investment, based on the Andrx closing price at September 30, 1997 of $45.50 per
share, has appreciated by $85.5 million from its original cost. This unrealized
gain, net of applicable income taxes of $34.2 million, is reflected as a
separate component of stockholders' equity.
NOTE E - JOINT VENTURES
SOMERSET PHARMACEUTICALS, INC. ("SOMERSET")
The Company owns 50% of the outstanding common stock of Somerset and utilizes
the equity method to account for this
investment. Somerset manufactures and markets the product Eldepryl/Registered
trademark/, which is used in the treatment of Parkinson's disease. Income
recognized from Somerset was approximately $2.3 million and $5.2 million for the
three months ended September 30, 1997 and 1996, respectively. Income is
comprised of the Company's 50% share of Somerset's earnings and management fees,
offset by amortization of goodwill. At September 30, 1997 and December 31, 1996,
the net excess cost of this investment over its net assets was $6.7 million and
$7.4 million, respectively. Goodwill is being amortized on a straight-line basis
over 15 years.
11
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WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
In recent years, Somerset has increased its research and development spending in
order to 1) develop additional indications for selegiline (the parent compound
of Eldepryl/Registered trademark/), using a transdermal delivery system and 2)
develop and evaluate different therapeutic areas using selegiline and other
compounds. In November 1997, Somerset announced completion of the Phase III
clinical trials of its selegiline transdermal system for the treatment of
Alzheimer's disease. Somerset reported that the preliminary analyses of the
efficacy data did not yield statistically significant differences between the
placebo and the selegiline treatment group. In light of these results, Somerset
is reviewing its current research projects and is considering alternatives that
include third party contract research and other options. Watson's equity in
earnings from Somerset is expected to continue to decline from current levels.
Somerset has been notified by the Internal Revenue Service ("IRS") that it may
be subject to additional income taxes and interest for its 1993, 1994 and 1995
tax years. The IRS has proposed adjustments relating to credits claimed under
Internal Revenue Code Section 936. These proposed adjustments amount to
approximately $12.5 million plus interest, 50% of which would be Watson's share.
Management of Somerset believes that it has complied with all relevant tax laws
and intends to vigorously defend its position on this matter.
Condensed income statements and balance sheets of Somerset are as follows (in
thousands):
CONDENSED INCOME STATEMENTS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
------- ------- ------- -------
Net revenues $15,110 $26,224 $54,655 $81,826
Costs and expenses 8,007 11,734 23,191 39,516
Income taxes 2,485 5,336 11,014 14,911
------- ------- ------- -------
Net income $ 4,618 $ 9,154 $20,450 $27,399
======= ======= ======= =======
CONDENSED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1997 1996
------- -------
Current assets $47,043 $45,871
Other assets 6,223 7,006
------- -------
Total assets $53,266 $52,877
======= =======
Current liabilities $15,013 $19,075
Stockholders' equity 38,253 33,802
------- -------
Total liabilities and
stockholders' equity $53,266 $52,877
======= =======
12
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
ANCIRC
In July 1994, the Company and Andrx formed a joint venture, ANCIRC, to develop
off-patent pharmaceutical products utilizing Andrx's controlled-release
technology. The Company utilizes the equity method to account for this joint
venture and recognized losses from ANCIRC of approximately $498,000 and $353,000
for the quarters ended September 30, 1997 and 1996, respectively.
Condensed statements of operations and balance sheets of ANCIRC are as follows
(in thousands):
CONDENSED STATEMENTS OF OPERATIONS
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
----- ----- ------- -------
Research and development
expenses $ 998 $ 711 $ 2,545 $ 2,776
===== ===== ======= =======
Net (loss) $(995) $(706) $(2,522) $(2,768)
===== ===== ======= =======
CONDENSED BALANCE SHEETS
September 30, December 31,
1997 1996
----- ------
Current assets $ 2 $ 701
Other assets 251 25
----- ------
Total assets $ 253 $ 726
===== ======
Current liabilities $ 697 $1,048
Partners' deficit (444) (322)
----- ------
Total liabilities and
partners' deficit $ 253 $ 726
===== ======
13
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WATSON PHARMACEUTICALS, INC.
NOTE F - RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128 , "Earnings per Share". SFAS 128
specifies the computation, presentation and disclosure requirements for earnings
per share ("EPS") and will become effective for both interim and annual periods
ending after December 15, 1997. Earlier application to the Company's financial
statements is prohibited. However, disclosure of pro forma EPS computed using
SFAS 128 is permitted in the notes to the financial statements. The following
table sets forth unaudited pro forma EPS data computed under the provisions of
SFAS 128:
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
----- ----- ----- -----
Basic EPS $0.32 $0.23 $0.70 $0.70
===== ===== ===== =====
Diluted EPS $0.31 $0.22 $0.68 $0.65
===== ===== ===== =====
In June 1997, SFAS No. 130, "Reporting Comprehensive Income," was issued and
established standards for the reporting and disclosure of components of
comprehensive income (revenues, expenses, gains and losses). Also in June 1997,
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information," was issued. This statement requires that certain financial
information regarding operating segments be publicly reported on the same basis
used internally by management to evaluate segment performance. These statements
are effective for fiscal years beginning after December 15, 1997. SFAS No.'s 130
and 131 both address disclosure matters and, therefore, will not have any effect
on the Company's financial position, cash flows or results of operations.
14
<PAGE>
WATSON PHARMACEUTICALS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Revenues for the three months ended September 30, 1997 were $91.8 million
compared to $62.3 million for the three months ended September 30, 1996, an
increase of $29.5 million or 47.3%. The increase in revenues was largely due to
sales of Dilacor XR/Registered trademark/, the rights to which were purchased
from RPR on June 30, 1997. Simultaneous with the purchase of these product
rights, a partnership and royalty agreement with RPR was terminated. As a
result, the Company reported no royalty income in the third quarter of 1997, as
compared to royalties of $7.3 million in the third quarter of 1996. In the third
quarter of 1997, the Company also experienced an increase in sales of both
off-patent and proprietary products, offset by decreased sales of certain
established products.
In October 1997, a competitor received regulatory approval and began to market a
generic form of Dilacor XR/Registered trademark/. In response, the Company has
introduced its own off-patent alternative. Due to this recent generic
competition, the Company's product sales and gross profits from Dilacor
XR/Registered trademark/ are likely to decline in future periods.
Gross profit margins increased to 62.4% in 1997 from 53.8% in 1996. This
favorable increase was due to higher than average gross margins earned on sales
of the Company's brand products and new products introduced in 1997.
Research and development expenses decreased from $5.7 million in the three
months ended September 30, 1996 to $4.2 million in the 1997 period. The decrease
is due to the consolidation of certain research and development functions of
Circa Pharmaceuticals, Inc. ("Circa"), Oclassen and Royce into the Company.
Selling, general and administrative expenses were $11.6 million for the third
quarter of 1997, compared to $9.8 million in the year-ago period. This net
increase consists of a $2.1 million decrease in general and administrative
costs, offset by a $4.0 million increase in sales and marketing expenses. The
increased sales and marketing expenses were incurred by the Company in support
of the increased sales of its proprietary products. At September 30, 1997, the
Company had approximately 200 sales and marketing personnel as compared to
approximately 100 in the year-ago period. The decrease in general and
administrative expenses was primarily the result of the consolidation of the
acquired companies. See Note B, Acquisitions, of the Notes to Consolidated
Financial Statements. In addition, the 1997 period did not reflect deferred
compensation expense that was fully amortized during 1996.
15
<PAGE>
WATSON PHARMACEUTICALS, INC.
Equity in earnings from joint ventures decreased $3.0 million, or 62.6%, to $1.8
million in the third quarter of 1997 compared to $4.8 million in the comparable
1996 period. The significant ventures generating these earnings were Somerset, a
50% owned joint venture with Mylan Laboratories, Inc. and ANCIRC, a 50% owned
joint venture with Andrx. Equity in earnings from Somerset decreased from $5.2
million in the third quarter of 1996 to $2.3 million in the third quarter of
1997. The decreased earnings are due in part to the June 1996 loss of
exclusivity for Eldepryl/Registered trademark/. During 1996, three competitors
introduced generic tablets to compete with Eldepryl/Registered trademark/
capsules. The introduction of generic competition and increased research and
development spending in support of various clinical trials has significantly
reduced Somerset's contribution to the Company's operating results. Equity in
earnings of Somerset represented 5.5% of pre-tax income in the third quarter of
1997 compared to 18.1% of pre-tax income for the year-ago period. Management
expects the Company's earnings from Somerset will continue to decline. See Note
E, Joint Ventures, of the Notes to Consolidated Financial Statements. Watson's
equity in ANCIRC's losses for the three months ended September 30, 1997
increased slightly from $353,000 in 1996 to $498,000 in 1997.
The provision for income taxes increased to $14.8 million in 1997, compared to
$9.6 million in 1996. The effective income tax rate was 35.0% and 33.4% for the
three months ended September 30, 1997 and 1996, respectively. The increase in
the Company's effective income tax rate in 1997 as compared to 1996 was due to
higher tax credit utilization in 1996.
RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Revenues for the nine months ended September 30, 1997 were $228.5 million
compared to $183.5 million for the nine months ended September 30, 1996, an
increase of $45.0 million or 24.5%. The increase was largely due to sales of
Dilacor XR/Registered trademark/, the rights to which were purchased in June
1997. However, the recent introduction of generic competition for Dilacor
XR/Registered trademark/ will likely cause the Company's future sales and gross
profits of this product to decline. The Company also experienced increased sales
of both off-patent and proprietary products, partially offset by decreased sales
of certain established products. Royalty income for the nine months ended
September 30, 1997 decreased $5.6 million from 1996 levels to $14.2 million.
This decrease is due to the termination of a partnership and royalty agreement
with RPR simultaneous with the purchase of Dilacor XR/Registered trademark/.
Gross profit margins increased to 59.4% in 1997 from 54.1% in 1996. This
favorable increase was due to higher than average gross margins earned on sales
of Watson's proprietary products and new products introduced during the first
nine months of 1997.
Research and development expenses decreased from $17.3 million in the nine
months ended September 30, 1996 to $13.0 million in the 1997 period. The
decrease is due to the consolidation of certain Circa, Oclassen and Royce
research and development functions into the Company, as a result of the mergers
with these entities.
Selling, general and administrative expenses were $31.8 million for the first
nine months of 1997, compared to $28.7 million in the comparable period of 1996.
The increase consists of a $7.3 million increase in sales and marketing
expenses, offset by a $4.2 million decrease in general and administrative costs.
The increased sales and marketing expenses were incurred by the Company in
support of the increased sales of its proprietary products. At September 30,
1997, the Company had
16
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WATSON PHARMACEUTICALS, INC.
approximately 200 sales and marketing personnel as compared to approximately 100
in the year-ago period. The decrease in general and administrative expenses was
primarily the result of the consolidation of the acquired companies. See Note B,
Acquisitions, of the Notes to Consolidated Financial Statements. In addition,
the 1997 period did not reflect deferred compensation expense that was fully
amortized during 1996.
In connection with the Oclassen and Royce mergers, the Company recorded
non-recurring charges of $14.7 million in the nine months ended September 30,
1997. All such merger costs were incurred prior to the third quarter of 1997.
These costs included investment banking fees and other costs related to the
consolidation of the companies.
Equity in earnings from joint ventures decreased $4.5 million, or 31.7%, to $9.7
million in the first nine months of 1997, compared to $14.2 million in the
comparable 1996 period. The decreased earnings from Somerset are due to the June
1996 loss of exclusivity for Eldepryl/Registered trademark/ and to Somerset's
increased research and development expenditures in support of various clinical
trials. Equity in earnings of Somerset represented 11.2% of pre-tax income in
the first nine months of 1997 compared to 18.8% of pre-tax income for the
year-ago period. See Note E, Joint Ventures, of the Notes to Consolidated
Financial Statements. The Company's portion of ANCIRC's losses for the nine
months ended September 30, 1997 decreased slightly from $1.5 million in 1996 to
$1.3 million in 1997.
Investment and other income increased $2.7 million to $9.5 million in the first
nine months of 1997 from $6.8 million in the 1996 period. This increase was
primarily due to earnings on the Company's increased cash and marketable
securities balances in 1997.
The provision for income taxes increased to $37.1 million in 1997, compared to
$25.8 million in 1996. The effective income tax rate was 37.9% and 30.9% for the
nine months ended September 30, 1997 and 1996, respectively. The increase in the
Company's effective income tax rate was due primarily to the non-deductibility
of a significant portion of merger expenses incurred in 1997.
Exclusive of merger expenses of $14.7 million and related income taxes, net
income for the first nine months of 1997 would have been $73.7 million, or $0.83
per share, an increase of 27.7% over the first nine months of 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital decreased from $292.9 million at December 31, 1996
to $210.1 million at September 30, 1997. This $82.8 million decrease was
primarily due to the purchase of certain rights to Dilacor XR/Registered
trademark/ from RPR and the purchase of 600,000 additional shares of Andrx
common stock. See Note D, Increase in Investment in Andrx Corporation, of the
Notes to Consolidated Financial Statements. These decreases to working capital
were partially offset by cash flow from operations and increased accounts
receivable and inventory balances.
The growth in the Company's accounts receivable and inventory balances is the
result of increased product sales. The Company performs ongoing credit
evaluations of its customers and maintains reserves for potentially
uncollectible accounts and obsolete inventory. Actual losses have not exceeded
management's expectations.
17
<PAGE>
WATSON PHARMACEUTICALS, INC.
At September 30, 1997, the Company had notes payable outstanding of
approximately $3.5 million. In addition, a $20.0 million line of credit is
available to the Company. Watson has made no borrowings against this line of
credit.
The Company's purchase of the rights to Dilacor XR/Registered trademark/ was
structured with a $40.0 million cash payment in June 1997 and a $55.0 million
payment in July 1997. The remaining scheduled payments, excluding royalties and
future payments under an inventory supply agreement, are due as follows:
January 1, 1998 $45.0 million
January 1, 1999 30.0 million
January 1, 2000 15.0 million
January 1, 2001 5.0 million
-----
$95.0 million
=====
Management believes that cash provided from operations will be sufficient to
meet its normal operating requirements during the coming year. However, as
previously noted, the Company has entered into several acquisitions, all but one
of which has been closed, that are expected to require significant future cash
payments. Certain of these transactions also provide for the payment of certain
future contingent amounts. To date, the Company has used existing cash to fund
its acquisitions. However, Watson will require additional funding in order to
meet its remaining acquisition commitments. At the present time, the Company is
pursuing financing alternatives which include an increase to its existing line
of credit, a public or private debt offering, equity financing or some
combination of these alternatives. Management expects to complete acceptable
financing arrangements in the near future.
The Company continues to review additional opportunities to acquire or invest in
companies, technologies, product rights and other investments that are
compatible with its existing business. Watson could use sources other than cash,
such as financing alternatives discussed herein, to fund additional acquisitions
or investments. If such an acquisition or investment was completed, the
Company's operating results and financial condition could change materially in
future periods.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
18
<PAGE>
WATSON PHARMACEUTICALS, INC.
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
The Securities and Exchange Commission (SEC) encourages companies to disclose
forward-looking information so investors may better understand a company's
future prospects and make informed investment decisions. This report contains
such forward-looking statements made pursuant to the safe harbor provisions of
the Securities Litigation Reform Act of 1995. You must carefully consider all
such statements as they inherently involve certain risks and uncertainties that
could cause actual results to differ materially from the Company's
forward-looking statements. You should carefully evaluate such statements in
light of risk factors described herein or described in the Company's SEC
filings. In particular, you should refer to Watson's 1996 Annual Report on Form
10-K and all Form 8-K's filed in 1997.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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 affect the Company. Management believes, however, that the
ultimate resolution of such matters will not have a material adverse effect on
Watson's financial position or results of operations. There have been no
material developments in any such matters since the filing of the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 1997.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27.1 Financial Data Schedule (EDGAR version only)
(b) Reports on Form 8-K:
Subsequent to the end of the period, on October 31, 1997,
the Company filed a Form 8-K Report to disclose the acquisition of
certain products from G. D. Searle & Co.
19
<PAGE>
WATSON PHARMACEUTICALS, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
WATSON PHARMACEUTICALS, INC.
(Registrant)
By: /S/ ALLEN CHAO
-------------------------------------------------
Allen Chao, Ph.D.
Chairman and Chief Executive Officer
(Principal Executive Officer)
By: /S/ CHATO ABAD
-------------------------------------------------
Chato Abad
Vice President - Finance
(Principal Financial and Accounting Officer)
Dated: November 13,1997
20
<PAGE>
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JUL-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 100,673
<SECURITIES> 82,013
<RECEIVABLES> 66,939
<ALLOWANCES> 2,130
<INVENTORY> 44,699
<CURRENT-ASSETS> 302,364
<PP&E> 127,039
<DEPRECIATION> 45,218
<TOTAL-ASSETS> 742,001
<CURRENT-LIABILITIES> 92,253
<BONDS> 0
0
0
<COMMON> 290
<OTHER-SE> 552,313
<TOTAL-LIABILITY-AND-EQUITY> 742,001
<SALES> 91,817
<TOTAL-REVENUES> 91,817
<CGS> 34,525
<TOTAL-COSTS> 53,612
<OTHER-EXPENSES> (4,230)
<LOSS-PROVISION> (76)
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 42,435
<INCOME-TAX> 14,837
<INCOME-CONTINUING> 27,598
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 27,598
<EPS-PRIMARY> 0.31
<EPS-DILUTED> 0.31
</TABLE>
