<PAGE>
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 June 30, 1998
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _________
Commission file number 0-20045
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 as of August 3, 1998 of the Registrant's only
class of common stock was 89,296,763 shares.
<PAGE>
WATSON PHARMACEUTICALS, INC.
INDEX TO THE FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
<TABLE>
<S> <C> <C>
PART I FINANCIAL INFORMATION PAGE NUMBER
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets
as of June 30, 1998 and
December 31, 1997 3
Consolidated Statements of
Income for the Three and Six Months
Ended June 30, 1998 and 1997 5
Consolidated Statements of Cash
Flows for the Six Months Ended
June 30, 1998 and 1997 6
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and
Analysis of Financial Condition
and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosure About
Market Risk 17
PART II OTHER INFORMATION AND SIGNATURES
Item 1. Legal Proceedings 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---- ----
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $184,246 $ 82,837
Marketable securities 4,361 32,102
Accounts receivable, net of allowances for
doubtful accounts of $6,372 and $2,140 79,226 65,068
Inventories:
Raw materials 24,309 16,905
Work-in-process 7,590 9,303
Finished goods 39,603 20,759
Prepaid expenses and other current assets 1,120 416
Deferred tax assets 35,258 19,399
-------- --------
Total current assets 375,713 246,789
Property and equipment, net 97,029 88,004
Investments and other assets 149,927 131,083
Product rights and other intangibles, net 359,418 289,129
-------- --------
Total assets $982,087 $755,005
======== ========
</TABLE>
3
<PAGE>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---- ----
(unaudited)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 72,798 $ 44,423
Income taxes payable 23,917 9,553
Current portion of long-term debt 855 864
Current liability from acquisition of product rights 30,500 45,000
-------- --------
Total current liabilities 128,070 99,840
Long-term debt 150,615 2,385
Long-term liability from acquisition of product rights 20,000 50,000
Deferred tax liabilities 36,459 36,887
-------- --------
Total liabilities 335,144 189,112
-------- --------
Commitments and contingencies
Minority interest 1,022 859
-------- --------
Stockholders' equity:
Preferred stock; no par; 2,500,000 shares
authorized; none outstanding
Common stock; par value per share of $.0033;
500,000,000 shares authorized; 89,265,819 and
87,882,233 shares issued and outstanding 295 290
Additional paid-in capital 288,327 256,682
Retained earnings 319,625 275,037
Accumulated other comprehensive income 37,674 33,025
-------- --------
Total stockholders' equity 645,921 565,034
-------- --------
Total liabilities and stockholders' equity $982,087 $755,005
======== ========
</TABLE>
4
<PAGE>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Earnings Per Share)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Product sales, net $141,885 $63,735 $263,757 $122,434
Cost of sales 54,780 26,812 99,880 52,500
-------- ------- -------- --------
Gross profit 87,105 36,923 163,877 69,934
-------- ------- -------- --------
Royalty income 7,208 14,249
-------- ------- -------- --------
Operating expenses:
Research & development expense 8,326 4,219 13,974 8,840
Selling, general & administrative
expense 23,422 9,797 44,179 20,219
Amortization expense 5,454 10,071
Charge for acquired in-process
research and development 18,790
Merger expense 5,821 14,718
-------- ------- -------- --------
Total operating expenses 37,202 19,837 87,014 43,777
-------- ------- -------- --------
Operating income 49,903 24,294 76,863 40,406
-------- ------- -------- --------
Other income (expense):
Equity in earnings of joint ventures 2,180 3,760 3,790 7,895
Investment and other income 1,498 3,705 2,570 7,328
Interest expense (1,411) (89) (1,478) (197)
-------- ------- -------- --------
Total other income, net 2,267 7,376 4,882 15,026
-------- ------- -------- --------
Income before income tax provision 52,170 31,670 81,745 55,432
Provision for income taxes 19,407 12,558 37,157 22,269
-------- ------- -------- --------
Net income $ 32,763 $19,112 $ 44,588 $ 33,163
======== ======= ======== ========
Basic earnings per share $ 0.37 $ 0.22 $ 0.50 $ 0.38
======== ======= ======== ========
Diluted earnings per share $ 0.36 $ 0.22 $ 0.49 $ 0.37
======== ======= ======== ========
Weighted average shares
outstanding, no dilution 89,183 86,706 88,744 86,290
======== ======= ======== ========
Weighted average shares
outstanding, diluted basis 91,671 88,704 91,132 88,543
======== ======= ======== ========
</TABLE>
5
<PAGE>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-------------------
1998 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 44,588 $ 33,163
-------- --------
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 4,240 4,180
Amortization 10,071
Charge for acquired in-process research and
development 18,790
Deferred income tax (benefit) provision (10,338) 675
Dividends received from Somerset 8,000
Equity in earnings of joint ventures (3,194) (6,597)
Provision for (recovery of) doubtful accounts
and reserves 949 (224)
Tax benefit related to stock option plan 11,889 7,342
Changes in assets and liabilities, net of effect
of acquisition:
Accounts and other receivables 108 (13,970)
Inventories (11,079) (12,059)
Prepaid expenses and other current assets (704) 3,080
Other assets (1,402) (752)
Accounts payable and accrued expenses 8,993 2,544
Income taxes payable 17,364 5,634
-------- --------
Total adjustments 45,687 (2,147)
-------- --------
Net cash provided by operating activities 90,275 31,016
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (10,342) (4,519)
Purchase of marketable securities (11,277) (82,799)
Proceeds from maturities of marketable securities 39,273 85,565
Acquisition of product rights (35,106) (46,922)
Acquisition of business (67,695)
Investment in Andrx (15,300)
Increase in investment in joint ventures (7,189) (915)
-------- --------
Net cash used in investing activities $(92,336) $(64,890)
-------- --------
</TABLE>
6
<PAGE>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------
1998 1997
-------- ---------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt $148,662
Principal payments on long-term debt (453) $ (1,224)
Principal payments on liability for acquisition
of product rights (64,500)
Proceeds from exercise of stock options 19,761 7,130
-------- ---------
Net cash provided by financing activities 103,470 5,906
-------- ---------
Net increase (decrease) in cash and cash equivalents 101,409 (27,968)
Cash and cash equivalents at beginning of period 82,837 158,221
-------- ---------
Cash and cash equivalents at end of period $184,246 $ 130,253
======== =========
Supplemental disclosures of cash flow information:
Cash paid during the periods for:
Interest $ 128 $ 194
Income taxes $ 19,718 $ 9,248
Supplemental disclosures of noncash investing and
financing activities:
Acquisition of product rights:
Fair value of assets acquired $(55,106) $(196,922)
Fair value of liabilities assumed 20,000 150,000
-------- ---------
Net cash paid $(35,106) $ (46,922)
======== =========
Acquisition of business:
Fair value of assets acquired $(93,339)
Fair value of liabilities assumed 25,644
--------
Net cash paid $(67,695)
========
</TABLE>
7
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(Unaudited)
NOTE A - GENERAL
The unaudited consolidated financial statements as of June 30, 1998 and for the
three and six months ended June 30, 1998 and 1997, as well as related notes,
should be read in conjunction with the Company's Annual Report on Form 10-K, as
amended, for the year ended December 31, 1997 (the "1997 Form 10-K").
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 June 30,
1998, and the results of operations for the three and six months ended June 30,
1998 and 1997 and cash flows for the six months ended June 30, 1998 and 1997.
The results of operations and cash flows for the three and six months ended June
30, 1998 are not necessarily indicative of the results of operations or cash
flows which may be reported for the remainder of 1998. The accounting policies
followed during the three months ended June 30, 1998 were the same as those
disclosed in the Company's 1997 Form 10-K.
NOTE B - ACQUISITION OF RUGBY
On February 27, 1998, Watson completed its acquisition of Rugby from Hoechst
Marion Roussel, Inc. ("HMR"). Rugby develops and markets a wide array of off-
patent pharmaceutical products. The acquisition was accounted for as a purchase
and Rugby's results of operations have been recorded in the Company's
consolidated financial statements since the date of acquisition. Watson
acquired Rugby for an initial cash payment of approximately $67.5 million,
future royalty payments on sales of certain products licensed from HMR and a
contingent payment based on future operating results. The initial cash payment
was made from cash on hand. Watson expects to make future contingent payments
from a combination of cash on hand and future operating cash flows.
As a result of the allocation of the purchase price, the Company recorded a
first quarter charge of $18.8 million for acquired in-process research and
development and recorded goodwill of $25.1 million. Goodwill is amortized on
the straight-line basis over twenty years and is included in product rights and
other intangibles in the accompanying consolidated balance sheet.
8
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
NOTE C - EARNINGS PER SHARE ("EPS")
In 1997, the Company adopted Statement of Financial Accounting Standards No.
128, "Earnings per Share", ("SFAS 128"). In accordance with the implementation
provisions of SFAS 128, the Company has restated earnings per share in the
Consolidated Statement of Income for the three and six months ended June 30,
1997. A reconciliation of the numerators and the denominators of basic and
diluted earnings per share for the three and six months ended June 30, 1998 and
1997 is as follows (in thousands, except for EPS):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income (numerator) $32,763 $19,112 $44,588 $33,163
Weighted average shares
outstanding (denominator) 89,183 86,706 88,744 86,290
Basic EPS $ 0.37 $ 0.22 $ 0.50 $ 0.38
======= ======= ======= =======
Net income (numerator) $32,763 $19,112 $44,588 $33,163
Weighted average shares outstanding 89,183 86,706 88,744 86,290
Assumed exercise of all outstanding
stock options and warrants 2,488 1,998 2,388 2,253
------- ------- ------- -------
Diluted weighted average shares
outstanding (denominator) 91,671 88,704 91,132 88,543
Diluted EPS $ 0.36 $ 0.22 $ 0.49 $ 0.37
======= ======= ======= =======
</TABLE>
NOTE D - STOCK SPLIT
In October 1997, the Company effected a two-for-one stock split in the form of a
100% stock dividend. Share and per share amounts for all reported periods have
been restated to reflect the stock split.
9
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
NOTE E - LONG-TERM INVESTMENTS
Investments and other assets consisted of the following:
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
--------- ------------
(in thousands)
<S> <C> <C>
Investments in joint ventures $ 41,798 $ 31,626
Other long-term investments 99,556 92,233
Other assets 8,573 7,224
-------- --------
$149,927 $131,083
======== ========
</TABLE>
Investment in Joint Ventures
The Company owns 50% of the outstanding common stock of Somerset
Pharmaceuticals, Inc. ("Somerset"), and utilizes the equity method to account
for this investment. Somerset manufactures and markets the product Eldepryl(R),
which is used in the treatment of Parkinson's disease. Income recognized from
Somerset was approximately $2.3 million and $4.1 million for the three months
ended June 30, 1998 and 1997, respectively. Income is composed of the Company's
50% share of Somerset's earnings and management fees, offset by amortization of
goodwill. The net excess of the cost of this investment over the fair value of
net assets acquired was $5.9 million and $6.4 million at June 30, 1998 and
December 31, 1997, respectively. Such goodwill is amortized on the straight-
line basis over 15 years.
The Company has entered into several other joint ventures, including ANCIRC, the
Company's collaboration with Andrx Corporation ("Andrx"), and two agreements
with China-based Changzhou No. 4 Pharmaceuticals Factory.
Other Long-term Investments
Other long-term investments are comprised primarily of the Company's investment
in Andrx. Andrx is engaged in the formulation and commercialization of
controlled-release oral pharmaceuticals utilizing proprietary drug delivery
technologies. Andrx trades publicly on the Nasdaq Stock Market under the symbol
"ADRX". At June 30, 1998, the Company owned 2.7 million common shares of Andrx,
which represents approximately 18.1% of the total Andrx common shares
outstanding. The Company also has a warrant to acquire 337,100 shares of Andrx,
exercisable in whole or in part until July 8, 1999 at an exercise price of $8.90
per share. Watson accounts for its investment using the cost method, adjusted
to fair value. At June 30, 1998, the Company's net unrealized gain on its
investment in Andrx was $37.2 million (net of income taxes of $24.8 million).
Such amount is reported as a separate component of stockholders' equity under
the caption "Accumulated Other Comprehensive Income".
10
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
NOTE F - ISSUANCE OF SENIOR NOTES
In April 1998, the Company filed a $300 million universal shelf registration
with the Securities and Exchange Commission ("the Registration Statement"). The
Registration Statement allows the Company to raise up to $300 million from
offerings of senior or subordinated debt securities, common stock, preferred
stock or a combination thereof at such times, in amounts, at prices and on terms
that the Company believes raising funds would be advantageous. In May 1998,
pursuant to the Registration Statement, the Company issued $150.0 million of 7
1/8% senior unsecured notes ("Senior Notes") due May 2008. The Senior Notes were
issued at a discount to yield an effective interest rate of approximately 7
1/4%. Interest payments are due semi-annually on May 15 and November 15 of each
year.
NOTE G - ADOPTION OF NEW ACCOUNTING PRINCIPLES
Reporting Comprehensive Income
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130 "Reporting Comprehensive Income", ("SFAS 130"). SFAS 130
established new rules for the reporting and display of comprehensive income and
its components in the financial statements. Comprehensive income includes all
changes in equity during a period except those resulting from investments by and
distributions to the Company's stockholders. Watson's comprehensive income is
comprised of net income and the unrealized gain (loss) on equity securities.
The adoption of SFAS 130 had no effect on the Company's consolidated results of
operations, financial position or cash flows. The components of comprehensive
income during the three and six months ended June 30, 1998 and 1997, were as
follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income $32,763 $19,112 $44,588 $33,163
Unrealized gain on
equity securities, net of tax 14,635 21,158 4,649 32,150
------- ------- ------- -------
Comprehensive income $47,398 $40,270 $49,237 $65,313
======= ======= ======= =======
</TABLE>
Disclosures About Segments of an Enterprise and Related Information
In 1997, the Financial Accounting Standards Board issued Statement No. 131,
"Disclosures About Segments of an Enterprise and Related Information" ("SFAS
131") which is required to be adopted for the Company's year ending December 31,
1998. SFAS 131 requires that certain financial information regarding operating
segments be publicly reported on the same basis as used internally by management
to evaluate segment performance. The adoption of SFAS 131 will have no impact
on the Company's consolidated results of operations, financial position or cash
flows.
11
<PAGE>
WATSON PHARMACEUTICALS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations - Three Months Ended June 30, 1998 and 1997
Product sales for the three months ended June 30, 1998 were $141.9 million
compared to $63.7 million for the three months ended June 30, 1997, an increase
of $78.2 million or 123%. The sales increase was primarily due to 1) increased
sales of certain of the Company's core products, 2) sales generated by Rugby,
which was acquired in February 1998 and 3) sales generated from products
acquired in the second half of 1997, which included Dilacor XR(R) and certain
women's health products. The Company reported no royalty income in the second
quarter of 1998 due to its purchase of the rights to Dilacor XR(R) in June 1997.
Gross profit margins increased to 61% in 1998 from 58% in the second quarter of
1997. This increase was due to a higher percentage of branded products sold in
the second quarter of 1998 than in the second quarter of 1997. Generally,
branded pharmaceutical products have higher gross profit margins than off-patent
pharmaceutical products.
Research and development expenses increased from $4.2 million in the three
months ended June 30, 1997 to $8.3 million in the comparable 1998 period. This
increase was due to the acquisition of Rugby and increased activities in the
Company's research and development of branded and off-patent pharmaceutical
products. Research and development personnel increased from 100 as of June 1997
to 140 as of June 1998.
Selling, general and administrative expenses were $23.4 million for the second
quarter of 1998, compared to $9.8 million in the year-ago period. The Company
incurred additional selling and marketing expenses in support of its newly
acquired branded products. The increased selling and marketing expenses were
due primarily to sales force costs, advertising and other promotional expenses.
The Company more than doubled the number of its sales and marketing
representatives from June 1997 to June 1998 through internal growth and the
Rugby acquisition. General and administrative expenses increased primarily as a
result of the acquisition of Rugby.
Amortization expense in the second quarter of 1998 increased to $5.5 million,
primarily due to the amortization of product rights acquired in 1997. Watson
has capitalized these product rights and is amortizing them over estimated lives
of 17 years. The Company recorded costs in excess of net assets acquired
(goodwill) of $25.1 million related to its acquisition of Rugby in February
1998. Goodwill is amortized on the straight-line method over an estimated life
of 20 years. No significant amortization expense was recorded in the 1997
period.
In the second quarter of 1997, the Company recorded a one-time charge of $5.8
million for costs incurred in connection with its acquisition of Royce
Laboratories, Inc ("Royce"). These costs included investment banking fees and
other merger-related expenses. No such costs were incurred in the second
quarter of 1998.
12
<PAGE>
WATSON PHARMACEUTICALS, INC.
Equity in earnings from joint ventures decreased $1.6 million, or 42%, to $2.2
million in the second quarter of 1998 compared to $3.8 million in 1997, due
primarily to lower earnings from Somerset. The decrease in Somerset earnings is
due in part to increased competition on Eldepryl(R) and increased research and
development spending.
Watson owns approximately 18.1% of the outstanding common shares of Andrx
Corporation ("Andrx"), which trades on the Nasdaq Stock Market under the symbol
ADRX. The Company also has a warrant to acquire an additional 337,100 shares of
Andrx common stock. Should this warrant be exercised, the Company's ownership
may exceed 20% of the outstanding common shares of Andrx.
Investment and other income in the three months ended June 30, 1998 decreased by
$2.2 million to $1.5 million due to lower cash and marketable securities
balances in 1998. The reduced cash and marketable securities balances were due
to the Company's product acquisitions during the second half of 1997 and its
acquisition of Rugby in February 1998.
Interest expense increased during the second quarter of 1998, due to the
Company's $150.0 million note offering in May 1998. These notes have a stated
rate of 7 1/8% and were sold at a discount to yield an effective interest rate
of 7 1/4% to the Company.
The provision for income taxes increased to $19.4 million in 1998, compared to
$12.6 million in 1997. The effective income tax rate was 37% and 40% for the
three months ended June 30, 1998 and 1997, respectively. The decrease in the
Company's effective income tax rate in 1998 as compared to 1997 was due
primarily to the non-deductibility of certain acquisition costs incurred in
connection with the Royce acquisition in 1997.
Results of Operations - Six Months Ended June 30, 1998 and 1997
Product sales for the six months ended June 30, 1998 were $263.8 million
compared to $122.4 million for the six months ended June 30, 1997, an increase
of $141.4 million or 115%. The sales increase was primarily due to 1) increased
sales of certain of the Company's core products, 2) sales generated by Rugby,
which was acquired in February 1998 and 3) sales generated from products
acquired in the second half of 1997, which included Dilacor XR(R) and certain
women's health products. The Company reported no royalty income in the six
months ended June 30, 1998 due to its purchase of the rights to Dilacor XR(R) in
June 1997.
Gross profit margins increased to 62% in 1998 from 57% in the first six months
of 1997. This increase was due to a higher percentage of branded products sold
in the six months ended June 30, 1998, as compared to the first six months of
1997. Generally, branded pharmaceutical products have higher gross profit
margins than off-patent pharmaceutical products.
Research and development expenses increased from $8.8 million in the six months
ended June 30, 1997 to $14.0 million in the 1998 period. This increase was due
to Watson's acquisition of Rugby and the Company's increased activities in the
research and development of branded and off-patent pharmaceutical products.
13
<PAGE>
WATSON PHARMACEUTICALS, INC.
Selling, general and administrative expenses were $44.2 million for the six
months ended June 30, 1998, compared to $20.2 million in the year-ago period.
The Company incurred additional selling and marketing expenses in support of its
newly acquired branded products. The increased expenses were due primarily to
sales force costs, advertising and other promotional expenses. General and
administrative expenses increased in 1998 due to the acquisition of Rugby and
the payment of certain severance amounts associated with management changes in
the first quarter of 1998.
Amortization expense in the six months ended June 30, 1998 increased to $10.1
million, primarily due to the amortization of product rights acquired in 1997.
In addition, amortization expense includes amortization of goodwill associated
with the Company's acquisition of Rugby. No significant amortization expense
was recorded in the 1997 period.
In connection with the Rugby acquisition during the first quarter of 1998, the
Company recorded a special one-time charge of $18.8 million for the write-off of
in-process research and development associated with Rugby's wholly owned
subsidiary, Chelsea Laboratories, Inc. Watson based this charge on an
assessment, in conjunction with an independent valuation firm, of the value of
purchased research and development at Rugby. In the six months ended June 30,
1997, the Company recorded a one-time charge of $14.7 million for costs incurred
in connection with its acquisitions of Oclassen Pharmaceuticals, Inc. and Royce.
These costs included investment banking fees and other merger-related expenses.
Equity in earnings from joint ventures decreased $4.1 million, or 52%, to $3.8
million in the six months ended June 30, 1998 compared to $7.9 million in 1997,
due primarily to lower earnings from Somerset. The decrease in Somerset
earnings was due in part to increased competition on Eldepryl(R) and increased
research and development spending.
Investment and other income in the six months ended June 30, 1998 decreased by
$4.8 million to $2.6 million due to lower average cash and marketable securities
balances. The lower average cash and marketable securities balances were the
result of cash used in the Company's product acquisitions during the second half
of 1997 and its acquisition of Rugby in February 1998.
Increased interest expense for the six months ended June 30, 1998, compared to
the 1997 period, is due to the May 1998 $150.0 million note offering.
The provision for income taxes increased to $37.2 million in 1998, compared to
$22.3 million in 1997. The effective income tax rate was 45% and 40% for the
six months ended June 30, 1998 and 1997, respectively. The increase in the
Company's effective income tax rate in 1998 as compared to 1997 was due
primarily to the non-deductibility of the charge for acquired in-process
research and development incurred in connection with the Rugby acquisition.
14
<PAGE>
WATSON PHARMACEUTICALS, INC.
Liquidity and Capital Resources
The Company's working capital increased from $146.9 million at December 31, 1997
to $247.6 million at June 30, 1998. This $100.7 million increase was primarily
due to the Company's operating cash flows of $90.3 million in the six months
ended June 30 1998, working capital acquired in the February 1998 Rugby
acquisition and proceeds from the $150.0 million note offering in May 1998.
These increases were partially offset by payments in 1998 of $64.5 million
related to the purchase of product rights and approximately $68.0 million for
the Rugby acquisition.
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.
In April 1998, the Company filed a $300 million universal shelf registration
("the Registration Statement") with the Securities and Exchange Commission. The
Registration Statement allows the Company to raise up to $300 million from
offerings of senior or subordinated debt securities, common stock, preferred
stock or a combination thereof at such times, in amounts, at prices and on terms
that the Company believes raising funds would be advantageous. In May 1998,
pursuant to the Registration Statement, the Company issued $150.0 million of 7
1/8% senior unsecured notes ("Senior Notes") due May 2008. The Senior Notes
were issued at a discount to yield an effective interest rate of approximately 7
1/4%. Watson expects to use the proceeds for general corporate purposes,
including working capital, funding of potential acquisitions of complementary
products, technologies or businesses, future commitments with respect to recent
acquisitions, and capital expenditures.
In addition to the Senior Notes described above, at June 30, 1998 the Company
had bank notes payable outstanding of approximately $2.8 million. At June 30,
1998, an additional credit facility was also available to the Company with an
unsecured borrowing commitment totaling $75.0 million. The proceeds from the
Senior Notes have significantly reduced Watson's current borrowing needs, and in
August 1998, this commitment was reduced to $30 million. Watson has made no
borrowings under this credit facility in 1998.
Management believes that current cash balances and the cash provided from
operations will be sufficient to meet the Company's normal operating
requirements during the coming year.
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 a material acquisition or investment is
completed, the Company's operating results and financial condition could change
materially in future periods, including the possibility of a quarterly net loss
due to a one-time charge associated with the write off of purchased research and
development.
15
<PAGE>
WATSON PHARMACEUTICALS, INC.
Year 2000 Compliance Program
Watson has instituted a program to determine whether its computerized
information systems are able to interpret dates beyond the year 1999 (the "Year
2000 Compliance Program"). An inability to interpret dates beyond 1999 could
cause computer system errors or system failure, potentially leading to
disruptions in operations. The scope of the Company's Year 2000 Compliance
Program was initially focused on primary business application systems, including
manufacturing, sales, distribution and finance. Management believes that these
systems are currently Year 2000 compliant. This program was subsequently
expanded to all network systems, personal computers and telecommunications
systems. It is expected that these systems will be Year 2000 compliant by the
end of 1998. Watson recently began the final phase in its Year 2000 Compliance
Program, which is a review of external entities having significant relationships
with the Company. Initial communication with these entities has commenced and
is scheduled for completion by June 1999.
The cost of this program is not expected to be material to the Company's
consolidated financial position or results of operations. Although management
believes the Company has an adequate program in place in order to be Year 2000
compliant, there can be no assurance that this program ultimately will be
successful.
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. The reader 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. The reader should carefully evaluate such
statements in light of risk factors described herein or described in the
Company's SEC filings. In particular, the reader should refer to Watson's
Annual Report on Form 10-K/A for the year ended December 31, 1997 and all
filings on Form 10-Q and Form 8-K during 1998.
16
<PAGE>
WATSON PHARMACEUTICALS, INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
All of the Company's liquid investments are at fixed interest rates and
therefore the fair value of these instruments is affected by changes in market
interest rates. However, substantially all of these investments mature within
one year. As a result, the Company believes that the market risk arising from
its holding of these financial instruments is minimal.
The Company's investment in Andrx, which was stated at a fair value of $98.9
million at June 30, 1998, is composed of 2.7 million shares of Andrx common
stock. Andrx common stock has traded on The Nasdaq Stock Market since its
initial public offering in June 1996. As a publicly traded equity security,
this investment has exposure to price risk. The following table sets forth the
Andrx quarterly high and low share price information for 1997 and through June
30, 1998:
<TABLE>
<CAPTION>
1997, by quarter High Low
- ---------------- ------ -----
<S> <C> <C>
First $26.75 $15.25
Second $38.75 $20.50
Third $45.63 $31.75
Fourth $47.00 $28.75
1998, by quarter
- ----------------
First $38.25 $24.50
Second $42.63 $28.13
</TABLE>
17
<PAGE>
WATSON PHARMACEUTICALS, INC.
PART II - OTHER INFORMATION AND SIGNATURES
ITEM 1. LEGAL PROCEEDINGS
The Company is party to certain lawsuits and legal proceedings, which are
described in Part I, Item 3, "Legal Proceedings," of the Company's Annual Report
on Form 10-K/A for the year ended December 31, 1997. The following is a
description of material developments during the period covered by this Quarterly
Report:
Rugby has been named as a defendant in several additional product liability
suits relating to the use of phentermine hydrochloride. Hoechst Marion Roussel,
Inc. has agreed to indemnify Rugby for any liability arising from such cases and
is currently controlling the defense of these matters. No assurances can be made
that Rugby will not be named as a defendant in additional phentermine
hydrochloride lawsuits.
In June 1998, the Federal District Court for the Western District of Kentucky
dismissed all claims against Watson in the action entitled Michael D. Hardy, et
al. v. Royce Laboratories, Inc., et al. Royce remains a defendant in the above
action.
ITEM 5. OTHER INFORMATION
The Securities and Exchange Commission has recently amended Rules 14a-4 and 14a-
5 promulgated under the Securities Exchange Act of 1934, as amended (the "1934
Act"), in respect of the Company's exercise of discretionary voting authority in
connection with annual shareholder meetings, and in particular with respect to
matters not submitted under the Shareholder Proposal rule set forth in Rule 14a-
8 under the 1934 Act.
Under the amended Rules, a company is permitted discretionary voting authority
in those instances in which the company did not have notice of the matter by a
date more than 45 days before the month and day in the current year
corresponding to the date on which the company first mailed its proxy materials
for the prior year's annual meeting of shareholders, or by a date established by
an overriding advance notice provision in a company's articles of incorporation
or bylaws. The Company has not implemented such an advance notice provision.
Accordingly, in connection with the 1999 Annual Meeting of Stockholders of the
Company, the date after which notice of a stockholder proposal submitted outside
the processes of Rule 14a-8 under the 1934 Act is considered untimely is
February 14, 1999.
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:
On May 18, 1998, the Company filed a Form 8-K Report to disclose its
issuance of $150 million of 7 1/8% Senior Notes. The Senior Notes are
due May 2008 and were issued in an underwritten public offering.
18
<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, Chief Executive Officer and
President
(Principal Executive Officer)
By: /s/ MICHAEL BOXER
----------------------------------------------
Michael Boxer
Chief Financial Officer
(Principal Financial Officer)
By: /s/ CHATO ABAD
----------------------------------------------
Chato Abad
Vice President - Finance
(Principal Accounting Officer)
Dated: August 13, 1998
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 184,246
<SECURITIES> 4,361
<RECEIVABLES> 85,598
<ALLOWANCES> 6,372
<INVENTORY> 71,502
<CURRENT-ASSETS> 375,713
<PP&E> 155,751
<DEPRECIATION> 58,722
<TOTAL-ASSETS> 982,087
<CURRENT-LIABILITIES> 128,070
<BONDS> 150,615
0
0
<COMMON> 295
<OTHER-SE> 645,626
<TOTAL-LIABILITY-AND-EQUITY> 982,087
<SALES> 263,757
<TOTAL-REVENUES> 263,757
<CGS> 99,880
<TOTAL-COSTS> 99,880
<OTHER-EXPENSES> (4,882)
<LOSS-PROVISION> 949
<INTEREST-EXPENSE> 1,478
<INCOME-PRETAX> 81,745
<INCOME-TAX> 37,157
<INCOME-CONTINUING> 44,588
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 44,588
<EPS-PRIMARY> 0.50
<EPS-DILUTED> 0.49
</TABLE>
