<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 September 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 November 4, 1998 of the Registrant's only
class of common stock was 89,466,000 shares.
<PAGE>
WATSON PHARMACEUTICALS, INC.
INDEX TO THE FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
PART I FINANCIAL INFORMATION PAGE NUMBER
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997 3
Consolidated Statements of Income for the Three and
Nine Months Ended September 30, 1998 and 1997 5
Consolidated Statements of Cash Flows for the Nine Months
Ended September 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 13
Item 3. Quantitative and Qualitative Disclosure About Market Risk 18
PART II OTHER INFORMATION AND SIGNATURES
Item 1. Legal Proceedings 18
Item 6. Exhibits and Reports on Form 8-K 19
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 196,126 $ 82,837
Marketable securities 2,928 32,102
Accounts receivable, net of allowances for
doubtful accounts of $6,336 and $2,140 75,234 65,068
Inventories:
Raw materials 19,370 16,905
Work-in-process 11,122 9,303
Finished goods 39,455 20,759
Prepaid expenses and other current assets 1,051 416
Deferred tax assets 39,090 19,399
---------- --------
Total current assets 384,376 246,789
Property and equipment, net 105,409 88,004
Investments and other assets 153,314 131,083
Product rights and other intangibles, net 357,272 289,129
---------- --------
$1,000,371 $755,005
========== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
3
<PAGE>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
(unaudited)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 66,333 $ 44,423
Income taxes payable 11,367 9,553
Current portion of long-term debt 971 864
Current liability from acquisition of product rights 30,500 45,000
---------- --------
Total current liabilities 109,171 99,840
Long-term debt 150,093 2,385
Long-term liability from acquisition of product rights 20,000 50,000
Deferred tax liabilities 36,625 36,887
---------- --------
Total liabilities 315,889 189,112
---------- --------
Commitments and contingencies
Minority interest 1,000 859
---------- --------
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; 89,414,516 and
87,882,233 shares issued and outstanding, respectively 295 290
Additional paid-in capital 291,800 256,682
Retained earnings 353,450 275,037
Accumulated other comprehensive income 37,937 33,025
---------- --------
Total stockholders' equity 683,482 565,034
---------- --------
$1,000,371 $755,005
========== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
4
<PAGE>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Earnings Per Share)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1998 1997 1998 1997
-------- ------- -------- --------
<S> <C> <C> <C> <C>
Product sales, net $145,946 $91,817 $409,703 $214,251
Cost of sales 56,635 34,525 156,515 87,025
-------- ------- -------- --------
Gross profit 89,311 57,292 253,188 127,226
-------- ------- -------- --------
Royalty income -- -- -- 14,249
-------- ------- -------- --------
Operating expenses:
Research & development expense 8,428 4,201 22,402 13,041
Selling, general & administrative
expense 23,045 11,606 67,224 31,825
Amortization expense 5,571 3,280 15,642 3,280
Charge for acquired in-process
research and development -- -- 18,790 --
Merger expense -- -- -- 14,718
-------- ------- -------- --------
Total operating expenses 37,044 19,087 124,058 62,864
-------- ------- -------- --------
Operating income 52,267 38,205 129,130 78,611
-------- ------- -------- --------
Other income (expense):
Equity in earnings of joint ventures 1,898 1,818 5,688 9,713
Investment and other income 2,456 2,489 5,026 9,817
Interest expense (2,759) (77) (4,237) (274)
-------- ------- -------- --------
Total other income, net 1,595 4,230 6,477 19,256
-------- ------- -------- --------
Income before income tax provision 53,862 42,435 135,607 97,867
Provision for income taxes 20,037 14,837 57,194 37,106
-------- ------- -------- --------
Net income $ 33,825 $27,598 $ 78,413 $ 60,761
======== ======= ======== ========
Basic earnings per share $ 0.38 $ 0.32 $ 0.88 $ 0.70
======== ======= ======== ========
Diluted earnings per share $ 0.37 $ 0.31 $ 0.86 $ 0.68
======== ======= ======== ========
Weighted average shares
outstanding, no dilution 89,331 87,541 88,942 86,712
======== ======= ======== ========
Weighted average shares
outstanding, diluted basis 91,881 90,013 91,383 89,037
======== ======= ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
5
<PAGE>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------
1998 1997
---------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 78,413 $ 60,761
--------- ---------
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation 6,434 5,985
Amortization 15,642 3,280
Charge for acquired in-process research and development 18,790 --
Deferred income tax (benefit) provision (11,063) 2,775
Dividends received from Somerset -- 8,000
Equity in earnings of joint ventures (4,779) (8,832)
Provision for (recovery of) doubtful accounts and reserves 1,065 (76)
Tax benefit related to stock option plan 13,336 10,993
Changes in assets and liabilities, net of acquisitions:
Accounts and other receivables 4,308 (26,334)
Inventories (9,477) (12,270)
Prepaid expenses and other current assets (628) 5,357
Other assets (2,674) (2,355)
Accounts payable and accrued expenses 2,408 8,012
Income taxes payable 1,814 6,199
--------- ---------
Total adjustments 35,176 734
--------- ---------
Net cash provided by operating activities 113,589 61,495
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (20,326) (8,880)
Purchase of marketable securities (18,084) (101,825)
Proceeds from maturities of marketable securities 47,421 100,857
Acquisition of product rights (54,962) (48,478)
Acquisition of businesses (71,462) --
Investment in Andrx -- (15,307)
Additions to investment in joint ventures (7,489) ( 2,590)
--------- ---------
Net cash used in investing activities $(124,902) $ (76,223)
--------- ---------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
6
<PAGE>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 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 (847) (1,429)
Principal payments on liability for acquisition
of product rights (45,000) (55,000)
Proceeds from exercise of stock options 21,787 13,609
-------- ---------
Net cash provided by (used in) financing activities 124,602 (42,820)
-------- ---------
Net increase (decrease) in cash and cash equivalents 113,289 (57,548)
Cash and cash equivalents at beginning of period 82,837 158,221
-------- ---------
Cash and cash equivalents at end of period $196,126 $ 100,673
======== =========
Supplemental disclosures of cash flow information:
Cash paid during the periods for:
Interest $ 185 $ 264
Income taxes $ 55,398 $ 17,484
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
---------
Net cash paid -- $ (48,478)
=========
Acquisition of businesses:
Fair value of assets acquired $(97,226) --
Fair value of liabilities assumed 25,764 --
--------
Net cash paid $(71,462) --
========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
7
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - GENERAL
The unaudited consolidated financial statements as of September 30, 1998 and for
the three and nine months ended September 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 September 30,
1998, and the results of operations for the three and nine months ended
September 30, 1998 and 1997 and cash flows for the nine months ended September
30, 1998 and 1997. The results of operations and cash flows for the three and
nine months ended September 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 and nine months ended
September 30, 1998 were the same as those disclosed in the Company's 1997 Form
10-K.
NOTE B - ACQUISITIONS
Pending acquisition of TheraTech, Inc. ("TheraTech")
In October 1998, Watson entered into a definitive merger agreement under which
Watson will acquire TheraTech. TheraTech is a leading drug delivery company
that develops, manufactures and markets innovative products based on its
patented and proprietary technologies and systems. Under the terms of the
agreement, Watson will acquire all of TheraTech's outstanding stock in a
transaction intended to qualify as a pooling of interests for accounting
purposes and a tax-free reorganization for federal income tax purposes.
TheraTech stockholders will receive a fixed exchange ratio of between 0.2663 and
0.29589 of a share of Watson common stock for each share of TheraTech common
stock. The final exchange ratio will be based on the average closing price of
Watson common stock for a ten day period prior to the closing of the
transaction. A one-time charge of approximately $14.0 million in connection
with this transaction is anticipated at the time of closing. The merger, which
is subject to TheraTech stockholder approval and other customary closing
conditions, is expected to close in the first quarter of 1999. Upon completion,
TheraTech will become a wholly owned subsidiary of Watson.
8
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
Pending product acquisition from G. D. Searle & Co. ("Searle")
In September 1998, the Company entered into an agreement with Searle, a
subsidiary of Monsanto Company, to acquire the U.S. rights to three Searle oral
contraceptive products: Tri-Norinyl(R), Norinyl(R) and Brevicon(R) for $120.0
million in cash. The transaction is expected to be completed in the fourth
quarter of 1998. Upon closing, Watson and Searle expect to enter into a supply
agreement whereby Watson will have the right to purchase from Searle the
products in finished form for two years and in bulk form for an additional one
year.
Acquisition of The Rugby Group, Inc. ("Rugby")
In February 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.
9
<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 statements of income for the three and nine months ended September
30, 1997. A reconciliation of the numerators and the denominators of basic and
diluted earnings per share, for the three and nine months ended September 30,
1998 and 1997, is as follows (in thousands, except for EPS):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income (numerator) $33,825 $27,598 $78,413 $60,761
Weighted average shares
outstanding (denominator) 89,331 87,541 88,942 86,712
Basic EPS $ 0.38 $ 0.32 $ 0.88 $ 0.70
======= ======= ======= =======
Net income (numerator) $33,825 $27,598 $78,413 $60,761
Weighted average shares
outstanding 89,331 87,541 88,942 86,712
Assumed exercise of dilutive
stock options and warrants 2,550 2,472 2,441 2,325
------- ------- ------- -------
Diluted weighted average shares
outstanding (denominator) 91,881 90,013 91,383 89,037
Diluted EPS $ 0.37 $ 0.31 $ 0.86 $ 0.68
======= ======= ======= =======
</TABLE>
10
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
NOTE D - INVESTMENTS AND OTHER ASSETS
Investment in 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(R), which is used in the treatment of Parkinson's
disease. Income recognized from Somerset was approximately $2.1 million and
$2.3 million for the three months ended September 30, 1998 and 1997,
respectively. Somerset income recognized by Watson for the nine months ended
September 30, 1998 and 1997 was $6.3 million and $11.0 million, respectively.
Other long-term investments
Other long-term investments are composed 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 September 30, 1998, the Company owned 2.7 million common shares of
Andrx, which represents approximately 17.9% 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 this investment using the cost method, adjusted
to fair value. At September 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" in the accompanying
consolidated balance sheets.
NOTE E - 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 would be advantageous. In May 1998, pursuant to the
Registration Statement, the Company issued $150.0 million of 7 1/8% per annum
senior unsecured notes ("Senior Notes") due May 2008. The Senior Notes were
issued at a discount, to yield an effective annual interest rate of
approximately 7 1/4%. Interest payments are due semi-annually on May 15 and
November 15 of each year.
11
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, Continued
NOTE F - 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
composed of net income and the unrealized gain 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 nine months ended September 30, 1998 and 1997, were
as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income $33,825 $27,598 $78,413 $ 60,761
Unrealized gain on
equity securities, net of tax 263 11,982 4,912 44,132
------- ------- ------- --------
Comprehensive income $34,088 $39,580 $83,325 $104,893
======= ======= ======= ========
</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.
12
<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, 1998 and 1997
Product sales for the three months ended September 30, 1998 were $145.9 million
compared to $91.8 million for the three months ended September 30, 1997, an
increase of $54.1 million or 59%. The sales increase was primarily due to i)
sales of certain of the Company's established off-patent and certain dermatology
products, ii) sales of certain women's health products acquired in the fourth
quarter of 1997 and iii) sales of products previously marketed by Rugby, which
was acquired in February 1998.
Gross profit margins decreased to 61% in the third quarter of 1998 from 62% in
the third quarter of 1997. This decrease was due primarily to a higher
proportion of off-patent products sold in the third quarter of 1998 than in the
third quarter of 1997. The increased sales of off-patent products were largely
due to Watson's sales of products previously marketed by Rugby.
Research and development expenses increased to $8.4 million in the three months
ended September 30, 1998 from $4.2 million in the comparable 1997 period. This
increase was due to the acquisition of Rugby and increased activity in the
Company's research and development of branded and off-patent pharmaceutical
products.
Selling, general and administrative expenses were $23.0 million for the third
quarter of 1998, compared to $11.6 million in the year-ago period. The
increased selling and marketing expenses were due primarily to sales force
costs, advertising and other promotional expenses incurred in support of the
Company's branded products. The Company more than doubled the number of its
sales and marketing personnel from September 1997 to September 1998 through
internal growth and the Rugby acquisition. General and administrative expenses
also increased in support of the Company's growth.
Amortization expense in the third quarter of 1998 increased to $5.6 million from
$3.3 million in the third quarter of 1997, due to the acquisition of certain
product rights in the fourth quarter of 1997. Watson has capitalized such
acquired product rights and is amortizing them over estimated lives of 17 years.
In addition, the 1998 period reflects amortization of goodwill related to the
Rugby acquisition. Goodwill is amortized on the straight-line method over an
estimated life of 20 years. No goodwill amortization was recorded in the 1997
period.
Equity in earnings from joint ventures increased slightly to $1.9 million in the
third quarter of 1998 as compared to $1.8 million in the 1997 period. Compared
to the year-ago period, a decrease in the 1998 earnings of Somerset
Pharmaceuticals, Inc. ("Somerset"), was more than offset by a smaller 1998 loss
from Watson's ANCIRC joint venture with Andrx Corporation. In recent years, the
Company's earnings from Somerset have been negatively impacted by increased
competition on Eldepryl(R) (which lost patent exclusivity in 1996) and increased
research and development expenses at Somerset.
13
<PAGE>
WATSON PHARMACEUTICALS, INC.
Interest expense increased during the third quarter of 1998, due to the
Company's $150.0 million offering of senior unsecured notes in May 1998. These
notes have a stated annual rate of 7 1/8% and were sold at a discount, to yield
an effective annual interest rate of 7 1/4% to the Company.
The provision for income taxes increased to $20.0 million in the third quarter
of 1998, compared to $14.8 million in 1997 third quarter. The effective income
tax rate was 37% and 35% for the three months ended September 30, 1998 and 1997,
respectively.
Results of Operations - Nine Months Ended September 30, 1998 and 1997
Product sales for the nine months ended September 30, 1998 were $409.7 million
compared to $214.3 million for the nine months ended September 30, 1997, an
increase of $195.4 million or 91%. The sales increase was primarily due to i)
sales of certain of the Company's established off-patent and certain dermatology
products, ii) sales generated by Rugby, which was acquired in February 1998, and
iii) sales generated from products acquired in the second half of 1997, which
included Dilacor XR(R) and certain women's health products. Watson reported no
royalty income in the nine months ended September 30, 1998 due to its purchase
of the rights to Dilacor XR(R) in June 1997. In the 1997 nine-month period, the
Company reported royalty income of $14.2 million.
Gross profit margins increased to 62% in the first nine months of 1998 compared
to 59% in the first nine months of 1997. This increase was due to a higher
percentage of branded products sold in the nine months ended September 30, 1998,
as compared to the first nine months of 1997. Generally, branded pharmaceutical
products have higher gross profit margins than off-patent pharmaceutical
products.
Research and development expenses increased to $22.4 million for the nine months
ended September 30, 1998 from $13.0 million for the 1997 period. This increase
was due to Watson's acquisition of Rugby and increased activity in the research
and development of branded and off-patent pharmaceutical products.
Selling, general and administrative expenses were $67.2 million for the nine
months ended September 30, 1998, compared to $31.8 million for the 1997 period.
The increased expenses were due primarily to sales force costs, advertising and
other promotional expenses incurred in support of the Company's branded
products. 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.
14
<PAGE>
WATSON PHARMACEUTICALS, INC.
Amortization expense for the nine months ended September 30, 1998 increased to
$15.6 million from $3.3 million for the 1997 period, primarily due to the
amortization of product rights acquired in 1997 and the amortization of goodwill
associated with the Company's acquisition of Rugby in February 1998.
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 nine months ended September
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 Laboratories, Inc. These costs included investment banking fees and
other merger-related expenses.
Equity in earnings from joint ventures decreased $4.0 million, or 41%, to $5.7
million for the nine months ended September 30, 1998 as compared to $9.7 million
for the 1997 period, due primarily to lower earnings from Somerset. The
decreased Somerset earnings were due in part to increased competition on
Eldepryl(R) and Somerset's increased research and development expenses.
Investment and other income in the nine months ended September 30, 1998, as
compared to the 1997 period, decreased by $4.8 million to $5.0 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 the acquisition of Rugby
in February 1998.
Increased interest expense for the nine months ended September 30, 1998,
compared to the 1997 period, was due to the May 1998 $150.0 million note
offering.
The provision for income taxes increased to $57.2 million for the first nine
months of 1998, compared to $37.1 million in the 1997 period. The effective
income tax rate was 42% and 38% for the nine months ended September 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.
15
<PAGE>
WATSON PHARMACEUTICALS, INC.
Liquidity and Capital Resources
The Company's working capital increased from $146.9 million at December 31, 1997
to $275.2 million at September 30, 1998. This $128.3 million increase was
primarily due to the Company's operating cash flows of $113.6 million in the
nine months ended September 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 $100.0
million related to the purchase of product rights and $71.5 million for the
acquisitions of Rugby and The Nicobrand Company, a manufacturer of nicotine
polacrilex resin.
The growth in the Company's accounts receivable and inventory balances is the
result of increased product sales and Watson's acquisition of Rugby. 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. In
May 1998, pursuant to the Registration Statement, the Company issued $150.0
million of 7 1/8% per annum senior unsecured notes due May 2008.
In addition to the senior unsecured notes described above, at September 30, 1998
the Company had long-term debt outstanding of approximately $1.6 million.
During the quarter ended September 30, 1998, the Company did not renew a bank
credit facility totaling $30.0 million. Watson had made no borrowings under
this credit facility.
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 including cash
and financing sources discussed herein, or financing sources which subsequently
become available to the Company, 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 acquired in-process research and development.
16
<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 Watson's primary business application systems,
including manufacturing, sales, distribution and finance. This stage has been
completed and management believes that these systems are currently Year 2000
compliant. The second phase of the Year 2000 Compliance Program is underway and
includes all internal network systems, personal computers and telecommunications
systems. These systems are expected to be Year 2000 compliant by approximately
March 1999. In the third quarter of 1998, Watson 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 the Company expects its review of these external
entities to be completed by June 1999.
The aggregate cost of Watson's Year 2000 Compliance Program has not been and is
not expected to be material to its consolidated financial position or results of
operations. The Company's management believes that an adequate program is in
place in order to be Year 2000 compliant, however, there can be no assurance
that this program ultimately will be successful. Watson is developing a
contingency plan for unanticipated Year 2000 exposure, and it intends to
incorporate the plan as part of its overall efforts to ensure that its systems
are Year 2000 compliant on a timely basis. Any unanticipated failure in the
Company's internal systems to be Year 2000 compliant, or any failure by a
material third party to bring its own systems into compliance, could have a
material adverse effect on Watson's business, its financial position and its
results of operations.
The foregoing represents a Year 2000 readiness disclosure entitled to protection
as provided in the Year 2000 Information and Readiness Disclosure Act.
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE EVENTS
This report may contain certain statements of a forward-looking nature relating
to future events or future business performance. Any such statements that refer
to Watson's estimated or anticipated future results, product performance or
other non-historical facts are forward-looking and reflect Watson's current
perspective of existing trends and information. These statements involve risks
and uncertainties that cannot be predicted or quantified and, consequently,
actual results may differ materially from those expressed or implied by such
forward-looking statements. Such risks and uncertainties include, among others,
the success of Watson's product development activities and the timeliness with
which regulatory authorizations and product roll-out may be achieved, market
acceptance of Watson's products and the impact of competitive products and
pricing, the availability on commercially reasonable terms of raw materials and
other third party sourced products, dependence on sole source suppliers,
successful compliance with extensive, costly, complex and evolving governmental
regulations and restrictions, the ability to timely and cost effectively
integrate acquisitions, exposure to product liability and other lawsuits and
contingencies, the successful and timely implementation of the Company's Year
2000 Compliance Program, and other risks and uncertainties detailed from time to
time in Watson's Securities and Exchange Commission filings.
17
<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 September 30, 1998, is composed of 2.7 million shares of Andrx common
stock. This investment has exposure to price risk, as the Andrx common stock is
a publicly traded equity security. The following table sets forth the Andrx
quarterly high and low share price information, based on published financial
sources, for 1997 and through September 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
Third $43.00 $25.88
</TABLE>
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. Watson Laboratories,
Inc. (a wholly owned subsidiary of the Company) has also been named as a
defendant in certain of such suits as Rugby's successor. Hoechst Marion
Roussel, Inc. (the former parent of Rugby) has agreed to indemnify the Company
for any liability arising from such cases and is currently controlling the
defense of these matters. No assurances can be made that Rugby or any other
Watson affiliate will not be named as a defendant in additional phentermine
hydrochloride lawsuits.
18
<PAGE>
WATSON PHARMACEUTICALS, INC.
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:
None
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, 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: November 16, 1998
20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 196,126
<SECURITIES> 2,928
<RECEIVABLES> 81,570
<ALLOWANCES> 6,336
<INVENTORY> 69,947
<CURRENT-ASSETS> 384,376
<PP&E> 163,452
<DEPRECIATION> 58,043
<TOTAL-ASSETS> 1,000,371
<CURRENT-LIABILITIES> 109,171
<BONDS> 150,093
0
0
<COMMON> 295
<OTHER-SE> 683,187
<TOTAL-LIABILITY-AND-EQUITY> 1,000,371
<SALES> 409,703
<TOTAL-REVENUES> 409,703
<CGS> 156,515
<TOTAL-COSTS> 156,515
<OTHER-EXPENSES> (6,477)
<LOSS-PROVISION> 1,065
<INTEREST-EXPENSE> 4,237
<INCOME-PRETAX> 135,607
<INCOME-TAX> 57,194
<INCOME-CONTINUING> 78,413
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 78,413
<EPS-PRIMARY> 0.88
<EPS-DILUTED> 0.86
</TABLE>
