<PAGE>
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UNITED STATES
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, 2000
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 92880
(Address of principal executive offices, including 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 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes [X] No [_]
The number of shares of the Registrant's only class of common stock outstanding
as of August 4, 2000 was approximately 96,944,200.
================================================================================
<PAGE>
WATSON PHARMACEUTICALS, INC.
INDEX TO FORM 10-Q
FOR THE
QUARTERLY PERIOD ENDED JUNE 30, 2000
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets as of June 30, 2000 and
December 31, 1999.......................................... 1
Consolidated Statements of Income for the
Three and Six Months Ended June 30, 2000 and 1999.......... 2
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2000 and 1999.................... 3
Notes to Consolidated Financial Statements................. 4
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.............. 8
Item 3. Quantitative and Qualitative Disclosure about Market Risk.... 12
PART II. OTHER INFORMATION AND SIGNATURES
Item 1. Legal Proceedings............................................ 13
Item 5. Other Information............................................ 14
Item 6. Exhibits and Reports on Form 8-K............................. 14
Signatures............................................................ 15
<PAGE>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited; in thousands, except share amounts)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................... $ 353,704 $102,057
Marketable securities....................................... 23,735 13,865
Accounts receivable, net.................................... 134,372 180,860
Inventories................................................. 149,731 108,532
Prepaid expenses and other current assets................... 17,556 9,582
Deferred tax assets......................................... 25,827 19,815
---------- ----------
Total current assets.................................... 704,925 434,711
Property and equipment, net.................................... 147,351 138,848
Investments and other assets................................... 334,155 291,448
Product rights and other intangibles, net...................... 563,790 573,743
---------- ----------
$1,750,221 $1,438,750
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses....................... $ 66,966 $ 56,487
Income taxes payable........................................ 38,986 33,550
Current portion of long-term debt........................... 1,280 1,691
Current liability from acquisitions of products and 7,658 37,458
businesses................................................. ---------- ----------
Total current liabilities............................... 114,890 129,186
Long-term debt................................................. 149,161 149,503
Long-term liability from acquisition of products and
businesses.................................................... 12,099 18,049
Deferred income taxes and other liabilities.................... 117,476 87,460
---------- ----------
Total liabilities....................................... 393,626 384,198
---------- ----------
Commitments and contingencies..................................
Stockholders' equity:
Preferred stock; no par value per share;
2,500,000 shares authorized; none outstanding.............. --- ---
Common stock; $0.0033 per share par value; 500,000,000
shares authorized; 96,871,200,and 96,133,200 shares issued. 320 317
Additional paid-in capital................................... 417,231 397,705
Retained earnings............................................ 788,721 549,000
Accumulated other comprehensive income....................... 150,323 107,530
---------- ----------
Total stockholders' equity.............................. 1,356,595 1,054,552
---------- ----------
$1,750,221 $1,438,750
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-1-
<PAGE>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited, in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net revenues............................... $189,927 $170,242 $369,559 $329,485
Cost of sales.............................. 67,561 55,427 130,639 105,424
-------- -------- -------- --------
Gross profit.......................... 122,366 114,815 238,920 224,061
-------- -------- -------- --------
Operating expenses:
Research and development................ 12,095 13,573 24,120 23,715
Selling, general and administrative..... 32,505 28,539 62,962 56,011
Amortization............................ 8,767 7,350 17,436 14,040
Merger and related expenses (Note B).... --- --- --- 20,467
-------- -------- -------- --------
Total operating expenses.............. 53,367 49,462 104,518 114,233
-------- -------- -------- --------
Operating income........................... 68,999 65,353 134,402 109,828
-------- -------- -------- --------
Other income (expense):
Equity in earnings (losses)
of joint ventures..................... (1,658) 354 (3,711) 385
Gain on sales of Andrx securities....... 81,465 --- 248,395 ---
Interest and other income............... 5,737 927 8,670 1,886
Interest expense........................ (2,541) (2,797) (5,309) (5,615)
-------- -------- -------- --------
Total other income (expense), net..... 83,003 (1,516) 248,045 (3,344)
-------- -------- -------- --------
Income before income tax provision......... 152,002 63,837 382,447 106,484
Provision for income taxes................. 57,001 17,671 142,726 37,347
-------- -------- -------- --------
Net income................................. $ 95,001 $ 46,166 $239,721 $ 69,137
======== ======== ======== ========
Basic earnings per share................... $ 0.98 $ 0.48 $ 2.48 $ 0.72
======== ======== ======== ========
Diluted earnings per share................. $ 0.96 $ 0.47 $ 2.44 $ 0.71
======== ======== ======== ========
Weighted average shares
outstanding, no dilution................ 96,645 95,690 96,670 95,595
======== ======== ======== ========
Weighted average shares
outstanding, diluted basis.............. 98,525 97,930 98,390 98,045
======== ======== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-2-
<PAGE>
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
----------------------
2000 1999
--------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income..................................................... $ 239,721 $ 69,137
--------- --------
Reconciliation to net cash provided by operating activities:
Depreciation................................................ 6,637 6,506
Amortization................................................ 17,436 14,040
Deferred income tax provision............................... 4,725 17,557
Equity in losses (earnings) of joint ventures............... 3,931 (144)
Gain on sale of Andrx securities............................ (248,395) ---
Tax benefits related to exercise of stock options........... 4,824 9,397
Other....................................................... 3,635 2,604
Cash provided (used) by changes in:
Accounts receivable...................................... 46,488 (39,154)
Inventories.............................................. (41,199) (26,716)
Prepaid expenses and other current assets................ (7,974) 10,768
Accounts payable and accrued expenses.................... 10,479 (2,777)
Income taxes payable..................................... 5,436 6,194
--------- --------
Total adjustments..................................... (193,977) (1,725)
--------- --------
Net cash provided by operating activities.......... 45,744 67,412
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment............................ (15,140) (14,671)
Purchases of marketable securities............................. (25,393) (27,240)
Proceeds from maturities of marketable securities.............. 15,523 25,967
Proceeds from sales of Andrx and other securities.............. 269,630 ---
Contingent payment related to acquisition of Rugby............. (23,407) ---
Issuance of note receivable.................................... (9,000) ---
Acquisitions of product rights................................. (3,875) (32,984)
Additions to investments in joint ventures and other........... (437) (500)
Additions to investments in Andrx.............................. --- (3,000)
--------- --------
Net cash provided (used) by investing activities... 207,901 (52,428)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on long-term debt........................... (1,703) (625)
Payments on liability for acquisition of product rights........ (15,000) (30,380)
Proceeds from exercise of stock options and warrants........... 14,705 12,176
--------- --------
Net cash used by financing activities.............. (1,998) (18,829)
--------- --------
Increase (decrease) in cash and cash equivalents... 251,647 (3,845)
Cash and cash equivalents at beginning of period............... 102,057 59,663
--------- --------
Cash and cash equivalents at end of period..................... $ 353,704 $ 55,818
========= ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-3-
<PAGE>
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - GENERAL
The accompanying unaudited consolidated financial statements of Watson
Pharmaceuticals, Inc. and its subsidiaries ("Watson" or the "company") should be
read in conjunction with the company's Annual Report on Form 10-K for the year
ended December 31, 1999. In the opinion of management, the accompanying
financial statements contain all adjustments necessary to present fairly
Watson's consolidated financial position and results of operations for the
periods presented. Unless otherwise noted, all such adjustments are of a
normal, recurring nature. In addition, we have reclassified certain prior year
amounts in the consolidated financial statements to conform to the current year
presentation. The results of operations for any interim period are not
necessarily indicative of the results of operations that Watson may achieve for
the entire year.
On May 24, 2000, Watson and Schein Pharmaceutical, Inc. ("Schein") entered into
a definitive agreement under which Watson would acquire all of the outstanding
stock of Schein through a two-step transaction comprised of a cash tender
followed by a taxable stock merger. The acquisition, which we will account for
under the purchase method of accounting, is expected to be completed on or about
August 28, 2000. Accordingly, the accompanying consolidated financial
statements do not include any revenues or expenses related to the acquisition of
Schein. See Note B for further discussion of this pending acquisition.
NOTE B - ACQUISITIONS OF BUSINESSES
Schein Pharmaceutical, Inc.
Schein develops, manufactures and markets a broad line of generic products and
has a branded business focused in the area of nephrology for the management of
iron deficiency and anemia. On July 3, 2000, Watson's tender offer expired and
thereafter a Watson subsidiary purchased approximately 26,068,500 shares of
Schein common stock, constituting 77.8% of Schein's outstanding shares as of
that date. Upon purchasing these shares, Watson also repaid approximately $170
million of previous Schein indebtedness, utilizing $500 million borrowed under a
new term loan facility and cash on hand. The following pro forma financial
information assumes that Watson will also borrow $50 million under its new
revolving credit facility to retire the remaining $50 million of previous Schein
indebtedness in August 2000.
In the second step of the acquisition, upon approval of the merger and adoption
of the merger agreement by Schein's stockholders, each remaining outstanding
share of Schein will be converted into the right to receive a fraction of a
share of Watson common stock. The actual fraction (the "exchange ratio") in
this transaction will be determined two trading days before a special meeting of
Schein stockholders, scheduled on August 28, 2000 for purposes of approving the
merger and adopting the merger agreement, based on Watson common stock closing
prices during the last ten trading days ending on the determination date. As of
the record date of the special meeting, which was July 25, 2000, Watson's
subsidiary owned 75.7% of the outstanding shares of Schein common stock.
Watson's subsidiary will vote its Schein shares for approval of the merger and
adoption of the merger agreement.
We estimate that the cost to acquire all of the outstanding Schein shares will
be approximately $795 million. This estimate assumes an exchange ratio of
0.42187, based on Watson common stock
-4-
<PAGE>
closing prices during the last ten trading days in the period ended July 31,
2000. At this exchange ratio, the company would issue approximately 4.9 million
shares of Watson common stock with a market value of approximately $270 million,
based on the closing stock price on July 31, 2000, in exchange for the remaining
shares of Schein common stock, including shares assumed to be issued under
certain Schein stock option plans prior to the second closing. It is assumed
that all employees who hold stock options that will terminate if not exercised
prior to the effective time of the merger, will exercise all of their options.
The estimated purchase price also includes transaction costs, including
investment banker fees, estimated to be $20 million.
Watson will allocate the purchase price to the assets acquired and the
liabilities assumed according to their respective fair values. Management
believes that a portion of this purchase price will be allocated to product
rights, with estimated useful lives of up to 20 years. The excess purchase price
over the fair values of acquired assets and liabilities will be allocated to
goodwill. For purposes of the following pro forma information, management has
assumed that the amount of goodwill to be recorded will approximate $610 million
and that this balance will be amortized to expense on a straight-line basis over
a period of 20 years. In addition, the company will allocate a portion of the
purchase price to Schein's in-process research and development ("IPR&D")
projects. This amount, estimated at $60 million for purposes of this pro forma
financial information, represents acquired, to-be-completed research products
and will be charged to expense at the date of the acquisition.
The total cost to acquire Schein, and the related pro forma information
presented below, may change, subject to fluctuations in the closing prices of
Watson's common stock as used in the determination of the exchange ratio and
based on whether all of the employee stock options discussed above are in fact
exercised prior to closing. In addition, the final allocation of the purchase
price is dependent upon certain valuations, including an IPR&D valuation, and
other studies that have not progressed to a stage where there is sufficient
information to make such an allocation.
The following selected unaudited pro forma condensed combined financial
information for the six months ended June 30, 2000 and 1999 has been derived
from the unaudited financial statements of Watson, included herein, and Schein.
It has been prepared to give effect to the merger using the purchase method of
accounting for business combinations and assumes the merger had been effective
as of the beginning of each period presented.
<TABLE>
<CAPTION>
Six Months Ended
June 30,
---------------------------------
(in thousands, except per share data) 2000 1999
-------------- --------------
<S> <C> <C>
Net revenues............................ $562,634 $570,752
Net income.............................. 204,100 47,790
Diluted earnings per share.............. $ 1.94 $ 0.45
</TABLE>
In the third quarter of 2000, the company expects to record a one-time
restructuring charge related to this acquisition, in an amount not yet
quantifiable, that is expected to include certain operational, facilities and
product rationalization costs.
-5-
<PAGE>
TheraTech, Inc. ("TheraTech")
In January 1999, the company completed its acquisition of TheraTech, a
developer, manufacturer and marketer of branded pharmaceutical products. This
acquisition was accounted for as a pooling of interests and, accordingly, the
accompanying consolidated financial statements include the results of TheraTech
for all periods presented. In connection with this acquisition, during the
first quarter of 1999, the company recorded a special charge of $20.5 million
for certain merger and related expenses.
NOTE C - EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted
average common shares actually outstanding during a period. Diluted earnings
per share is computed by dividing net income by the weighted average common
shares that would have been outstanding during the period, assuming, among other
things, that all vested in-the-money stock options had been exercised at the
beginning of the period. The effect of such dilutive stock options was to
increase weighted average common shares outstanding, for diluted earnings per
share purposes, by 1,880,000 and 2,240,000 shares for the three months ended
June 30, 2000 and 1999, respectively, and by 1,720,000 and 2,450,000 shares for
the six months ended June 30, 2000 and 1999, respectively.
NOTE D - INVENTORIES
Inventories consisted of the following (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
-------- ---------
<S> <C> <C>
Raw materials........................... $ 55,060 $ 48,832
Work-in-progress........................ 14,047 13,472
Finished goods.......................... 80,624 46,228
-------- --------
$149,731 $108,532
======== ========
</TABLE>
NOTE E - INVESTMENTS AND OTHER ASSETS
Long-term investments consist primarily of the company's investment in Andrx
Corporation, a drug-delivery company utilizing controlled-release technologies
to develop oral pharmaceutical products. Andrx' common stock trades on the
NASDAQ National Market System under the symbol ADRX. During the three months
ended June 30, 2000, and as adjusted to reflect Andrx' April 2000 two-for-one
stock split, Watson sold 1.7 million shares of Andrx' stock for $85 million and
recorded a pretax gain of $81 million. During the six months ended June 30,
2000,Watson sold 5.9 million shares of Andrx stock, as adjusted for Andrx' April
2000 stock split, for $268 million and recorded a pretax gain of $248 million.
As of June 30, 2000, Watson owned 4.1 million common shares of Andrx, or
approximately 6% of the total Andrx common shares outstanding. The company
accounts for this investment at fair value as an available-for-sale security.
The unrealized gain on the company's investment in Andrx was $150 million and
$109 million (net of income taxes of $100 million and $72 million), at June 30,
2000 and December 31, 1999, respectively. This unrealized gain was the primary
component of accumulated other comprehensive income in the stockholders' equity
section of Watson's consolidated balance sheets.
-6-
<PAGE>
NOTE F - COMPREHENSIVE INCOME
Comprehensive income (loss) includes all changes in equity during a period
except those resulting from investments by and distributions to our
stockholders. Watson's comprehensive income (loss) consisted of the following:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- -----------------------
(in thousands) 2000 1999 2000 1999
-------- -------- --------- --------
<S> <C> <C> <C> <C>
Net income.................................. $ 95,001 $ 46,166 $ 239,721 $ 69,137
-------- -------- --------- --------
Other comprehensive income, net of tax: 195,330
Unrealized holding gains 130,520
on securities.......................... 9,871 198,540
Reclassification for gains included (50,915) --- (155,747) ---
in net income.......................... -------- -------- --------- --------
Other comprehensive income (loss)........... (41,044) 130,520 42,793 195,330
-------- -------- --------- --------
Comprehensive income........................ $ 53,957 $176,686 $ 282,514 $264,467
======== ======== ========= ========
</TABLE>
NOTE G - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
Six Months Ended
June 30,
----------------------
(in thousands) 2000 1999
--------- ----------
<S> <C> <C>
Cash paid during the periods for:
Income taxes............................ $128,155 $ 13,535
Interest................................ 5,415 5,530
</TABLE>
-7-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations - Three Months Ended June 30, 2000 Compared to the 1999
Period
Net revenues for the three months ended June 30, 2000 were $189.9 million
compared to $170.2 million for the 1999 period, an increase of $19.7 million or
12%. Our second quarter 2000 revenue growth was primarily attributable to
increased sales of branded women's health and generic products, partially offset
by lower sales of branded dermatology products. In total, branded product sales
accounted for 54% of our net product sales in the second quarter of 2000, up
slightly from 52% in the year-ago quarter. Sales of women's health products have
grown steadily since we expanded that group's sales force in third quarter 1999.
The increase in generic sales was largely attributable to the April 2000 launch
of our nicotine polacrilex gum, the generic equivalent to SmithKline Beecham's
Nicorette(R) Gum, following the court decision in the litigation brought by
SmithKline.
Continuing price competition in the generic market, as well as a shortage of new
generic product introductions, resulted in lower margins on generic products in
the second quarter of 2000. Under the terms of a new supply agreement, the cost
of obtaining Dilacor XR(R) has increased in 2000, which also contributed to the
decline in our overall gross profit margin on product sales from 65% in the
second quarter 1999 as compared to 63% in the second quarter 2000.
Research and development expenses decreased to $12.1 million in the second
quarter of 2000, compared to $13.6 million in the same period of 1999.
Proprietary product development continued to be our focus, while spending on
certain generic projects declined. In this regard, spending on clinical studies
for proprietary products increased significantly in the second quarter 2000,
while administrative costs were lower due to efficiencies realized resulting
from the consolidation of Watson-Utah's proprietary development program into the
company-wide program in 1999.
Selling, general and administrative expenses increased to $32.5 million for the
second quarter of 2000 compared to $28.5 million in the prior year period, due
primarily to higher selling and marketing costs. This increase was primarily due
to expansion of the women's health sales force and higher advertising and
promotional expenses incurred for those products.
Second quarter amortization expense increased to $8.8 million in 2000, compared
to $7.4 million in the 1999 period. This increase was primarily due to
amortization expense recorded on our 1999 product acquisitions.
Our $1.7 million loss from joint ventures in the second quarter of 2000 resulted
primarily from our 50% interest in Somerset Pharmaceuticals, Inc., which
reported a higher net loss in the 2000 period caused by lower revenues and
higher research and development costs.
In the second quarter of 2000, we sold approximately 1.7 million shares of Andrx
common stock (adjusted to reflect Andrx' two-for-one stock split distributed in
April 2000). Proceeds from these sales amounted to $85.5 million and we
recorded pre-tax gains in the second quarter of 2000 of $81.5 million.
Interest and other income in the second quarter of 2000 increased to $5.7
million from $0.9 million in 1999 due to higher 2000 cash balances, primarily as
a result of the proceeds received from the Andrx sales discussed above.
-8-
<PAGE>
Our income tax provision in the second quarter of 2000 reflected a 37.5%
effective tax rate on pre-tax income, compared to 27.7% in 1999. The lower
effective tax rate in 1999 was primarily attributable to June 1999 changes in
income tax regulations relating to the "separate return limitation year"
limitations on the use of acquired net operating loss carryforwards to reduce
taxable income. As a result of these changes, we recorded a one-time $4.1
million reduction in income tax expense in second quarter 1999 and also
recognized a reduction in our overall effective tax rate during the final three
quarters of 1999.
Six Months Ended June 30, 2000 Compared to the 1999 Period
Net revenues for the six months ended June 30, 2000 were $369.6 million compared
to $329.5 million for the 1999 period, an increase of $40.1 million or 12%. The
revenue growth was primarily attributable to increased sales of women's health
products, which have grown steadily since we expanded that group's sales force
in third quarter 1999. In total, branded product sales accounted for 57% of our
net product sales in the first six months of 2000, up from 52% in the 1999
period. Despite continuing price competition in the generic market, our net
sales of generic products increased slightly during the first half of 2000, with
the April 2000 launch of our nicotine polacrilex gum contributing to this
increase.
Our overall gross profit margin on product sales decreased to 63% in the first
six months of 2000 from 66% in the year ago period due to price competition in
the generic market and a lack of new generic product introductions, with the
exception of our nicotine gum.
Research and development expenses increased slightly to $24.1 million in the
2000 period, compared to $23.7 million in the same period of 1999. This
increase results from higher spending on clinical studies on developmental
proprietary products, partially offset by lower spending on certain generic
projects. In this regard, spending on clinical studies for proprietary products
increased significantly in the second quarter 2000, while administrative costs
were lower due to efficiencies realized resulting from the consolidation of
Watson-Utah's proprietary development program into the company-wide program in
1999.
Selling, general and administrative expenses increased to $63.0 million for the
first half of 2000 compared to $56.0 million in the prior year period, due
primarily to higher selling and marketing costs. This increase was primarily due
to expansion of the women's health sales force and higher advertising and
promotional expenses incurred for those products.
Amortization expense in the six months ended June 30, 2000 increased to $17.4
million compared to $14.0 million in the 1999 period. This increase was
primarily due to amortization expense recorded on our 1999 product acquisitions.
We recorded a nonrecurring $20.5 million charge in the first quarter of 1999
relating to our acquisition of TheraTech. The charge consisted of transaction
fees for investment bankers, attorneys, accountants and financial printing costs
($11.1 million) and closure costs associated with the elimination of duplicate
or discontinued products, operations and facilities ($9.4 million).
Our $3.7 million loss from joint ventures in the first half of 2000 results
primarily from our interest in Somerset Pharmaceuticals, Inc., which reported a
higher net loss in the 2000 period caused by lower revenues and higher research
and development costs.
-9-
<PAGE>
Interest and other income in the first half of 2000 increased to $8.7 million
from $1.9 million in 1999 due to higher 2000 cash balances, primarily as a
result of the proceeds received from the Andrx sales discussed above.
Our income tax provision for the six months ended June 30, 2000 reflected a
37.3% effective tax rate on pre-tax income, compared to 35.1% in 1999. The
lower effective tax rate in 1999 was primarily attributable to June 1999 changes
in income tax regulations relating to the "separate return limitation year"
limitations on the use of acquired net operating loss carryforwards to reduce
taxable income. As a result of these changes, we recorded a one-time $4.1
million reduction in income tax expense in second quarter 1999 and also
recognized a reduction in our overall effective tax rate during the final three
quarters of 1999. On the other hand, a portion of our first quarter 1999 charge
related to the TheraTech acquisition was not deductible for income tax purposes,
which had the effect of increasing the effective tax rate in 1999.
Liquidity and Capital Resources
The company's working capital increased to $590.0 million at June 30, 2000 from
$305.5 million at December 31, 1999, primarily due to net income of
approximately $240 million during the six month period. The most significant
sources of cash during the first six months of 2000 were from Andrx common stock
sales (approximately $270 million) and from lower accounts receivable balances
(approximately $45 million), resulting from the elimination of extended payment
terms that had been offered in late 1999. Significant uses of cash included
payments of federal and state income taxes (approximately $130 million), which
were considerably higher in 2000 due to the Andrx stock sales, and an increased
investment in inventories (approximately $40 million), to help reduce the risk
that certain intermittent future supply interruptions would negatively impact
revenues over the short term. Other significant first half 2000 uses of cash
included acquisitions of property and equipment and a final, contingent payment
related to the 1998 acquisition of The Rugby Group, Inc.
On July 5, 2000, we entered into a credit agreement with a bank that includes a
$500 million term loan facility and a $200 million revolving credit facility
that is available for working capital and other needs. The $500 million term
loan was drawn upon in its entirety, along with approximately $250 million in
cash on hand, to pay off certain existing Schein indebtedness and to purchase
approximately 26 million shares of Schein common stock through the tender offer.
Quarterly prepayments of the term borrowings, beginning at $15 million per
quarter during the first four quarters and increasing thereafter, are required,
with any outstanding borrowings under the facility maturing in July 2005. The
interest rate under this facility is fixed at the London Interbank Offered Rate
("LIBOR") plus 1.375% (approximately 8.2% at July 31, 2000) for the first six
months; thereafter, the margin over LIBOR will be determined based on a leverage
test. Under the terms of the facility, we are subject to customary financial
and other operational covenants. We cancelled our previous $30 million credit
facility with another bank before we entered into this credit agreement.
In April 1998, we filed a registration statement with the Securities and
Exchange Commission to raise up to $300 million from offerings of senior or
subordinated debt securities, common stock, preferred stock or a combination
thereof. In May 1998, pursuant to this registration statement, we issued $150
million of 7-1/8% senior unsecured notes due May 2008, with interest payable
semi-annually in May and November. Subject to preparation of a supplement to
the existing prospectus, the balance of this registration statement remains
available for issuance at the company's discretion.
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<PAGE>
Our cash and marketable securities totaled approximately $375 million at June
30, 2000. Aside from the July 2000 borrowings noted above for the purposes of
acquiring Schein and refinancing certain of Schein's indebtedness, we believe
that our cash and marketable securities balance, our cash flow from operations
and the financing sources discussed herein, will be sufficient to meet our
normal operating requirements during the next twelve months. However, we
continue to review opportunities to acquire or invest in companies,
technologies, product rights and other investments that are compatible with our
existing business. We could use cash and financing sources discussed herein, or
financing sources that subsequently become available, to fund additional
acquisitions or investments. If a material acquisition or investment is
completed, our operating results and financial condition could change materially
in future periods.
FORWARD-LOOKING STATEMENTS
We caution the reader that certain important factors may affect our actual
results and could cause such results to differ materially from any forward
looking statement which may have been deemed to have been made in this report or
which are otherwise made by us or on our behalf. For this purpose any
statements contained in this report that are not statements of historical fact
may be deemed to be forward looking statements. Without limiting the generality
of the foregoing, words such as "may", "will", "expect", "believe",
"anticipate", "intend", "could", "would", "estimate", or "continue", or the
negative other variations thereof or comparable terminology are intended to
identify forward looking statements.
Forward looking 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 other things, 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 and risks associated with a production
interruption or shipment delays at such suppliers, successful compliance with
extensive, costly, complex and evolving governmental regulations and
restrictions, the scope, outcome and timeliness of any governmental, court or
other regulatory action (including, without limitation, the scope, outcome, or
timeliness of any inspection or other action of the FDA), the ability to timely
and cost effectively integrate acquisitions, exposure to product liability and
other lawsuits and contingencies, the outcome of litigation involving us and
related costs and expenses and possible diversion of management's time and
attention arising from such litigation, and other risks and uncertainties
detailed in this report and from time to time in Watson's other Securities and
Exchange Commission ("SEC") filings, including, but not limited to, Watson's
Annual Report and Form 10-K filed for the period ended December 31, 1999 and
Watson's Registration Statement on Form S-4, filed on July 14, 2000, and as
amended through July 28, 2000.
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<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
As discussed in Note E to the accompanying Notes to Consolidated Financial
Statements, our investment in Andrx consisted of 4.1 million Andrx common shares
with a fair market value of approximately $260 million at June 30, 2000. As a
publicly traded equity security, this investment has exposure to price risk.
The market price of Andrx common shares has been, and may continue to be,
volatile. The following table sets forth the Andrx high and low market price
per share information, based on published financial sources, for 1999 and
through June 30, 2000 (adjusted for Andrx' two-for-one stock split distributed
in April 2000):
<TABLE>
<CAPTION>
2000, by quarter High Low
---------------- ---- ---
<S> <C> <C>
First...................... $65.50 $20.13
Second..................... 68.31 43.63
1999, by quarter
----------------
First...................... $23.13 $11.13
Second..................... 39.00 15.41
Third...................... 39.00 28.57
Fourth..................... 29.00 19.25
</TABLE>
Substantially all of our cash equivalents and marketable securities are at fixed
interest rates and, as such, changes in market interest rates will affect the
fair value of these instruments. However, all of these investments mature
within one year and we believe that the market risk arising from our holding of
these investments is minimal.
We believe that the fair value of our fixed-rate long-term debt approximates its
carrying value of approximately $150 million at June 30, 2000. While changes in
market interest rates may affect the fair value of our long-term debt, we
believe the effect, if any, of reasonably possible near-term changes in the fair
value of such debt on our financial condition, results of operations or cash
flows will not be material.
Our exposure to interest rate risk increased in July 2000, when we borrowed $500
million under our new term credit facility, which bears interest at a variable
rate, at our option, based on the lenders' base rate or LIBOR, plus in each case
a specified percentage. For the first six months, the interest rate will be
LIBOR plus 1.375% (approximately 8.2% at July 31, 2000); thereafter, the margin
over LIBOR will be determined based on a leverage test, with the margin
increasing and decreasing in 1/8% increments based on an interest rate grid.
After the first six months, the interest rate is subject to adjustment each
quarter, based on our leverage ratio, and the LIBOR rate is also subject to
market fluctuations. The annual impact on the company's results of operations
of a 100 basis point interest rate change on the July 31, 2000 outstanding
balance of the variable rate debt would be approximately $3 million after tax.
At this time, we are not party to any interest rate or derivative hedging
contracts and have no material foreign exchange or commodity price risks.
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<PAGE>
PART II - OTHER INFORMATION AND SIGNATURES
ITEM 1. LEGAL PROCEEDINGS
Reference is made to the "Legal Proceedings" sections of our Annual Report on
Form 10-K for the year ended December 31, 1999 and our Form 10-Q for the quarter
ended March 31, 2000 for background information on certain litigation. The
following provides updated information regarding certain previously disclosed
Legal Proceedings and certain actions recently served on the company.
In the matter of SmithKline Beecham Consumer Healthcare LP v. Watson
Pharmaceuticals, et. al., on July 5, 2000, SmithKline Beecham Consumer
Healthcare filed a petition seeking review by the U.S. Supreme Court of the
Court of Appeals' April 4, 2000 decision. On August 2, 2000, Watson filed its
opposition to the petition.
With respect to the phentermine hydrochloride product liability suits filed
against a Watson subsidiary, Rugby Laboratories, Inc., and other Watson
entities, additional actions raising similar issues have been filed. As of
August 1, 2000, a total of approximately 1,630 cases have been filed against
Rugby and other Watson entities in a number of state and federal courts. The
Company believes that it will be fully indemnified by Rugby's former owner,
Hoechst Marion Roussel, Inc. ("HMR"), for the defense of all such cases and for
any liability that may arise out of these cases. HMR is currently controlling
the defense of all these cases as the indemnifying party under its agreements
with the Company.
On July 14, 2000, a suit was filed against a Watson subsidiary, The Rugby Group,
Inc. ("Rugby"), and several other corporations (Louisiana Wholesale Drug Co.,
Inc. v. Bayer Corporation, Barr Laboratories, Inc. and The Rugby Group, Inc.) in
the United States District Court for the Southern District of New York. On
August 1, 2000, a suit was filed against the company and Rugby and several other
corporations (Maria Locurto v. Bayer AG, Bayer Corporation, Barr Laboratories,
Inc., The Rugby Group, Inc., Watson Pharmaceuticals, Inc. and Hoechst Marion
Roussel, Inc.) in the United States District Court for the Eastern District of
New York. Both actions allege that the defendants engaged in unlawful,
anticompetitive conduct in connection with alleged agreements, entered into
prior to Watson's acquisition of Rugby, related to the development, manufacture
and sale of the drug substance ciprofloxacin hydrochloride, the generic version
of Bayer's brand drug, Cipro(R). The actions allege claims under various
federal and state competition and consumer protection laws, and seek declaratory
judgment, damages, injunctive relief, restitution and other relief on behalf of
certain purported classes. The company has not yet responded to the complaints.
The company intends to vigorously defend itself in these actions. The company
also believes that to the extent liability exists, if at all, the company is
entitled to indemnification from HMR for the defense of such cases and for any
liability that may arise out of such cases.
The company and its affiliates are involved in various other disputes,
governmental and/or regulatory inspections, investigations and proceedings, and
litigation matters that arise from time to time in the ordinary course of
business. The process of resolving matters through litigation or other means is
inherently uncertain and it is possible that the resolution of these matters
will adversely affect the company.
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<PAGE>
ITEM 5. OTHER INFORMATION
Watson has initiated and continues to implement quality improvements at its
Corona, California facility. Among other things, these quality improvements
seek to address deficiencies noted by the FDA in the warning letter issued to
Watson in January 1999 and subsequent Form 483 notices. However, to date,
matters with the agency concerning the company's Corona facility continue to be
unresolved. Watson cannot predict what the ultimate outcome will be or when
the agency will approve additional pending applications from its Corona
facility. Watson did receive one ANDA approval from its Corona facility in July
2000 and received approval of an ANDA supplement from its Corona facility in
August 2000.
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 filed during the quarter ended June 30, 2000:
On May 25, 2000, we filed a Form 8-K report, dated May 25, 2000,
announcing that we had reached a definitive agreement with Schein
Pharmaceutical, Inc. under which we will acquire all of the
outstanding common stock of Schein through a two-step transaction
comprised of a cash tender offer followed by a taxable stock merger.
On May 31, 2000, we filed a Form 8-K report, dated May 24, 2000,
providing further details on the Schein merger and which included, as
an exhibit, the definitive Agreement and Plan of Merger dated as of
May 24, 2000.
Also, On July 7, 2000, we filed a Form 8-K report, dated July 5,
2000, announcing the expiration of the cash tender offer for Schein
common stock and that approximately 78% of the total outstanding
shares of Schein had been tendered in that offer.
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<PAGE>
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/ MICHAEL E. BOXER
--------------------------------------------------
Michael E. Boxer
Senior Vice President - Chief Financial Officer
(Principal Financial Officer)
By: /s/ R. CHATO ABAD
--------------------------------------------------
R. Chato Abad
Vice President - Finance
(Principal Accounting Officer)
Dated: August 11, 2000
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