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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-20045
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WATSON PHARMACEUTICALS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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NEVADA 95-3872914
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
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311 BONNIE CIRCLE, CORONA, CA 92880
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(909) 270-1400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.0033 PAR VALUE
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes [X]
Aggregate market value, as of March 15, 2000, of Common Stock held by
non-affiliates of the registrant: $3,126,025,000 based on the last reported sale
price on the New York Stock Exchange.
Number of shares of Common Stock outstanding on March 15, 2000: 96,338,200.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Registrant's 2000 Annual Meeting of
Stockholders, to be held on May 9, 2000, are incorporated by reference in Part
III of this report.
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WATSON PHARMACEUTICALS, INC
INDEX TO FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1999
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PART I
Item 1. Business.................................................... 1
Overview of Our Business.................................... 1
Joint Ventures.............................................. 5
Product Development......................................... 6
Sales and Marketing......................................... 9
Suppliers and Materials..................................... 11
Patents and Proprietary Rights.............................. 12
Government Regulation....................................... 13
Seasonality................................................. 14
Employees................................................... 15
Forward-Looking Statements.................................. 15
Item 2. Properties.................................................. 16
Item 3. Legal Proceedings........................................... 16
Item 4. Submission of Matters to a Vote of Security Holders......... 18
Item 4A. Executive Officers of the Registrant........................ 19
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 20
Item 6. Selected Financial Data..................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 22
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 29
Item 8. Financial Statements and Supplementary Data................. 29
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 29
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 29
Item 11. Executive Compensation...................................... 30
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 30
Item 13. Certain Relationships and Related Transactions.............. 30
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 31
Signatures.............................................................. 34
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PART I
ITEM 1. BUSINESS
Watson Pharmaceuticals, Inc. is a pharmaceutical company primarily engaged
in the development, production, marketing and distribution of both branded and
off-patent pharmaceutical products. Our products include therapeutic and
preventive agents generally sold by prescription or over-the-counter for the
treatment of human diseases and disorders. For full prescribing information for
any Watson product, please contact the company at (800) 272-5525.
OVERVIEW OF OUR BUSINESS
Watson was incorporated in January 1985, and commenced operations as a
manufacturer and marketer of off-patent pharmaceuticals. We have grown, through
internal product development and synergistic acquisitions of products and
businesses, into a diversified specialty pharmaceutical company that currently
markets over 100 branded and off-patent products. We are also engaged in the
development of advanced drug delivery systems primarily designed to enhance the
therapeutic benefits of pharmaceutical products, both to expand our own product
line and under collaborative agreements with other parties.
BRANDED PHARMACEUTICAL PRODUCTS
Newly developed pharmaceutical products are normally patented and, as a
result, generally are offered by a single provider when first introduced to the
market. In addition to patented products, we classify certain trademarked
off-patent products that we promote directly to healthcare professionals as
branded pharmaceutical products.
The company's branded pharmaceutical business operates primarily in three
specialty areas: Dermatology, Women's Health and General Products. During 1999,
we consolidated our Neurology/Psychiatry product line into the General Products
line, which we had previously referred to as the Primary Care line. We have
strategically focused on these markets due to their anticipated growth
opportunities. We believe that the nature of these markets and the identifiable
base of physician prescribers provide the company with the opportunity to
achieve significant market penetration through our specialized sales forces. As
compared to our off-patent products, we also believe that our branded products
will generate more consistent earnings, over a longer period, since these
products are normally proprietary and, as a result, generally realize higher
profit margins. We intend to continue to expand our branded product portfolio
through internal product development and acquisition. We may also choose to
enter into collaborative or licensing agreements at various stages of product
development or commercialization.
In January 1999, we completed our acquisition of TheraTech, Inc, now named
Watson Laboratories, Inc.-Utah ("TheraTech" or "Watson-Utah"). Watson-Utah
develops, manufactures and markets advanced controlled-release and other
products that administer drugs through the skin, by mouth to the
gastrointestinal tract, through the tissues of the mouth, and by other means. We
believe these products provide advantages over existing controlled-release
drug-delivery products and conventional oral, injectable and continuous infusion
methods by increasing efficacy, safety, bioavailability and/or patient
compliance and comfort.
In separate transactions during 1999, we reacquired the marketing rights to
two products that had been developed by TheraTech, the Androderm(R) and Alora(R)
transdermal hormone replacement systems, for our General Products and Women's
Health product lines, respectively. Also during 1999, we broadened our Women's
Health product line by acquiring the Low-Ogestrel(TM) oral contraceptive upon
its approval by the United States Food and Drug Administration ("FDA"). These
and other recent acquisitions are described in further detail in "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and in Note 2 to our consolidated financial statements.
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We sell our Dermatology products under the "Oclassen(R) Dermatologics"
label. In this area, we presently market the following products for the
prevention and treatment of skin diseases:
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OCLASSEN(R) BRAND PRODUCT ACTIVE INGREDIENTS THERAPEUTIC CLASSIFICATION
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Monodox(R) Doxycycline monohydrate Antibiotic
Cordran(R) Flurandrenolide Topical corticosteroid
Cormax(TM) Clobetasol propionate Topical corticosteroid
Condylox(R) Podofilox Topical antimitotic for
genital warts
Cinobac(R) Cinoxacin Antibiotic
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In the Women's Health area, we presently market a number of oral
contraceptive and female hormone replacement products, including the following:
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WATSON BRAND PRODUCT ACTIVE INGREDIENTS THERAPEUTIC CLASSIFICATION
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Zovia(R) Ethynodiol diacetate and ethinyl estradiol Oral contraceptive
Levora(R) Levonorgestrel Oral contraceptive
Nor-QD(R) Norethindrone Oral contraceptive
Trivora(R) Levonorgestrel and ethinyl estradiol Oral contraceptive
Norinyl(R) and Tri-Norinyl(R) Norethindrone and ethinyl estradiol Oral contraceptive
Necon(R) Norethindrone and mestranol Oral contraceptive
Low-Ogestrel(TM) Norgestrel and ethinyl estradiol Oral contraceptive
Alora(R) Estradiol (transdermal patch) Female hormone replacement
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In connection with our reacquisition of Alora(R) in 1999, we also
reacquired rights to an estradiol and progestin combination hormone replacement
patch product developed at Watson-Utah under a collaborative agreement with
Procter & Gamble. We submitted this product for regulatory approval in December
1999.
In the General Products area, we presently market a number of products
directly to physicians, including the following:
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WATSON BRAND PRODUCT ACTIVE INGREDIENTS THERAPEUTIC CLASSIFICATION
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Dilacor XR(R) Diltiazem Anti-hypertensive
Microzide(R) Hydrochlorothiazide Anti-hypertensive
Norco(R) Hydrocodone bitartrate & acetaminophen Analgesic
Loxitane(R) Loxapine succinate Anti-psychotic
Androderm(R) Testosterone (transdermal patch) Male hormone replacement
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Sales of Dilacor XR(R) accounted for approximately 19% of total revenues in
1997 following our June 1997 purchase of the rights to that product. As a
percent of net revenues, sales of Dilacor XR(R) decreased to approximately 15%
in 1998 and 7% in 1999 due to increased generic competition and, in 1999, due
primarily to supply interruptions from a third party supplier. In March 2000, we
entered into an agreement with another pharmaceutical manufacturer to secure an
alternate supply source for Dilacor XR(R), under that manufacturer's ANDA
approval.
Sales of our branded products accounted for 53% of total product sales in
1999, up from 42% in 1998, and are expected to remain at approximately that
level in 2000. The increase from 1998 to 1999 is due primarily to the timing of
acquisitions of branded products, including certain Women's Health products
acquired in late 1998, and expansion of the branded sales forces. In addition,
revenues from new generic products were minimal in 1999 due to delays in
obtaining FDA approval of pending new product applications. (See "Product
Development" and "Government Regulation.")
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OFF-PATENT PHARMACEUTICAL PRODUCTS
When the relevant patents no longer protect a branded product (normally as
a result of the patent's expiration), opportunities exist for third parties to
introduce generic counterparts to the branded product. Such generic or
off-patent pharmaceutical products are therapeutically equivalent to their
brand-name counterparts and are generally sold at prices significantly less than
the branded product. Accordingly, off-patent pharmaceuticals provide a safe,
effective and cost-efficient alternative to users of branded products.
We are recognized as a leader in the development, manufacture and sale of
off-patent pharmaceutical products. With respect to off-patent products, our
strategy is to enter markets where we believe we enjoy competitive advantages.
In this regard, the drugs we target for development are generally those that are
difficult to formulate or manufacture, or that will complement or broaden our
existing product line.
We presently market approximately 90 off-patent prescription products in
capsule or tablet form in more than 400 packaging sizes and/or dosage strengths,
including the following:
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WATSON
OFF-PATENT PRODUCT COMPARABLE BRAND NAME BRAND HOLDER THERAPEUTIC CLASSIFICATION
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Hydrocodone/ Lorcet(R), Forest Pharmaceuticals Analgesic
acetaminophen Vicodin(R), Knoll Pharmaceutical
Lortab(R) UCB Pharmaceuticals
Lorazepam Ativan(R) Wyeth-Ayerst Tranquilizer
Laboratories
Estradiol Estrace(R) Bristol-Myers Squibb Female hormone replacement
Estropipate Ogen(R) Pharmacia/Upjohn Female hormone replacement
Clorazepate Tranxene(R) Abbott Laboratories Tranquilizer
Carisoprodol Soma(R) Wallace Laboratories Muscle relaxant
Dicyclomine Bentyl(R) Aventis Antispasmodic
Pharmaceuticals
Sulfasalazine Azulfidine(R) Pharmacia/Upjohn Bowel anti-inflammatory
Furosemide Lasix(R) Aventis Diuretic
Pharmaceuticals
Loxapine succinate Loxitane(R) Watson Laboratories Anti-psychotic
Pentazocine/naloxone TalwinNX(R) Sanofi-Synthelabo Analgesic
Butalbital, aspirin, Fiorinal(R) w/codeine Novartis Analgesic
caffeine and
codeine (BACC)
Guanfacine Tenex(R) A.H. Robins Anti-hypertensive
Ranitidine Zantac(R) Glaxo Wellcome Anti-ulcer
Sucralfate Carafate(R) Aventis Anti-ulcer
Pharmaceuticals
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Generally, our sales of off-patent drugs have increased significantly over
the past several years. We believe this growth is attributable to a number of
factors, including:
- acquisitions of other off-patent businesses in 1998 and 1997;
- modification of certain federal and state laws to permit or require
substitution of off-patent drugs by pharmacists;
- changes in government and third-party reimbursement policies to encourage
cost containment by healthcare providers and consumers;
- increased acceptance of off-patent drugs by physicians, pharmacists and
consumers; and
- an increasing number of branded products which have lost patent
protection.
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However, compared to 1998, sales of off-patent drugs decreased in 1999.
This was primarily the result of reduced sales of diltiazem as the result of
supply interruptions, our phasing-out a number of Rugby Group products from the
product line beginning in mid-1998, and increased price competition in 1999. Our
original supplier's failure to provide us with an adequate and reliable supply
of generic diltiazem has caused our customers to seek generic diltiazem from our
competitors. It is generally commercially impracticable to regain lost market
share for a generic product. Although we have negotiated a new supply agreement
for Dilacor XR(R), under the pricing structure in that agreement, it will not be
commercially practicable to obtain generic diltiazem from that manufacturer.
Upon exhaustion of our nominal existing inventory, we do not anticipate any
further sales of generic diltiazem.
During 1999, the hydrocodone/acetaminophen off-patent product group
accounted for approximately 11% of total revenues. In 1998 and 1997, this same
product group accounted for approximately 12% and 19% of total revenues,
respectively.
The competitive nature of the generic drug industry generally requires the
regular introduction of new products into the product line in order to maintain
historic sales levels. Sales of our off-patent products were adversely impacted
during 1999 by delays in receiving FDA approvals of pending product
applications. See "Product Development" and "Government Regulation." During
1999, we did receive FDA approval to manufacture and market our nicotine
polacrilex gum, a generic equivalent to SmithKline Beecham Consumer Healthcare's
Nicorette(R) gum for smoking cessation. However, launch of that product has been
delayed by legal action taken against us by SmithKline. (See "Item 3. Legal
Proceedings.")
RESEARCH, DEVELOPMENT AND LICENSING REVENUES
Our subsidiary, Watson-Utah, develops drug delivery products under
collaborative agreements with several major pharmaceutical companies. Generally,
under these agreements, our partners provide research funds and clinical and
other support during the product development process. After product approval, we
generally manufacture and supply the product to our partners at an agreed-upon
price, and our partners market the product utilizing their established sales and
marketing forces. In the future, we may enter into fewer such collaborative
agreements because Watson's sales and marketing forces can now market
Watson-Utah's development efforts directly.
REVENUES
Company revenues for the last three fiscal years were derived as follows:
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YEARS ENDED DECEMBER 31,
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1999 1998 1997
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$ % $ % $ %
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($ IN THOUSANDS)
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Branded product sales................. $346,770 50% $242,992 41% $152,125 40%
Off-patent product sales.............. 306,978 45% 329,805 55% 187,360 50%
Research, development and licensing... 35,484 5% 23,396 4% 22,736 6%
Royalty income(1)..................... 0 0% 0 0% 14,249 4%
-------- --- -------- --- -------- ---
Total revenues.............. $689,232 100% $596,193 100% $376,470 100%
======== === ======== === ======== ===
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(1) Following our acquisition of the rights to Dilacor XR(R) from Rhone-Poulenc
Rorer as of June 30, 1997, no further royalty income was earned.
GROWTH THROUGH ACQUISITIONS
A substantial portion of our growth over the past five years has resulted
from acquisitions of businesses and products. We plan to continue making such
acquisitions as part of our business strategy. We regularly review potential
transactions related to technologies, products or product rights and businesses
complementary to our business. Such transactions could include mergers,
acquisitions, strategic alliances, licensing agreements or co-promotion
agreements. In the future, we may choose to enter into such transactions at any
time.
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We may experience difficulty integrating the businesses of companies that
we have acquired into our operations, which would be disruptive to our
management and operations. The merger of two companies involves the integration
of two businesses that have previously operated independently. As a result of
uncertainty following a merger and during the integration process, we could
experience disruption in our business or employee base. There is also a risk key
employees of a merged company may seek employment elsewhere, including with
competitors, or that valued employees are lost upon the elimination of duplicate
functions. If Watson and a merger partner are not able to successfully blend
their products and technologies to create the advantages the merger is intended
to create, it may affect our results of operations and financial condition, and
our ability to develop and introduce new products. Further, there may be overlap
between the products or customers of Watson and a merged company that may create
conflicts in relationships or other commitments detrimental to the integrated
businesses.
In addition, as a result of acquiring businesses or entering into other
significant transactions, we have experienced, and will likely continue to
experience, significant charges to earnings for merger and related expenses that
may include transaction costs, closure costs or acquired in-process research and
development costs. These costs may include substantial fees for investment
bankers, attorneys, accountants and financial printing costs and severance and
other closure costs associated with the elimination of duplicate or discontinued
products, operations and facilities. These charges could have a material adverse
effect on our results of operations for particular quarterly or annual periods,
however we would not expect such charges to have a material adverse effect upon
our financial condition.
JOINT VENTURES
We own a 50% interest in Somerset Pharmaceuticals, Inc., a joint venture
with Mylan Laboratories, Inc. Currently, Somerset's only marketed product is
Eldepryl(R), a drug for the treatment of Parkinson's disease that lost Orphan
Drug exclusivity in 1996. Somerset is actively involved in research projects
regarding additional indications for Eldepryl(R) and other chemical compounds.
In addition, we own a 50% interest in ANCIRC, a joint venture with Andrx
Corporation, formed for the purpose of developing off-patent pharmaceutical
products utilizing Andrx's controlled-release technology. To date, ANCIRC has
received two off-patent product approvals from the FDA; however, the revenues
generated by those two products have not been significant. At March 15, 2000, we
owned approximately 9.1% of Andrx' outstanding common stock.
We also own interests in two joint ventures with China-based Changzhou No.
4 Pharmaceutical Factory. We own 95% of what we refer to as Joint Venture A,
which has built a manufacturing facility in China for the production, marketing
and sales of pharmaceuticals and related products. We own 25% of Joint Venture
B, which is designed to provide raw materials to Joint Venture A. Changzhou owns
the balance of these two joint ventures. To date, several products have been
marketed, but sales revenues have been immaterial.
We have made substantial investments in these joint ventures and may use
this method of investment in the future. These arrangements typically involve
other pharmaceutical companies as partners, such as Mylan and Andrx, which
otherwise are competitors of ours in certain markets. We do not control these
joint ventures or the commercial exploitation of the licensed products, and can
not assure you that these ventures will be profitable in the future. Although
restrictions contained in certain of the joint venture arrangements have not had
a material adverse impact on the marketing of our own products to date, any such
marketing restriction could affect future revenues and have a material adverse
effect on our operations. Our results of operations may be negatively impacted
if existing collaborative or joint venture partners withdraw, or if these
products are not timely developed, approved or successfully commercialized.
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PRODUCT DEVELOPMENT
The company devotes significant resources to the research and development
of branded and off-patent products. In that regard, we incurred research and
development expenditures of $49.3 million in 1999, $50.7 million in 1998 and
$35.0 million in 1997. Our research and development strategy focuses on the
following product development areas:
- development of sustained-release technologies and the application of
these technologies to existing products;
- application of proprietary drug-delivery technology for new product
development in specialty areas;
- expansion of our existing oral immediate-release products with respect to
additional dosage strengths;
- medium-to-late stage new drug opportunities;
- off-patent drugs technically difficult to develop or manufacture because
of unusual factors that affect their shelf life or bioequivalence; and
- off-patent drugs that target smaller specialized or under-served markets.
Our January 1999 acquisition of TheraTech significantly increased our
branded product development resources, while our acquisitions of Royce
Laboratories, Inc. in 1997 and The Rugby Group, Inc. in 1998 increased our
resources in the area of off-patent product development. We presently maintain
research and development facilities in Corona, California; Salt Lake City, Utah;
Miami, Florida and Cincinnati, Ohio.
Our future results of operations will depend in part upon our ability to
develop and successfully commercialize new branded and off-patent pharmaceutical
products in a timely manner. These new products must be continually developed,
tested and manufactured and, in addition, must meet regulatory standards and
receive regulatory approvals. (See "Government Regulation.") Furthermore, the
development and commercialization process is time-consuming and costly. If any
of our development products cannot be successfully or timely commercialized, our
operating results could be adversely affected. This risk particularly exists
with respect to the development of branded products because of the
uncertainties, higher costs and lengthy timeframes associated with research and
development of such products, and their inherent unproven market acceptance.
FDA approval is required before any dosage form of any new drug, including
an off-patent equivalent of a previously approved drug, can be marketed. The
process for obtaining governmental approval to manufacture and market
pharmaceutical products is rigorous, time-consuming and costly, and we cannot
predict the extent to which it may be affected by legislative and regulatory
developments. We are dependent on receiving FDA and other governmental approvals
prior to manufacturing, marketing and shipping new products. Consequently, there
is always the chance the FDA or other applicable agency will not approve new
products, or the rate, timing and cost of such approvals will adversely affect
our product introduction plans or results of operations. (See also "Government
Regulation.")
All applications for FDA approval must contain information relating to
product formulation, raw material suppliers, stability, manufacturing processes,
packaging, labeling and quality control. There are generally two types of
applications for FDA approval that would be applicable to our new products:
New Drug Application ("NDA"). We file an NDA when we seek approval for
drugs with active ingredients and/or with dosage strengths, dosage forms or
delivery systems that have not been previously approved by the FDA. Generally,
NDAs are filed for our newly developed branded products or for a new dosage form
of previously approved drugs.
Abbreviated New Drug Application ("ANDA"). We file an ANDA when we seek
approval for off-patent, or "generic," equivalents of a previously approved
drug.
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BRANDED PRODUCT DEVELOPMENT
The process required by the FDA before a previously unapproved
pharmaceutical product may be marketed in the U.S. generally involves the
following:
- preclinical laboratory and animal tests;
- submission of an investigational new drug application ("IND"), which must
become effective before clinical trials may begin;
- adequate and well-controlled human clinical trials to establish the
safety and efficacy of the proposed product for its intended use;
- submission of an NDA containing the results of the clinical trials
establishing the safety and efficacy of the proposed product for its
intended use; and
- FDA approval of an NDA.
Preclinical tests include laboratory evaluation of the product, its
chemistry, formulation and stability, as well as animal studies to assess the
potential safety and efficacy of the product. We then submit the results of
these studies, which must demonstrate the product delivers sufficient quantities
of the drug to the bloodstream to produce the desired therapeutic results, to
the FDA as part of an IND, which must become effective before we may begin human
clinical trials. The IND automatically becomes effective 30 days after receipt
by the FDA unless the FDA, during that 30-day period, raises concerns or
questions about the conduct of the trials as outlined in the IND. In such cases,
the IND sponsor and the FDA must resolve any outstanding concerns before
clinical trials can begin. In addition, an independent Institutional Review
Board at the medical center proposing to conduct the clinical trials must review
and approve any clinical study.
Human clinical trials are typically conducted in three sequential phases,
which may overlap:
- Phase I: The drug is initially introduced into a relatively small number
of healthy human subjects or patients and is tested for safety, dosage
tolerance, absorption, metabolism, distribution and excretion.
- Phase II: Involves studies in a limited patient population to identify
possible adverse effects and safety risks, to determine the efficacy of
the product for specific targeted diseases or conditions, and to
determine dosage tolerance and optimal dosage.
- Phase III: When Phase II evaluations demonstrate a dosage range of the
product is effective and has an acceptable safety profile, Phase III
trials are undertaken to further evaluate dosage, clinical efficacy and
to further test for safety in an expanded patient population at
geographically dispersed clinical study sites.
The results of product development, preclinical studies and clinical
studies are then submitted to the FDA as part of an NDA, for approval of the
marketing and commercial shipment of the new product. The NDA drug development
and approval process now averages approximately five to ten years.
Watson is presently developing a number of branded products, some of which
utilize novel drug-delivery systems products, through a combination of internal
and collaborative programs, including joint ventures. Our proprietary product
development continues to emphasize mid-to-late-stage new drug opportunities that
can quickly be brought to market in the three specialty areas where we have an
existing sales and marketing presence, namely Dermatology, Women's Health and
General Products. Products currently in development include:
- an estradiol/progestin combination hormone replacement patch;
- a transdermal patch for urinary incontinence;
- a transdermal patch for nail fungus;
- a topical steroid line extension;
- an oral anti-acne product;
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- an oral hormone replacement therapy product; and
- an Orphan Drug for biopterin deficiency.
We anticipate increasing the number of NDAs submitted to the FDA to an
average of three NDA submissions per year over the next three to four years.
However, product development is inherently risky, especially when the
development concerns new products for which safety and efficacy has not been
established and the market for which is yet unproven. The development process
also requires substantial time, effort and financial resources and any
commercialization of a product will require prior government approval, which may
not be forthcoming. We cannot be certain that we will be successful in
commercializing any of the products we are developing on a timely basis, if at
all. We also cannot guarantee that any investment we make in developing products
will be recouped, even if we are successful in commercializing those products.
For products we are developing under collaborative agreements, our partners
typically are responsible for the clinical and regulatory approval process. We
participate in this process by submitting to our partner portions of the drug
master file, which describes the physical and chemical properties of the product
and data concerning our manufacturing processes.
In recent years, Somerset has increased its research and development
spending to (a) develop additional indications for selegiline (the active
ingredient of Eldepryl(R)), using a transdermal delivery system and (b) develop
and evaluate different therapeutic areas using selegiline and other compounds.
Clinical studies using the selegiline transdermal system for the treatment of
several disorders, including depression, were performed in 1998 and 1999 and
additional studies are planned for 2000.
OFF-PATENT PRODUCT DEVELOPMENT
FDA approval of an ANDA is required before we may begin marketing an
off-patent equivalent of a drug that has been approved under an NDA, or a
previously unapproved dosage form of a drug that has been approved under an NDA.
The ANDA approval process generally differs from the NDA approval process in
that it does not require new preclinical and clinical studies since it relies on
the clinical studies establishing safety and efficacy conducted for the
previously approved drug. The ANDA process does, however, require a new study to
show that the ANDA drug is bioequivalent to the previously approved drug.
"Bioequivalence" compares the bioavailability of one drug product with another
and, when established, indicates whether the rate of absorption and levels of
concentration of an off-patent drug in the body are substantially equivalent to
the previously approved drug. "Bioavailability" indicates the rate and extent of
absorption and levels of concentration of a drug product in the bloodstream
needed to produce a therapeutic effect. The ANDA drug development and approval
process generally takes less time than the NDA drug development and approval
process since the ANDA process does not require new clinical trials establishing
the safety and efficacy of the drug product.
Among other things, supplemental NDAs or ANDAs are required for approval to
transfer products from one manufacturing site to another and may be under review
for a year or more. In addition, certain products may only be approved for
transfer once new bioequivalency studies are conducted or other requirements are
satisfied.
The Generic Drug Enforcement Act of 1992 established penalties for
wrongdoing in connection with the development or submission of an ANDA. Under
the Act, the FDA has the authority to permanently or temporarily debar companies
or individuals from submitting or assisting in the submission of an ANDA, and to
temporarily deny approval and suspend applications to market off-patent drugs.
The FDA may also suspend the distribution of all drugs approved or developed in
connection with certain wrongful conduct and/or withdraw approval of an ANDA and
seek civil penalties. The FDA can also significantly delay the approval of any
pending NDA or ANDA under the Fraud, Untrue Statements of Material Facts,
Bribery and Illegal Gratuities Policy Act.
Among the requirements for FDA approval of both NDAs and ANDAs is that the
company's manufacturing procedures and operations conform to FDA requirements
and guidelines generally referred to as current Good Manufacturing Practices
("cGMP"), as defined in Title 21 of the U.S. Code of Federal
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Regulations. These regulations encompass all aspects of the production process,
including validation and record keeping, and involve changing and evolving
standards. In complying with the cGMP regulations, the company must continue to
expend time, money and effort in such areas as production and quality control to
ensure full technical compliance. The evolving and complex nature of regulatory
requirements, the broad authority and discretion of the FDA, and the generally
high level of regulatory oversight results in a continuing possibility that we
may be adversely affected by regulatory actions despite our efforts to maintain
compliance with regulatory requirements.
During 1998 and 1999, the FDA conducted inspections of our Corona,
California and Miami, Florida manufacturing facilities and noted certain
deficiencies with respect to cGMP regulations. The company has initiated and
continues to implement quality improvements at both of these facilities.
However, in light of the uncertainties inherent in the regulatory process, we
can not assure you that the agency will not require additional action. (See
"Governmental Regulation.")
During 1999 and through March 30, 2000, Watson received seven ANDA product
approvals from the FDA. We presently have pending with the FDA approximately 20
product submissions (including NDAs, ANDAs and supplemental product approvals)
seeking, among other things, approval to manufacture certain products at our
Corona or Miami facilities. The FDA may withhold approval of product submissions
of a facility if deficiencies are found at that facility. (See "Government
Regulation.") Delays or unanticipated costs in any part of the product
development process or our inability to obtain regulatory approval for our
products, which could result from failure to maintain our manufacturing
facilities in compliance with all applicable regulatory requirements, could
adversely affect our operating results and financial condition.
Over the next few years, patent protection on a relatively large number of
branded drugs will expire, thereby providing additional off-patent product
opportunities. We intend to continue to concentrate our off-patent product
development activities on brand products with U.S. sales exceeding $50 million
in specialized or growing markets and in areas that offer significant
opportunities and competitive advantages. In addition, we intend to continue to
focus our development efforts on technically difficult-to-formulate products, or
products that require advanced manufacturing technology. When evaluating which
drug development projects to undertake, we also consider whether the product
would complement other products in our portfolio, or would otherwise assist in
making our product line more complete. During 2000, we plan to invest in
significant bioequivalence studies for approximately 20 developmental off-patent
products or dosage forms.
The design, development and manufacture of both branded and off-patent
pharmaceutical products involve an inherent risk of product liability claims and
associated adverse publicity. Insurance coverage is expensive and may be
difficult to obtain, and may not be available in the future on acceptable terms,
or at all. We currently maintain product liability insurance for our products in
amounts we believe to be commercially reasonable. If, however, the coverage
limits of these insurance policies are not adequate, a product liability claim
brought against us could have a material adverse effect upon our financial
condition and/or results of operations.
SALES AND MARKETING
We sell our pharmaceutical products primarily to drug wholesalers,
retailers and distributors, including large chain drug stores, hospitals,
clinics, government agencies and managed healthcare providers such as health
maintenance organizations and other institutions.
BRANDED PRODUCTS
We market our branded products through our specialty sales groups:
Dermatology, Women's Health and General Products. During 1999, we consolidated
our Neurology/Psychiatry product line into the General Products line, which we
had previously referred to as the Primary Care line. Each of these sales groups
focuses on physicians who specialize in the diagnosis and treatment of different
medical conditions and each offers products to satisfy the needs of these
specialty physicians. We believe this focused marketing approach
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enables us to develop highly knowledgeable and dedicated sales representatives
and to foster close professional relationships with physicians.
During 1999, we continued to develop the sales forces for the three
therapeutic areas, as well as the marketing infrastructure to support sales
efforts in these specialty areas. The company's branded products sales group had
grown to include nearly 400 sales representatives in the United States by the
end of 1999.
We sell our branded products primarily under the "Watson Pharma" label,
except for our dermatological products that we sell under the "Oclassen(R)
Dermatologics" label.
OFF-PATENT PRODUCTS
We market our off-patent products through a team of approximately 50 people
involved in sales, marketing, telemarketing and administrative functions. During
1998, Rugby's telemarketing organization and other sales and marketing personnel
were integrated into the company's existing infrastructure, enhancing its sales
and marketing efforts in the off-patent product area.
We sell our off-patent products primarily under the "Watson Laboratories"
label, except for our over-the-counter products that we sell under our "Rugby"
label.
CUSTOMERS
We market our products primarily to pharmaceutical wholesalers, drug
distributors and chain drug stores that in turn market to retailers, managed
care entities, hospitals and government agencies. We have seen a consolidation
of our customers, as chain drug stores and wholesalers merge or consolidate. In
addition, a number of our customers have instituted source programs that reduce
the number of suppliers they use for off-patent pharmaceutical products. As a
result of these developments, there is heightened competition among off-patent
drug producers for the business of this smaller and more selective customer
base. This has also led to greater dependence on a fewer number of customers for
a greater percentage of sales. While we believe that we have a good relationship
with our key customers, we can not guarantee that continued consolidation, and
the increased dependence on fewer customers that follows, will not impact the
company's business or that such impact will not be significant.
Sales to certain of our customers accounted for 10% or more of our annual
net revenues during the past three years. McKesson HBOC, Inc. accounted for 20%,
16% and 11% of our net revenues in 1999, 1998 and 1997, respectively. Bergen
Brunswig Corporation accounted for 12%, 11% and 10% of our net revenues in 1999,
1998 and 1997, respectively. Cardinal Health, Inc. accounted for 12% of our net
revenues in 1999.
COMPETITION
The pharmaceutical industry is highly competitive. Our competitors vary
depending upon categories, and within each product category, upon dosage
strengths and drug-delivery systems. Such competitors include the major brand
name and off-patent manufacturers of pharmaceuticals, especially those doing
business in the United States. In addition to product development, other
competitive factors in the pharmaceutical industry include product quality and
price, reputation, service, and access to technical information. It is possible
that developments by others will make our products or technologies
noncompetitive or obsolete.
The intensely competitive environment of the branded product business
requires an ongoing, extensive search for technological innovations and the
ability to market products effectively, including the ability to communicate the
effectiveness, safety and value of branded products to healthcare professionals
in private practice, group practices and managed care organizations. Our
competitors include the major brand name manufacturers of pharmaceuticals such
as Johnson & Johnson, American Home Products and Aventis S.A. Based on total
assets, annual revenues, and market capitalization, we are smaller than these
and other national competitors in the branded product arena. For example, our
market capitalization as of March 15, 2000 is approximately $3.5 billion
compared to Johnson & Johnson ($100 billion), American Home Products ($70
billion) and Aventis S.A. ($80 billion). These competitors, as well as others,
have been in business longer than Watson, have a greater number of products on
the market, and have greater financial and other
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resources. If we compete directly with them for the same markets and/or
products, their financial strength could prevent us from capturing a profitable
share of those markets.
Revenues and gross profit derived from the sales of off-patent
pharmaceutical products tend to follow a pattern based on certain regulatory and
competitive factors. As patents for brand name products and related exclusivity
periods mandated by regulatory authorities expire, the first off-patent
manufacturer to receive regulatory approval for off-patent equivalents of such
products is generally able to achieve a relatively significant market
penetration. As competing off-patent manufacturers receive regulatory approvals
on similar products, market share, revenues and gross profit typically decline.
Accordingly, the level of market share, revenues and gross profit attributable
to a particular off-patent product is normally related to (a) the number of
competitors in that product's market and (b) the timing of that product's
regulatory approval and launch, in relation to competing approvals and launches.
Consequently, we must continue to develop and introduce new products in a timely
and cost-effective manner to maintain and increase our revenues and gross
margins.
In addition to off-patent competition from other off-patent drug
manufacturers, we face competition from brand name companies as they
increasingly seek to participate in sales of generic products by, among other
things, establishing, acquiring or forming licensing or business arrangements
with other off-patent pharmaceutical companies or marketing their own generic
equivalent to their branded product.
SUPPLIERS AND MATERIALS
The principal components used in our products are active and inactive
pharmaceutical ingredients and packaging materials. We manufacture many of our
own finished products at plants in Corona, California; Miami, Florida; Salt Lake
City, Utah and Copiague, New York. We also contract with third parties for the
manufacture of a number of our finished products. Some of the materials we use
in manufacturing products in our own facilities, and some of the finished
products that are manufactured by others (including certain products that have
historically accounted for a significant portion of our revenues) are currently
available only from sole or limited suppliers.
The FDA (and in some cases, other regulatory agencies) must approve the
vendors who supply us with certain raw materials or finished products and these
third-party manufacturers are also required by FDA regulations to follow cGMP.
Accordingly, we are dependent upon our contract manufacturers to comply with
such requirements or similar standards imposed by foreign regulators. Our
arrangements with foreign suppliers are subject to certain additional risks,
including the availability of government clearances, export duties, political
instability, currency fluctuations and restrictions on the transfer of funds.
In the event an existing supplier should lose its regulatory status as an
approved source, we would attempt to locate a qualified alternative; however, we
may be unable to obtain the required components or products on a timely basis or
at commercially reasonable prices. From time to time, certain of our outside
suppliers have experienced regulatory or supply-related difficulties that have
inhibited their ability to deliver products to us. To the extent such
difficulties cannot be resolved within a reasonable time, and at reasonable
cost, the resulting delay could have a material adverse effect on the company.
For example, at the time we acquired the rights to Dilacor XR(R), we
entered into an agreement with Rhone-Poulenc Rorer, Inc. and its affiliates
(collectively "RPR") whereby RPR agreed to supply us with all of our
requirements for Dilacor XR(R) and its generic equivalent, diltiazem, through
June 2000. For purposes of this supply agreement, RPR designated Centeon LLC as
its contract manufacturer, and agreed to remain fully liable for Centeon's
performance. In August 1998, Centeon ceased manufacturing operations after an
FDA inspection and has not manufactured Dilacor XR(R) or diltiazem since that
date. RPR/Centeon was our sole source for these products. During 1999, we worked
with the FDA to secure the release of the remaining Dilacor XR(R) and diltiazem
inventory from Centeon. However, RPR's ongoing supply interruptions caused us to
be unable to fulfill customer orders, which contributed to materially lower
sales of these products in 1999.
In March 2000, we entered into an agreement with another pharmaceutical
manufacturer to secure an alternate supply source for Dilacor XR(R), under that
manufacturer's ANDA approval. Due to RPR's failure to provide us with a reliable
source of product, customers who had purchased generic diltiazem from us are now
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purchasing such product from our competitors. Although we have negotiated a new
supply agreement for Dilacor XR(R), under the pricing structure in that
agreement, it will not be commercially practicable to obtain generic diltiazem
from that manufacturer. Upon exhaustion of our nominal existing inventory, we do
not anticipate any further sales of generic diltiazem. Due to RPR's failures to
fulfill its contractual obligations to us, we have filed a lawsuit against RPR
seeking, among other things, damages and injunctive relief. (See "Item 3. Legal
Proceedings.")
PATENTS AND PROPRIETARY RIGHTS
We believe patent protection of our proprietary products is important to
our business. Our success with our brand name products will depend in part on
our ability to obtain and maintain patent or other proprietary protection for
such products. We currently have a number of U.S. and foreign patents issued and
pending. However, the issuance of a patent is not conclusive as to its validity
or as to the enforceable scope of the claims of the patent. Accordingly, our
patents may not prevent other companies from developing similar or functionally
equivalent products or from successfully challenging the validity of our
patents. Hence, if our patent applications are not approved or, even if
approved, if such patents are circumvented or successfully challenged in court,
our ability to competitively exploit our patented products and technologies may
be significantly diminished.
From time to time, we may need to obtain licenses to patents and other
proprietary rights held by third parties to develop, manufacture and market our
products. If we are unable to obtain these licenses on commercially reasonable
terms, our ability to commercially exploit such products may be inhibited or
prevented.
We also rely on trade secrets and proprietary know-how that we seek to
protect, in part, through confidentiality agreements with our partners,
customers, employees and consultants. It is possible these agreements will be
breached or will not be enforceable in every instance, and we will not have
adequate remedies for any such breach. It is also possible our trade secrets
will otherwise become known or independently developed by competitors.
Watson may find it necessary to initiate litigation to enforce its patent
rights, to protect its trade secrets or know-how or to determine the scope and
validity of the proprietary rights of others. Litigation concerning patents,
trademarks, copyrights and proprietary technologies can often be protracted and
expensive and, as with litigation generally, the outcome is inherently
uncertain.
Pharmaceutical companies with patented brand name products are increasingly
suing companies that produce generic products for alleged patent and/or
copyright infringement or other violations of intellectual property rights which
may delay or prevent the entry of such a generic product into the market. Since
a large part of our business involves the development and marketing of generic
products, there is a significant risk brand product manufacturers may sue us for
alleged patent, trademark and/or copyright infringement or other alleged
violations of intellectual property rights.
For example, most (if not all) of the brand name products for which we are
developing off-patent versions are, or have been, covered by one or more
patents. Under the Drug Price Competition and Patent Restoration Act of 1984
(the "Hatch-Waxman Amendments"), when we file an ANDA for a generic drug, we
must certify to the FDA as to whether we believe any listed unexpired patents
covering the relevant brand-name product will be infringed by our product. If we
certify to the FDA that our product does not infringe any listed patent, or any
such unexpired patent is invalid or unenforceable, it is referred to as a
"Paragraph IV Certification". In such cases, the certification must be provided
to the patent holder, who may then challenge our Paragraph IV Certification by
filing a lawsuit for patent infringement. If a lawsuit is filed within 45 days
from the day the patent holder received the Paragraph IV Certification, the FDA
is prohibited from approving the ANDA for 30 months or until the suit is
litigated, whichever is sooner. If a patent holder commences a lawsuit like
this, the outcome of such litigation is difficult to predict due to the
uncertainties inherent in litigation.
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Litigation alleging infringement of patents, copyrights or other
intellectual property rights may be costly and time consuming, and could result
in a substantial delay or prevention of the introduction of Watson's products,
any of which could have a material adverse effect on our business, financial
condition or results of operations.
For example, in August 1999, we began shipping a new product, nicotine
polacrilex gum, which is the generic equivalent to SmithKline Beecham Consumer
Healthcare's Nicorette(R) Gum and is used as an aid to smoking cessation.
Shortly after product launch, SmithKline Beecham filed a lawsuit against Watson
alleging the user guide and audiocassette we had packaged with our gum product
infringed upon their copyrights. (See "Item 3. Legal Proceedings.")
GOVERNMENT REGULATION
All pharmaceutical manufacturers, including Watson, are subject to
extensive, complex and evolving regulation by the federal government,
principally the FDA, and to a lesser extent, by the U.S. Drug Enforcement
Administration and state government agencies. The Federal Food, Drug and
Cosmetic Act, the Controlled Substances Act and other federal statutes and
regulations govern or influence the testing, manufacturing, packing, labeling,
storing, record keeping, safety, approval, advertising, promotion, sale and
distribution of the company's products.
We are subject to the periodic inspection of our facilities, procedures and
operations and/or the testing of our products by the FDA, the Drug Enforcement
Administration and other authorities, which conduct periodic inspections to
confirm we are in compliance with all applicable regulations. In addition, the
FDA conducts pre-approval and post-approval reviews and plant inspections to
determine whether our systems and processes are in compliance with cGMP and
other FDA regulations. Among other things, the FDA may withhold approval of
NDAs, ANDAs or other product applications of a facility if deficiencies are
found at that facility. Certain of our vendors are subject to similar regulation
and periodic inspections.
Following such inspections, the FDA may issue notices on Form 483 and
Warning Letters that could cause us to modify certain activities identified
during the inspection. A Form 483 notice is generally issued at the conclusion
of an FDA inspection and lists conditions the FDA inspectors believe may violate
cGMP or other FDA regulations. FDA guidelines specify that a Warning Letter is
issued only for violations of "regulatory significance" for which the failure to
adequately and promptly achieve correction may be expected to result in an
enforcement action.
Failure to comply with FDA and other governmental regulations can result in
fines, unanticipated compliance expenditures, recall or seizure of products,
total or partial suspension of production and/or distribution, suspension of the
FDA's review of NDAs, ANDAs or other product applications, enforcement actions,
injunctions and criminal prosecution. Under certain circumstances, the FDA also
has the authority to revoke previously granted drug approvals. Although we have
internal compliance programs, if these programs do not meet regulatory agency
standards or if our compliance is deemed deficient in any significant way, it
could have a material adverse effect on the company.
In connection with an FDA inspection of the company's Corona, California
facility in December 1998, the FDA issued a Warning Letter to the company in
January 1999. The Warning Letter related to our quality systems and cGMP
compliance, including areas such as documentation, training and laboratory
controls. The FDA conducted additional inspections of our Corona facility in the
first and fourth quarters of 1999. At the close of each of these inspections,
the FDA issued a Form 483 notice listing observations made during those
inspections. The observations from the first quarter inspection generally
related to our quality systems and cGMP compliance, including areas such as
laboratory controls, documentation, investigations, training, data review, and
validation. The observations from the fourth quarter inspection generally
related to our quality systems and cGMP compliance, including areas such as
training and documentation.
The company has initiated and continues to implement quality improvements
at its Corona facility. Among other things, these quality improvements seek to
address deficiencies noted by the FDA in the Warning Letter and the Form 483
notices. However, to date, matters with the agency concerning our Corona
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facility continue to be unresolved. We cannot predict what the ultimate outcome
will be or when product approvals from our Corona facility will be forthcoming.
In this regard, we have not received any product approvals from our Corona
facility within the last 12 months. Resolution of these matters with the FDA has
been and will continue to be a top priority for us.
In connection with a January 1999 inspection of our Miami, Florida
facility, the FDA issued a Warning Letter to Watson in April 1999. In that
Warning Letter, the agency commented that observations about inadequate
investigations, documentation and training had appeared in past inspection
reports (although the FDA acknowledged a number of these had occurred prior to
our purchase of the Miami facility in 1997). The FDA conducted a follow-up
inspection of our Miami facility in the first quarter of 2000. At the close of
this inspection, the FDA issued a Form 483 notice listing observations that
related to our quality systems and cGMP compliance, including areas such as
validation and investigations. The company has initiated and continues to
implement quality improvements at its Miami facility.
Based on the follow-up inspection conducted in the first quarter 2000, the
Florida District Office of the FDA has recommended to the FDA's Center for Drug
Evaluation and Research (CDER) approval of pending ANDAs from our Miami
facility. The Florida District Office found that sufficient corrections have
been made to now recommend approval of Watson's ANDAs. The recommendation of the
Florida District Office is not binding on CDER since final action on product
applications is the responsibility of CDER. We cannot predict whether or when
CDER will approve our pending applications from our Miami facility. However,
CDER has approved one ANDA from our Miami facility since the time the Florida
District Office made its approval recommendation.
Medicaid, Medicare and other reimbursement legislation or programs govern
reimbursement levels, and require all pharmaceutical manufacturers to rebate a
percentage of their revenues arising from Medicaid-reimbursed drug sales to
individual states. The required rebate is currently 11% of the average wholesale
price for sales of Medicaid-reimbursed products marketed under ANDAs. For sales
of Medicaid-reimbursed products marketed under NDAs, manufacturers are required
to rebate the greater of approximately 15% of the average wholesale price or,
the difference between the average net sales price and the lowest net sales
price during a specified period. We believe that the federal and/or state
governments may continue to enact measures in the future aimed at reducing the
cost of drugs to the public. For example, over the past year, the extension of
prescription drug coverage to all Medicare recipients has gained support among
many federal legislators. We cannot predict the nature of any measures that may
be enacted, or their impact on our profitability.
Federal, state and local laws of general applicability, such as laws
regulating working conditions, also govern Watson. In addition, we are subject,
as are all manufacturers generally, to various federal, state and local
environmental protection laws and regulations, including those governing the
discharge of material into the environment. We do not expect the costs of
complying with such environmental provisions to have a material effect on our
earnings, cash requirements or competitive position in the foreseeable future.
However, changes to, or compliance with, such environmental provisions could
have a material effect on our earnings, cash requirements or competitive
position.
Continuing studies of the proper utilization, safety, and efficacy of
pharmaceuticals and other health care products are being conducted by industry,
government agencies and others. Such studies, which increasingly employ
sophisticated methods and techniques, can call into question the utilization,
safety and efficacy of previously marketed products and in some cases have
resulted, and may in the future result, in the discontinuance of their
marketing.
SEASONALITY
The company's business, taken as a whole, is not materially affected by
seasonal factors.
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EMPLOYEES
As of December 31, 1999, the company had approximately 1,950 full-time
employees, none of whom are represented by labor unions. Of the company's
employees, approximately 245 are engaged in research and development, 750 in
manufacturing, 190 in quality assurance and quality control, 600 in sales and
marketing, and 165 in administration. We believe our relations with our
employees are good.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements concerning future events or
performance of Watson. You should not rely excessively on these forward-looking
statements, because they are only predictions based on our current expectations
and assumptions. Forward-looking statements often contain words like "estimate,"
"anticipate," "believe" or "expect." Many known and unknown risks and
uncertainties could cause our actual results to differ materially from those
indicated in these forward-looking statements.
For example, this report describes the company's overall strategy of
increasing emphasis on the development of proprietary (i.e., branded) drugs
because management believes those drugs offer higher margins than generic drugs.
With these potentially higher rewards, however, also come higher risks. The
company has less experience in the proprietary drug area than it does in
generics, and a variety of risk factors may cause actual results to differ from
the projection of greater reliance on branded drugs and resulting higher profit
margins. These include, but are not limited to, the following: (i) competition
from competitors' products which treat the same symptoms or illnesses may
diminish the availability of higher margins, even while expenses increase
because the costs of developing branded products (or buying the rights to
established branded products) is generally higher than it is for generics; (ii)
it is generally more difficult to obtain FDA regulatory approval for new drugs
as opposed to generic equivalents of existing approved drugs, and such approvals
cannot be predicted with any assurance; (iii) while new drugs are subject to
rigorous clinical trials prior to FDA approval, a number of recent cases have
shown that unanticipated harmful effects from new drugs can come to light even
after FDA approval, with resulting product recalls and product liability suits;
these risks are probably higher for new drugs as opposed to generics, because
with generics there will generally be a longer history of human use of the
underlying chemical compound; and (iv) to a degree, the company's strategy is
focussed on the acquisition of new branded products, and such acquisition
candidates may not be available, or may only be available at premium prices
which would enhance the risk associated with the company's strategy.
In addition, this report states that Watson currently has approximately 20
product submissions on file with the FDA, and that we intend to increase the
number of submissions in the near future. While Watson hopes to obtain approval
for the applications already on file and for those which it anticipates filing,
this expectation depends, among other things, on no unexpected problems arising
in the course of product development and on the company's ongoing relationship
with the FDA. An ongoing positive relationship with the FDA is important to
achieving the company's goals. As discussed within, the company received Warning
Letters in January and April 1999 and Form 483 notices after subsequent FDA
inspections. Although the company's quality improvement initiatives seek to
address the deficiencies noted by the FDA in the Warning Letters and Form 483
notices, the company cannot guarantee it will be successful in these efforts.
Matters with the FDA related to the company's Corona facility continue to be
unresolved; and only very recently has the FDA's Florida District Office
recommended approval of the company's pending product applications from its
Miami facility. Consequently, it is difficult, if not impossible, to predict how
the FDA will treat the company and its product approval requests in the future.
Furthermore, as evidenced by the lawsuit filed against the company by
SmithKline Beecham regarding the company's generic nicotine polacrilex gum, a
certain amount of litigation risk is inherent in the company's business, and
this is probably going to increase as the company introduces generic products
that challenge established branded franchises and moves increasingly into the
branded area. In either case, the company's actual or potential competitors
(many of which have financial resources greater than the company's) are likely
to respond vigorously to the threat of competition. Litigation is inherently
uncertain and it is difficult, if not
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impossible, to predict the multitude of potential outcomes that could arise in
the course of current or future litigation, but some of those outcomes could be
adverse to the company and they could be material.
This report also describes the reorganization of the company's sales
forces. While management believes this reorganization offers potential future
benefits, a reorganization may be accompanied by the loss of valued personnel
and/or a "learning curve" cost as personnel lose time in the field to be trained
on new products and begin selling products with which they are less familiar.
These are not all the risks associated with Watson's forward-looking
statements or an investment in Watson stock. Generally, such risks and
uncertainties include 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.
Therefore, the company wishes to caution each reader of this report to
consider carefully these factors as well as the specific factors that may be
discussed with each forward-looking statement in this report or disclosed in the
company's other filings with the SEC as such factors, in some cases, could
affect the ability of the company to implement its business strategy and may
cause actual results to differ materially from those contemplated by the
statements expressed herein. The company does not undertake to publicly update
or revise any of its forward-looking statements even if experience or future
changes show that the indicated results or events will not be realized.
ITEM 2. PROPERTIES
We conduct our operations using a combination of owned and leased
properties. We believe that these facilities are well maintained and in good
condition. Our owned properties consist of facilities used for research and
development, manufacturing, warehouse, distribution and administrative
functions. These properties are located in Corona, California; Miami, Florida;
Salt Lake City, Utah; Copiague, New York; and Dayton, Ohio and total
approximately 670,000 square feet. Outside of the United States, we own a 10,000
square foot raw material processing facility in Coleraine, Northern Ireland and
a majority interest in a 90,000 square foot pharmaceutical facility located in
Changzhou City, People's Republic of China.
Properties that we lease are located throughout the United States and
include a distribution center, research and development, manufacturing, sales
and marketing and administrative facilities. These leased properties total
approximately 470,000 square feet and are subject to lease terms that expire
between 2000 and 2005. In addition, a 40-year lease on approximately seven acres
of land will expire in 2033. Many of these leases have renewal options available
to us. We have also leased a 32,000 square foot manufacturing facility in Corona
through 2001 from a related party trust.
We believe that we have sufficient facilities to conduct our operations
during 2000. However, we continue to evaluate the purchase or lease of
additional properties, as our business requires.
ITEM 3. LEGAL PROCEEDINGS
Beginning in late 1997, a number of product liability suits were filed
against the company, Rugby Laboratories, Inc., and certain other company
affiliates, as well as numerous other manufacturing defendants, for personal
injuries allegedly arising out of the use of phentermine hydrochloride. The
plaintiffs allege various injuries, ranging from minor injuries and anxiety to
heart damage and death. As of March 15, 2000,
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approximately 1,400 cases have been filed against the company and its affiliates
in numerous state and federal courts. Most of the cases involve multiple
plaintiffs, and several were filed or certified as class actions. The company
believes that it will be fully indemnified by 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
matters as the indemnifying party under its agreements with the company.
Additionally, the company may have recourse against the manufacturing defendants
in these cases.
In November 1997, a suit was filed against Royce, Watson and several other
corporations (Michael D. Hardy, Individually and Michael D. Hardy as Executor of
the Estate of Judith Marie Hardy v. Royce Laboratories, Inc., et. al.) in the
Western District of Kentucky at Louisville. The suit alleged that the
plaintiff's wife suffered personal injuries as a result of her June 1995
ingestion of the drug quinine sulfate for leg cramps, and further injuries
leading to her June 1997 death due to another ingestion of the same drug in
April 1997. In February 2000, the parties entered into a confidential settlement
agreement, the terms of which will not have a material effect on the company's
results of operations for first quarter 2000, and the suit was dismissed with
prejudice.
On August 4, 1999, Watson Laboratories, Inc. filed suit in the United
States District Court for the Central District of California against Rhone
Poulenc Rorer, Inc. and certain of its affiliates (collectively "RPR") (Watson
Laboratories, Inc. v. Rhone-Poulenc Rorer, Inc., et. al.). Watson Laboratories,
Inc. filed a first amended complaint on November 4, 1999. The suit seeks
unspecified damages, restitution and injunctive relief to enjoin RPR and its
successors from producing or selling products in the United States that compete
with the company's Dilacor XR(R) product or its generic equivalent. The suit
contends that the announced plans to combine RPR with HMR, which sells
Cardizem(R) CD, a product that competes with the company's Dilacor(R) XR
product, would constitute a breach of the agreements entered into by RPR and
Watson Laboratories, Inc. in connection with the company's June 1997 acquisition
of certain worldwide rights to the Dilacor(R) XR product and its generic
equivalent. The complaint also seeks unspecified damages and injunctive relief
from RPR for unfair competition and breach of contract arising, in part, from
RPR's failure to fulfill its supply obligations to the company for the Dilacor
XR(R) product and its generic equivalent. On September 9, 1999, RPR filed a
separate action against the company and certain of its affiliates for
declaratory relief. On November 22, 1999, the court granted the company's motion
to dismiss the RPR action. On November 29, 1999, RPR answered the company's
first amended complaint, denying its material allegations, and filed a
counterclaim for declaratory relief. The counterclaim seeks a declaration that
the agreements between Watson and RPR will not be violated if Cardizem(R) CD is
produced or sold by a corporate entity "upstream" of Rhone Poulenc Rorer, Inc.
It also seeks a determination that if the merger between Rhone Poulenc S.A. and
Hoechst A.G. (the parent companies of RPR and HMR) would implicate the
non-compete provision, RPR could avoid a breach by committing to divest
Cardizem(R) CD within 12 months of the merger. On January 10, 2000, the company
responded to the counterclaim, denying its material allegations. The company
intends to vigorously prosecute the action to enforce its rights.
On August 26, 1999, a suit was filed against the company and certain of its
subsidiaries (SmithKline Beecham Consumer Healthcare LP v. Watson
Pharmaceuticals, et. al.) in the United States District Court for the Southern
District of New York. The suit alleges that the User Guide and Audiocassette
included with the company's nicotine polacrilex gum product infringe SmithKline
Beecham's copyrights. The User Guide and Audiocassette are included with the
product as part of the product labeling. On September 10, 1999, the court issued
a preliminary injunction enjoining the company, during the pendency of the
lawsuit, from selling or shipping its nicotine polacrilex gum with a User Guide
or Audiocassette that is "strikingly or substantially similar" to SmithKline
Beecham's User Guide or Audiocassette. The court also ordered the company to
recall any product it had previously shipped to customers. On October 5, 1999,
the court stayed all further proceedings in the action (other than the
injunction) for 45 days so that the company could seek FDA approval of revised
labeling. The FDA thereafter approved the company's revised labeling, and on
December 22, 1999, the District Court granted the company's request to dissolve
the injunction to permit the company to sell its nicotine gum with the revised
labeling. On December 22, 1999, SmithKline Beecham appealed the District Court's
ruling to the U.S. Court of Appeals for the Second Circuit, and, on December 28,
1999, obtained a stay of the District Court's decision to dissolve the
injunction pending the
17
<PAGE> 20
appeal. The appeal has been briefed and argued by the parties, and the matter
has been submitted to the Court of Appeals for decision. The company believes it
has substantial meritorious defenses to the claims and intends to vigorously
defend the action.
On June 9, 1999, a suit was filed against the company (William Higuchi and
Setsuko Higuchi v. Watson Pharmaceuticals, Inc.) in the United States District
Court for the District of Utah. The plaintiffs allege that they were holders of
TheraTech, Inc. stock certificates and were entitled to receive company stock
certificates free of any restrictive legends in connection with the company's
acquisition of TheraTech. The complaint contends, among other things, that the
company breached its obligation to the plaintiffs by initially issuing company
stock certificates that contained restrictive legends and by unreasonably
delaying issuance of certificates without restrictive legends, during which time
the trading prices of the company's stock declined. The complaint includes
various tort and contract claims, and seeks consequential damages of
approximately $11,500,000 and punitive damages. On December 7, 1999, the court
granted in part and denied in part the company's motion to dismiss the
complaint, and denied the plaintiffs' motion for partial summary judgment. On
January 21, 2000, the company responded to the complaint, denying its material
allegations. The company believes it has substantial meritorious defenses to the
plaintiffs' claims and intends to vigorously defend the action. The company also
believes that, to the extent liability exists, if at all, the company may be
entitled to indemnification and/or contribution from third parties.
In October 1999, the company's subsidiary, Watson Laboratories,
Inc. -- Ohio, filed an ANDA application seeking approval from the FDA to market
a sustained release formulation of bupropion hydrochloride, the generic
equivalent of Glaxo Wellcome, Inc.'s Wellbutrin(R) SR. The company notified
Glaxo Wellcome pursuant to the provisions of the Hatch-Waxman Act and, on
December 2, 1999, Glaxo Wellcome filed a patent infringement action against the
company's subsidiary (Glaxo Wellcome, Inc. v. Watson Laboratories, Inc. -- Ohio)
in the United States District Court for the Southern District of Ohio. The
complaint alleges two counts of patent infringement. The plaintiff seeks to
prevent the company from marketing its sustained release bupropion hydrochloride
until certain U.S. patents expire. On February 22, 2000, the company's
subsidiary responded to the complaint, denying its material allegations, and
asserted counterclaims against Glaxo Wellcome for declaratory relief and unfair
competition. On March 13, 2000, Glaxo Wellcome responded to the company's
counterclaims, denying their material allegations. The company believes there
are substantial meritorious defenses to the plaintiff's claims. The company
intends to vigorously defend the action against it and to prosecute its
counterclaims to enforce the company's rights.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the company's fiscal year ended December 31, 1999.
18
<PAGE> 21
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
Below are the company's executive officers as of March 30, 2000.
<TABLE>
<CAPTION>
NAME AGE PRINCIPAL POSITION WITH REGISTRANT
---- --- ----------------------------------
<S> <C> <C>
Allen Y. Chao, Ph.D. 54 Chairman, Chief Executive Officer and
President
Michael E. Boxer 38 Senior Vice President and Chief Financial
Officer
Charles D. Ebert, Ph.D. 46 Senior Vice President, Proprietary Research
and Development
Robert C. Funsten 40 Senior Vice President, General Counsel and
Secretary
David C. Hsia, Ph.D. 55 Senior Vice President, Scientific Affairs
and Generic Drug Development
G. Frederick Wilkinson 43 Chief Operating Officer and Senior Vice
President, Sales and Marketing
</TABLE>
ALLEN Y. CHAO, PH.D., age 54, a co-founder of the company, has been
Chairman of the company since May 1996, Chief Executive Officer of the company
since 1985 and President of the company since February 1998. Dr. Chao also
serves on the Board of Directors of Somerset. Dr. Chao served as Director of
Pharmaceutical Technology and Packaging Development at Searle Laboratories, Inc.
from September 1979 to August 1983, where he had overall responsibility for new
product implementation and new pharmaceutical technology development. He
received a Ph.D. in industrial and physical pharmacy from Purdue University in
1973.
MICHAEL E. BOXER, age 38, has served as Senior Vice President and Chief
Financial Officer since June 1999; previously he served as Chief Financial
Officer of the company since July 1998. Before joining Watson, Mr. Boxer was
President of The Enterprise Group, a financial advisory firm, which provided
consulting services to the company. From 1991 to 1997, he was Vice President of
the Health Care Group at Furman Selz, LLC, a New York-based investment bank.
While at Furman Selz, Mr. Boxer participated in Watson's public financings and
its acquisition of Oclassen Pharmaceuticals, Inc. Mr. Boxer received a M.B.A.
from the University of Chicago in 1991.
CHARLES D. EBERT, PH.D., age 46, has served as Senior Vice President,
Proprietary Research and Development of the company since June 1999. Previously
he served TheraTech as Senior Vice President, Research and Development since
1992, and as Vice President, Research and Development from 1987 to 1992. Prior
to joining TheraTech, he was Director of Research and Development at Cygnus
Therapeutic Systems from 1986 to 1987 where he directed the development of
transdermal products. From 1984 to 1986, he was Senior Research Scientist and
Manager in the Systems Development Group of Ciba-Geigy Corporation, responsible
for the development of new transdermal, gastrointestinal and mucosal drug
delivery systems. Dr. Ebert received his B.S. in Biology from the University of
Utah in 1977 and his Ph.D. in Pharmaceutics from the University of Utah in 1981.
ROBERT C. FUNSTEN, age 40, has served as Senior Vice President, General
Counsel and Secretary of the company since June 1999. Previously, Mr. Funsten
was the Vice President, General Counsel and Secretary of the company from
December 1998 to June 1999, and was Vice President, Legal Affairs of the company
from July 1998 to December 1998. Before joining the company, Mr. Funsten was the
Vice President and General Counsel of Chiron Vision Corporation, an ophthalmic
surgical device company, from August 1995 to June 1998 and previously served as
its Vice President and Corporate Counsel from November 1993 to August 1995.
Prior to joining Chiron Vision Corporation, Mr. Funsten was in private practice
at Stradling, Yocca, Carlson & Rauth. Mr. Funsten received a J.D. from Stanford
School of Law in 1986.
DAVID C. HSIA, PH.D., age 55, has served as Watson's Senior Vice President,
Scientific Affairs and Generic Drug Development since May 1995 and has been a
Vice President of Watson since 1985. Dr. Hsia is also co-founder of the company.
He has been involved in the development of pharmaceutical formulations for oral
contraceptives, sustained-release products and novel dosage forms. Dr. Hsia
received a Ph.D. in industrial and physical pharmacy from Purdue University in
1975. Dr. Hsia is Dr. Chao's brother-in-law.
19
<PAGE> 22
G. FREDERICK WILKINSON, age 43, has been Chief Operating Officer and Senior
Vice President, Sales and Marketing of the company since June 1999. Previously,
Mr. Wilkinson was Vice President of Watson Pharmaceuticals, Inc. since July
1997, and Executive Vice President -- Sales & Marketing of Watson Laboratories,
Inc. since July 1996. Mr. Wilkinson also serves as a director of Somerset. Prior
to his employment with Watson, Mr. Wilkinson was the President and General
Manager of Creighton Pharmaceuticals, a wholly owned subsidiary of Sandoz
Pharmaceuticals, Inc. ("Sandoz") from 1994 to 1996. Prior to that, he held
various marketing management positions at Sandoz since 1980. Mr. Wilkinson
received his M.B.A. from Capital University in 1984 and his B.S. in Pharmacy
from Ohio Northern University in 1979.
The executive officers of the company are appointed annually by the Board
of Directors, hold office until their successors are chosen and qualify, and may
be removed at any time by the affirmative vote of a majority of the Board. The
company has employment agreements with each of the executive officers. David C.
Hsia is the brother-in-law of Allen Y. Chao. There are no other family
relationships between any director and executive officer of the company.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the New York Stock Exchange under the symbol
"WPI". The following table sets forth the quarterly high and low share price
information for the periods indicated:
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
Year ended December 31, 1998
First quarter.............................................. $42.94 $30.50
Second quarter............................................. 49.50 36.25
Third quarter.............................................. 52.88 40.25
Fourth quarter............................................. 63.00 42.00
Year ended December 31, 1999
First quarter.............................................. $62.94 $37.06
Second quarter............................................. 47.50 30.50
Third quarter.............................................. 40.31 28.00
Fourth quarter............................................. 43.31 26.50
</TABLE>
As of March 15, 2000, we estimate that there were approximately 90,000
holders of our common stock, including those who held in street or nominee name.
We have not paid any cash dividends since our initial public offering in
February 1993, and do not anticipate paying any cash dividends in the
foreseeable future.
20
<PAGE> 23
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA(1)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENTS:
Net revenues........................................... $689,232 $596,193 $362,221 $258,347 $193,258
Cost of sales.......................................... 230,633 210,405 131,037 107,157 84,003
-------- -------- -------- -------- --------
Gross profit.................................. 458,599 385,788 231,184 151,190 109,255
-------- -------- -------- -------- --------
Royalty income......................................... -- -- 14,249 27,162 22,247
-------- -------- -------- -------- --------
Operating expenses:
Research and development............................. 49,270 50,706 35,007 40,981 44,521
Selling, general and administrative.................. 121,444 109,347 60,967 46,599 43,692
Amortization......................................... 29,986 22,469 7,213 386 306
Merger and related expenses(2)....................... 20,467 -- 14,718 -- 13,939
Charge for acquired in-process research and
development(3)..................................... -- 13,000 -- -- --
-------- -------- -------- -------- --------
Total operating expenses...................... 221,167 195,522 117,905 87,966 102,458
-------- -------- -------- -------- --------
Operating income.............................. 237,432 190,266 127,528 90,386 29,044
-------- -------- -------- -------- --------
Other income (expense):
Equity in earnings (loss) of joint ventures.......... (2,591) 6,788 10,694 17,909 22,766
Gain on sales of securities(4)....................... 44,275 -- -- -- 6,243
Interest and other income............................ 4,549 8,011 13,511 11,935 8,634
Interest expense..................................... (11,121) (8,136) (1,284) (1,527) (1,480)
-------- -------- -------- -------- --------
Total other income, net....................... 35,112 6,663 22,921 28,317 36,163
-------- -------- -------- -------- --------
Income before income tax provision............ 272,544 196,929 150,449 118,703 65,207
Provision for income taxes............................. 93,663 78,247 54,799 35,521 21,267
-------- -------- -------- -------- --------
Net income.................................... $178,881 $118,682 $ 95,650 $ 83,182 $ 43,940
======== ======== ======== ======== ========
Basic earnings per share............................... $ 1.87 $ 1.25 $ 1.03 $ 0.92 $ 0.50
======== ======== ======== ======== ========
Diluted earnings per share............................. $ 1.83 $ 1.22 $ 1.01 $ 0.89 $ 0.48
======== ======== ======== ======== ========
Basic weighted average shares outstanding.............. 95,760 94,745 92,525 90,430 88,585
======== ======== ======== ======== ========
Diluted weighted average shares outstanding............ 97,780 97,425 95,115 93,830 91,135
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
AT DECEMBER 31,
------------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Current assets.................................. $ 434,711 $ 322,794 $278,910 $357,184 $258,841
Working capital................................. 305,525 219,841 171,659 315,977 210,265
Total assets.................................... 1,438,750 1,131,343 820,476 531,423 419,315
Long-term debt.................................. 149,503 151,083 9,857 8,725 10,278
Liabilities-acquired rights and businesses...... 55,507 53,420 98,800 3,800 3,800
Deferred tax liabilities........................ 87,060 54,512 36,887 12,226 --
Total stockholders' equity...................... 1,054,552 799,355 612,202 463,852 354,743
</TABLE>
- ---------------
(1) The company merged with Circa Pharmaceuticals, Inc. in 1995, with Oclassen
Pharmaceuticals, Inc. and with Royce Laboratories, Inc. in 1997 and with
TheraTech, Inc. in 1999. These transactions were all accounted for under the
pooling of interests accounting method, and accordingly, the consolidated
financial data includes the results of these businesses for all periods
presented.
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 prior periods
have been restated to reflect the stock split.
(2) Merger expenses of $13.9 million in 1995, $14.7 million in 1997, and $20.5
million in 1999 relate to the company's acquisitions of Circa, Oclassen,
Royce and TheraTech, as discussed in (1) above.
(3) The charge for acquired in-process research and development relates to the
company's February 1998 acquisition of The Rugby Group, Inc. This charge is
discussed further in Note 2 to the consolidated financial statements.
(4) In November 1999, the company sold 1.1 million shares of Andrx Corporation
and recorded a gain of $44.3 million from this sale. At December 31, 1999,
the company owned approximately 5 million shares of Andrx. In 1995, the
company recorded a gain of $6.2 million from sales of common stock of Marsam
Pharmaceuticals, Inc. The company has had no investment in Marsam since
1995.
21
<PAGE> 24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the company's financial condition and results
of operations should be read in conjunction with the company's consolidated
financial statements and notes thereto included elsewhere in this report. As
more fully described in Note 2 of the company's consolidated financial
statements, we accounted for the January 1999 acquisition of TheraTech under the
pooling-of-interests method. Accordingly, we have restated this discussion and
the consolidated financial statements for all periods presented to include the
accounts and results of operations of TheraTech.
Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. Such risks and uncertainties are discussed under the caption
"Forward-Looking Statements" in Item 1 of this Form 10-K.
GENERAL
Watson is a diversified specialty pharmaceutical company that develops,
manufactures and markets branded and off-patent pharmaceutical products. From
our incorporation in 1985 until 1996, our business was primarily engaged in the
development, manufacturing and marketing of off-patent versions of branded
pharmaceutical products. While our off-patent business remains an integral
component of our overall business strategy, beginning in 1996, we invested
significantly in branded pharmaceutical businesses and products. We believe that
branded pharmaceutical products generally offer stronger proprietary positions
and provide more consistent profit margins than off-patent products. Through
internal product development and acquisitions, we intend to continue to expand
our portfolios of both branded and off-patent pharmaceutical products.
ACQUISITIONS OF PRODUCTS AND BUSINESSES
1999 acquisition of TheraTech, Inc. -- In January 1999, we completed the
acquisition of TheraTech (also referred to as Watson-Utah). TheraTech is a
drug-delivery company that develops, manufactures and markets innovative
products based on its patented and proprietary technologies and systems. Under
the terms of the merger agreement, we converted each share of TheraTech common
stock into the right to receive 0.2663 of a share of Watson's common stock. In
exchange for all of the outstanding shares of TheraTech, we issued approximately
5.8 million Watson common shares having a market value of approximately $330
million on the date of acquisition. We accounted for this acquisition as a
pooling of interests and it qualified as a tax-free merger for federal income
tax purposes.
During the first quarter of 1999, the company recorded a special charge of
$20.5 million for certain merger and related expenses of the TheraTech
acquisition. 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). The eliminated operations were not
significant to the company. The $9.4 million of closure costs consisted of
employee termination costs ($3.9 million), non-cash facility shutdown and asset
impairment costs ($4.2 million) and lease and contract termination costs ($1.3
million). As of December 31, 1999, we had paid all material merger-related costs
and charged off all applicable assets.
1999 acquisitions of transdermal systems product rights -- In May 1999, we
reacquired the U.S. and Canadian rights to the Androderm(R) testosterone
transdermal system from SmithKline Beecham for $24.5 million in cash. In
addition, we reacquired the marketing and distribution rights for the Alora(R)
estradiol transdermal system from Procter & Gamble in October 1999 for
approximately $37.5 million in cash. In connection with the Alora(R)
acquisition, we also reacquired rights to an estradiol and progestin combination
patch product for certain future contingent payments aggregating $37.5 million
payable upon FDA approval of a pending new drug application.
Acquisitions of oral contraceptive products from G.D. Searle & Co. -- In
October 1997, we acquired the U.S. rights to certain existing and future Searle
branded off-patent oral contraceptive products. For the existing products
acquired in 1997, we made cash payments of $85 million and $51.5 million to
Searle in 1997
22
<PAGE> 25
and 1998, respectively. Under the terms of this agreement, we exercised our
right to acquire two additional oral contraceptives, Ogestrel(R) and
Low-Ogestrel(R), during 1999. For the 1999 product acquisitions, we made cash
payments aggregating $33.8 million to Searle and agreed to certain contingent
payments based on the technology transfer and net aggregate annual sales of
certain of the acquired products. We entered into supply agreements with Searle
whereby we have the right to purchase these products from Searle through October
2001 and, for some products, beyond.
Under a separate agreement with Searle, in November 1998, we acquired the
U.S. rights to three other oral contraceptive products for $120 million in cash.
We entered into a supply agreement allowing us to purchase these products in
finished form from Searle for two years and in bulk form for an additional
one-year period.
1998 acquisition of The Rugby Group, Inc. -- In February 1998, the company
acquired Rugby from Hoechst Marion Roussel, Inc. Rugby developed, manufactured,
and marketed a wide array of off-patent pharmaceutical products. We accounted
for this acquisition as a purchase and Rugby's results of operations are
included in our consolidated financial statements from the date of acquisition
forward. In this acquisition, we recorded a charge of $13 million for acquired
in-process research and development. See Note 2 to the consolidated financial
statements for a further discussion of this charge. Watson acquired Rugby's
abbreviated new drug applications, its sales and marketing operations for U.S.
off-patent and over-the-counter pharmaceutical products, its product development
group and its product development pipeline. The company paid approximately $67.5
million in cash at closing and agreed to a contingent payment, due in March
2000, based on future sales and operating results. The total contingent amount
payable to Hoechst Marion Roussel is estimated to be $19.8 million. In the
fourth quarter of 1999, when we achieved the agreed-upon sales and operating
results, we recorded the contingent payment as an addition to the cost of the
Rugby acquisition.
1997 acquisition of product rights to Dilacor XR(R) -- In June 1997, the
company acquired from Rhone-Poulenc Rorer, Inc. and its affiliates (collectively
"RPR") the exclusive U.S. and certain worldwide marketing, sales and
distribution rights to Dilacor XR(R) for $190 million in cash and future
royalties. Dilacor XR(R) is indicated for the treatment of hypertension and
chronic stable angina. Prior to this acquisition, the company had a royalty
agreement with RPR for RPR's sales of Dilacor XR(R). In the year ended December
31, 1997, through the date of the acquisition, Watson earned royalties of $14.2
million under the terms of this royalty agreement.
The company has agreements with RPR whereby RPR agreed to supply Watson
with all of its requirements for Dilacor XR(R) and its generic equivalent
through June 2000. However, RPR's designated contract manufacturer, Centeon LLC,
ceased operations in August 1998 after an FDA inspection and has not
manufactured any Dilacor XR(R) or its generic equivalent since that time. During
1999, we obtained intermittent releases of these products from the inventories
that existed at the time of the production shutdown, and have recently received
all remaining inventories from Centeon. These supply interruptions adversely
impacted our 1999 sales of Dilacor XR(R) and its generic equivalent.
Sales of these products, which aggregated approximately $50 million in
1999, will be nominal in 2000 until an alternate supply source is established.
In March 2000, we entered into an agreement with another pharmaceutical
manufacturer to secure an alternate supply source for Dilacor XR(R), under that
manufacturer's ANDA approval. We expect to receive our first shipment of Dilacor
XR(R) from our new supplier during the second quarter of 2000. Under the terms
of the new supply agreement, Watson will pay a higher price for the Dilacor
XR(R) product, and will therefore realize lower gross margins, than under the
RPR agreement. Due to the pricing structure in the new agreement, it will not be
commercially practicable to obtain generic diltiazen from our new supplier. Upon
exhausting our nominal existing inventory, we do not anticipate any further
sales of generic diltiazen.
1997 acquisition of Royce Laboratories, Inc. -- In April 1997, the company
acquired Royce by issuing approximately 5.2 million shares of its common stock
having a market value of approximately $100 million at the date of acquisition.
Royce developed and manufactured off-patent prescription drugs in solid dosage
forms (tablets and capsules). We accounted for the acquisition as a pooling of
interests and it qualified as a tax-free merger for federal income tax purposes.
23
<PAGE> 26
1997 acquisition of Oclassen Pharmaceuticals, Inc. -- In February 1997, we
acquired Oclassen by issuing approximately 6.6 million shares of our common
stock having a market value of approximately $135 million at the date of
acquisition. The acquisition was accounted for as a pooling of interests and
qualified as a tax-free merger for federal income tax purposes. Oclassen
marketed dermatology products used to prevent and treat skin diseases.
SIGNIFICANT INVESTMENTS AND JOINT VENTURES
Somerset joint venture -- The company owns 50% of the outstanding shares of
Somerset Pharmaceuticals, Inc., which markets a single product, Eldepryl(R),
used for the treatment of Parkinson's disease. Somerset continues to develop
additional indications for selegiline (the active compound of Eldepryl(R)),
using a transdermal delivery system. Watson recorded a loss of $2.9 million in
1999 and equity in earnings from this joint venture of $7.4 million in 1998 and
$12.7 million in 1997. Somerset's 1999 loss was primarily due to increased
competition in the market for Eldepryl(R) and additional research and
development spending to develop alternative indications for Eldepryl(R). The
company expects that Somerset will continue to experience losses in near-term
future periods and that the loss recorded by the company will increase in 2000.
Investment in Andrx -- In 1994 and through June 1999, we acquired common
shares of Andrx Corporation (Nasdaq:ADRX), a drug-delivery company utilizing
controlled-release technologies to develop oral pharmaceutical products.
Following the June 1999 exercise of a warrant to acquire 0.7 million Andrx
shares, we owned approximately 6.1 million shares of Andrx common stock. In
November 1999, Watson sold approximately 1.1 million Andrx shares for $54.6
million, and recorded a gain of $44.3 million. At December 31, 1999, the company
owned approximately 5 million Andrx shares, or approximately 15.8% of the total
Andrx shares outstanding. In 2000, through March 15, 2000, we sold an additional
2.1 million Andrx shares, reducing our ownership to 9.1% of the total Andrx
shares outstanding. (See "Item 7A. Quantitative and Qualitative Disclosures
About Market Risk" for further discussion.)
QUARTERLY FLUCTUATIONS
Our quarterly earnings have fluctuated in the past, and may continue to
fluctuate. We believe such fluctuations are primarily due to new product
introductions and to a variety of additional factors including, but not limited
to, the sales mix between branded and generic products, the purchasing practices
of our customers, market acceptance of our products, the impact of competitive
products and pricing and the timeliness with which regulatory authorizations and
product roll-out may be achieved. Other factors include the timing of research
and development projects, developments, both positive and adverse in our
relations with regulators, principally the FDA, the results of operations
reported for our joint venture interests, including Somerset, gains on security
sales and charges for merger and related expenses.
24
<PAGE> 27
CONSOLIDATED STATEMENTS OF INCOME
The following table presents the company's consolidated statements of
income, which have been restated to reflect the acquisition of TheraTech, in
thousands of dollars and as percentages of net revenues:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------
1999 1998 1997
---------------- ---------------- ----------------
$ % $ % $ %
-------- ----- -------- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C>
Net revenues............................ $689,232 100.0% $596,193 100.0% $362,221 100.0%
Cost of sales........................... 230,633 33.5 210,405 35.3 131,037 36.2
-------- ----- -------- ----- -------- -----
Gross profit....................... 458,599 66.5 385,788 64.7 231,184 63.8
-------- ----- -------- ----- -------- -----
Royalty income.......................... -- -- -- -- 14,249 3.9
-------- ----- -------- ----- -------- -----
Operating expenses:
Research and development.............. 49,270 7.1 50,706 8.5 35,007 9.7
Selling, general and administrative... 121,444 17.6 109,347 18.3 60,967 16.7
Amortization.......................... 29,986 4.4 22,469 3.8 7,213 2.0
Merger and related expenses........... 20,467 3.0 -- -- 14,718 4.1
Charge for acquired in-process
research and development........... -- -- 13,000 2.2 -- --
-------- ----- -------- ----- -------- -----
Total operating expenses...... 221,167 32.1 195,522 32.8 117,905 32.5
-------- ----- -------- ----- -------- -----
Operating income...................... 237,432 34.4 190,266 31.9 127,528 35.2
-------- ----- -------- ----- -------- -----
Other income (expense):
Equity in earnings (loss) of joint
ventures........................... (2,591) (0.4) 6,788 1.1 10,694 3.0
Gain on sales of Andrx securities..... 44,275 6.4 -- -- -- --
Interest and other income............. 4,549 0.7 8,011 1.3 13,511 3.7
Interest expense...................... (11,121) (1.6) (8,136) (1.3) (1,284) (0.4)
-------- ----- -------- ----- -------- -----
Total other income, net....... 35,112 5.1 6,663 1.1 22,921 6.3
-------- ----- -------- ----- -------- -----
Income before income tax provision.... 272,544 39.5 196,929 33.0 150,449 41.5
Provision for income taxes.............. 93,663 13.5 78,247 13.1 54,799 15.1
-------- ----- -------- ----- -------- -----
Net income............................ $178,881 26.0% $118,682 19.9% $ 95,650 26.4%
======== ===== ======== ===== ======== =====
</TABLE>
YEAR ENDED DECEMBER 31, 1999 COMPARED TO 1998
Net revenues for the year ended December 31, 1999 were $689.2 million
compared to $596.2 million for the year ended December 31, 1998, an increase of
$93 million or 16%. This revenue growth was attributable to increased sales of
branded products, primarily our core brand products and women's health products
acquired in the fourth quarter of 1998. These sales increases were partially
offset by lower sales of Dilacor XR(R) and its generic equivalent, diltiazem,
due to continuing supply interruptions at Watson's third party supplier. We
believe that sales of these products, which aggregated approximately $50 million
in 1999, will be nominal in 2000 until an alternate supply source is
established. In March 2000, we entered into an agreement with another
pharmaceutical manufacturer to secure an alternate supply source for Dilacor
XR(R). We expect to receive our first shipment of Dilacor XR(R) from our new
supplier during the second quarter of 2000.
Our overall sales of generic products were lower in 1999 compared to 1998.
This was primarily the result of our phasing-out a number of Rugby products from
the product line beginning in mid-1998, reduced sales of diltiazem as discussed
previously, and increased price competition in 1999. In the full year of 1999,
branded products accounted for approximately 53% of net product sales, compared
to approximately 42% in 1998. Our gross profit margin on product sales increased
to 65% in 1999 from 63% in 1998, largely due to the higher margins typically
generated by branded products. In 2000, we expect the overall sales mix of
branded and generic products to approximate the 1999 mix.
Research and development expenses decreased to $49.3 million in 1999 from
$50.7 million in 1998. This decrease was due to a combination of efficiencies
realized upon consolidation of the Watson-Utah proprietary
25
<PAGE> 28
drug development program into the company-wide program during 1999, as well as
timing differences among the various development projects between the two years.
Selling, general and administrative expenses increased to $121.4 million in
1999 from $109.3 million in 1998. Selling and marketing expenses accounted for
most of the increase, while general and administrative costs were essentially
flat year over year. The company incurred higher personnel-related expenses in
1999 due to the expansion of its proprietary products sales force. During 1999,
we added new sales force personnel in the women's health and general products
sales groups. In addition, we increased promotional spending in support of the
women's health products acquired in the fourth quarter of 1998.
Amortization expense increased to $30 million in 1999 from $22.5 million in
1998 due primarily to our acquisition of certain women's health products in the
fourth quarter of 1998 and the 1999 purchases of Androderm(R) and Alora(R)
transdermal products.
During the first quarters of 1999 and 1998, the company recorded
non-recurring charges related to its acquisitions of TheraTech and Rugby,
respectively. In the TheraTech acquisition, we recorded a special charge of
$20.5 million for merger and related expenses. This 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).
The eliminated operations were not significant to the company. The $9.4 million
of closure costs consisted of employee termination costs ($3.9 million),
non-cash facility shutdown and asset impairment costs ($4.2 million) and lease
and contract termination costs ($1.3 million). As of December 31, 1999, we had
paid all material merger-related costs and charged off all applicable assets. In
the first quarter of 1998, we recorded a non-recurring charge of $13 million for
in-process research and development costs associated with our acquisition of
Rugby.
In 1999, we incurred a net loss of $2.6 million from our joint ventures,
primarily due to the pass-through of Somerset's 1999 loss. The equity in
earnings from these joint ventures was $6.8 million in 1998. Somerset's 1999
loss resulted from increased competition in the market for Eldepryl(R)
(Somerset's sole product) and increased research and development spending by
Somerset to develop alternative indications for selegiline (the active compound
of Eldepryl(R)). The company expects that Somerset will continue to experience
losses in near-term future periods and that the loss recorded by the company
will increase in 2000.
In November 1999, we sold approximately 1.1 million common shares of our
investment in Andrx. The company recognized a gain of $44.3 million from these
sales. At December 31, 1999, we owned 5 million Andrx shares, which was
approximately 15.8% of the total Andrx common shares outstanding at that date.
Interest and other income decreased to $4.5 million in 1999 from $8 million
in 1998 because cash, cash equivalents and marketable securities were higher in
1998 following our issuance of $150 million of senior unsecured notes in May
1998. Interest expense increased in 1999 as these senior notes were outstanding
for the full year.
The provision for income taxes of $93.7 million for 1999 reflects an
overall tax rate of 34%, while the $78.2 million provision for 1998 reflects an
overall rate of 40%. The lower effective tax rate in 1999 is primarily
attributable to June 1999 changes in income tax regulations relating to the
"separate return limitation year" ("SRLY") limitations on the use of acquired
net operating loss carryforwards. Previously, we had maintained a valuation
allowance against certain deferred tax assets related to acquired net operating
loss carryforwards because of uncertainty as to their future realization under
the SRLY limitations. With the June 1999 change in the SRLY rules, management
determined that those carryforwards would be realized. Therefore, we have
reversed the related valuation allowance and reduced our 1999 income tax
provision by $9.8 million. Based on the tax year in which these carryforwards
will be deductible, $4.1 million of that total was recorded as a one-time
reduction in income tax expense during second quarter 1999, and the remaining
$5.7 million was recognized through a reduction in the company's effective tax
rate during the final three quarters of 1999. In addition, approximately $2.8
million of valuation allowance was released during 1999, when the company
determined that the deferred tax assets to which it had related would be
realized.
26
<PAGE> 29
YEAR ENDED DECEMBER 31, 1998 COMPARED TO 1997
Net revenues for the year ended December 31, 1998 were $596.2 million
compared to $362.2 million for the year ended December 31, 1997, an increase of
$234 million or 65%. This sales increase was due primarily to increased sales of
certain core off-patent and branded products and higher sales of off-patent
products obtained through the Rugby acquisition. In addition, we experienced
increased sales of branded products, primarily as a result of the Dilacor XR(R)
acquisition in June 1997 and the purchase of Searle oral contraceptive products
in October 1997. In 1998, branded products accounted for approximately 42% of
net product sales, compared to approximately 45% in 1997. Our gross profit
margin on product sales was unchanged at 63% in these two years.
The company earned royalties of $14.2 million in 1997 from Rhone-Poulenc
Rorer's sales of Dilacor XR(R). Subsequent to Watson's June 1997 purchase of the
Dilacor XR(R) product rights, no further royalties were earned.
Research and development expenses increased to $50.7 million in 1998 from
$35 million in 1997. This increase was due primarily to the 1998 acquisition of
Rugby's off-patent product development group and increased spending by Watson's
and TheraTech's existing development groups.
Selling, general and administrative expenses increased to $109.3 million in
1998 from $61 million in 1997. The increase consists of a $38.5 million increase
in sales and marketing expenses and a $9.8 million increase in general and
administrative costs. The increased sales and marketing expenses were primarily
the result of increased sales force personnel costs, advertising and other
promotional expenses incurred in support of the company's branded products.
General and administrative costs increased during 1998 as a result of increased
staffing in certain administrative areas to support the company's growth. As a
percentage of net revenues, general and administrative costs decreased to 4.8%
in 1998 from 5.2% in 1997.
Amortization expense increased to $22.5 million in 1998 from $7.2 million
in 1997 due to product right acquisitions (Dilacor XR(R) and Searle oral
contraceptive products) and goodwill recorded in the Rugby acquisition.
In connection with the acquisition of Rugby during the first quarter of
1998, the company recorded a special charge of $13 million for the write-off of
in-process research and development associated with Rugby's wholly owned
subsidiary, Chelsea Laboratories, Inc. Watson, in conjunction with an
independent valuation firm, based this charge on an assessment of the value of
purchased research and development at Rugby. This charge is discussed further in
Note 2 to the consolidated financial statements. No such charge was incurred in
1997.
In 1997, the company recorded one-time charges aggregating $14.7 million
for costs incurred in connection with the mergers of Royce and Oclassen. These
costs included investment banking fees and other merger-related expenses.
Equity in earnings from joint ventures decreased $3.9 million to $6.8
million in 1998 from $10.7 million in 1997, due primarily to lower earnings from
Somerset. The decrease in Somerset earnings is due in part to increased
competition with respect to Eldepryl(R) (Somerset's sole product) and increased
research and development spending in support of various clinical trials.
Investment and other income decreased to $8 million in 1998 from $13.5
million in 1997 due to lower average cash and marketable securities balances in
1998. The lower average cash and marketable securities balances in 1998 were due
to the company's acquisition-related activities.
Interest expense during 1998 increased to $8.1 million from $1.3 million in
1997 as a result of the company's $150 million senior debt issuance in May 1998.
These notes have a stated annual interest 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 $78.2 million in 1998, compared
to $54.8 million in 1997. The effective income tax rate was 40% and 36% for the
years ended December 31, 1998 and 1997, respectively. The increase in the
company's effective income tax rate was due primarily to the non-
27
<PAGE> 30
deductibility for income tax purposes of the $13 million in-process research and
development charge incurred as a result of Watson's acquisition of Rugby.
LIQUIDITY AND CAPITAL RESOURCES
The company's working capital increased to $305.5 million at December 31,
1999 from $219.8 million at December 31, 1998. This $85.7 million increase was
primarily due to Watson's net income for the year ended December 31, 1999, the
growth during 1999 in accounts receivable and inventory balances, primarily due
to Year 2000 ("Y2K") issues as discussed below, and proceeds from the sale of
approximately 1.1 million shares of Andrx. These working capital increases were
partially offset by cash used for the acquisition of product rights during 1999,
purchases of property and equipment and a scheduled first quarter 1999 payment
related to the acquisition of Dilacor XR(R). Due to Y2K-related concerns on the
part of both our customers and ourselves, we granted extended payment terms to
certain customers during the second half of 1999 and also increased our own raw
materials inventories. During 2000, we expect our accounts receivable and
inventory balances to return to levels that are more consistent with historic
trends.
In 1999, we spent $105.8 million to acquire product rights to certain
women's health products and to reacquire the product rights to the Androderm(R)
and Alora(R) transdermal products. The company's 1999 investment in property and
equipment amounted to $26.8 million and consisted primarily of additions to
buildings and manufacturing equipment. We expect to spend approximately $50
million in property and equipment additions during 2000.
In April 1998, the company filed a registration statement (also known as a
shelf offering) 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, through this shelf
offering, we issued $150 million of 7 1/8% senior unsecured notes. These senior
notes are due May 2008, with interest payable semi-annually in May and November.
Subject to preparation of a current prospectus, the balance of this shelf
offering remains available for issuance at the company's discretion. In
addition, the company has a credit facility available through January 2001 that
provides for unsecured borrowing commitments totaling $30 million. To date, we
have made no borrowings under this facility.
As discussed previously, in 1999 we sold approximately 1.1 million shares
of Andrx common stock. In 2000, through March 15, 2000, we sold an additional
2.1 million Andrx shares at significant gains and received proceeds of
approximately $180 million from these sales. We may sell additional shares in
first quarter 2000 and beyond.
The company's cash and marketable securities totaled approximately $116
million at December 31, 1999. We believe that our cash and marketable securities
balance, plus cash flow from operations, will be sufficient to meet our normal
operating requirements during the next twelve months.
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. We could use cash and financing sources
discussed in this MD&A, or financing sources that subsequently become available,
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.
We do not believe that inflation has had a significant impact on the
company's revenues or operations.
YEAR 2000 COMPLIANCE PROGRAM
The Y2K issue arises because some computer systems and programs may be
unable to properly recognize and process dates beyond December 31, 1999 and may
consequently fail or produce erroneous data. We instituted a multi-phase Y2K
Compliance Program beginning in 1998 to minimize the possibility of serious Y2K
disruptions. Since beginning the year 2000, we have not experienced any major
disruptions to our business, nor are we aware of any significant Y2K-related
disruptions experienced by our customers or suppliers. Although we do not
anticipate any significant Y2K-related disruptions, either internally or from
the
28
<PAGE> 31
activities of our suppliers or customers, we will continue to monitor our
critical systems over the next several months.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The company's investment in Andrx comprised 5 million common shares, with a
fair market value of $210.6 million at December 31, 1999. The Andrx common stock
has exposure to price risk as this investment is a publicly traded equity
security, the market price of which has been, and may continue to be, volatile.
The following table sets forth the Andrx quarterly high and low share market
price information, based on published financial sources, for 1999 and 1998
(adjusted for Andrx' June 1999 two-for-one stock split):
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1999, BY QUARTER
First.............................................. $46.25 $22.25
Second............................................. 78.00 30.82
Third.............................................. 78.00 57.13
Fourth............................................. 58.00 38.50
1998, BY QUARTER
First.............................................. $19.13 $12.25
Second............................................. 21.32 14.07
Third.............................................. 21.50 12.94
Fourth............................................. 24.94 12.32
</TABLE>
Substantially all of the company's cash, cash equivalents and marketable
securities are at fixed interest rates and, as such, the fair value of these
instruments is affected by changes in market interest rates. However, 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 believes that the fair value of its fixed-rate long-term
debt approximated its carrying value of approximately $150 million at December
31, 1999. While changes in market interest rates may affect the fair value of
the company's long-term debt, management believes the effect, if any, of
reasonably possible near-term changes in the fair value of such debt on the
company's financial condition, results of operations or cash flows will not be
material. The company has no material foreign exchange or commodity price risks.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is contained in the financial
statements set forth in Item 14(a) under the caption "Consolidated Financial
Statements" as a part of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on
accounting or financial disclosure matters.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The information concerning directors of the company required under this
Item is incorporated herein by reference from the company's definitive proxy
statement, filed pursuant to Regulation 14A, related to the Registrant's 2000
Annual Meeting of Stockholders to be held on May 9, 2000 (the "2000 Proxy
Statement").
29
<PAGE> 32
EXECUTIVE OFFICERS
The information concerning executive officers of the company required under
this Item is provided under Item 4A of this report.
ITEM 11. EXECUTIVE COMPENSATION
The information required under this Item is incorporated herein by
reference from the company's 2000 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this Item is incorporated herein by
reference from the company's 2000 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this Item is incorporated herein by
reference from the company's 2000 Proxy Statement.
30
<PAGE> 33
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. CONSOLIDATED FINANCIAL STATEMENTS
The following are included herein under Item 8:
Reports of Independent Accountants.
Consolidated Balance Sheets as of December 31, 1999 and 1998.
Consolidated Statements of Income for each of the three years in the
period ended December 31, 1999.
Consolidated Statements of Stockholders' Equity for each of the three
years in the period ended December 31, 1999.
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1999.
Notes to Consolidated Financial Statements.
(a)2. FINANCIAL STATEMENT SCHEDULES:
None. All financial statement schedules are omitted because they are not
applicable or the required information is included in the Consolidated Financial
Statements or notes thereto.
(a)3. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
2.1 Agreement and Plan of Merger, among Watson Pharmaceuticals,
Inc. (the "Company"), TheraTech, Inc. and the Jazz Merger
Corp. dated as of October 23, 1998, is incorporated by
reference to Appendix A of the Proxy Statement/ Prospectus
included in the Registration Statement on Form S-4 (Reg. No.
333-68007) dated November 25, 1998.
3.1 Articles of Incorporation of the Company, and all amendments
thereto, are incorporated by reference to Exhibit 3.1 to the
Company's June 30, 1995 Form 10-Q and to Exhibit 3.1(A) to
the Company's June 30, 1996 Form 10-Q.
3.2 The Company's By-laws, as amended as of December 11, 1998,
are incorporated by reference to Exhibit 3.2 to the
Company's Registration Statement on Form S-8 (Reg. No.
333-70933), filed on January 19, 1999.
4.1 Trust Indenture dated May 18, 1998 between the Company and
First Union National Bank, as Trustee for the issuance of
the Company's Senior Unsecured Notes, is incorporated by
reference to Exhibit 4.1 to the Company's Registration
Statement on Form S-3/A (Reg. No. 333-49079), filed on April
30, 1999.
4.2 Credit Agreement dated February 3, 1999 between the Company
and Mellon Bank N.A. is incorporated by reference to Exhibit
4.2 to the Company's 1998 Form 10-K. Amendment Number One to
Credit Agreement dated February 2, 2000 is filed herewith.
10.1 Lease between Westgate Associates and the Company dated
October 1991, and addendums thereto, are incorporated by
reference to Exhibit 10.5 to the Company's Registration
Statement on Form S-1, Reg. No. 33-46229 ("33-46229").
10.2 Industrial Real Estate Lease, with addendum, dated December
23, 1985, between His-Hsiung Hsu Hwa Chao (Chao Family)
Trust I and the Company, is incorporated by reference to
Exhibit 10.6 to 33-46229. Second Amendment thereto dated
August 8, 1995 is incorporated by reference to Exhibit 10.1
to the Company's September 30, 1995 Form 10-Q. Third
Amendment thereto dated August 31, 1998 is incorporated by
reference to Exhibit 10.3 to the Company's 1998 Form 10-K.
</TABLE>
31
<PAGE> 34
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
*10.3 1991 Stock Option Plan of the Company, as revised, is
incorporated by reference to Exhibit 10.1 to the Company's
June 30, 1995 Form 10-Q. Plan amendments are incorporated by
reference to Exhibit 10.6(a) to the Company's June 30, 1996
Form 10-Q and by reference to Exhibit 10.6(a) to the
Company's March 31, 1997 Form 10-Q.
*10.4 1995 Non-Employee Directors' Stock Option Plan, as amended,
is incorporated by reference to Exhibit 10.2 to the
Company's June 30, 1995 Form 10-Q.
*10.5 Form of Key Employee Agreement is incorporated by reference
to Exhibit 10.26 to the Company's June 30, 1999 Form 10-Q.
The Company has entered into a Key Employee Agreement with
each of its executive officers, who include Michael E.
Boxer, Allen Y. Chao, Ph.D., Charles Ebert, Robert C.
Funsten, David C. Hsia, Ph.D. and G. Frederick Wilkinson. A
copy of each of these individual's Key Employee Agreements
will be provided to the Staff upon request.
*10.6 Release, Exit and Consulting Agreement between Alec D. Keith
and the Company, dated July 18, 1996, is incorporated by
reference to Exhibit 10.15 to the Company's September 30,
1996 Form 10-Q.
10.7 Asset Purchase Agreement among the Company, G. D. Searle &
Co. and SCS Pharmaceuticals, dated September 30, 1997, is
incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K dated October 16, 1997.
10.8 Supply Agreement between the Company and G. D. Searle & Co.,
dated October 16, 1997, is incorporated by reference to
Exhibit 10.2 to the Company's Current Report on Form 8-K
dated October 16, 1997.
10.9 Stock Purchase Agreement among the Company, Hoechst Marion
Roussel, Inc. and Marisub, Inc. dated August 25, 1997, filed
as Exhibit 10.27. Amendment dated November 26, 1997 is
incorporated by reference to Exhibit 10.27(a) to the
Company's 1997 Form 10-K. Second Amendment dated February
27, 1998, is incorporated by reference to Exhibit 10.27(b)
to the Company's 1997 Form 10-K.
10.10 Supply and License Agreement by and between Hoechst Marion
Roussel, Inc. and The Rugby Group, Inc. dated February 27,
1998, is incorporated by reference to Exhibit 10.28 to the
Company's 1997 Form 10-K.
10.11 Contract Manufacturing Agreement by and between Hoechst
Marion Roussel, Inc. and The Rugby Group, Inc., dated
February 27, 1998, is incorporated by reference to Exhibit
10.29 to the Company's 1997 Form 10-K.
10.12 Supply Agreement by and between the Company and G. D. Searle
& Co. dated November 18, 1998 is incorporated by reference
to Exhibit 10.2 to the Company's Current Report on Form 8-K
dated November 18, 1998.
10.13 License Agreement between the Company and Rorer
Pharmaceutical Products, Inc., dated June 30, 1997, is
incorporated by reference to Exhibit 10.1 to the Company's
Current Report 8-K dated June 30, 1997.
</TABLE>
32
<PAGE> 35
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
21.1 Subsidiaries of the Company
23.1 Consent of PricewaterhouseCoopers LLP.
23.2 Consent of Ernst & Young LLP.
23.3 Consent of Deloitte & Touche LLP.
27.1 Financial Data Schedule (EDGAR version only).
</TABLE>
- ---------------
* Compensation Plan or Agreement
(b) REPORTS ON FORM 8-K:
No Reports on Form 8-K were filed during the quarter ended December 31,
1999.
33
<PAGE> 36
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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 Y. CHAO
------------------------------------
Allen Y. Chao, Ph.D.
Chairman, Chief Executive Officer
and President
(Principal Executive Officer)
By: /s/ MICHAEL E. BOXER
------------------------------------
Michael E. Boxer
Senior Vice President and Chief
Financial Officer
(Principal Financial Officer)
By: /s/ R. CHATO ABAD
------------------------------------
R. Chato Abad
Vice President -- Finance
(Principal Accounting Officer)
Date: March 30, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ ALLEN Y. CHAO Chairman, Chief Executive March 30, 2000
- -------------------------------------------------------- Officer and President
Allen Y. Chao, Ph.D.
/s/ MICHAEL J. FEDIDA Director March 30, 2000
- --------------------------------------------------------
Michael J. Fedida
/s/ MICHEL J. FELDMAN Director March 30, 2000
- --------------------------------------------------------
Michel J. Feldman
/s/ ALBERT F. HUMMEL Director March 30, 2000
- --------------------------------------------------------
Albert F. Hummel
/s/ ALEC D. KEITH Director March 30, 2000
- --------------------------------------------------------
Alec D. Keith, Ph.D.
/s/ RONALD R. TAYLOR Director March 30, 2000
- --------------------------------------------------------
Ronald R. Taylor
/s/ ANDREW L. TURNER Director March 30, 2000
- --------------------------------------------------------
Andrew L. Turner
/s/ FRED G. WEISS Director March 30, 2000
- --------------------------------------------------------
Fred G. Weiss
</TABLE>
34
<PAGE> 37
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Reports of Independent Accountants.......................... F-2
Consolidated Balance Sheets as of December 31, 1999 and
1998...................................................... F-5
Consolidated Statements of Income for each of the three
years in the period ended December 31, 1999............... F-6
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended December 31, 1999..... F-7
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 1999............... F-8
Notes to Consolidated Financial Statements.................. F-9
</TABLE>
All financial statement schedules are omitted because they are not
applicable or the required information is included in the Consolidated Financial
Statements or notes thereto.
F-1
<PAGE> 38
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Watson Pharmaceuticals, Inc.
In our opinion, based upon our audits and the reports of other auditors,
the accompanying consolidated financial statements listed in the accompanying
index on page F-1 present fairly, in all material respects, the financial
position of Watson Pharmaceuticals, Inc. and its subsidiaries at December 31,
1999 and 1998, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1999 in conformity with
accounting principles generally accepted in the United States. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We did not audit the financial statements of TheraTech, Inc.
(TheraTech), a wholly owned subsidiary, which statements reflect total assets of
$57,690,000 at December 31, 1998, and total net revenues of $40,045,000 and
$38,206,000 for the years ended December 31, 1998 and 1997, respectively. In
addition, we did not audit the financial statements of Somerset Pharmaceuticals,
Inc. (Somerset), an entity which is 50% owned by the Company, as of December 31,
1997 and for the year ended December 31, 1997. The Company's investment in
Somerset aggregated $27,643,000 at December 31, 1997, and its equity in the
earnings of Somerset totaled $12,672,000 for the year ended December 31, 1997.
Those statements were audited by other auditors whose reports thereon have been
furnished to us, and our opinion expressed herein, insofar as it relates to the
amounts included for TheraTech and Somerset, is based solely on the reports of
each of the respective other auditors. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits and the respective reports of other auditors provide a reasonable basis
for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
February 4, 2000
F-2
<PAGE> 39
REPORT OF INDEPENDENT AUDITORS
The Stockholder
TheraTech, Inc.
We have audited the consolidated balance sheet of TheraTech, Inc. and
subsidiaries as of December 31, 1998, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the years ended December
31, 1998 and 1997 (not presented separately herein). These financial statements
are the responsibility of the company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of TheraTech,
Inc. and subsidiaries as of December 31, 1998, and the results of their
operations and their cash flows for the years ended December 31, 1998 and 1997
in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Salt Lake City, Utah
February 5, 1999
F-3
<PAGE> 40
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Somerset Pharmaceuticals, Inc.:
We have audited the consolidated balance sheet of Somerset Pharmaceuticals,
Inc. and subsidiaries as of December 31, 1997, and the related consolidated
statements of income, stockholders' equity, and cash flows for the year then
ended (not presented separately herein). These financial statements are the
responsibility of the company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Somerset
Pharmaceuticals, Inc. and subsidiaries as of December 31, 1997, and the results
of their operations and their cash flows for the year then ended in conformity
with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania
February 4, 1998
F-4
<PAGE> 41
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1999 1998
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 102,057 $ 59,663
Marketable securities..................................... 13,865 32,903
Accounts receivable, net of allowances for doubtful
accounts of $3,375 and $4,150.......................... 180,860 91,329
Inventories............................................... 108,532 81,907
Prepaid expenses and other current assets................. 9,582 27,358
Deferred tax assets....................................... 19,815 29,634
---------- ----------
Total current assets.............................. 434,711 322,794
Property and equipment, net................................. 138,848 125,918
Investments and other assets................................ 291,448 201,080
Product rights and other intangibles, net................... 573,743 481,551
---------- ----------
$1,438,750 $1,131,343
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses..................... $ 56,487 $ 70,730
Income taxes payable...................................... 33,550 --
Current portion of long-term debt......................... 1,691 1,843
Current liability from acquisitions of products and
businesses............................................. 37,458 30,380
---------- ----------
Total current liabilities......................... 129,186 102,953
Long-term debt.............................................. 149,503 151,083
Long-term liability from acquisitions of products and
businesses................................................ 18,049 23,040
Deferred tax liabilities.................................... 87,060 54,512
---------- ----------
Total liabilities................................. 383,798 331,588
---------- ----------
Commitments and contingencies
Minority interest........................................... 400 400
---------- ----------
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; 96,133,200 and 95,312,200 shares
issued................................................. 317 315
Additional paid-in capital................................ 397,705 368,777
Retained earnings......................................... 549,000 370,119
Accumulated other comprehensive income.................... 107,530 60,144
---------- ----------
Total stockholders' equity........................ 1,054,552 799,355
---------- ----------
$1,438,750 $1,131,343
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-5
<PAGE> 42
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Net revenues............................................... $689,232 $596,193 $362,221
Cost of sales.............................................. 230,633 210,405 131,037
-------- -------- --------
Gross profit.......................................... 458,599 385,788 231,184
-------- -------- --------
Royalty income............................................. -- -- 14,249
-------- -------- --------
Operating expenses:
Research and development................................. 49,270 50,706 35,007
Selling, general and administrative...................... 121,444 109,347 60,967
Amortization............................................. 29,986 22,469 7,213
Merger and related expenses.............................. 20,467 -- 14,718
Charge for acquired in-process research and
development........................................... -- 13,000 --
-------- -------- --------
Total operating expenses......................... 221,167 195,522 117,905
-------- -------- --------
Operating income........................................... 237,432 190,266 127,528
-------- -------- --------
Other income (expense):
Equity in earnings (loss) of joint ventures.............. (2,591) 6,788 10,694
Gain on sales of Andrx securities........................ 44,275 -- --
Interest and other income................................ 4,549 8,011 13,511
Interest expense......................................... (11,121) (8,136) (1,284)
-------- -------- --------
Total other income, net.......................... 35,112 6,663 22,921
-------- -------- --------
Income before income tax provision......................... 272,544 196,929 150,449
Provision for income taxes................................. 93,663 78,247 54,799
-------- -------- --------
Net income................................................. $178,881 $118,682 $ 95,650
======== ======== ========
Basic earnings per share................................... $ 1.87 $ 1.25 $ 1.03
======== ======== ========
Diluted earnings per share................................. $ 1.83 $ 1.22 $ 1.01
======== ======== ========
Weighted average shares outstanding, no dilution........... 95,760 94,745 92,525
======== ======== ========
Weighted average shares outstanding, diluted basis......... 97,780 97,425 95,115
======== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-6
<PAGE> 43
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1999 1998 1997
---------- -------- --------
<S> <C> <C> <C>
Common stock -- shares outstanding:
Beginning balance....................................... 95,312 93,479 90,909
Exercise of options and warrants........................ 821 1,833 2,570
---------- -------- --------
Ending balance.......................................... 96,133 95,312 93,479
========== ======== ========
Common stock -- amount:
Beginning balance....................................... $ 315 $ 308 $ 300
Exercise of options and warrants........................ 2 7 8
---------- -------- --------
Ending balance.......................................... 317 315 308
---------- -------- --------
Additional paid-in capital:
Beginning balance....................................... 368,777 327,432 300,576
Exercise of options and warrants........................ 16,933 27,593 16,018
Tax benefits related to exercise of stock options....... 12,125 13,593 10,882
Other................................................... (130) 159 (44)
---------- -------- --------
Ending balance.......................................... 397,705 368,777 327,432
---------- -------- --------
Retained earnings:
Beginning balance....................................... 370,119 251,437 155,787
Net income.............................................. 178,881 118,682 95,650
---------- -------- --------
Ending balance.......................................... 549,000 370,119 251,437
---------- -------- --------
Accumulated other comprehensive income:
Beginning balance....................................... 60,144 33,025 7,189
Other comprehensive income.............................. 47,386 27,119 25,836
---------- -------- --------
Ending balance.......................................... 107,530 60,144 33,025
---------- -------- --------
Total stockholders' equity...................... $1,054,552 $799,355 $612,202
========== ======== ========
Comprehensive income:
Net income.............................................. $ 178,881 $118,682 $ 95,650
---------- -------- --------
Other comprehensive income, net of tax:
Unrealized holding gains on securities............... 75,412 27,119 25,836
Reclassification for gains included in net income.... (28,026) -- --
---------- -------- --------
Other comprehensive income.............................. 47,386 27,119 25,836
---------- -------- --------
Comprehensive income.................................... $ 226,267 $145,801 $121,486
========== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-7
<PAGE> 44
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1999 1998 1997
-------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $178,881 $ 118,682 $ 95,650
-------- --------- ---------
Reconciliation to net cash provided by operating activities:
Depreciation.............................................. 14,022 12,708 10,438
Amortization.............................................. 29,986 22,469 7,213
Charge for acquired in-process research and development... -- 13,000 --
Deferred income tax (benefit) provision................... (3,026) 1,593 (1,563)
Dividends received from Somerset.......................... -- -- 8,000
Equity in loss (earnings) of joint ventures............... 3,051 (5,706) (9,012)
Provision for (recovery of) doubtful accounts and
allowances.............................................. 1,029 762 (66)
Tax benefits related to exercise of options............... 12,125 13,593 10,882
Gain on sales of Andrx securities......................... (44,275) -- --
Other..................................................... 812 667 333
Changes in assets and liabilities, net of acquisitions:
Accounts receivable..................................... (90,428) (17,061) (32,254)
Royalty receivable...................................... -- -- 5,554
Inventories............................................. (26,625) (18,607) (15,091)
Prepaid expenses and other current assets............... 27,463 (12,327) 6,249
Accounts payable and accrued expenses................... (14,243) 412 10,955
Income taxes payable.................................... 33,550 (9,553) 9,081
Other................................................... 915 _(1,981) __(2,155)
-------- --------- ---------
Total adjustments..................................... (55,644) (31) 8,564
-------- --------- ---------
Net cash provided by operating activities............. 123,237 118,651 104,214
-------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment....................... (26,771) (27,219) (16,318)
Purchases of marketable securities........................ (55,061) (77,880) (142,776)
Proceeds from maturities of marketable securities......... 74,711 84,262 185,227
Acquisitions of product rights............................ (105,825) (177,322) (146,587)
Acquisition of business................................... -- (71,559) --
Proceeds from sales of Andrx securities................... 54,580 -- --
Investment in Andrx....................................... (3,000) -- (15,307)
Additions to investment in joint ventures................. (4,173) (10,207) (5,804)
-------- --------- ---------
Net cash used in investing activities............... $(65,539) $(279,925) $(141,565)
-------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt.................. $ -- $ 148,418 $ --
Principal payments on long-term debt...................... (1,732) (7,231) (3,566)
Payments on liability for acquisition of product rights... (30,380) (45,000) (55,000)
Proceeds from issuance of common stock.................... -- -- 1,396
Proceeds from exercises of stock options and warrants..... 16,808 26,933 15,000
-------- --------- ---------
Net cash (used in) provided by financing activities..... (15,304) 123,120 (42,170)
-------- --------- ---------
Net increase (decrease) in cash and cash equivalents.... 42,394 (38,154) (79,521)
Cash and cash equivalents at beginning of year.............. 59,663 97,817 177,338
-------- --------- ---------
Cash and cash equivalents at end of year.................... $102,057 $ 59,663 $ 97,817
======== ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the years for:
Interest.................................................. $ 11,010 $ 5,895 $ 335
Income taxes.............................................. $ 42,875 $ 82,915 $ 36,735
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Acquisitions of product rights:
Fair value of assets acquired........................... $ -- $ -- $(296,587)
Fair value of liabilities assumed....................... -- -- 150,000
-------- --------- ---------
Net cash paid........................................... $ -- $ -- $(146,587)
======== ========= =========
Acquisition of business:
Fair value of assets acquired........................... $ 31,465 $ (97,323) $ --
Fair value of liabilities assumed....................... (31,465) 25,764 --
-------- --------- ---------
Net cash paid........................................... $ -- $ (71,559) $ --
======== ========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
F-8
<PAGE> 45
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of business and principles of consolidation
Watson Pharmaceuticals, Inc. ("Watson" or the "company") is engaged in the
development, production, marketing and distribution of branded and off-patent
pharmaceutical products. The consolidated financial statements include the
accounts of wholly owned and majority-owned subsidiaries after elimination of
intercompany accounts and transactions. Watson operates in a single reportable
business segment, pharmaceutical products.
Investments are accounted for under the equity method when the company can
exert significant influence and ownership does not exceed 50% (primarily
Somerset Pharmaceuticals, Inc. and ANCIRC). Investments in which the company
owns less than a 20% interest and does not exert significant influence are
generally accounted for at fair value as available-for-sale securities
(primarily Andrx Corporation).
The company completed its acquisition of TheraTech, Inc., now known as
Watson Laboratories, Inc. -- Utah ("TheraTech" or "Watson -- Utah") in January
1999, as further discussed in Note 2. This acquisition was accounted for as a
pooling of interests and, accordingly, the accompanying consolidated financial
statements have been restated to reflect the operations of TheraTech for all
periods presented.
Use of estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Cash equivalents and marketable securities
Cash equivalents are highly liquid investments with original maturities of
three months or less at the date of acquisition. Marketable securities consist
primarily of time deposits, commercial paper, U.S. and state and local
government obligations with original maturities between three and twelve months.
Debt securities in which the company has the ability and intent to hold the
security until maturity are classified as held-to-maturity securities. All other
securities are classified as available-for-sale securities. Available-for-sale
securities are recorded at fair value based on quoted market prices. Unrealized
holding gains and losses on available-for-sale securities are excluded from
earnings and are reported as a separate component of accumulated other
comprehensive income, net of applicable income taxes, until realized. Held-
to-maturity securities are recorded at amortized cost, adjusted for the
amortization of premiums or discounts. Realized gains and losses are determined
on the specific identification method and are reported in interest and other
income. Realized gains and losses on cash equivalents and marketable securities
were not material for the three years in the period ended December 31, 1999.
F-9
<PAGE> 46
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The fair value of cash, cash equivalents and marketable securities is
summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
-------- -------
(IN THOUSANDS)
<S> <C> <C>
Available-for-sale:
U.S. government obligations........................... $ 4,950 $14,824
State and local government obligations................ -- 23,143
Corporate and non-government obligations.............. 14,908 7,317
Equity securities..................................... -- 1,500
Money market funds and cash........................... 96,064 37,421
-------- -------
$115,922 $84,205
======== =======
Held-to-maturity:
U.S. government obligations........................... $ -- $ 1,503
Corporate obligations................................. -- 6,858
-------- -------
$ -- $ 8,361
======== =======
</TABLE>
Fair value of other financial instruments
The fair values of the company's accounts receivable, accounts payable,
accrued expenses and long-term debt approximate their carrying values at
December 31, 1999. The fair value of the company's investment in Andrx is based
on quoted market prices at December 31, 1999 and 1998.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or
market.
Property and equipment
Property and equipment are stated at cost, less accumulated depreciation.
Major renewals and improvements are capitalized, while routine maintenance and
repairs are expensed as incurred. At the time properties are retired from
service, the cost and accumulated depreciation are removed from the respective
accounts and the related gains or losses are reflected in income.
Depreciation expense is computed principally on the straight-line basis,
over estimated useful lives of two to ten years for furniture, fixtures and
equipment and twenty to thirty years for buildings and building improvements.
Leasehold improvements are amortized on the straight-line basis over the shorter
of the respective lease terms or the estimated useful life of the assets, and
generally range from five to thirty years.
Product rights and other intangible assets
Product rights are stated at cost, less accumulated amortization, and are
amortized on the straight-line basis over their estimated useful lives ranging
from seventeen to twenty years. Goodwill is amortized on the straight-line basis
over twenty years or less and is primarily related to the company's acquisition
of The Rugby Group, Inc. (Note 2). Other intangible assets are amortized over
their estimated useful lives, using the straight-line method. Total accumulated
amortization related to product rights and other intangible assets was $63.3
million and $39.7 million at December 31, 1999 and 1998, respectively.
F-10
<PAGE> 47
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Potential impairment of long-lived assets
The company annually evaluates its long-lived assets, including product
rights, for potential impairment. When circumstances indicate that the carrying
amount of the asset may not be recoverable, as demonstrated by estimated future
cash flows, an impairment loss would be recorded based on fair value.
Revenue recognition
The company recognizes revenue, net of sales discounts and allowances, from
the sale of its pharmaceutical products upon shipment.
The company has entered into various collaborative research and
development, product licensing and marketing agreements with certain
pharmaceutical and other companies. Research, development and licensing revenues
are recognized as earned based on terms in the specific contracts. Milestone
payments are included in revenues during the period in which the applicable
milestone is achieved.
Sales to major customers
McKesson HBOC, Inc. accounted for 20%, 16% and 11% of the company's net
revenues in 1999, 1998 and 1997, respectively. Bergen Brunswig Corporation
accounted for 12%, 11% and 10% of the company's net revenues in 1999, 1998 and
1997, respectively. Cardinal Health, Inc. accounted for 12% of the company's net
revenues in 1999.
Research and development activities
Research and development activities are expensed as incurred and consist of
self-funded research and development costs and the costs associated with work
performed under collaborative research and development agreements. Research and
development expenses include direct and allocated expenses and exclude
reimbursable general and administrative costs. Research and development expenses
incurred under collaborative agreements were approximately $6.8 million, $11.9
million and $12.6 million for the years ended December 31, 1999, 1998 and 1997,
respectively.
Income taxes
Income taxes are accounted for using an asset and liability approach that
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between the financial statement
and tax bases of assets and liabilities at the applicable tax rates. A valuation
allowance is provided when it is more likely than not that some portion or all
of the deferred tax assets will not be realized.
Earnings per share ("EPS")
Basic EPS is computed by dividing net income by the weighted average number
of common shares outstanding in each year. Diluted EPS is computed by dividing
net income by the weighted average number of common shares outstanding plus any
potential dilution that could occur if options and warrants were converted
F-11
<PAGE> 48
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
into common stock in each year. A reconciliation of the numerators and the
denominators of basic and diluted EPS for the years ended December 31, 1999,
1998, and 1997 is as follows (in thousands, except for EPS):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1999 1998 1997
-------- -------- -------
<S> <C> <C> <C>
Numerator:
Net income................................ $178,881 $118,682 $95,650
======== ======== =======
Denominators:
Denominator for basic EPS, weighted
average shares outstanding............. 95,760 94,745 92,525
Assumed exercise of dilutive stock options
and warrants........................... 2,020 2,680 2,590
-------- -------- -------
Denominator for diluted EPS............... 97,780 97,425 95,115
======== ======== =======
Basic EPS................................... $ 1.87 $ 1.25 $ 1.03
======== ======== =======
Diluted EPS................................. $ 1.83 $ 1.22 $ 1.01
======== ======== =======
</TABLE>
Concentration of credit risk
The company is subject to a concentration of credit risk with respect to
its accounts receivable balance, all of which is due from wholesalers,
distributors, chain drug stores and service providers in the health care and
pharmaceutical industries throughout the United States. At December 31, 1999 and
1998, approximately 54% and 57%, respectively, of the trade receivable balances
represented amounts due from three customers in 1999 and four customers in 1998.
The company performs ongoing credit evaluations of its customers and maintains
reserves for potential uncollectible accounts. Actual losses from uncollectible
accounts have been minimal.
Reclassifications
Certain amounts in the 1998 and 1997 financial statements have been
reclassified to conform with the 1999 presentation. These reclassifications had
no effect on net income or retained earnings.
NOTE 2 -- ACQUISITIONS OF PRODUCTS AND BUSINESSES
1999 acquisition of TheraTech
In January 1999, Watson's acquisition of TheraTech was completed. TheraTech
is a drug-delivery company that develops, manufactures and markets innovative
products based on its patented and proprietary technologies and systems. Under
the terms of the merger agreement, each share of TheraTech common stock was
converted into the right to receive 0.2663 of a share of the company's common
stock. Accordingly, the company issued approximately 5.8 million common shares
having a market value of approximately $330 million on the date of acquisition
in exchange for all the outstanding common shares of TheraTech. The acquisition
qualified as a tax-free merger for federal income tax purposes and was accounted
for as a pooling of interests.
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. 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). The eliminated operations
were not significant to the company. The $9.4 million of closure costs consisted
of employee termination costs ($3.9 million), non-cash facility shutdown and
asset impairment costs ($4.2 million) and lease and contract termination costs
($1.3 million). As of December 31, 1999, the company had paid all material
merger-related costs and charged-off the impaired assets and shutdown
facilities.
F-12
<PAGE> 49
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Combined and separate selected financial data of Watson and TheraTech for
the two years in the period ended December 31, 1998 are summarized as follows
(in thousands):
<TABLE>
<CAPTION>
WATSON THERATECH ADJUSTMENTS COMBINED
-------- --------- ----------- --------
<S> <C> <C> <C> <C>
1998
Net revenues................. $556,148 $40,045 $ -- $596,193
======== ======= ===== ========
Net income (loss)............ $120,829 $(2,147) $ -- $118,682
======== ======= ===== ========
1997
Net revenues................. $324,015 $38,206 $ -- $362,221
======== ======= ===== ========
Net income................... $ 90,184 $ 5,851 $(385) $ 95,650
======== ======= ===== ========
</TABLE>
The separate 1999 operating results of TheraTech, for the period prior to
its acquisition in January 1999, were not material. The combined financial
results of the company and TheraTech include certain reclassifications to
conform the financial statement presentations of the companies.
1999 acquisitions of transdermal systems product rights
In May 1999, Watson reacquired the U.S. and Canadian rights to the
Androderm(R) testosterone transdermal system from SmithKline Beecham for $24.5
million in cash and, in October 1999, reacquired the marketing and distribution
rights for the Alora(R) estradiol transdermal system from Procter & Gamble for
approximately $37.5 million in cash. In connection with the Alora(R)
acquisition, Watson also reacquired rights to an estradiol and progestin
combination patch product for certain contingent payments aggregating $37.5
million payable upon FDA approval of a pending new drug application.
Acquisitions of oral contraceptive products from G. D. Searle & Co.
In October 1997, Watson acquired the U.S. rights to certain existing and
future Searle branded off-patent oral contraceptive products. For the existing
products acquired in 1997, the company made cash payments of $85 million and
$51.5 million to Searle in 1997 and 1998, respectively. Under the terms of this
agreement, Watson exercised its right to acquire two additional oral
contraceptives, Ogestrel(R) and Low-Ogestrel(R), during 1999. For the 1999
product acquisitions, the company made cash payments aggregating $33.8 million
to Searle and agreed to certain contingent payments based on the technology
transfer and net aggregate annual sales of certain of the acquired products.
Watson entered into supply agreements with Searle whereby the company has the
right to purchase these products from Searle through October 2001 and, for some
products, beyond.
Under a separate agreement with Searle, in November 1998, Watson acquired
the U.S. rights to three other oral contraceptive products for $120 million in
cash. The company entered into a supply agreement allowing it to purchase these
products in finished form from Searle for two years and in bulk form for an
additional one-year period.
1998 acquisition of The Rugby Group, Inc.
In February 1998, Watson completed its acquisition of Rugby from Hoechst
Marion Roussel, Inc. Rugby developed, manufactured and marketed a wide array of
off-patent pharmaceutical products. Under the terms of the agreement, the
company acquired Rugby and its abbreviated new drug applications, which included
several licensed products, plus Rugby's sales and marketing operations for U.S.
off-patent and over-the-counter pharmaceutical products. The transaction also
included Rugby's product development group and product development pipeline.
Under the terms of the acquisition agreement, the company paid approximately
$67.5 million in cash at closing and agreed to a contingent payment, due in
March 2000, based on future sales and operating results. The total contingent
amount payable is estimated to be $19.8 million and has been
F-13
<PAGE> 50
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
recorded as an addition to the cost of the Rugby acquisition in the consolidated
balance sheets at December 31, 1999. The excess of the aggregate purchase price
over the fair value of the assets acquired was $45.6 million at December 31,
1999, and is being amortized over 20 years.
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. Under the purchase method of accounting, the
purchase price is generally allocated to the acquired assets and liabilities
based on their estimated fair values at the date of acquisition. However, the
portion of the purchase price allocated to in-process research and development
("IPR&D") is not an asset, but instead, represents the valuation of acquired,
to-be-completed research projects and is charged to expense. The company charged
$13 million of the Rugby purchase price to IPR&D expense in the first quarter of
1998.
1997 acquisition of product rights to Dilacor XR(R)
In June 1997, the company acquired the exclusive U.S. and certain worldwide
marketing, sales, and distribution rights to Dilacor XR(R) from Rhone-Poulenc
Rorer, Inc. and its affiliates (collectively "RPR") for $190 million in cash and
future royalties. Dilacor XR(R) has been available in the U.S. for the treatment
of hypertension since June 1992 and was approved for the treatment of chronic
stable angina in March 1995.
Watson and RPR entered into a supply agreement whereby RPR agreed to supply
Watson with all of its requirements for Dilacor XR(R) and its generic equivalent
through June 2000. However, RPR's designated contract manufacturer ceased
operations in August 1998 after an FDA inspection and has not manufactured any
Dilacor XR(R) or its generic equivalent since that time. During 1999, the
company obtained intermittent releases of these products from the inventories
that existed at the time of the production shutdown and, in late 1999, received
all remaining inventories from RPR's contract manufacturer. Watson is exploring
alternate supply sources for Dilacor XR(R).
1997 acquisition of Royce Laboratories, Inc.
In April 1997, the company acquired Royce by issuing approximately 5.2
million shares of its common stock having a market value of approximately $100
million at the date of acquisition. Royce developed and manufactured off-patent
prescription drugs in solid dosage forms (tablets and capsules). The acquisition
was accounted for as a pooling of interests and the transaction qualified as a
tax-free merger.
1997 acquisition of Oclassen Pharmaceuticals, Inc.
In February 1997, the company acquired Oclassen by issuing approximately
6.6 million shares of its common stock having a market value of approximately
$135 million at the date of acquisition. The acquisition was accounted for as a
pooling of interests for accounting purposes and qualified as a tax-free merger
for federal income tax purposes. Oclassen marketed dermatology products used to
prevent and treat skin diseases.
F-14
<PAGE> 51
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 -- BALANCE SHEET COMPONENTS
Selected balance sheet components consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Inventories:
Raw materials...................................... $ 48,832 $ 25,961
Work-in-progress................................... 13,472 12,728
Finished goods..................................... 46,228 43,218
-------- --------
$108,532 $ 81,907
======== ========
Property and equipment:
Buildings and improvements......................... $ 64,114 $ 58,682
Leasehold improvements............................. 14,596 14,432
Land and land improvements......................... 10,633 9,674
Machinery and equipment............................ 90,065 72,031
Research and laboratory equipment.................. 24,571 20,778
Furniture and fixtures............................. 6,658 4,607
-------- --------
210,637 180,204
Less accumulated depreciation and
amortization.................................. (83,360) (66,926)
-------- --------
127,277 113,278
Construction in progress........................... 11,571 12,640
-------- --------
$138,848 $125,918
======== ========
Accounts payable and accrued expenses:
Trade accounts payable............................. $ 34,464 $ 35,382
Royalties payable.................................. 8,061 8,227
Accrued payroll and benefits....................... 6,827 8,170
Other accrued liabilities.......................... 7,135 18,951
-------- --------
$ 56,487 $ 70,730
======== ========
</TABLE>
NOTE 4 -- INVESTMENTS AND OTHER ASSETS
Investments and other assets consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Long-term investments.................................. $211,895 $138,514
Investments in joint ventures.......................... 40,639 46,232
Long-term deferred tax assets.......................... 25,838 3,610
Other assets........................................... 13,076 12,724
-------- --------
$291,448 $201,080
======== ========
</TABLE>
Long-term investments
Long-term investments consisted primarily of the company's investment in
Andrx Corporation. Andrx is a drug-delivery company utilizing controlled-release
technologies to develop oral pharmaceutical products. Andrx' common stock trades
on the Nasdaq Stock Market under the symbol ADRX. At December 31, 1998,
F-15
<PAGE> 52
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the company owned 5.4 million Andrx common shares (adjusted for a June 1999
two-for-one stock split). In June 1999, the company exercised a warrant to
acquire an additional 0.7 million common shares for $3 million and, in November
1999, sold approximately 1.1 million Andrx shares on the open market for $54.6
million, recording a gain of $44.3 million. At December 31, 1999, the company
owned approximately 5 million of Andrx' common shares, or 15.8% of the total
shares outstanding. The company's unrealized gain on its Andrx investment was
approximately $109 million and $61 million (net of income taxes of approximately
$72 million and $40 million), at December 31, 1999 and 1998, respectively. The
unrealized gain on Andrx is the primary component of accumulated other
comprehensive income in the stockholders' equity section of Watson's
consolidated balance sheets.
Investment in Somerset joint venture
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. The company recorded a loss from Somerset's operations of
$2.9 million in 1999, and recorded earnings from Somerset of $7.4 million and
$12.7 million in 1998 and 1997, respectively. The Somerset joint venture results
reported by Watson consist of 50% of Somerset's earnings and management fees,
offset by the amortization of goodwill. The net excess of the cost of this
investment over the fair value of net assets acquired was $4.5 million and $5.4
million at December 31, 1999 and 1998, respectively. Such goodwill is amortized
on the straight-line basis over 15 years.
In connection with an examination of Somerset's federal income tax returns
for the three years ended December 31, 1995, the Internal Revenue Service, in
June 1997, issued to Somerset a report that contains proposed adjustments to
Somerset's use of tax credits claimed under Internal Revenue Code Section 936.
Under the proposed adjustments, Somerset could be subject to approximately $34
million of additional income taxes and interest charges that have not been
accrued at December 31, 1999. This estimate reflects an approximately $20
million increase in potential income taxes over the prior year primarily due to
losses incurred by Somerset in 1999 and the anticipation of losses in the near
future which would not allow Somerset to utilize Puerto Rican tax credits. Of
any income tax and interest expense amounts ultimately recorded by Somerset, 50%
would be Watson's share.
In September 1999, Somerset's case was transferred from the appellate level
back to the agent level for further development of the facts. Management of
Somerset believes that it has met all of the requirements to qualify for the tax
credits available under Internal Revenue Code Section 936, and intends to
continue to vigorously defend its position in this matter.
NOTE 5 -- LONG-TERM DEBT
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Senior unsecured notes, 7.125%, face amount of $150 million,
due 2008
(effective rate of 7.25%)................................. $148,608 $148,489
Unsecured note, 8.1%, due August 2001....................... 1,383 2,174
Other notes payable......................................... 1,203 2,263
-------- --------
151,194 152,926
Less current portion........................................ (1,691) (1,843)
-------- --------
$149,503 $151,083
======== ========
</TABLE>
F-16
<PAGE> 53
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In May 1998, the company issued $150 million of 7.125% senior unsecured
notes. These notes are due in May 2008, with interest-only payments due
semi-annually in November and May. The company must maintain specified financial
ratios and comply with certain restrictive covenants.
Annual maturities of notes payable, other than the senior unsecured notes,
are as follows: $1.7 million in 2000, $0.8 million in 2001 and $0.1 million
thereafter.
NOTE 6 -- INCOME TAXES
The provision for income taxes is summarized as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Current provision:
Federal............................................. $86,992 $67,352 $47,113
State............................................... 9,697 9,340 9,372
------- ------- -------
96,689 76,692 56,485
------- ------- -------
Deferred provision (benefit):
Federal............................................. (2,869) 920 (1,966)
State............................................... (157) 635 280
------- ------- -------
(3,026) 1,555 (1,686)
------- ------- -------
Provision for income taxes............................ $93,663 $78,247 $54,799
======= ======= =======
</TABLE>
The exercise of certain stock options results in a tax benefit and has been
reflected as a reduction of income taxes payable and an increase to additional
paid-in capital. Such benefits recorded were $12.1 million, $13.6 million and
$10.9 million for the years ended December 31, 1999, 1998 and 1997,
respectively. Income taxes of $1.9 million have been provided for the possible
distribution of approximately $26 million of undistributed earnings related to
the company's investments in joint ventures.
Reconciliations between the statutory federal income tax rate and the
company's effective income tax rate were as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------
1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
Federal income tax at statutory rates....................... 35% 35% 35%
State income taxes, net of federal benefit.................. 2 3 4
Merger costs capitalized for tax purposes................... 1 -- 2
Valuation allowance reduction for tax law change............ (4) -- --
IPR&D costs capitalized for tax purposes.................... -- 2 --
Dividends received deduction................................ -- -- (2)
Other....................................................... -- -- (3)
-- -- --
34% 40% 36%
== == ==
</TABLE>
F-17
<PAGE> 54
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Deferred tax assets and liabilities are measured based on the difference
between the financial statement and tax bases of assets and liabilities at the
applicable tax rates. The significant components of the company's net deferred
tax assets and liabilities were:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Benefits from net operating loss carryforwards.............. $ 11,650 $ 18,574
Benefits from tax credit carryforwards...................... 3,043 2,833
Differences in financial statement and tax accounting for:
Inventory and receivables................................. 15,827 21,633
Research and development.................................. 805 1,732
Property, equipment and intangible assets................. (11,973) (11,487)
Investments in joint ventures............................. (1,948) (2,241)
Non-compete agreement..................................... 10,209 --
Unrealized holding gains on securities...................... (72,515) (40,605)
Valuation allowance......................................... -- (20,145)
Other....................................................... 3,495 8,599
-------- --------
$(41,407) $(21,107)
======== ========
</TABLE>
The company had net operating loss ("NOL") carryforwards at December 31,
1999 of approximately $28 million, $25 million and $3 million for federal, Utah
and Florida state income tax purposes, respectively. During 1999, the company
utilized NOL carryforwards of approximately $23 million to offset federal
taxable income. Due to restrictions imposed as a result of ownership changes to
acquired subsidiaries, the amount of the NOL carryforward available to offset
future taxable income is subject to limitation. The annual NOL utilization may
be further limited if additional changes in ownership occur. The company's NOL
carryforwards will begin to expire at various dates beginning in year 2003, if
not utilized.
The company had maintained a valuation allowance against certain deferred
tax assets related to acquired NOL carryforwards because of uncertainty as to
their future realization under the Separate Return Limitation Year ("SRLY")
rules. As a result of changes made to the SRLY rules in June 1999, management
determined that the carryforwards would be realized and that the related
valuation allowance should be reversed. The reversal of the valuation allowance
resulted in a reduction in the company's 1999 income tax provision, and a
corresponding increase in the company's deferred tax assets, aggregating $9.8
million. For tax purposes, $4.1 million of that total may not be utilized until
future years, and was reflected as a one-time reduction in income tax expense
during the second quarter 1999. The remaining $5.7 million was utilized for tax
purposes during 1999 and was recognized through a reduction in the company's
effective tax rate during the final three quarters of 1999.
Approximately $7.5 million of the valuation allowance for deferred tax
assets at December 31, 1998 related to benefits of stock option deductions that
were recognized and credited to additional paid-in capital in 1999. In addition,
approximately $2.8 million of valuation allowance was released during 1999, when
the company determined that the deferred tax assets to which it had related
would be realized.
NOTE 7 -- STOCKHOLDERS' EQUITY
Preferred stock
In 1992, the company authorized 2.5 million shares of no par preferred
stock. The Board of Directors has the authority to fix the rights, preferences,
privileges and restrictions, including dividend rates, conversion and voting
rights, terms and prices of redemptions and liquidation preferences without vote
or action by the stockholders. At December 31, 1999, no preferred stock had been
issued.
F-18
<PAGE> 55
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Stock option plans
The company has adopted several stock option plans that authorize the
granting of options to purchase the company's common stock subject to certain
conditions. At December 31, 1999, the company had reserved 9.8 million shares of
its common stock for issuance upon exercise of options granted or to be granted
under these plans. The options are granted at the fair market value of the
shares underlying the options at the date of the grant, generally become
exercisable over a five-year period and expire in ten years. In conjunction with
certain of the company's acquisitions, Watson assumed stock option and warrant
plans from the acquired companies. The options and warrants in these plans were
adjusted by the individual exchange ratios specified in each transaction. No
additional options or warrants will be granted under any of the assumed plans.
The company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25"), and related
interpretations, which require compensation expense for options to be recognized
when the market price of the underlying stock exceeds the exercise price on the
date of the grant. Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("FAS 123"), permits companies to apply existing
accounting rules under APB 25 and provide pro forma disclosures of net income
and earnings per share as if the fair value method (as defined in FAS 123) had
been applied. Had compensation cost been determined using the fair value method
prescribed by FAS 123, the company's net income and earnings per share would
have been as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------
1999 1998 1997
----------- ----------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Pro forma net income................................ $161,475 $105,425 $86,775
======== ======== =======
Pro forma basic EPS................................. $ 1.69 $ 1.11 $ 0.94
======== ======== =======
Pro forma diluted EPS............................... $ 1.65 $ 1.08 $ 0.91
======== ======== =======
</TABLE>
The weighted average fair value of the options has been estimated on the
date of grant using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in 1999, 1998 and 1997,
respectively: no dividend yield; expected volatility of 49%, 41% and 49%,
risk-free interest rate of 5.59%, 5.14% and 6.15% per annum; and expected terms
ranging from approximately seven to eight years. Weighted averages are used
because of varying assumed exercise dates.
A summary of the company's stock option plans as of December 31, 1999, 1998
and 1997, and for the years then ended is presented below (shares in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
1999 1998 1997
----------------- ------------------ ------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding -- beginning of year.......... 6,784 $24.26 7,580 $19.09 8,138 $13.62
Granted................................. 1,720 38.30 1,272 42.26 2,520 23.88
Exercised............................... (642) 15.99 (1,643) 14.49 (2,500) 6.14
Cancelled............................... (668) 31.58 (425) 20.63 (578) 19.00
------ ------- -------
Outstanding -- end of year................ 7,194 $27.11 6,784 $24.26 7,580 $19.09
====== ======= =======
Weighted average fair value of
options granted......................... $23.46 $ 20.42 $ 12.31
====== ======= =======
</TABLE>
F-19
<PAGE> 56
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes information about stock options outstanding
at December 31, 1999 (shares in thousands):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
RANGE OF REMAINING EXERCISE EXERCISE
EXERCISE PRICES SHARES LIFE IN YEARS PRICE SHARES PRICE
--------------- ------ ------------- -------- ------- --------
<S> <C> <C> <C> <C> <C>
$ 3.13 to $15.00.................... 1,068 4.1 $ 8.92 1,018 $ 8.72
$15.01 to $20.00.................... 1,954 6.2 17.86 1,243 18.00
$20.01 to $30.00.................... 864 7.1 23.99 403 23.24
$30.01 to $40.00.................... 1,940 8.5 34.64 428 34.36
$40.01 to $50.00.................... 1,081 8.3 43.45 276 42.70
$50.01 to $58.21.................... 287 8.9 54.75 26 53.10
----- -----
7,194 7.1 $27.11 3,394 $20.18
===== =====
</TABLE>
NOTE 8 -- RELATED PARTIES
The company leases a portion of its facilities from a trust in which
Watson's Chairman and Senior Vice President, Scientific Affairs, have beneficial
interests. The aggregate rent expense paid to related parties in 1999, 1998 and
1997 was $360,000, $345,000 and $330,000, respectively, and was allocated to
cost of sales, research and development and selling, general and administrative
expenses.
One of TheraTech's former directors is also a director of Palatin
Technologies, Inc. During 1998, the company made a $2 million equity investment
in Palatin, a publicly traded company. Also, in 1998, the company entered into a
licensing and development agreement with Palatin to develop oral transmucosal
delivery systems for peptide products. Under this agreement, in 1999 and 1998,
the company earned research and development revenues of $250,000 and $860,000,
respectively.
The company had notes receivable due from executive officers aggregating
$920,000 at December 31, 1998. The notes were repaid to the company in 1999.
NOTE 9 -- COMMITMENTS AND CONTINGENCIES
Facility and equipment leases
The company has entered into operating leases for certain facilities and
equipment. The terms of the operating leases for the company's facilities
require the company to pay property taxes, normal maintenance expenses and
maintain minimum insurance coverage. Total rental expense for operating leases
in 1999, 1998 and 1997, including rent paid to related parties, was $6.8
million, $6.6 million and $3.7 million, respectively.
At December 31, 1999, future minimum lease payments under all
non-cancelable operating leases consisted of $6.2 million in 2000, $5.2 million
in 2001, $4.4 million in 2002, $0.9 million in 2003, $0.6 million in 2004, and
$3.3 million thereafter.
Employee retirement plans
The company maintains 401(k) retirement plans covering substantially all
employees. The company contributes to the plans based upon the employee
contributions. Watson contributed $1.7 million, $1.3 million and $0.9 million to
these retirement plans for the years ended December 31, 1999, 1998, and 1997,
respectively.
F-20
<PAGE> 57
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Legal matters
The company is involved in various disputes and litigation matters that
arise in the ordinary course of business. The litigation process is inherently
uncertain and it is possible that the resolution of these disputes and lawsuits
may adversely affect the company. Management believes, however, that the
ultimate resolution of such matters will not have a material adverse impact on
the company's consolidated financial position or results of operations.
NOTE 10 -- QUARTERLY FINANCIAL DATA (UNAUDITED)
Unaudited quarterly financial and market price information follows (in
thousands, except per share data):
<TABLE>
<CAPTION>
FOURTH THIRD SECOND FIRST
1999 QUARTER QUARTER QUARTER QUARTER
---- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net revenues................... $188,529 $171,218 $170,242 $159,243
Cost of sales.................. 64,481 60,728 55,427 49,997
-------- -------- -------- --------
Gross profit................. 124,048 110,490 114,815 109,246
-------- -------- -------- --------
Operating expenses............. 54,770 52,164 49,462 64,771
Gain on sales of Andrx
securities................... 44,275 -- -- --
Other expense, net............. (2,933) (2,886) (1,516) (1,828)
Provision for income taxes..... 37,578 18,738 17,671 19,676
-------- -------- -------- --------
Net income................... $ 73,042 $ 36,702 $ 46,166 $ 22,971
======== ======== ======== ========
Basic earnings per share..... $ 0.76 $ 0.38 $ 0.48 $ 0.24
======== ======== ======== ========
Diluted earnings per share... $ 0.75 $ 0.38 $ 0.47 $ 0.23
======== ======== ======== ========
Market price per share....... High $ 43.31 $ 40.31 $ 47.50 $ 62.94
Low $ 26.50 $ 28.00 $ 30.50 $ 37.06
</TABLE>
<TABLE>
<CAPTION>
FOURTH THIRD SECOND FIRST
1998 QUARTER QUARTER QUARTER QUARTER
---- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net revenues................... $152,408 $158,765 $152,684 $132,336
Cost of sales.................. 53,436 57,194 54,135 45,640
-------- -------- -------- --------
Gross profit................. 98,972 101,571 98,549 86,696
-------- -------- -------- --------
Operating expenses............. 47,843 47,179 47,434 53,066
Other income (expense), net.... (538) 1,892 2,490 2,819
Provision for income taxes..... 21,053 20,037 19,407 17,750
-------- -------- -------- --------
Net income................... $ 29,538 $ 36,247 $ 34,198 $ 18,699
======== ======== ======== ========
Basic earnings per share..... $ 0.31 $ 0.38 $ 0.36 $ 0.20
======== ======== ======== ========
Diluted earnings per share... $ 0.30 $ 0.37 $ 0.35 $ 0.19
======== ======== ======== ========
Market price per share....... High $ 63.00 $ 52.88 $ 49.50 $ 42.94
Low $ 42.00 $ 40.25 $ 36.25 $ 30.50
</TABLE>
The quarterly data above were restated, as applicable, for the acquisition
of TheraTech in January 1999, accounted for under the pooling of interests
method as further discussed in Note 2.
F-21
<PAGE> 58
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
2.1 Agreement and Plan of Merger, among Watson Pharmaceuticals,
Inc. (the "Company"), TheraTech, Inc. and the Jazz Merger
Corp. dated as of October 23, 1998, is incorporated by
reference to Appendix A of the Proxy Statement/Prospectus
included in the Registration Statement on Form S-4 (Reg. No.
333-68007) dated November 25, 1998.
3.1 Articles of Incorporation of the Company, and all amendments
thereto, are incorporated by reference to Exhibit 3.1 to the
Company's June 30, 1995 Form 10-Q and to Exhibit 3.1(A) to
the Company's June 30, 1996 Form 10-Q.
3.2 The Company's By-laws, as amended as of December 11, 1998,
are incorporated by reference to Exhibit 3.2 to the
Company's Registration Statement on Form S-8 (Reg. No.
333-70933), filed on January 19, 1999.
4.1 Trust Indenture dated May 18, 1998 between the Company and
First Union National Bank, as Trustee for the issuance of
the Company's Senior Unsecured Notes, is incorporated by
reference to Exhibit 4.1 to the Company's Registration
Statement on Form S-3/A (Reg. No. 333-49079), filed on April
30, 1999.
4.2 Credit Agreement dated February 3, 1999 between the Company
and Mellon Bank N.A. is incorporated by reference to Exhibit
4.2 to the Company's 1998 Form 10-K. Amendment Number One to
Credit Agreement dated February 2, 2000 is filed herewith.
10.1 Lease between Westgate Associates and the Company dated
October 1991, and addendums thereto, are incorporated by
reference to Exhibit 10.5 to the Company's Registration
Statement on Form S-1, Reg. No. 33-46229 ("33-46229").
10.2 Industrial Real Estate Lease, with addendum, dated December
23, 1985, between His-Hsiung Hsu Hwa Chao (Chao Family)
Trust I and the Company, is incorporated by reference to
Exhibit 10.6 to 33-46229. Second Amendment thereto dated
August 8, 1995 is incorporated by reference to Exhibit 10.1
to the Company's September 30, 1995 Form 10-Q. Third
Amendment thereto dated August 31, 1998 is incorporated by
reference to Exhibit 10.3 to the Company's 1998 Form 10-K.
*10.3 1991 Stock Option Plan of the Company, as revised, is
incorporated by reference to Exhibit 10.1 to the Company's
June 30, 1995 Form 10-Q. Plan amendments are incorporated by
reference to Exhibit 10.6(a) to the Company's June 30, 1996
Form 10-Q and by reference to Exhibit 10.6(a) to the
Company's March 31, 1997 Form 10-Q.
*10.4 1995 Non-Employee Directors' Stock Option Plan, as amended,
is incorporated by reference to Exhibit 10.2 to the
Company's June 30, 1995 Form 10-Q.
*10.5 Form of Key Employee Agreement is incorporated by reference
to Exhibit 10.26 to the Company's June 30, 1999 Form 10-Q.
The Company has entered into a Key Employee Agreement with
each of its executive officers, who include Michael E.
Boxer, Allen Y. Chao, Ph.D., Charles Ebert, Robert C.
Funsten, David C. Hsia, Ph.D. and G. Frederick Wilkinson. A
copy of each of these individual's Key Employee Agreements
will be provided to the Staff upon request.
*10.6 Release, Exit and Consulting Agreement between Alec D. Keith
and the Company, dated July 18, 1996, is incorporated by
reference to Exhibit 10.15 to the Company's September 30,
1996 Form 10-Q.
10.7 Asset Purchase Agreement among the Company, G. D. Searle &
Co. and SCS Pharmaceuticals, dated September 30, 1997, is
incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K dated October 16, 1997.
</TABLE>
<PAGE> 59
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
10.8 Supply Agreement between the Company and G. D. Searle & Co.,
dated October 16, 1997, is incorporated by reference to
Exhibit 10.2 to the Company's Current Report on Form 8-K
dated October 16, 1997.
10.9 Stock Purchase Agreement among the Company, Hoechst Marion
Roussel, Inc. and Marisub, Inc. dated August 25, 1997, filed
as Exhibit 10.27. Amendment dated November 26, 1997 is
incorporated by reference to Exhibit 10.27(a) to the
Company's 1997 Form 10-K. Second Amendment dated February
27, 1998, is incorporated by reference to Exhibit 10.27(b)
to the Company's 1997 Form 10-K.
10.10 Supply and License Agreement by and between Hoechst Marion
Roussel, Inc. and The Rugby Group, Inc. dated February 27,
1998, is incorporated by reference to Exhibit 10.28 to the
Company's 1997 Form 10-K.
10.11 Contract Manufacturing Agreement by and between Hoechst
Marion Roussel, Inc. and The Rugby Group, Inc., dated
February 27, 1998, is incorporated by reference to Exhibit
10.29 to the Company's 1997 Form 10-K.
10.12 Supply Agreement by and between the Company and G. D. Searle
& Co. dated November 18, 1998 is incorporated by reference
to Exhibit 10.2 to the Company's Current Report on Form 8-K
dated November 18, 1998.
10.13 License Agreement between the Company and Rorer
Pharmaceutical Products, Inc., dated June 30, 1997, is
incorporated by reference to Exhibit 10.1 to the Company's
Current Report 8-K dated June 30, 1997.
21.1 Subsidiaries of the Company
23.1 Consent of PricewaterhouseCoopers LLP.
23.2 Consent of Ernst & Young LLP.
23.3 Consent of Deloitte & Touche LLP.
27.1 Financial Data Schedule (EDGAR version only).
</TABLE>
- ---------------
* Compensation Plan or Agreement
<PAGE> 1
EXHIBIT 4.2
AMENDMENT NUMBER ONE
TO CREDIT AGREEMENT
This AMENDMENT NUMBER ONE TO CREDIT AGREEMENT, dated as of February
2, 2000 (this "Amendment"), is entered into between MELLON BANK, N.A., a
national banking association ("Bank"), and WATSON PHARMACEUTICALS, INC., a
Nevada corporation ("Borrower").
WHEREAS, Bank and Borrower have entered into that certain Credit
Agreement, dated as of February 3, 1999 (as amended, restated, supplemented, or
otherwise modified from time to time, the "Credit Agreement");
WHEREAS, Borrower has requested that the Credit Agreement be amended
to, among other things, modify the Maturity Date and adjust the minimum net
worth covenant;
WHEREAS, subject to the terms and conditions contained herein, Bank
is willing to so amend the Credit Agreement; and
WHEREAS, capitalized terms used herein but not otherwise defined
herein shall have the meanings ascribed thereto in the Credit Agreement.
NOW, THEREFORE, in consideration of the mutual covenants,
conditions, and provisions hereinafter set forth, the parties hereto agree as
follows:
ARTICLE 1
AMENDMENT
1.1 Amendment to Section 1.1 of the Credit Agreement. The definition of
"Maturity Date" contained in Section 1.1 of the Credit Agreement hereby is
amended by deleting the text "February 2, 2000" appearing in said definition and
inserting the text "January 31, 2001" in lieu thereof.
1.2 Amendment to Section 6.2 of the Credit Agreement. Section 6.2 of the
Credit Agreement hereby is amended by deleting the text "$580,000,000" appearing
in paragraph (b) of said Section; inserting the text "$750,000,000" in lieu
thereof; deleting the text "December 31, 1998" appearing in paragraph (b) of
said Section; and inserting the text "December 31, 1999" in lieu thereof.
1.3 Amendment and Restatement of Exhibit A to the Credit Agreement.
Exhibit A to the Credit Agreement hereby is amended and restated in the form of
Exhibit A attached hereto.
<PAGE> 2
ARTICLE 2
REPRESENTATIONS AND WARRANTIES
2.1 Borrower hereby represents and warrants to Bank that (a) the
execution, delivery, and performance of this Amendment are within its corporate
powers, have been duly authorized by all necessary corporate action, and (b)
this Amendment and the Credit Agreement, as amended by this Amendment,
constitute Borrower's legal, valid, and binding obligation, enforceable against
Borrower in accordance with its terms, except in each case as such
enforceability may be limited by bankruptcy, insolvency, reorganization,
liquidation, moratorium or other similar laws of general application and
equitable principles relating to or affecting creditors' rights.
ARTICLE 3
CONDITIONS PRECEDENT
3.1 The effectiveness of this Amendment is subject to the
fulfillment, to the satisfaction of Bank and its counsel, of each of the
following conditions:
3.1.1 Bank shall have received a duly executed and delivered
promissory note, substantially in the form of Exhibit A attached hereto, and
such promissory note shall be in full force and effect;
3.1.2 The representations and warranties set forth in this
Amendment, the Credit Agreement as amended by this Amendment, and the other Loan
Documents shall be true and correct in all material respects on and as of the
date hereof, as though made on such date (except to the extent that such
representations and warranties relate solely to an earlier date); and
3.1.3 No Default or Event of Default shall have occurred and be
continuing on the date hereof, nor shall result from the consummation of the
transactions contemplated herein.
ARTICLE 4
MISCELLANEOUS
4.1 Execution in Counterparts. This Amendment may be executed in any
number of counterparts, each of which when so executed and delivered shall be
deemed an original. All of such counterparts shall constitute but one and the
same instrument. Delivery of an executed counterpart of the signature page of
this Amendment by telecopier shall be equally effective as delivery of a
manually executed counterpart. Any party delivering an executed counterpart of
the signature page of this Amendment by telecopier thereafter also shall deliver
promptly a manually executed counterpart, but the failure to deliver such
<PAGE> 3
manually executed counterpart shall not affect the validity, enforceability, or
binding effect of this Amendment.
4.2 No Other Amendment. The Credit Agreement, as amended hereby,
shall be and remain in full force and effect in accordance with its respective
terms and hereby is ratified and confirmed in all respects. The execution,
delivery, and performance of this Amendment shall not operate as a waiver of or,
except as expressly set forth herein, as an amendment, of any right, power, or
remedy of Bank under the Credit Agreement, as in effect prior to the date
hereof. This Amendment shall be deemed a part of and hereby is incorporated in
the Credit Agreement.
4.3 Governing Law. This Amendment shall be governed by, and
construed and enforced in accordance with, the laws of the State of California.
4.4 Further Assurances. Borrower shall execute and deliver all
agreements, documents, and instruments, in form and substance reasonably
satisfactory to Bank, and take all actions as Bank may reasonably request from
time to time, to fully consummate the transactions contemplated under this
Amendment and the Credit Agreement as amended by this Amendment.
4.5 References.
(a) Upon the effectiveness of this Amendment, each reference in
the Credit Agreement to "this Agreement," "hereunder," "herein," "hereof," or
words of like import referring to the Credit Agreement shall mean and refer to
the Credit Agreement as amended by this Amendment.
(b) Upon the effectiveness of this Amendment, each reference in
the Loan Documents to the "Credit Agreement," "thereunder," "therein,"
"thereof," or words of like import referring to the Credit Agreement shall mean
and refer to the Credit Agreement as amended by this Amendment.
(c) Upon the effectiveness of this Amendment, each reference in
the Credit Agreement to "Exhibit A" shall mean and refer to Exhibit A attached
hereto.
[Remainder of page intentionally left blank.]
<PAGE> 4
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to
be executed and delivered as of the date first set forth above.
WATSON PHARMACEUTICALS, INC.
a Nevada corporation
By: /s/ Allen Chao
-------------------------------------------
Allen Chao, Ph.D.
President, Chief Executive Officer
and Chairman
MELLON BANK, N.A.
a national banking association
By: /s/ William R. Murray
-------------------------------------------
William R. Murray
Vice President
<PAGE> 5
EXHIBIT A
TO CREDIT AGREEMENT
AMENDED AND RESTATED PROMISSORY NOTE
$30,000,000.00 February 2, 2000
Corona, California
FOR VALUE RECEIVED, WATSON PHARMACEUTICALS, INC., a Nevada
corporation (the "Borrower"), promises to pay to the order of MELLON BANK, N.A.
(the "Bank") on the Maturity Date (as defined in the Credit Agreement referred
to below) the principal amount of Thirty Million Dollars ($30,000,000.00), or,
if less, the aggregate amount of Revolving Loans (as defined in the Credit
Agreement) made by the Bank to the Borrower pursuant to the Credit Agreement
outstanding on the Maturity Date. All unpaid amounts of principal and interest
shall be due and payable in full on January 31, 2001.
The Borrower also promises to pay interest on the unpaid principal
amount hereof from the date hereof until paid at the rates and at the times
which shall be determined in accordance with the provisions of the Credit
Agreement. Any interest not paid when due shall be compounded and shall
thereafter accrue interest at the rates and at the times which shall be
determined in accordance with the provisions of the Credit Agreement.
All payments of principal and interest in respect of this Note shall
be made in lawful money of the United States of America in same day funds at the
office of the Bank located at Three Mellon Bank Center, 23rd Floor/Loan
Administration, Pittsburgh, Pennsylvania 15259 or at such other place as shall
be designated in writing for such purpose in accordance with the terms of the
Credit Agreement. Until notified of the transfer of this Note, the Borrower
shall be entitled to deem the Bank or such person who has been so identified by
the transferor in writing to the Borrower as the holder of this Note, as the
owner and holder of this Note. Each of the Bank and any subsequent holder of
this Note agrees that before disposing of this Note or any part hereof, it will
make a notation hereon of all principal payments previously made hereunder and
of the date to which interest hereon has been paid on the schedule attached
hereto, if any; provided, however, that the failure to make notation of any
payment made on this Note shall not limit or otherwise affect the obligation of
the Borrower hereunder with respect to payments of principal or interest on this
Note.
This Note is referred to in, and is entitled to the benefits of, the
Credit Agreement dated as of February 3, 1999 (as amended, the "Credit
Agreement") between Borrower and the Bank. The Credit Agreement, among other
things, (i) provides for the making of advances (the "Loans") by the Bank to the
Borrower from time to time in an aggregate amount not to exceed at any time
outstanding the U.S. dollar amount first above mentioned, the indebtedness of
the Borrower resulting from each such Loan being evidenced by this Note, and
(ii) contains provisions for acceleration of the maturity hereof upon the
<PAGE> 6
happening of certain stated events and also for prepayments on account of
principal hereof prior to the maturity hereof upon the terms and conditions
therein specified. This Note amends and restates in its entirety that certain
Promissory Note, dated as of February 3, 1999, made by Borrower to the order of
Bank, in the original principal amount of $30,000,000 on the Closing Date (as
defined in the Credit Agreement).
The terms of this Note are subject to amendment only in the manner
provided in the Credit Agreement.
No reference herein to the Credit Agreement and no provision of this
Note or the Credit Agreement shall alter or impair the obligation of the
Borrower, which is absolute and unconditional, to pay the principal of and
interest on this Note at the place, at the respective times, and in the currency
herein prescribed.
The Borrower promises to pay all reasonable costs and expenses,
including reasonable attorneys' fees, incurred in the collection and enforcement
of this Note. The Borrower hereby consents to renewals and extensions of time at
or after the maturity hereof, without notice, and, subject to the Credit
Agreement, hereby waives diligence, presentment, protest, demand and notice of
every kind and, to the full extent permitted by law, the right to plead any
statute of limitations as a defense to any demand hereunder.
IN WITNESS WHEREOF, the Borrower has caused this Note to be executed
and delivered by its duly authorized officer, as of the date and the place first
above-written.
WATSON PHARMACEUTICALS, INC.,
a Nevada corporation
By:
----------------------------------
Name: Allen Chao, Ph.D.
Title: President, Chief Executive Officer
and Chairman
<PAGE> 7
SCHEDULE OF
TRANSACTIONS ON
NOTE
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Amount of Amount of Interest Principal Notation Made
Loan Made Principal Paid Interest Paid Paid Through Balance By
</TABLE>
<PAGE> 1
EXHIBIT 21.1
Watson Pharmaceuticals, Inc.
Subsidiaries of the Company
as of March 15, 2000
<TABLE>
<CAPTION>
NAME JURISDICTION OF INCORPORATION
<S> <C>
Watson Laboratories, Inc. Nevada
Watson Laboratories, Inc. - New York New York
Watson Laboratories, Inc. - Utah Delaware
WatsonPharma, Inc. Delaware
The Rugby Group, Inc. New York
Watson Laboratories, Inc. - Ohio New York
Rugby Laboratories, Inc. New York
Royce Laboratories, Inc. Florida
Nicobrand Limited Northern Ireland
Watson Pharmaceuticals (Asia) Ltd. Territory of the British Virgin Islands
</TABLE>
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-3 (No. 333-20029-01, No. 333-49079 and No. 333-70943) and
on Form S-8 (No. 33-70878, No. 33-94350, No. 333-05737, No. 333-20029-02, No.
333-24577, No. 333-37733, and No. 333-70933) of Watson Pharmaceuticals, Inc. of
our report dated February 4, 2000 relating to the financial statements, which
appears in this Form 10-K.
/s/ PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
March 29, 2000
<PAGE> 1
Exhibit 23.2
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in Registration Statement Nos.
33-70878, 33-94350, 333-05737, 333-20029-02, 333-24577, 333-37733 and 333-70933
on Form S-8 and 333-20029-01, 333-49079 and 333-70943 on Form S-3 of Watson
Pharmaceuticals, Inc. of our report dated February 5, 1999 with respect to the
consolidated financial statements of TheraTech, Inc. appearing in this Annual
Report on Form 10-K of Watson Pharmaceuticals, Inc. for the year ended December
31, 1999.
/s/ ERNST & YOUNG LLP
Salt Lake City, Utah
March 29, 2000
<PAGE> 1
Exhibit 23.3
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
33-70878, 33-94350, 333-05737, 333-20029-02, 333-24577, 333-37733 and 333-70933
on Form S-8 and 333-20029-01, 333-49079 and 333-70943 on Form S-3 of Watson
Pharmaceuticals, Inc. of our report dated February 4, 1998 (relating to the
consolidated financial statements of Somerset Pharmaceuticals, Inc. and
subsidiaries as of December 31, 1997 and for the year then ended) appearing in
this Annual Report on Form 10-K of Watson Pharmaceuticals, Inc. for the year
ended December 31, 1999.
/s/ DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania
March 29, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE WATSON
PHARMACEUTICALS, INC. FORM 10-K FOR THE PERIOD ENDED DECEMBER 31, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH REPORT.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 102,057
<SECURITIES> 13,865
<RECEIVABLES> 184,235
<ALLOWANCES> 3,375
<INVENTORY> 108,532
<CURRENT-ASSETS> 434,711
<PP&E> 222,208
<DEPRECIATION> 83,360
<TOTAL-ASSETS> 1,438,750
<CURRENT-LIABILITIES> 129,186
<BONDS> 149,503
0
0
<COMMON> 317
<OTHER-SE> 1,054,235
<TOTAL-LIABILITY-AND-EQUITY> 1,438,750
<SALES> 689,232
<TOTAL-REVENUES> 689,232
<CGS> 230,633
<TOTAL-COSTS> 230,633
<OTHER-EXPENSES> (35,112)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11,121
<INCOME-PRETAX> 272,544
<INCOME-TAX> 93,663
<INCOME-CONTINUING> 178,881
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 178,881
<EPS-BASIC> 1.87
<EPS-DILUTED> 1.83
</TABLE>
