<PAGE> 1
This filing is made pursuant
to Rule 424(b)(3) under the
Securities Act of 1933 in
connection with Registration
Statement No. 333-53312
PROSPECTUS
2,839,306 SHARES
WATSON PHARMACEUTICALS, INC.
COMMON STOCK
-------------------
Of the 2,839,306 shares of which this prospectus relates to, we issued
2,776,500 shares of our common stock to the shareholders of Makoff R&D
Laboratories, Inc. ("Makoff") in connection with the acquisition of all
outstanding shares of Makoff on November 15, 2000; and we issued 62,806 shares
of our common stock to Jerome Stevens Pharmaceuticals, Inc. ("Jerome Stevens")
under a Stock Acquisition Agreement dated October 16, 2000. This prospectus may
be used by former shareholders of Makoff or by Jerome Stevens to resell the
common stock received by them in the transactions.
Our common stock is traded on the New York Stock Exchange under the
symbol "WPI". On January 11, 2001, the last reported sale price for our common
stock on the New York Stock Exchange was $48.63 per share.
INVESTING IN WATSON COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS"
BEGINNING ON PAGE 2.
-------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this prospectus is January 12, 2001
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUMMARY................................................... 1
RISK FACTORS......................................................... 2
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS.................10
INCORPORATION BY REFERENCE...........................................11
USE OF PROCEEDS......................................................12
PRICE RANGE OF COMMON STOCK..........................................12
DIVIDEND POLICY......................................................12
DESCRIPTION OF CAPITAL STOCK.........................................12
SELLING SECURITYHOLDERS..............................................12
PLAN OF DISTRIBUTION.................................................14
LEGAL MATTERS........................................................16
EXPERTS..............................................................16
HOW TO OBTAIN MORE INFORMATION.......................................16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS................................................17
</TABLE>
i
<PAGE> 3
PROSPECTUS SUMMARY
WATSON PHARMACEUTICALS, INC.
Watson is a pharmaceutical company primarily engaged in the development,
production, marketing and distribution of both branded and off-patent
pharmaceutical products. It was incorporated in January 1985, and has 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. Watson is also
engaged, both internally and under collaborative agreements with other parties,
in the development of advanced drug delivery systems primarily designed to
enhance therapeutic benefits of pharmaceutical products.
Our principal executive offices are located at 311 Bonnie Circle,
Corona, California 92880-2882.
ACQUISITION OF MAKOFF R&D LABORATORIES, INC.
On November 15, 2000, we completed the acquisition of all outstanding
capital stock of Makoff R&D Laboratories, Inc., a developer, licensor and
marketer of medical foods and pharmaceutical products related to the management
of kidney disease, located in Marina del Rey, California. The purchase price was
approximately $155 million based on the closing price of Watson common stock on
the closing date of the acquisition, of which 255,107 shares of our common stock
were escrowed to pay contingent indemnification obligations and any expenses of
the Makoff shareholder representative. The purchase price consisted of 2,521,393
shares of our common stock, which we issued to the shareholders of Makoff, and
our assumption of options to purchase 12,000 shares of Makoff common stock,
which have been converted into options to purchase 23,466 shares of Watson
common stock.
Under the Agreement and Plan of Merger dated as of October 5, 2000 among
Watson, Watson Acquisition Corp. No. 1 (a wholly-owned subsidiary of Watson) and
Makoff, we agreed to register the resale of the shares of our common stock
issued in connection with the Makoff acquisition transaction. The merger was
treated as a pooling-of-interests for accounting and financial reporting
purposes and qualified as a tax-free reorganization under Section 368(a) of the
Internal Revenue Code. Under the pooling-of-interests method of accounting, the
recorded assets and liabilities of Watson and Makoff will be carried forward in
the combined company at their recorded amounts, the operating results of the
combined company will include the operating results of Watson and Makoff for the
entire fiscal year in which the combination occurs, and the reported operating
results of the separate companies for prior periods will be combined and
restated as the operating results of the combined company. (See "Supplemental
Financial Statements" on page F-1 of this prospectus.)
Each of the following individuals, prior to the acquisition of Makoff on
November 15, 2000, held the following position with Makoff: Rhoda Makoff,
Chairman, Chief Executive Officer, President and Director; Dwight Makoff,
Secretary and Director; Robert G. Weitzman, Chief Financial Officer; Jur
Strobos, Vice President-Clinical and Regulatory; Greg Little, Vice
President-Sales and Marketing; and Gregory Makoff, Director.
All of the shares received by the selling securityholders in connection
with the Makoff acquisition transaction were "restricted securities" under the
Securities Act prior to this registration.
STOCK ACQUISITION BY JEROME STEVENS PHARMACEUTICALS, INC.
On October 16, 2000 we entered into an exclusive worldwide agreement
with Jerome Stevens Pharmaceuticals, Inc. to market and distribute Jerome
Stevens' NDA (New Drug Application) approved form of levothyroxine sodium, USP
tablets. In connection with that agreement, Watson issued to Jerome Stevens
62,806 shares of Watson Common Stock pursuant to a stock acquisition agreement.
Under the stock acquisition agreement, we agreed to register the resale
of the shares of our common stock issued to Jerome Stevens. All of the shares
received by Jerome Stevens under the stock acquisition agreement were issued as
"restricted securities" under the Securities Act prior to this registration.
<PAGE> 4
RISK FACTORS
Our business faces significant risks. The risks described below may not
be the only risks we face. Additional risks that we do not yet know of or that
we currently think are immaterial may also impair our business operations. If
any of the events or circumstances described in the following risks actually
occurs, our business, financial condition or results of operations could be
materially adversely affected and the trading price of our common stock could
decline. You should carefully consider and evaluate all of the information in
this prospectus, including the risk factors listed below.
RISKS ASSOCIATED WITH INVESTING IN WATSON COMMON STOCK
AS PART OF WATSON'S BUSINESS STRATEGY, WATSON INTENDS TO PURSUE TRANSACTIONS
THAT MAY CAUSE IT TO EXPERIENCE SIGNIFICANT CHARGES TO EARNINGS THAT MAY
ADVERSELY AFFECT ITS STOCK PRICE AND FINANCIAL CONDITION.
Watson regularly reviews potential transactions related to technologies,
products or product rights and businesses complementary to Watson's business.
Such transactions could include, but are not limited to, mergers, acquisitions,
strategic alliances, licensing agreements or co-promotion agreements. In the
future, Watson may choose to enter into such transactions at any time. During
the fourth quarter of 2000, Watson will record a special, one-time charge for
certain Makoff merger and related expenses, in an amount not yet determinable,
that will include transaction costs for professional fees and severance,
contract termination and asset impairment costs. Depending upon the nature of
any transaction, Watson may experience significant charges to earnings, which
could be material, and could possibly have an adverse impact upon the market
price of Watson's common stock. For example, in connection with the TheraTech,
Inc. merger in January 1999, Watson recorded merger-related expenses of $20.5
million in the first quarter of 1999. In addition, in connection with the Schein
Pharmaceutical, Inc. ("Schein") merger in August 2000, Watson announced on
September 12, 2000, that its earnings per share would be adversely affected for
the third and fourth quarters of 2000 and the first quarter of 2001 due to lower
than anticipated product sales of Schein, aggressive generic pricing competition
in Watson's branded dermatology line and higher than anticipated goodwill and
operating expenses associated with the Schein merger. Total product rights,
other identifiable intangible assets and goodwill amortization from the Schein
merger aggregated approximately $900 million (generally amortized over a 20-year
period). In the third quarter of 2000, Watson recorded a charge of $115 million
related to the Schein merger for purchased, in-process research and development
expenses.
At its December 20, 2000 board meeting, the Financial Accounting
Standards Board ("FASB") reached a tentative decision that purchased goodwill
should not be amortized; rather it should be reviewed and accounted for using an
impairment approach. Under this approach, goodwill would be reviewed for
impairment, that is, written down and expensed against earnings, only in the
periods in which the recorded value of goodwill is more than its fair value.
Separately recognized, non-goodwill intangible assets with a definite life would
continue to be accounted for under an amortization approach. The FASB plans to
publish a revised Exposure Draft in the first quarter of 2001 for a 30-day
comment period. A new statement is expected to be issued in the second quarter
of 2001. Under the FASB's tentative new statement, goodwill amortization expense
would be eliminated in future periods, however, if the fair value of Watson's
goodwill is determined at some future date to be less than its recorded value, a
charge to earnings may be required. Such a charge may be in an amount that is
material to the company's results of operations and net worth.
WATSON'S STOCK PRICE HAS EXPERIENCED SUBSTANTIAL VOLATILITY, WHICH MAY AFFECT
YOUR ABILITY TO SELL THE STOCK AT AN ADVANTAGEOUS PRICE.
The market price of Watson common stock has been and may continue to be
volatile. For example, the market price of Watson common stock has fluctuated
during the past twelve months between $33.68 per share and $71.50 per share and
may continue to fluctuate. Therefore, especially if you have a short-term
investment horizon, the volatility may affect your ability to sell your Watson
stock at an advantageous price. Market price fluctuations in Watson's stock may
be due to acquisitions or other material public announcements, along with a
variety of additional factors including, without limitation:
- new product introductions,
- the purchasing practices of Watson's customers,
- changes in the degree of competition for Watson's products,
2
<PAGE> 5
- the announcement of technological innovations or new commercial products by
Watson or its competitors,
- changes in governmental regulation affecting Watson's business environment,
- regulatory issues, including but not limited to, receipt of new drug
approvals from the FDA, compliance with FDA or other agency regulations, or
the lack or failure of either of the foregoing,
- the issuance of new patents or other proprietary rights,
- the announcement of earnings,
- the loss of key personnel,
- the inability to acquire sufficient supplies of finished products or raw
materials,
- litigation and/or threats of litigation,
- failure or delay in meeting milestones in collaborative arrangements
expected to result in revenues,
- unanticipated expenses from joint ventures not under the control of Watson,
- publicity regarding actual or potential clinical results with respect to
products Watson has under development, and
- political developments or proposed legislation in the pharmaceutical or
healthcare industry.
These and similar factors have had and could in the future have a
significant impact on the market price of Watson's common stock. Some companies
that have had volatile market prices for their securities have been subject to
securities class action suits filed against them. If a suit were to be filed
against Watson, regardless of the outcome or the merits of the action, it could
result in substantial costs and a diversion of Watson's management's attention
and resources. This could have a material adverse effect on Watson's business,
results of operations and financial condition.
INVESTORS SHOULD NOT LOOK TO DIVIDENDS AS A SOURCE OF INCOME.
Watson has not paid any cash dividends since inception. In addition,
Watson does not anticipate paying cash dividends in the foreseeable future.
Consequently, any economic return to a stockholder will be derived, if at all,
from appreciation in the price of Watson's stock, and not as a result of
dividend payments.
WATSON MAY ISSUE ADDITIONAL EQUITY SECURITIES, WHICH WOULD LEAD TO DILUTION OF
YOUR OWNERSHIP INTEREST.
In April 1998, Watson filed a shelf registration statement with the SEC
which allows it to raise up to $300 million from offerings of senior or
subordinated debt securities, common stock, preferred stock or a combination
thereof, at such times and in such amounts as Watson deems appropriate. To date,
Watson has issued $150 million in senior unsecured notes pursuant to such
registration statement. These securities may be used to acquire technology,
products, product rights and businesses, reduce or retire existing indebtedness,
among other purposes. The issuance of additional equity securities or securities
convertible into equity securities for these or other purposes would result in
dilution of existing stockholders' equity interests in Watson.
Watson is authorized to issue, without stockholder approval, one or more
preferred series of stock, which may give other stockholders dividend,
conversion, voting, and liquidation rights, among other rights, which may be
superior to the rights of holders of Watson common stock. The Watson board of
directors has the authority to issue, without vote or action of stockholders,
shares of preferred stock in one or more series, and has the ability to fix the
rights, preferences, privileges and restrictions of any such series. Any such
series of preferred stock could contain dividend rights, conversion rights,
voting rights, terms of redemption, redemption prices, liquidation preferences
or other rights superior to the rights of holders of Watson common stock. The
Watson board of directors has no present intention of issuing any such preferred
series, but reserves the right to do so in the future.
In addition, Watson is authorized to issue, without stockholder
approval, common stock. For example, in connection with the Makoff acquisition
and the Jerome Stevens transaction, Watson issued shares of its common stock to
the shareholders of Makoff and to Jerome Stevens without stockholder approval.
3
<PAGE> 6
RISKS ASSOCIATED WITH INVESTING IN THE BUSINESS OF WATSON
IN ORDER TO REMAIN PROFITABLE AND CONTINUE TO GROW AND DEVELOP WATSON'S
BUSINESS, WATSON IS DEPENDENT ON SUCCESSFUL PRODUCT DEVELOPMENT AND
COMMERCIALIZATION OF NEWLY DEVELOPED PRODUCTS. IF WATSON IS UNABLE TO
SUCCESSFULLY DEVELOP OR COMMERCIALIZE NEW PRODUCTS, ITS OPERATING RESULTS WILL
SUFFER.
Watson's future results of operations will depend to a significant
extent upon its ability to 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 requisite regulatory approvals in a timely
manner. Products currently in development by Watson may or may not receive the
regulatory approvals necessary for marketing by Watson or other third-party
partners. Furthermore, the development and commercialization process is
time-consuming and costly. If any of Watson's products, if and when acquired or
developed and approved, cannot be successfully or timely commercialized,
Watson's operating results could be adversely affected. This risk particularly
exists with respect to the development of proprietary products because of the
uncertainties, higher costs and lengthy time frames associated with research and
development of such products and the inherent unproven market acceptance of such
products. Delays or unanticipated costs in any part of the process or the
inability of Watson to obtain regulatory approval for its products, including
failure to maintain its manufacturing facilities in compliance with all
applicable regulatory requirements, could adversely affect Watson's operating
results. Watson cannot guarantee any investment it makes in developing products
will be recouped, even if Watson is successful in commercializing those
products.
WATSON IS DEPENDENT ON KEY PERSONNEL FOR ITS CONTINUED GROWTH AND DEVELOPMENT.
LOSS OF SUCH KEY PERSONNEL COULD HAVE A MATERIAL ADVERSE EFFECT ON WATSON.
The success of Watson's present and future operations will depend, to a
significant extent, upon the experience, abilities and continued services of
certain of its executive officers. In this regard, Allen Chao, Ph.D., Chairman,
Chief Executive Officer and President of Watson, was diagnosed with very early
stage stomach cancer in 1999. Subsequently, he underwent successful surgery and
voluntarily completed a course of chemotherapy which he elected to undertake to
better ensure a complete and thorough recovery. Dr. Chao has since reported that
his recovery is complete and his physicians have declared him cancer-free.
Although Watson has other senior management personnel, a significant loss of the
services of Dr. Chao or other key personnel could have a material adverse effect
on Watson. Watson has entered into employment agreements with all of its senior
executive officers, including Dr. Chao. Watson does not carry key-man life
insurance on any of its officers.
IF WATSON IS UNABLE TO ADEQUATELY PROTECT ITS TECHNOLOGY OR ENFORCE ITS PATENTS,
WATSON MAY BE LESS ABLE TO SUCCESSFULLY EXPLOIT SUCH TECHNOLOGY OR USE SUCH
PATENTS TO SECURE AN ADVANTAGE OVER ITS COMPETITORS.
Although Watson has not experienced significant problems to date,
Watson's success with the patented brand name products that Watson has developed
may depend in part on its ability to obtain patent protection for such products.
Watson currently has a number of U.S. and foreign patents issued and pending.
However, if Watson's patent applications are not approved, or, if approved, if
such patents are not upheld in a court of law, it may reduce Watson's ability to
competitively exploit its patented products. Also, such patents may or may not
provide competitive advantages for their respective products or they may be
challenged or circumvented by competitors, in which case Watson's ability to
commercially exploit these products may be diminished.
Watson also relies on trade secrets and proprietary know-how that Watson
seeks to protect, in part, through confidentiality agreements with its partners,
customers, employees and consultants. It is possible that these agreements will
be breached or that they will not be enforceable in every instance, and that
Watson will not have adequate remedies for any such breach. It is also possible
that Watson's trade secrets will become known or independently developed by
competitors.
FROM TIME TO TIME WATSON MAY NEED TO RELY ON LICENSES TO PROPRIETARY
TECHNOLOGIES, WHICH MAY BE DIFFICULT OR EXPENSIVE TO OBTAIN.
Watson may need to obtain licenses to patents and other proprietary
rights held by third parties to develop, manufacture and market products. If
Watson is unable to timely obtain these licenses on commercially reasonable
terms, Watson's ability to commercially exploit its products may be inhibited or
prevented.
4
<PAGE> 7
PATENT, TRADEMARK AND COPYRIGHT LITIGATION IS BECOMING MORE WIDESPREAD AND CAN
BE EXPENSIVE AND MAY DELAY OR PREVENT ENTRY OF WATSON'S PRODUCTS, ESPECIALLY
GENERICS, INTO THE MARKET.
Litigation concerning patents, trademarks, copyrights and proprietary
technologies can be protracted and expensive. Additionally, pharmaceutical
companies with patented brand products are increasingly suing companies that
produce off-patent generic forms of their patented brand name 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. For instance, when an abbreviated new drug application, or
ANDA, is filed with the U.S. Food and Drug Administration, or FDA, for approval
of a generic drug, Watson may certify that any patent listed by the FDA as
covering the generic product will expire in which case, the ANDA will not become
effective until the expiration of such patent(s). On the other hand, Watson
could certify that any patent listed as covering the generic drug is invalid or
will not be infringed by the manufacture, sale or use of the new drug for which
the ANDA is filed. In that case, Watson is required to notify the branded
product holder or the patent holder that such patent is not infringed or is
invalid. The patent holder has forty-five (45) days from receipt of the notice
in which to sue for patent infringement. The FDA is then prevented from
approving Watson's ANDA for 30 months after receipt of the notice unless a
shorter period is deemed appropriate by the authority of a court. Since a large
part of Watson's business involves the marketing and development of off-patent
products, there is a risk that such a brand company may sue us for alleged
patent, trademark and/or copyright infringement or other violations of
intellectual property rights. The outcome of litigation is inherently uncertain.
Litigation 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 its business, financial condition, cash flows,
or results of operations.
AS A PART OF ITS BUSINESS STRATEGY, WATSON PLANS TO CONTINUE MAKING ACQUISITIONS
OF BUSINESSES. INHERENT IN THIS PRACTICE IS A RISK THAT WATSON MAY EXPERIENCE
DIFFICULTY INTEGRATING THE BUSINESSES OF COMPANIES THAT IT HAS ACQUIRED INTO ITS
OPERATIONS, WHICH WOULD BE DISRUPTIVE TO ITS MANAGEMENT AND OPERATIONS.
The merger of two companies involves the integration of two businesses
that have previously operated independently. Difficulties encountered in
integrating two businesses could have a material adverse effect on the operating
results or financial condition of the combined company's business. As a result
of uncertainty following a merger and during the integration process, Watson
could experience disruption in its business or employee base. There is also a
risk that key employees of a merged company may seek employment elsewhere,
including with competitors. If Watson and a merger partner are not able to
successfully blend their products and technology to create the advantages that
the merger is intended to create, it may affect Watson's results of operations,
its ability to develop and introduce new products and the market price of
Watson's shares. Furthermore, there may be overlap between the products or
customers of Watson and the merged company that may create conflicts in
relationships or other commitments detrimental to the integrated businesses. For
example, on September 12, 2000, Watson announced that its earnings per share
would be adversely affected for the third and fourth quarters of 2000 and the
first quarter of 2001 due to lower than anticipated product sales of Schein,
aggressive generic pricing competition in Watson's branded dermatology line and
higher than anticipated goodwill and operating expenses associated with the
Schein merger.
In addition, as a result of acquiring businesses or entering into other
significant transactions, Watson has 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 charges. 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 the results of operations for particular quarterly or annual periods,
however Watson would not expect such charges to have a material adverse effect
upon its financial condition.
IF WATSON IS UNABLE TO OBTAIN SUFFICIENT SUPPLIES FROM KEY SUPPLIERS THAT IN
SOME CASES MAY BE THE ONLY SOURCE OF FINISHED PRODUCTS OR RAW MATERIALS, THEN
WATSON'S ABILITY TO DELIVER ITS PRODUCTS TO THE MARKET MAY BE IMPEDED.
Some materials used in Watson's manufactured products, and some products
sold by Watson, are currently available only from sole or limited suppliers.
This includes products that have historically accounted for a significant
portion of Watson's revenues. In the event an existing supplier should lose its
regulatory status as an approved source, Watson would attempt to locate a
qualified alternative; however, it 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 Watson's outside suppliers have experienced
regulatory or supply-related difficulties that have inhibited their ability to
deliver products to Watson. 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 Watson. Watson's arrangements with foreign
suppliers are
5
<PAGE> 8
subject to certain additional risks, including the availability of government
clearances, export duties, political instability, currency fluctuations and
restrictions on the transfer of funds.
For example, Rhone-Poulenc Rorer, Inc. and its affiliates, or RPR, were
Watson's sole supplier of Dilacor XR(R) and its generic equivalent, diltiazem.
In this regard, RPR agreed to supply Watson with all of its requirements for
Dilacor XR(R) and its generic equivalent through June 2000. For this purpose,
RPR designated as its contract manufacturer Centeon LLC. In August 1998, Centeon
ceased its manufacturing operations after an FDA inspection. Since that time,
Centeon has not manufactured any Dilacor XR(R) or its generic equivalent. RPR's
failure to provide Watson with an adequate and reliable supply of generic
diltiazem caused Watson's customers to seek generic diltiazem from its
competitors. It is generally commercially impracticable to regain lost market
share for a generic product. Although Watson has subsequently negotiated a new
supply agreement for Dilacor XR(R) with a new supplier, under the pricing
structure in that agreement, it is not commercially practicable to obtain
generic diltiazem from that manufacturer. As a result, Watson does not
anticipate any further sales of generic diltiazem. On August 4, 1999, Watson
filed suit against RPR and certain of its affiliates for their failure to
fulfill supply obligations to Watson for Dilacor XR(R) and its generic
equivalent, among other claims. In late 1999, RPR and its affiliates merged with
Hoechst Marion Roussel, Inc. and its affiliates to form Aventis. Watson is
unable to predict the likelihood of the outcome of the litigation against
Aventis.
GOVERNMENT ACTIONS IN CONNECTION WITH THIRD-PARTY REIMBURSEMENT PROGRAMS MAY
ADVERSELY AFFECT WATSON'S BUSINESS.
Recently, there has been enhanced political attention and governmental
scrutiny at the federal and state levels of the prices paid or reimbursed for
pharmaceutical products under Medicaid, Medicare and other government programs.
In November 1999, Schein, a wholly-owned subsidiary of Watson acquired in August
2000, was informed by the U.S. Department of Justice that it, along with several
other pharmaceutical companies, is a defendant in a qui tam action brought in
1995 under the U.S. False Claims Act currently pending in the Federal District
Court for the Southern District of Florida. As of the date hereof, Schein has
not been served in this action. A qui tam action is a civil lawsuit brought by
an individual for an alleged violation of a federal statute, in which the
Department of Justice has the right to intervene and take over the prosecution
of the lawsuit at its option. The Department of Justice has not yet intervened
in that action. Pursuant to applicable federal law, the qui tam action is under
seal and no details are available concerning the name of the plaintiff, the
various theories of liability or the amount of damages sought from any of the
defendants. Schein believes that the matter relates to whether allegedly
improper price reporting by pharmaceutical manufacturers led to increased
payments by Medicare and/or Medicaid. The qui tam action may seek to recover
damages from Schein based on its price reporting practices. Schein has also
received notices or subpoenas from the attorneys general of various states
including Florida, Nevada, New York and Texas indicating investigations and
possible lawsuits relating to pharmaceutical pricing issues and whether
allegedly improper efforts by pharmaceutical manufactures led to increased
payments by Medicare and/or Medicaid. Other state and federal inquiries
regarding pricing and reimbursements issues are anticipated. Any actions which
may be instituted to recover damages from Schein based on its price reporting
practices, if successful, could adversely affect Watson and may have a material
adverse effect on our business results of operations and financial condition.
In order to assist us in commercializing products, we have obtained from
government authorities and private health insurers and other organizations, such
as HMOs and MCOs, authorization to receive reimbursement at varying levels for
the cost of certain products and related treatments. Third party payors
increasingly challenge pricing of pharmaceutical products. The trend toward
managed healthcare in the United States, the growth of organizations such as
HMOs and MCOs and legislative proposals to reform healthcare and government
insurance programs could significantly influence the purchase of pharmaceutical
products, resulting in lower prices and a reduction in product demand. Such cost
containment measures and healthcare reform could affect our ability to sell our
products and may have a material adverse effect on our business, results of
operations and financial condition. Due to the uncertainty surrounding
reimbursement of newly approved pharmaceutical products, reimbursement may not
be available for some of Watson's products. Additionally, any reimbursement
granted may not be maintained or limits on reimbursement available from
third-party payors may reduce the demand for, or negatively effect the price of,
those products and could have a material adverse effect on our business, results
of operations and financial condition.
FEDERAL REGULATION OF ARRANGEMENTS BETWEEN MANUFACTURERS OF BRAND-NAME AND
GENERIC DRUGS COULD AFFECT WATSON.
Recently the Federal Trade Commission announced its intention to conduct
a study of whether brand-name and generic drug manufacturers have entered into
agreements, or have used other strategies, to delay competition from generic
versions of patent-protected drugs. The FTC's announcement, and subsequent
study, could affect the manner in which generic drug manufacturers resolve
intellectual property litigation with branded pharmaceutical companies, and
could result generally in an increase in private-party litigation against
pharmaceutical companies. For example, Watson and its subsidiary, The Rugby
Group, Inc., have been named in a number of lawsuits seeking to recover on
behalf of various classes of plaintiffs in connection with an allegedly
anticompetitive
6
<PAGE> 9
arrangement between Bayer AG and its affiliates, Barr Laboratories, Inc.,
Hoechst Marrion Roussel (HMR) and The Rugby Group concerning Bayer's Cipro(R)
product and its generic equivalent. The arrangement in question was entered into
prior to Watson's acquisition of The Rugby Group from HMR, and Watson believes
that to the extent liability exists, if at all, it is entitled to
indemnification from HMR for the defense of such cases and for any liability
that may arise out of such cases. However, the impact of the FTC's study, and
the potential private-party lawsuits associated with arrangements between
brand-name and generic drug manufacturers is uncertain, and could have an
adverse effect on Watson.
WATSON DOES NOT MANUFACTURE THE ACTIVE PHARMACEUTICAL INGREDIENTS USED IN THE
PREPARATION OF ITS PRODUCTS AND IS DEPENDENT ON THIRD PARTIES FOR THE ACTIVE
INGREDIENT USED IN ITS PRODUCTS.
The principal components of Watson's products are active and inactive
pharmaceutical ingredients. Watson does not manufacture the active
pharmaceutical ingredients used in the preparation of its products. Instead,
Watson purchases these active pharmaceutical ingredients from both domestic and
international sources. The FDA requires pharmaceutical manufacturers to identify
in their drug applications the supplier(s) of all the raw materials for its
products. If raw materials for a particular product become unavailable from an
approved supplier specified in a drug application, any delay in the required FDA
approval of a substitute supplier could interrupt manufacture of the product.
The qualification of a new supplier could materially and adversely affect
Watson's profit margins and market share for the product, as well as delay
Watson's development and marketing efforts. To the extent practicable, Watson
attempts to identify more than one supplier in each drug application. However,
many raw materials are available only from a single source and, in many of
Watson's drug applications, only one supplier of raw materials has been
identified, even in instances where multiple sources exist. Any interruption of
supply could have a material adverse effect on Watson's ability to manufacture
its products. In addition, Watson obtains a significant portion of its raw
materials from foreign suppliers. Arrangements with international raw material
suppliers are subject to, among other things, FDA regulation, various import
duties and other government clearances. Acts of governments outside the United
States may affect the price or availability of raw materials needed for the
development or manufacture of generic drugs. In addition, recent changes in
patent laws in jurisdictions outside the United States may make it increasingly
difficult to obtain raw materials for research and development prior to the
expiration of the applicable U.S. patents. There can be no assurance that Watson
will establish or, if established, maintain good relationships with its
suppliers or that such suppliers will continue to supply ingredients in
conformity with legal or regulatory requirements.
THE TESTING, MARKETING AND SALE OF WATSON'S PRODUCTS INVOLVES THE RISK OF
PRODUCT LIABILITY CLAIMS BY CONSUMERS AND OTHER THIRD PARTIES, AND INSURANCE
AGAINST SUCH POTENTIAL CLAIMS IS EXPENSIVE.
The design, development and manufacture of Watson's 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. Although Watson
currently maintains product liability insurance for its products in the amounts
it believes to be commercially reasonable, if the coverage limits of these
insurance policies are not adequate, a claim brought against Watson, whether
covered by insurance or not, could have a material adverse effect upon Watson's
financial condition and/or results of operations and cash flows.
RISKS RELATING TO INVESTING IN THE PHARMACEUTICAL INDUSTRY
EXTENSIVE INDUSTRY REGULATION HAS HAD, AND WILL CONTINUE TO HAVE, A SIGNIFICANT
IMPACT ON WATSON'S BUSINESS, ESPECIALLY ITS PRODUCT DEVELOPMENT AND
MANUFACTURING CAPABILITIES.
All pharmaceutical companies, including Watson, are subject to
extensive, complex, costly and evolving regulation by the federal government,
principally the U.S. Food and Drug Administration and to a lesser extent by the
U.S. Drug Enforcement Agency 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 Watson's products.
Watson is subject to periodic inspection of its facilities, procedures
and operations and/or the testing of its products by the FDA, the DEA and other
authorities, which conduct periodic inspections to confirm that Watson is in
compliance with all applicable regulations. In addition, the FDA conducts
pre-approval and post-approval reviews and plant inspections to determine
whether systems and processes of Watson are in compliance with current good
manufacturing practices, or cGMP, and other FDA regulations.
7
<PAGE> 10
Following such inspections, the FDA may issue notices on Form 483 and
warning letters that could cause the combined company 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 new drug applications, or NDAs, abbreviated new drug
applications, or 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 Watson
has instituted internal compliance programs, if these programs do not meet
regulatory agency standards or if compliance is deemed deficient in any
significant way, it could have a material adverse effect on the combined
company. Certain of Watson's vendors are subject to similar regulation and
periodic inspections.
In connection with an FDA inspection of Watson's Corona, California
facility in December 1998, the FDA issued to Watson a warning letter in January
1999. The warning letter related to Watson's quality systems and cGMP
compliance, including areas such as documentation, training and laboratory
controls. The FDA conducted additional inspections of Watson's Corona facility
in the first and fourth quarters of 1999. At the close of each of these
inspections, the FDA issued to Watson a Form 483 notice listing observations
made during those inspections. The observations from the first quarter
inspection generally related to Watson's 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 Watson's quality systems and cGMP compliance
including areas such as training and documentation.
Watson 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, the FDA has not performed a comprehensive cGMP
inspection of the Corona facility to determine the sufficiency and adequacy of
these quality improvements. Watson cannot predict the timing of any subsequent
FDA inspections or what the outcome of such inspections will be. Watson did
receive three ANDA approvals from its Corona facility, one in each month of
July, September and October of 2000, and received approval of an ANDA supplement
from its Corona facility in August 2000.
In connection with a January 1999 inspection of Watson's Miami, Florida
facility, the FDA issued a warning letter 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 that a number of these had occurred prior to Watson's purchase
of the Miami facility in 1997). The FDA conducted a follow-up inspection of
Watson's 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 Watson quality systems and cGMP compliance, including areas such as
validation and investigations. Watson has initiated and continues to implement
quality improvements at its Miami facility.
Based on a follow-up inspection conducted in the first quarter of 2000,
the Florida District Office of the FDA recommended to the FDA's Center for Drug
Evaluation and Research, or CDER, approval of pending ANDAs from the 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. Watson cannot predict whether or
when CDER will approve the pending applications from its Miami facility.
However, CDER has approved three ANDAs from Watson's Miami facility since the
time the Florida District Office made its approval recommendation, one in each
month of March, September, and December of 2000.
On July 29, 1999, the FDA concluded an inspection of Schein's Marsam
Pharmaceuticals, Inc. ("Marsam") sterile manufacturing facility, located in
Cherry Hill, N.J. Schein is a wholly-owned subsidiary of Watson and Marsam is a
wholly-owned subsidiary of Schein. At the close of the inspection, Marsam
received a Form 483 detailing the FDA's inspectional observations and noting a
number of significant deficiencies in current good manufacturing practices.
During the inspection, Marsam initiated actions to address a number of the FDA's
inspectional observations by voluntarily recalling all Marsam products within
expiry and suspending manufacturing and testing activities. In September 1999,
Marsam submitted its response to the FDA's inspectional observations, together
with its proposed corrective action plan (Marsam corrective action plan). A
corrective action plan is a systematic approach to assure that processes,
quality assurance and quality control programs, validation programs, employee
training, and management controls comply with cGMP regulations. The Marsam
corrective action plan contemplates resumption of manufacturing on a
product-by-product basis. On March 3, 2000, Marsam received a warning letter
from the FDA relating to the
8
<PAGE> 11
observations made during the inspection. This FDA warning letter also
acknowledged the commitments Schein made under the Marsam corrective plan.
Schein has confirmed in meetings with FDA representatives its approach to
addressing current cGMP deficiencies at Marsam on a voluntary basis. Marsam is
currently ineligible to receive new product approvals, and Schein cannot predict
when Marsam will resume manufacturing specific products. Watson is currently
reviewing strategic alternatives, including possible divestiture, for the Marsam
facility.
On September 10, 1998, the United States, on behalf of the FDA, based on
actions it filed in Federal court in the Southern District of New York on
September 9, 1998 and the District of Arizona on September 10, 1998, initiated
seizures of drugs and drug related products manufactured by Schein's Steris
Laboratories, Inc. ("Steris") facility. Steris is a wholly-owned subsidiary of
Schein. The action alleged certain instances in which the Steris facility,
located in Phoenix, Arizona, was not operating in conformity with cGMP
regulations. The actions resulted in the seizure of all drugs and drug related
products in Schein's possession manufactured at the Steris facility and halted
the manufacture and distribution of Schein's Steris Laboratories, Inc.
manufactured products.
On October 16, 1998, Steris and certain of its officers, without
admitting any allegations of the complaints and disclaiming any liability in
connection therewith, entered into a consent agreement with the FDA. Under the
terms of the consent agreement, Steris is required, among other things, to
demonstrate through independent certification that Steris' processes, quality
assurance and quality control programs, and management controls comply with cGMP
regulations. The consent agreement also provides for independent certification
of Steris' management controls, quality assurance and quality control programs,
and employee cGMP training. It further requires that Steris develop a timeline
and corrective action plan for implementing these actions and for expert
certification with respect to matters covered in previous FDA inspections of the
facility. Steris has submitted to the FDA the corrective action plan provided
for under the consent agreement ("Steris corrective action plan") and is
implementing the Steris corrective action plan.
As a result of the consent agreement, Steris has divided its product
line into three categories: products that it will seek to manufacture under
expedited certification procedures under the consent agreement, products that it
will seek to manufacture once it satisfies all conditions under the consent
agreement and products it has decided not to manufacture in the near term.
Expedited certification procedures apply for certain products that are
particularly important to the medical community because they are primarily or
exclusively available from Schein or that are particularly significant to
Schein.
In October 1998, Schein resumed commercial distribution of INFeD, its
branded injectable iron product, from existing inventory. In the second quarter
of 1999, Schein began distribution of newly manufactured lots of INFeD under the
consent agreement and, in the fourth quarter of 1999, Schein resumed the
manufacture of one other product deemed medically necessary under the expedited
certification procedures in the consent agreement. On February 11, 2000, the FDA
concluded an inspection at Steris.
Steris is currently ineligible to receive new product approvals, and
Watson cannot predict when Steris will resume manufacturing additional products.
In March 2000, Schein resumed the manufacture and commercial distribution of
vecuronium under the expedited certification procedures provided in the consent
agreement. Newly manufactured products must undergo certification by independent
experts and review by the FDA prior to commercial distribution. On August 25,
2000, Schein announced that the FDA had authorized it to monitor its commercial
distribution of INFeD without certification by independent third-party
consultants. Watson is currently reviewing strategic alternatives, including
possible divestiture, for the Steris facility.
There can be no assurance that the FDA will determine that Watson has
adequately corrected the deficiencies at its operating sites, that subsequent
inspectional observations will not result in additional deficiencies, that
approval of any of the pending or subsequently submitted ANDAs by Watson will be
granted or that the FDA will not seek to impose additional sanctions against
Watson or any of its subsidiaries. The range of possible sanctions includes FDA
issuance of adverse publicity, product recalls or seizures, injunctions, and
civil or criminal prosecution. Any such sanctions, if imposed, could have a
material adverse effect on Watson's business. Additionally, significant delays
in the review or approval of applications for new products or in complying with
the requirements of the Marsam corrective action plan, the Steris corrective
action plan or the consent agreement could have a material adverse effect on
Watson's business, results of operation and financial condition.
The process for obtaining governmental approval to manufacture and
market pharmaceutical products is rigorous, time-consuming and costly, and
Watson cannot predict the extent to which it may be affected by legislative and
regulatory developments. Watson is dependent on receiving FDA and other
governmental approvals prior to manufacturing, marketing and shipping its
products. Consequently, there is always the chance that the FDA or other
applicable agency will not approve products, or that the rate, timing and cost
of such approvals will adversely affect the combined company's product
introduction plans or results of operations.
9
<PAGE> 12
THE PHARMACEUTICAL INDUSTRY IS HIGHLY COMPETITIVE.
The competitors of Watson 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 the
combined company's products or technologies noncompetitive or obsolete.
BECAUSE THE COMBINED COMPANY WILL BE SMALLER THAN MANY OF ITS NATIONAL
COMPETITORS IN THE BRANDED PHARMACEUTICAL PRODUCTS SECTOR, THE COMBINED COMPANY
MAY LACK THE FINANCIAL AND OTHER RESOURCES NEEDED TO MAINTAIN ITS PROFIT MARGINS
AND TO CAPTURE INCREASED MARKET SHARE IN THIS SECTOR.
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. The
combined company's branded pharmaceutical business will operate primarily in the
following divisional areas: Dermatology, Women's Health, General Products and
Nephrology. The combined company's competitors vary depending upon product
categories, and within each product category, upon dosage strengths and
drug-delivery systems. Such competitors include the major brand name
manufacturers of pharmaceuticals such as Johnson & Johnson and American Home
Products. Based on total assets, annual revenues, and market capitalization,
Watson is, and the combined company will be, smaller than these and other
national competitors in the branded product arena. For example, in mid December
2000, Watson's market capitalization was approximately $4.7 billion compared to
Johnson & Johnson ($137 billion) and American Home Products ($77 billion). These
competitors, as well as others, have been in business for a longer period of
time than the combined company, have a greater number of products on the market
and have greater financial and other resources. If the combined company directly
competes with them for the same markets and/or products, their financial
strength could prevent it from capturing a profitable share of those markets.
SALES OF THE COMBINED COMPANY'S PRODUCTS MAY CONTINUE TO BE ADVERSELY AFFECTED
BY THE CONTINUING CONSOLIDATION OF ITS DISTRIBUTION NETWORK AND THE
CONCENTRATION OF ITS CUSTOMER BASE.
The principal customers of Watson are wholesale drug distributors and
major retail drug store chains. These customers comprise a significant part of
the distribution network for pharmaceutical products in the United States. This
distribution network is continuing to undergo significant consolidation marked
by mergers and acquisitions among wholesale distributors and the growth of large
retail drug store chains. As a result, a small number of large wholesale
distributors control a significant share of the market, and the number of
independent drug stores and small drug store chains has decreased. Watson
expects that consolidation of drug wholesalers and retailers will increase
pricing and other competitive pressures on drug manufacturers, including the
combined company. For the year ended December 1999, the three largest customers
of Watson accounted for 20%, 12% and 12%, respectively, of Watson's net
revenues. The loss of any of these customers could materially and adversely
affect the combined company's business, results of operations or financial
condition. Our recent revenue growth is principally a result of our plan, begun
in 1995, to diversify our business and expand into selected related product
platforms.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
We caution the reader that certain important factors may affect our
actual results and could cause such results to differ materially from any
forward looking statement which may have been deemed to have been made in or
incorporated by reference into this prospectus or which are otherwise made by us
or on our behalf. For this purpose any statements contained in this prospectus
that are not statements of historical fact may be deemed to be forward looking
statements. Without limiting the generality of the foregoing, words such as
"may", "will", "expect", "believe", "anticipate", "intend", "could", "would",
"estimate", or "continue", or the negative other variations thereof or
comparable terminology are intended to identify forward looking statements.
Forward looking statements involve risks and uncertainties that cannot
be predicted or quantified and, consequently, actual results may differ
materially from those expressed or implied by such forward-looking statements.
Such risks and uncertainties include, among other things:
- the ability to integrate the operations of Watson and Makoff;
10
<PAGE> 13
- 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 prospectus and from
time to time in Watson's SEC filings, including, but not limited to,
the Annual Report on Form 10-K for the year ended December 31, 1999
of Watson, and Watson's Form 10-Q for the three and nine months
ended September 30, 2000, Schein's Annual Report on Form 10-K for
the fiscal year ended December 25, 1999, Schein's Form 10-Q for the
three and six months ended June 24, 2000 and the Form S-4 filed by
Watson pursuant to the Schein acquisition, originally filed on July
14, 2000, as amended.
INCORPORATION BY REFERENCE
The SEC's rules allow us to "incorporate by reference" into this
prospectus the information we file with the SEC. This means that we can disclose
important information to you by referring you to those filings. This information
we incorporate by reference is considered a part of this prospectus, and
subsequent information that we file with the SEC will automatically update and
supersede this information. Any information which is subsequently modified or
superseded will not constitute a part of this prospectus, except as so modified
or superseded. We incorporate by reference the following documents and any
future filings we make with the SEC under Sections 13(a), 13(c), 14 or 15(d) of
the Securities Exchange Act of 1934 until the selling securityholders sell all
of the shares of common stock offered by this prospectus:
(a) Our Annual Report on Form 10-K for the year ended December 31,
1999;
(b) Our Quarterly Report on Form 10-Q for the quarter ended March 31,
2000;
(c) Our Quarterly Report on Form 10-Q for the quarter ended June 30,
2000;
(d) Our Quarterly Report on Form 10-Q for the quarter ended September
30, 2000;
(e) Schein's Annual Report on Form 10-K for the fiscal year ended
December 25, 1999;
(f) Schein's Quarterly Report on Form 10-Q for the quarter ended
March 25, 2000;
(g) Schein's Quarterly Report on Form 10-Q for the quarter ended June
24, 2000;
(h) Watson's current reports on Form 8-K dated May 25, 2000, May 31,
2000, July 7, 2000, and September 11, 2000; and
(i) The description of our Common Stock contained on Form 8-A filed
August 22, 1997.
11
<PAGE> 14
All documents subsequently filed by Watson pursuant to Sections 13(a),
13(c), 14 and 15(d) of the Securities Exchange Act prior to the filing of a
post-effective amendment which indicates that all securities offered hereby have
been sold or which deregisters all securities then remaining unsold, shall be
deemed to be incorporated herein by reference and be a part hereof from the date
of filing of such documents. Any statement herein or contained in a document
incorporated or deemed to be incorporated herein by reference shall be deemed to
be modified or superseded for purposes of this Registration Statement to the
extent that a statement contained herein or in any other subsequently filed
document which also is or is deemed to be incorporated by reference herein
modifies or supersedes that statement. Any such statement so modified or
superseded shall not constitute a part of this Registration Statement, except as
so modified or superseded. For example, the risks and uncertainties under the
heading "Risk Factors" above may change or be modified by future filings, from
time to time, as our business develops or changes and you should read those
updated risk factors.
Upon written or oral request, we will provide you with a copy of any of
the incorporated documents without charge (not including exhibits to the
documents unless the exhibits are specifically incorporated by reference into
the documents). You may submit such a request for this material to Watson
Pharmaceuticals, Inc., 311 Bonnie Circle, Corona, California 92880-2882
(telephone number (909) 270-1400).
USE OF PROCEEDS
The selling securityholders will receive all of the proceeds from the
sales of common stock by them pursuant to this prospectus. We will not receive
any proceeds from these sales.
PRICE RANGE OF COMMON STOCK
Our common stock is listed for trading on the New York Stock Exchange
under the symbol "WPI". The following table lists the high and low sales prices
for our common stock as reported on the New York Stock Exchange for the periods
indicated.
<TABLE>
<CAPTION>
HIGH LOW
-------- --------
1999
<S> <C> <C>
First Quarter ................ $ 62.94 $ 37.06
Second Quarter ............... 47.50 30.50
Third Quarter ................ 40.31 28.00
Fourth Quarter ............... 43.31 26.50
2000
First Quarter ................ $ 45.75 $ 33.69
Second Quarter ............... 54.69 37.50
Third Quarter ................ 71.50 48.13
Fourth Quarter ............... 67.88 42.25
</TABLE>
On January 11, 2001, the closing price of our common stock as reported
on the New York Stock Exchange was $48.63. As of December 29, 2000 there were
approximately 90,000 holders of record of Watson common stock.
DIVIDEND POLICY
We have never paid cash dividends on our common stock and do not
anticipate paying any cash dividends in the foreseeable future.
SELLING SECURITYHOLDERS
The shares which may be resold hereunder by the selling securityholders
are shares issued by us in connection with the Makoff acquisition transaction
and Jerome Stevens' transaction. The shares were issued in transactions exempt
from the registration requirements of the Securities Act. Selling
securityholders, including their transferees, pledgees or donees or their
successors, may from time to time offer and sell pursuant to this prospectus any
or all of their shares of our common stock.
The following table sets forth information, as of December 29, 2000,
with respect to the selling securityholders and the shares of Watson common
stock beneficially owned by each selling securityholder that may be offered
pursuant to this prospectus. The information is based on information provided by
or on behalf of the selling securityholders. The selling securityholders may
offer all, some or none of the shares of common stock. An aggregate of 255,107
of the shares offered pursuant to the prospectus are held in
12
<PAGE> 15
escrow to pay contingent indemnification obligations and any expenses of the
Makoff shareholder representative, and thus may be returned to Watson. In
addition, certain selling securityholders may not sell their shares until such
time as Watson has published financial statements containing 30 days of combined
results of operations of Watson and Makoff. Consequently, we cannot estimate the
amount of the common stock that will be held by the selling securityholders upon
termination of any of these sales. In addition, the selling securityholders
identified below may have sold, transferred or otherwise disposed of all or a
portion of their shares of common stock since the date on which they provided
the information regarding their shares in transactions exempt from the
registration requirements of the Securities Act. No selling securityholder named
in the table below beneficially owns one percent or more of our common stock
based on 105,299,530 shares of Watson common stock outstanding on December 29,
2000.
<TABLE>
<CAPTION>
COMMON STOCK
OFFERED
NAME HEREBY(1)
---- ------------
<S> <C>
Howard Arvey, Trustee of the Howard Arvey Trust Dated 11/26/79 57,491
Harriet Bay, Trustee of the Bay Family Trust 19,247
Kenneth W. Blake (Joint Tenant with Robert G. Weitzman) 4,888
Jack Brown 5,399
Joseph Chazan 21,007
Leslie Trutner, As Custodian For Laina S. Chin 47,502
Leslie Trutner, As Custodian For Justin M. Chin 46,294
Leslie Trutner, As Custodian For Shana L. Chin 46,931
Silvio Coccia 14,471
Lisa Coccia 40,674
Silvio Coccia, Trustee of the SMC Irrevocable Trust for the Benefit of Daniel Coccia 7,822
Silvio Coccia, Trustee of the SMC Irrevocable Trust for the Benefit of Crista Coccia 7,822
Silvio Coccia, Trustee of the SMC Irrevocable Trust for the Benefit of Frances Coccia 7,822
Silvio Coccia, Trustee of the SMC Irrevocable Trust for the Benefit of Dominic Coccia 7,822
Silvio Coccia, Trustee of the SMC Irrevocable Trust for the Benefit of Jessica Coccia 7,822
Robert G. Weitzman, As Custodian For Vernon Dowse, Jr. 4,888
Robert G. Weitzman, As Custodian For Rebecca Dowse 4,888
Richard Franklin Drake and Margaret Evelyn Drake as Trustees of the Drake Family Trust 10,600
Daniel Epstein 24,060
Daniel J. Epstein, As Trustee Of The Epstein Family Trust Dated 4/14/93 68,637
Stanley S. Franklin and Ruth Franklin, Trustees of the Franklin Family Trust dated 6/12/84 22,138
Erwin P. Gabor and Thea S. Gabor, Trustees under the Gabor Living Trust dated 12/13/91 11,578
The Gurian Family Living Trust 9,190
Aaron M. Levy 5,670
Allison B. Levy 5,670
Merryl L. Levy 5,670
Michael A. Levy 5,670
Ora Levy 11,976
Steve & Carolyn Levy, As Trustees For The Levy Family Trust 34,696
Greg Little 11,732
Mervin Luria 21,007
Jeffrey Makoff 147,037
James Kinnear, As Custodian For Roxanne E. Makoff 52,981
James Kinnear, As Custodian For Celeste C. Makoff 52,981
Gregory Makoff 220,172
Karen Makoff 83,483
Eve Makoff 195,925
Rhoda & Dwight Makoff 28,941
Rhoda Makoff 538,944
Shannon McCool 9,190
Barry S. Naditch (Joint Tenant with Robert G. Weitzman) 4,888
Ken Natkin 9,622
</TABLE>
13
<PAGE> 16
<TABLE>
<CAPTION>
COMMON STOCK
OFFERED
NAME HEREBY(1)
---- ------------
<S> <C>
David Sandler 17,844
Reuben Sandler 391,099
Julia Sandler 16,866
David Segal 6,257
Michael Sklanowsky 15,643
Jur Strobos 43,248
Richard & Betty Treiman 11,578
Joan Wright 1,173
Michael Weitzman (Joint Tenant with Robert G. Weitzman) 19,555
Steven Weitzman 19,555
Robert G. Weitzman 161,328
Robert G. Weitzman, As Trustee For Stephanie A. Weitzman Irrevocable Trust 63,553
Robert G. Weitzman, As Trustee For Melanie J. Weitzman Irrevocable Trust 63,553
Jerome Stevens Pharmaceuticals, Inc. 62,806
</TABLE>
-------------
(1) Except for Jerome Stevens, includes an aggregate of 255,107 shares of
Watson common stock held in escrow to pay contingent indemnification
obligations and any expenses of the Makoff shareholder representative,
after which, the remaining shares will be distributed pro rata to Makoff
shareholders.
No selling securityholders set forth in the table above are parties to
the Agreement and Plan of Merger dated as of October 5, 2000 among Watson,
Watson Acquisition Corp. No. 1 and Makoff.
PLAN OF DISTRIBUTION
The selling securityholders and their successors, which term includes
their transferees, pledgees or donees or their successors, may sell the common
stock directly to purchasers or through underwriters, broker-dealers or agents,
who may receive compensation in the form of discounts, concessions or
commissions from the selling securityholders or the purchasers. These discounts,
concessions or commissions as to any particular underwriter, broker-dealer or
agent may be in excess of those customary in the types of transactions involved.
The common stock may be sold in one or more transactions at:
- fixed prices,
- prevailing market prices at the time of sale,
- prices related to the prevailing market prices,
- varying prices determined at the time of sale, or
- negotiated prices.
These sales may be effected in transactions:
- on any national securities exchange or quotation service on which
our common stock may be listed or quoted at the time of sale,
including the New York Stock Exchange,
- in the over-the-counter market,
- otherwise than on such exchanges or services or in the
over-the-counter market,
14
<PAGE> 17
- through the writing of options, whether the options are listed on an
options exchange or otherwise, or
- through the settlement of short sales.
These transactions may include block transactions or transactions in which the
same broker acts as agent on both sides of the trade.
In connection with the sale of the common stock or otherwise, the
selling securityholders may enter into hedging transactions with broker-dealers
or other financial institutions. These broker-dealers or financial institutions
may in turn engage in short sales of the common stock in the course of hedging
the positions they assume with selling securityholders. The selling
securityholders may also sell the common stock short and deliver these
securities to close out such short positions, or loan or pledge the common stock
to broker-dealers that in turn may sell these securities.
The aggregate proceeds to the selling securityholders from the sale of
the common stock offered by them hereby will be the purchase price of the common
stock less discounts and commissions, if any. Each of the selling
securityholders reserves the right to accept and, together with their agents
from time to time, to reject, in whole or in part, any proposed purchase of
common stock to be made directly or through agents. We will not receive any of
the proceeds from the offering of shares by the selling securityholders.
Our outstanding common stock is listed for trading on the New York Stock
Exchange.
In order to comply with the securities laws of some states, if
applicable, the common stock may be sold in these jurisdictions only through
registered or licensed brokers or dealers.
The selling securityholders and any broker-dealers or agents that
participate in the sale of the common stock may be deemed to be "underwriters"
within the meaning of Section 2(11) of the Securities Act. Profits on the sale
of the common stock by selling securityholders and any discounts, commissions or
concessions received by any broker-dealers or agents might be deemed to be
underwriting discounts and commissions under the Securities Act. Selling
securityholders who are deemed to be "underwriters" within the meaning of
Section 2(11) of the Securities Act will be subject to the prospectus delivery
requirements of the Securities Act.
The selling securityholders and any other person participating in a
distribution will be subject to applicable provisions of the Exchange Act and
the rules and regulations thereunder. Regulation M of the Exchange Act may limit
the timing of purchases and sales of any of the securities by the selling
securityholders and any other person. In addition, Regulation M may restrict the
ability of any person engaged in the distribution of the securities to engage in
market-making activities with respect to the particular securities being
distributed for a period of up to five business days before the distribution.
To our knowledge, there are currently no plans, arrangements or
understandings between any selling securityholder and any underwriter,
broker-dealer or agent regarding the sale of the common stock by the selling
securityholders.
A selling securityholder may decide not to sell any common stock
described in this prospectus. We cannot assure you that any selling
securityholder will use this prospectus to sell any or all of the common stock.
Any securities covered by this prospectus which qualify for sale pursuant to
Rule 144 of the Securities Act may be sold under Rule 144 rather than pursuant
to this prospectus. In addition, a selling securityholder may transfer, devise
or gift the common stock by other means not described in this prospectus.
With respect to a particular offering of the common stock, to the extent
required, an accompanying prospectus supplement or, if appropriate, a
post-effective amendment to the registration statement of which this prospectus
is a part will be prepared and will set forth the following information:
- the specific shares of common stock to be offered and sold,
- the names of the selling securityholders,
- the respective purchase prices and public offering prices and other
material terms of the offering,
- the names of any participating agents, broker-dealers or
underwriters, and
15
<PAGE> 18
- any applicable commissions, discounts, concessions and other items
constituting, compensation from the selling securityholders.
LEGAL MATTERS
The validity of the issuance of the common stock will be passed upon for
us by Kummer, Kaempfer, Bonner and Renshaw, Watson's Nevada counsel.
EXPERTS
The consolidated financial statements of Watson Pharmaceuticals, Inc.
incorporated in this prospectus by reference to the Annual Report on Form 10-K
for the year ended December 31, 1999, except as they relate to TheraTech, Inc.
and Somerset Pharmaceuticals, Inc., have been audited by PricewaterhouseCoopers
LLP, independent accountants, and, insofar as they relate to TheraTech, Inc. and
Somerset Pharmaceuticals, Inc., by other independent accountants, whose reports
thereon appear therein. Such financial statements have been so incorporated in
reliance on the reports of such independent accountants given on the authority
of such firms as experts in auditing and accounting.
The supplemental consolidated financial statements of Watson
Pharmaceuticals, Inc. as of December 31, 1999 and 1998 and for each of the three
years in the period ended December 31, 1999 included in this Prospectus, except
as they relate to Makoff R&D Laboratories, Inc., TheraTech, Inc. and Somerset
Pharmaceuticals, Inc., have been audited by PricewaterhouseCoopers LLP,
independent accountants, and, insofar as they relate to Makoff R&D Laboratories,
Inc., TheraTech, Inc. and Somerset Pharmaceuticals, Inc., by other independent
accountants, whose reports thereon appear herein. Such financial statements have
been so included in reliance on the reports of such independent accountants
given on the authority of such firms as experts in auditing and accounting.
The consolidated financial statements of TheraTech, Inc. at December 31,
1998 and 1997 and for the years then ended, included in Watson Pharmaceuticals,
Inc.'s Annual Report and incorporated herein by reference, have been audited by
Ernst & Young LLP, independent auditors, as set forth in their report appearing
elsewhere herein, and are incorporated herein by reference in reliance upon such
report given on the authority of such firm as experts in accounting and
auditing.
The consolidated financial statements of Somerset Pharmaceuticals, Inc.
and subsidiaries as of December 31, 1997 and for the year then ended (not
presented herein) have been audited by Deloitte & Touche LLP, independent
auditors, as stated in their report included herein. The report of such firm is
given upon their authority as experts in accounting and auditing.
The consolidated financial statements and schedule of Schein
Pharmaceutical, Inc. incorporated by reference in this prospectus have been
audited by BDO Seidman, LLP, independent certified public accountants, to the
extent and for the periods set forth in their reports incorporated herein by
reference, and are incorporated herein in reliance upon such reports given upon
the authority of said firm as experts in auditing and accounting.
The consolidated financial statements of Makoff R&D Laboratories, Inc.
and subsidiaries as of December 31, 1999 and 1998 and for each of the three
years in the period ended December 31, 1999 have been audited by Singer Lewak
Greenbaum & Goldstein LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
HOW TO OBTAIN MORE INFORMATION
Information regarding Watson, including historical financial statements
and detailed descriptions of the business of Watson, is included in documents
other than this prospectus. Watson files annual, quarterly and special reports,
proxy statements and other information with the Securities and Exchange
Commission. You may read and copy reports, statements or other information about
Watson on file at the Securities and Exchange Commission's public reference
rooms in Washington, D.C., New York, New York and Chicago, Illinois. Please call
the Securities and Exchange Commission at 1-800-SEC-0330 for further information
on the public reference rooms. You may also find Watson's Securities and
Exchange Commission filings through commercial document retrieval services and
the web site maintained by the Securities and Exchange Commission at
http://www.sec.gov. You may find additional information about Watson via its
website: http://www.watsonpharm.com. The information in Watson's web site is
intended to be timely and accurate; however, there can be no assurance that this
is the case. Such information is expressly excluded from this prospectus.
16
<PAGE> 19
Watson has filed with the Securities and Exchange Commission under the
Securities Act a registration statement on Form S-3 (herein, together with all
amendments and exhibits thereto, referred to as the "registration statement")
with respect to the shares of Watson's common stock to be issued pursuant to
this prospectus. This document is a part of that registration statement. This
prospectus does not contain all of the information set forth in the registration
statement, certain parts of which are omitted in accordance with the rules and
regulations of the Securities and Exchange Commission. Statements contained
herein or in any document incorporated by reference herein as to the contents of
any contract or other document referred to herein or therein are not necessarily
complete, and in each circumstance reference is made to the copy of such
contract or other document filed as an exhibit to the registration statement, or
incorporated by reference. Each such statement is qualified in all respects by
such reference. The registration statement and any amendments thereto, including
exhibits filed as a part thereof, are available for inspection and copying as
set forth above.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Watson has included in this prospectus certain portions of the
Management's Discussion and Analysis of Financial Condition and Results of
Operations disclosures contained in Watson's Annual Report on Form 10-K for the
year ended December 31, 1999 ("1999 MD&A"), and Watson's report on Form 10-Q for
the quarterly period ended September 30, 2000 ("September 2000 MD&A"). On
November 15, 2000, Watson completed its acquisition of Makoff R&D Laboratories,
Inc., a developer, licensor and marketer of pharmaceutical products and medical
foods relating to the management of kidney disease. The following disclosure
restates certain sections of the 1999 MD&As and the September 2000 MD&A solely
to reflect the completion of the acquisition of Makoff. The restatement of the
1999 MD&A and September 2000 MD&A have been made as of their respective dates
and do not reflect subsequent developments other than the acquisition of Makoff.
Under the terms of the merger agreement, Watson issued approximately 2.8 million
shares of its common stock in exchange for all the outstanding common shares of
Makoff. The acquisition qualified as a pooling of interests for accounting
purposes and the accompanying consolidated financial statements set forth a
supplemental presentation of Watson's previously-issued financial statements
retroactively restated to reflect the operations of Makoff for all periods
presented. The following disclosure should be read in conjunction with Watson's
supplemental consolidated financial statements and notes thereto included
elsewhere in this prospectus which have been restated to include the accounts
and results of operations of Makoff for all periods presented. The sections of
the 1999 MD&A entitled "General," "Acquisitions of Products and Businesses,"
"Significant Investments and Joint Ventures," "Quarterly Fluctuations," and
"Year 2000 Compliance Program" were not impacted by the Makoff acquisition and
accordingly have not been restated below.
Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. We discuss such risks and uncertainties under the caption
"Cautionary Note Regarding Forward-Looking Statements" beginning on page 10 of
this prospectus.
17
<PAGE> 20
CONSOLIDATED SUPPLEMENTAL STATEMENTS OF INCOME
The following table presents Watson's consolidated statements of income
which have been restated to reflect the acquisition of Makoff, 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 ........................... $ 704,890 100.0% $ 607,185 100.0% $ 369,260 100.0%
Cost of sales .......................... 234,340 33.2 212,041 34.9 132,531 35.9
--------- ----- --------- ----- --------- -----
Gross profit ....................... 470,550 66.8 395,144 65.1 236,729 64.1
--------- ----- --------- ----- --------- -----
Royalty income ......................... --- --- --- --- 14,249 3.9
--------- ----- --------- ----- --------- -----
Operating expenses:
Research and development ............. 51,158 7.3 53,077 8.7 38,033 10.3
Selling, general
and administrative ................. 127,864 18.1 113,344 18.8 64,372 17.4
Amortization ......................... 29,986 4.3 22,469 3.7 7,213 2.0
Merger and related expenses .......... 20,467 2.9 --- --- 14,718 4.0
Charge for acquired in-process
research and development ........... --- --- 13,000 2.1 --- ---
--------- ----- --------- ----- --------- -----
Total operating expenses ........... 229,475 32.6 201,890 33.3 124,336 33.7
--------- ----- --------- ----- --------- -----
Operating income ................... 241,075 34.2 193,254 31.8 126,642 34.3
--------- ----- --------- ----- --------- -----
Other income (expense):
Equity in earnings (loss)
of joint ventures .................. (2,591) (0.4) 6,788 1.1 10,694 2.9
Gain on sales of Andrx securities .... 44,275 6.3 --- --- --- ---
Interest and other income ............ 4,845 0.7 8,235 1.4 13,536 3.7
Interest expense ..................... (11,192) (1.6) (8,255) (1.4) (1,417) (0.4)
--------- ----- --------- ----- --------- -----
Total other income, net ............ 35,337 5.0 6,768 1.1 22,813 6.2
--------- ----- --------- ----- --------- -----
Income before income tax provision . 276,412 39.2 200,022 32.9 149,455 40.5
Provision for income taxes ............. 93,751 13.3 78,248 12.8 54,800 14.9
--------- ----- --------- ----- --------- -----
Net income ......................... $ 182,661 25.9% $ 121,774 20.1% $ 94,655 25.6%
========= ===== ========= ===== ========= =====
</TABLE>
18
<PAGE> 21
YEAR ENDED DECEMBER 31, 1999 COMPARED TO 1998
Net revenues for the year ended December 31, 1999 were $704.9 million
compared to $607.2 million for the year ended December 31, 1998, an increase of
$97.7 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 54% of net product
sales, compared to approximately 43% 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 $51.2 million in 1999
from $53.1 million in 1998. This decrease was due to a combination of
efficiencies realized upon consolidation of the Watson-Utah proprietary 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 $127.9 million
in 1999 from $113.3 million in 1998. Selling and marketing expenses accounted
for most of the increase, while general and administrative costs were
essentially flat year over year. Watson 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, Watson 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 Watson. 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.
19
<PAGE> 22
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)). Watson expects that Somerset will continue to experience losses
in near-term future periods and that the loss recorded by Watson will increase
in 2000.
In November 1999, we sold approximately 1.1 million common shares of our
investment in Andrx. Watson 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 $4.8 million in 1999 from $8.2
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 $93.8 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 Watson'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 Watson determined that the
deferred tax assets to which it had related would be realized.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO 1997
Net revenues for the year ended December 31, 1998 were $607.2 million
compared to $369.3 million for the year ended December 31, 1997, an increase of
$237.9 million or 64%. 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 43% of
net product sales, compared to approximately 46% in 1997. Our gross profit
margin on product sales was unchanged at 63% in these two years.
Watson 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 $53.1 million in 1998
from $38 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 $113.3 million
in 1998 from $64.4 million in 1997. The increase consists of a $39.1 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 Watson's branded products.
General and administrative costs increased during 1998 as a result of increased
staffing in certain administrative areas to support Watson's growth. As a
percentage of net revenues, general and administrative costs decreased to 4.7%
in 1998 from 5.1% 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.
20
<PAGE> 23
In connection with the acquisition of Rugby during the first quarter of
1998, Watson 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, Watson 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 $8.2 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 Watson's acquisition-related activities.
Interest expense during 1998 increased to $8.3 million from $1.4 million
in 1997 as a result of Watson'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 Watson.
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
Watson's effective income tax rate was due primarily to the non-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.
21
<PAGE> 24
LIQUIDITY AND CAPITAL RESOURCES -- DECEMBER 31, 1999
This Liquidity and Capital Resources section should be read in
conjunction with "Liquidity and Capital Resources -- September 30, 2000"
appearing at page 26 of this Prospectus.
Watson's working capital increased to $309.1 million at December 31,
1999 from $222.3 million at December 31, 1998. This $86.8 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. Watson's 1999 investment in property and
equipment amounted to $27.3 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, Watson 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 Watson's discretion. In addition,
Watson 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.
Watson's cash and marketable securities totaled approximately $122
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.
Watson 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, Watson's operating results and financial condition
could change materially in future periods.
We do not believe that inflation has had a significant impact on
Watson's revenues or operations.
22
<PAGE> 25
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THE
1999 PERIOD
Net revenues for the three months ended September 30, 2000 were $187.9
million compared to $173.0 million for the 1999 period, an increase of $14.9
million or 9%. Our third quarter 2000 revenue growth was primarily attributable
to sales of nicotine polacrilex gum (the generic equivalent of SmithKline
Beecham's Nicorette(R)) and sales of Ferrlecit(R) and INFeD(R), nephrology
products we obtained in the Schein acquisition. In addition, in the third
quarter of 2000 we recorded our initial sales of Schein generic products. For
the products noted above, we had no comparable prior year sales. In part due to
our sales of the Schein generic products, our total sales of generic products
increased in the third quarter of 2000, compared to the 1999 period. Our third
quarter 2000 sales of branded products decreased from the third quarter of 1999,
primarily due to aggressive generic price competition in the branded dermatology
line. Our total branded product sales accounted for 42% of our net product sales
in the third quarter of 2000, compared with 54% in the year-ago quarter.
In the third quarter of 2000, we continued to experience price
competition in the generic market. As noted above, we also experienced price
competition from generic products in our branded dermatology line. These
competitive factors, plus a larger generic mix during the quarter, resulted in
overall gross margins on product sales of 46% in the third quarter of 2000, down
from 62% in the third quarter 1999.
Research and development expenses increased to $12.9 million in the
third quarter of 2000, compared to $12.6 million in the same period of 1999.
Proprietary product development continued to be our focus, while spending on
certain generic projects declined. In this regard, spending on clinical studies
for proprietary products increased significantly in the third quarter 2000. At
the same time, administrative costs were lower due to efficiencies realized
resulting from the consolidation of our Utah-based proprietary development
program into the company-wide program in 1999.
Selling, general and administrative expenses increased to $49.1 million
in the third quarter of 2000, compared to $33.7 million in the prior year
period, due primarily to the addition of the sales, marketing and administrative
personnel of Schein. We expect these expenses to decrease significantly in
fourth quarter 2000, when we will realize a full quarter's benefit of our
integration plan rather than the partial benefits realized in the third quarter.
In addition, general and administrative expenses were higher in the third
quarter of 2000 as Watson continued to build its corporate quality assurance
group and other support areas.
Third quarter amortization expense increased to $18.2 million in 2000,
compared to $7.7 million in the 1999 period. This increase was due to
amortization expense associated with intangibles recorded in the Schein
acquisition and to amortization expense recorded on our 1999 product
acquisitions.
In the third quarter of 2000, we accounted for the acquisition of Schein
using the purchase method of accounting. In recording this transaction, we
determined that a portion of the purchase price represented purchased,
to-be-completed research and development projects, referred to as in-process
research and development (IPR&D). We charged $115 million of the Schein purchase
price to IPR&D expense in the third quarter of 2000.
Our earnings from joint ventures were approximately breakeven in the
third quarter of 2000, compared with a loss of $1.3 million in the 1999 period.
This improvement resulted primarily from our 50% interest in Somerset
Pharmaceuticals, Inc., which reported a lower net loss in the 2000 period caused
primarily by reduced research and development costs.
In the third quarter of 2000, we sold approximately 1.2 million shares
of Andrx common stock. The proceeds from these sales amounted to approximately
$97 million and we recorded pre-tax gains on sales of securities in the third
quarter of 2000 of $93.8 million.
Interest and other income in the third quarter of 2000 increased to $5.2
million from $1.3 million in 1999 due to higher 2000 cash balances, primarily as
a result of the proceeds received from the Andrx sales discussed above.
Interest expense in the third quarter of 2000 increased to $10.6 million
from $2.7 million in 1999 due to interest expense on debt acquired in connection
with the Schein acquisition. We obtained a $700 million senior credit facility,
$500 million of which was borrowed in July 2000 in the form of a term loan
facility. In September 2000, we repaid $115 million of principal on this term
loan. The balance of the senior credit facility is a $200 million revolving
credit facility. To date, we have made no borrowings under the revolving
facility.
23
<PAGE> 26
Our income tax provision in the third quarter of 2000 reflected a 37%
effective tax rate on pre-tax income, compared to 34% in 1999. The lower
effective tax rate in 1999 was primarily attributable to June 1999 changes in
income tax regulations relating to the "separate return limitation year"
limitations on the use of acquired net operating loss carryforwards to reduce
taxable income. As a result of these changes, we recorded a one-time $4.1
million reduction in income tax expense in third quarter 1999 and also
recognized a reduction in our overall effective tax rate during the final three
quarters of 1999.
RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THE
1999 PERIOD
Net revenues for the nine months ended September 30, 2000 were $565.8
million compared to $511.7 million for the 1999 period, an increase of $54.0
million or 10%. The revenue growth was primarily attributable to increased sales
of women's health products, which have grown steadily since we expanded that
group's sales force in third quarter 1999. In total, branded product sales
accounted for 53% of our net product sales in the first nine months of both 2000
and 1999. Despite continuing price competition in the generic market, our net
sales of generic products increased during the first nine months of 2000, with
the April 2000 launch of our nicotine polacrilex gum contributing to this
increase. In addition, we recorded our initial sales of Schein generic products
during the third quarter of 2000.
Our overall gross profit margins on product sales decreased to 57% in
the first nine months of 2000 from 65% in the year ago period. The main factors
contributing to this decline were price competition in the generic market and
limited new generic product introductions, with the exception of our nicotine
gum. In addition, we also experienced generic competition in our branded
dermatology line.
Research and development expenses increased to $38.3 million in the 2000
period, compared to $36.7 million in the same period of 1999. We continue to
focus on proprietary product development, while spending on certain generic
projects declined. In this regard, spending on clinical studies for proprietary
products increased significantly in the third quarter 2000, while administrative
costs were lower due to efficiencies realized resulting from the consolidation
of our Utah-based proprietary development program into the company-wide program
in 1999.
24
<PAGE> 27
Selling, general and administrative expenses increased to $116.0 million
during the first nine months of 2000 compared to $93.0 million in the prior year
period. The largest contributor to this increase was the additional selling,
general and administrative costs resulting from combining our operations with
those of Schein. We expect Schein's contribution to this balance to decrease in
the fourth quarter 2000 and beyond as the full synergistic benefits of our
integration plan are realized. In addition, during 2000 we expanded our sales
force in the women's health area and, overall, incurred higher advertising and
promotional expenses.
Amortization expense in the nine months ended September 30, 2000
increased to $35.6 million compared to $21.7 million in the 1999 period. This
increase was primarily due to amortization expense associated with intangibles
recorded in the Schein acquisition and to amortization expense recorded on our
1999 product acquisitions.
We recorded a nonrecurring $20.5 million charge in the first quarter of
1999 relating to our acquisition of TheraTech. The charge consisted of
transaction fees for investment bankers, attorneys, accountants and financial
printing costs ($11.1 million) and closure costs associated with the elimination
of duplicate or discontinued products, operations and facilities ($9.4 million).
In the first nine months of 2000, we sold approximately 7.1 million
shares of Andrx common stock. The proceeds from these sales amounted to
approximately $365 million and we recorded pre-tax gains on these sales of
$342 million.
We recorded a $3.7 million loss from joint ventures in the first nine
months of 2000. The increase resulted primarily from our interest in Somerset
Pharmaceuticals, Inc., which reported a higher net loss in the 2000 period
caused by lower revenues and higher research and development costs.
Interest and other income in 2000 increased to $13.6 million from $3.2
million in 1999 due to higher 2000 cash balances, primarily as a result of the
proceeds received from the Andrx sales discussed above.
The increase in interest expense from $8.4 million in 1999 to $15.9
million in 2000, was due to interest expense on debt acquired in July 2000 in
connection with the Schein acquisition.
Our income tax provision for the nine months ended September 30, 2000
reflected a 36% effective tax rate on pre-tax income, compared to 35% for the
same period in 1999. The lower effective tax rate in 1999 was primarily
attributable to June 1999 changes in income tax regulations relating to the
"separate return limitation year" limitations on the use of acquired net
operating loss carryforwards to reduce taxable income. As a result of these
changes, we recorded a one-time $4.1 million reduction in income tax expense in
third quarter 1999 and also recognized a reduction in our overall effective tax
rate during the final three quarters of 1999. Partially offsetting this
decrease, a portion of our first quarter 1999 charge related to the TheraTech
acquisition was not deductible for income tax purposes, which had the effect of
increasing the effective tax rate in 1999.
25
<PAGE> 28
LIQUIDITY AND CAPITAL RESOURCES -- SEPTEMBER 30, 2000
Watson's working capital increased to $498.0 million at September 30,
2000 from $309.1 million at December 31, 1999, primarily due to net income of
approximately $186.1 million during the nine-month period. The most significant
sources of cash during the first nine months of 2000 were proceeds from
borrowings related to the Schein acquisition ($500 million), proceeds from sales
of Andrx common stock (approximately $342 million) and proceeds from lower
accounts receivable balances (approximately $95 million), resulting from the
elimination of extended payment terms that had been offered in late 1999.
Significant uses of cash included the acquisition of Schein common stock and
related expenses ($525 million), retirement of Schein's indebtedness ($240
million), payments of federal and state income taxes (approximately $155
million), which were considerably higher in 2000 due to the Andrx stock sales,
the payments made on long-term debt ($115 million), and an increased investment
in inventories to help reduce the risk that certain intermittent future supply
interruptions would negatively impact revenues over the short term. Other
significant uses of cash in the first nine months of 2000 included acquisitions
of property and equipment and a final, contingent payment related to the 1998
acquisition of The Rugby Group, Inc.
On July 5, 2000, we entered into a credit agreement with a bank that
included a $500 million term loan facility and a $200 million revolving credit
facility that is available for working capital and other needs. The $500 million
term loan was drawn upon in its entirety, along with approximately $250 million
in cash on hand, to pay off certain existing Schein indebtedness and to purchase
approximately 26 million shares of Schein common stock through a cash tender
offer. Quarterly payments of the term borrowings, beginning at $15 million per
quarter during the first four quarters and increasing thereafter, were required,
with any outstanding borrowings under the facility maturing in July 2005. In
September 2000, we paid the required $15 million, plus an additional $100
million of the term borrowings, which reduced the required quarterly payment to
$12 million for the next three quarters. The interest rate under this facility
is fixed at the London Interbank Offered Rate ("LIBOR") plus 1.375%
(approximately 8.0%) for the first six months; thereafter, the margin over LIBOR
will be determined based on a leverage test. Under the terms of the facility, we
are subject to customary financial and other operational covenants. We cancelled
our $30 million credit facility with another bank before we entered into this
credit agreement.
In April 1998, we filed a shelf registration statement with the
Securities and Exchange Commission that would allow us, from time to time, to
raise up to $300 million from offerings of senior or subordinated debt
securities, common stock, preferred stock or a combination thereof. In May 1998,
pursuant to this registration statement, we issued $150 million of 7-1/8% senior
unsecured notes due May 2008, with interest payable semi-annually in May and
November. Subject to preparation of a supplement to the existing prospectus, the
balance of this registration statement remains available for issuance at
Watson's discretion.
Our cash and marketable securities totaled approximately $132.5 million
at September 30, 2000. We believe that our cash and marketable securities
balance, our cash flow from operations and the financing sources discussed
herein, will be sufficient to meet our normal operating requirements during the
next twelve months. However, we continue to review opportunities to acquire or
invest in companies, technologies, product rights and other investments that are
compatible with our existing business. We could use cash and financing sources
discussed herein, or financing sources that subsequently become available, to
fund additional acquisitions or investments. If a material acquisition or
investment is completed, our operating results and financial condition could
change materially in future periods. However, no assurance can be given that
additional funds will be available on satisfactory terms, or at all.
26
<PAGE> 29
INDEX TO SUPPLEMENTAL AND PRO FORMA FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
SUPPLEMENTAL FINANCIAL STATEMENTS AS OF DECEMBER 31, 1999:
Reports of Independent Accountants.............................................. F-2
Supplemental Consolidated Balance Sheets as of December 31, 1999 and 1998....... F-6
Supplemental Consolidated Statements of Income
for each of the three years in the period ended December 31, 1999......... F-7
Supplemental Consolidated Statements of Stockholders' Equity
for each of the three years in the period ended December 31, 1999......... F-8
Supplemental Consolidated Statements of Cash Flows
for each of the three years in the period ended December 31, 1999......... F-9
Notes to Supplemental Consolidated Financial Statements......................... F-11
SUPPLEMENTAL FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 2000:
Supplemental Consolidated Balance Sheets as of September 30, 2000
and December 31, 1999..................................................... F-25
Supplemental Consolidated Statements of Operations
for the three and nine months ended September 30, 2000 and 1999........... F-26
Supplemental Consolidated Statements of Cash Flows
for the nine months ended September 30, 2000 and 1999..................... F-27
Notes to Supplemental Consolidated Financial Statements ........................ F-28
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000.............................. F-33
Notes to Unaudited Pro Forma Condensed Combined Statement of Operations
for the nine months ended September 30, 2000.............................. F-36
</TABLE>
All financial statement schedules are omitted because they are not
applicable or the required information is included in the Supplemental
Consolidated Financial Statements or notes thereto.
F-1
<PAGE> 30
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 supplemental consolidated balance sheets and the related
supplemental consolidated statements of income, of stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Watson Pharmaceuticals, Inc. and its subsidiaries (Watson) 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 of America. These
financial statements are the responsibility of Watson'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 Makoff R&D
Laboratories, Inc. (Makoff), which statements reflect total assets of
$10,035,000 and $6,460,000 at December 31, 1999 and 1998, respectively, and
total net revenues of $15,660,000, $10,990,000 and $7,040,000 for the years
ended December 31, 1999, 1998 and 1997, respectively. 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 Watson, as of December 31, 1997 and for the year ended December 31,
1997. Watson'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 Makoff, 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 of America, 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.
As described in Note 2, on November 15, 2000 Watson merged with Makoff in a
transaction accounted for as a pooling of interests. The accompanying
supplemental consolidated financial statements give retroactive effect to the
merger of Watson with Makoff. Accounting principles generally accepted in the
United States of America proscribe giving effect to a consummated business
combination accounted for by the pooling of interests method in the financial
statements that do not include the date of consummation. These financial
statements do not extend through the date of consummation; however, they will
become the historical consolidated financial statements of Watson after
financial statements covering the date of consummation of the business
combination are issued.
PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
February 4, 2000,
except as to the pooling of interests with
Makoff R&D Laboratories, Inc. which is as of November 15, 2000
F-2
<PAGE> 31
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Directors and Stockholders
Makoff R&D Laboratories, Inc.
We have audited the consolidated balance sheets of Makoff R&D Laboratories, Inc.
and subsidiaries as of December 31, 1999 and 1998, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1999 (not presented separately
herein). These financial statements are the responsibility of Watson'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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Makoff R&D
Laboratories, Inc. and subsidiaries as of December 31, 1999 and 1998, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1999 in conformity with generally
accepted accounting principles.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
February 25, 2000, except
for the second paragraph
of Note 19, as to which
the date is March 15, 2000
F-3
<PAGE> 32
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 Watson'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-4
<PAGE> 33
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 Watson'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-5
<PAGE> 34
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1999 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ................................. $ 108,172 $ 63,576
Marketable securities ..................................... 13,865 32,903
Accounts receivable, net of allowances for doubtful
accounts of $3,385 and $4,160 ........................... 182,616 92,370
Inventories ............................................... 109,077 82,307
Prepaid expenses and other current assets ................. 10,026 27,515
Deferred tax assets........................................ 19,815 29,634
---------- ----------
Total current assets .................................... 443,571 328,305
Property and equipment, net .................................. 139,603 126,340
Investments and other assets ................................. 291,642 201,300
Product rights and other intangibles, net..................... 574,418 482,286
---------- ----------
$1,449,234 $1,138,231
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ..................... $ 61,312 $ 73,578
Income taxes payable ...................................... 33,550 --
Current portion of long-term debt ......................... 2,114 2,012
Current liability from acquisitions of products and
businesses............................................... 37,458 30,380
---------- ----------
Total current liabilities ............................... 134,434 105,970
Long-term debt ............................................... 150,365 151,381
Long-term liability from acquisitions of products and
businesses ................................................. 18,067 23,071
Deferred tax liabilities ..................................... 87,060 54,512
---------- ----------
Total liabilities........................................ 389,926 334,934
---------- ----------
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; 98,853,000 and 98,057,100 shares issued 326 324
Additional paid-in capital ................................. 399,424 370,641
Retained earnings .......................................... 551,628 371,788
Accumulated other comprehensive income ..................... 107,530 60,144
---------- ----------
Total stockholders' equity .............................. 1,058,908 802,897
---------- ----------
$1,449,234 $1,138,231
========== ==========
</TABLE>
See accompanying Notes to Supplemental Consolidated Financial Statements.
F-6
<PAGE> 35
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTAL 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 .................................... $ 704,890 $ 607,185 $ 369,260
Cost of sales ................................... 234,340 212,041 132,531
--------- --------- ---------
Gross profit ................................ 470,550 395,144 236,729
--------- --------- ---------
Royalty income .................................. -- -- 14,249
--------- --------- ---------
Operating expenses:
Research and development ..................... 51,158 53,077 38,033
Selling, general and administrative .......... 127,864 113,344 64,372
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 .................... 229,475 201,890 124,336
--------- --------- ---------
Operating income ................................ 241,075 193,254 126,642
--------- --------- ---------
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 .................... 4,845 8,235 13,536
Interest expense ............................. (11,192) (8,255) (1,417)
--------- --------- ---------
Total other income, net ..................... 35,337 6,768 22,813
--------- --------- ---------
Income before income tax provision .............. 276,412 200,022 149,455
Provision for income taxes ...................... 93,751 78,248 54,800
--------- --------- ---------
Net income ...................................... $ 182,661 $ 121,774 $ 94,655
========= ========= =========
Basic earnings per share ........................ $ 1.85 $ 1.25 $ 0.99
========= ========= =========
Diluted earnings per share ...................... $ 1.82 $ 1.22 $ 0.97
========= ========= =========
Pro forma diluted earnings per share (Note 2).... $ 1.80
=========
Weighted average shares outstanding, basic ...... 98,500 97,460 95,240
========= ========= =========
Weighted average shares outstanding, diluted .... 100,520 100,140 97,830
========= ========= =========
</TABLE>
See accompanying Notes to Supplemental Consolidated Financial Statements.
F-7
<PAGE> 36
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTAL 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 ............................................ 98,057 96,158 93,378
Exercise of options and warrants ............................. 796 1,899 2,780
----------- ----------- -----------
Ending balance ............................................... 98,853 98,057 96,158
=========== =========== ===========
Common stock -- amount:
Beginning balance ............................................ $ 324 $ 317 $ 308
Exercise of options and warrants ............................. 2 7 9
----------- ----------- -----------
Ending balance ............................................... 326 324 317
=========== =========== ===========
Additional paid-in capital:
Beginning balance ............................................ 370,641 329,179 301,764
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 ........................................................ (275) 276 515
----------- ----------- -----------
Ending balance ............................................... 399,424 370,641 329,179
=========== =========== ===========
Retained earnings:
Beginning balance ............................................ 371,788 250,014 155,407
Net income ................................................... 182,661 121,774 94,655
Distributions to stockholders ................................ (2,821) -- (48)
----------- ----------- -----------
Ending balance ............................................... 551,628 371,788 250,014
=========== =========== ===========
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 ...................................... $ 1,058,908 $ 802,897 $ 612,535
=========== =========== ===========
Comprehensive income:
Net income ................................................... $ 182,661 $ 121,774 $ 94,655
----------- ----------- -----------
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 ......................................... $ 230,047 $ 148,893 $ 120,491
=========== =========== ===========
</TABLE>
See accompanying Notes to Supplemental Consolidated Financial Statements.
F-8
<PAGE> 37
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTAL 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 ............................................ $ 182,661 $ 121,774 $ 94,655
--------- --------- ---------
Reconciliation to net cash provided by
operating activities:
Depreciation ....................................... 14,192 12,797 10,509
Amortization ....................................... 30,086 22,569 7,313
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 .............................................. 997 678 340
Changes in assets and liabilities,
net of acquisitions:
Accounts receivable .............................. (91,177) (16,980) (32,358)
Royalty receivable ............................... -- -- 5,554
Inventories ...................................... (26,770) (18,824) (14,984)
Prepaid expenses and other current assets ........ 27,334 (12,375) 6,315
Accounts payable and accrued expenses ............ (12,484) 654 11,401
Income taxes payable ............................. 33,550 (9,553) 9,081
Other ............................................ 1,062 (1,965) (2,156)
--------- --------- ---------
Total adjustments ............................... (54,306) 243 9,256
--------- --------- ---------
Net cash provided by operating activities ....... 128,355 122,017 103,911
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment ................ (27,320) (27,424) (16,416)
Purchases of marketable securities ................. (55,061) (77,880) (142,961)
Proceeds from maturities of marketable securities .. 74,711 84,262 185,454
Acquisitions of product rights ..................... (105,865) (177,357) (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 ........... $ (66,128) $(280,165) $(141,621)
--------- --------- ---------
</TABLE>
F-9
<PAGE> 38
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(In thousands)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt .................. $ 1,000 $ 148,418 $ 241
Principal payments on long-term debt ...................... (1,882) (7,294) (4,008)
Payments on liability for acquisition of product rights ... (30,380) (45,000) (55,000)
Proceeds from issuance of common stock .................... -- -- 1,752
Distributions to stockholders ............................. (2,821) -- (49)
Proceeds from exercises of stock options and warrants ..... 16,808 26,933 15,000
Other ..................................................... (356) -- --
--------- --------- ---------
Net cash (used in) provided by financing activities ..... (17,631) 123,057 (42,064)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents..... 44,596 (35,091) (79,774)
Cash and cash equivalents at beginning of year ............... 63,576 98,667 178,441
--------- --------- ---------
Cash and cash equivalents at end of year ..................... $ 108,172 $ 63,576 $ 98,667
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the years for:
Interest .................................................. $ 11,080 $ 5,965 $ 375
Income taxes .............................................. $ 42,920 $ 82,960 $ 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 Supplemental Consolidated Financial Statements.
F-10
<PAGE> 39
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTAL 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 Watson can exert
significant influence and ownership does not exceed 50% (primarily Somerset
Pharmaceuticals, Inc. and ANCIRC). Investments in which Watson 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).
Basis of presentation of supplemental consolidated financial statements
The supplemental consolidated financial statements of Watson have been prepared
to give retroactive effect to the acquisition of Makoff R&D Laboratories, Inc.
on November 15, 2000, as further discussed in Note 2. Generally accepted
accounting principles proscribe giving effect to a consummated business
combination accounted for by the pooling of interests method in financial
statements that do not include the date of consummation. These financial
statements do not extend through the date of the consummation; however, they
will become the historical consolidated financial statements of Watson after
financial statements covering the date of consummation of the business
combination are issued.
Watson completed its acquisition of TheraTech, Inc., now known as Watson
Laboratories, Inc., a Delaware corporation ("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 also 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 Watson 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-11
<PAGE> 40
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 .................. $ 7,433 $ 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 .................. 99,696 41,334
-------- --------
$122,037 $ 88,118
======== ========
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 Watson's accounts receivable, accounts payable, accrued
expenses and long-term debt approximate their carrying values at December 31,
1999. The fair value of Watson'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 Watson'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 $63.8
million and $40.1 million at December 31, 1999 and 1998, respectively.
Potential impairment of long-lived assets
Watson 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.
F-12
<PAGE> 41
Revenue recognition
Watson recognizes revenue, net of sales discounts and allowances, from the sale
of its pharmaceutical products upon shipment.
Watson 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 Watson's net revenues in
1999, 1998 and 1997, respectively. Bergen Brunswig Corporation accounted for
12%, 11% and 10% of Watson's net revenues in 1999, 1998 and 1997, respectively.
Cardinal Health, Inc. accounted for 12% of Watson'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 $7.9 million, $14.0
million and $15.6 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 into
common stock in each year.
F-13
<PAGE> 42
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 ............................... $182,661 $121,774 $ 94,655
======== ======== ========
Denominators:
Denominator for basic EPS, weighted
average shares outstanding ............ 98,500 97,460 95,240
Assumed exercise of dilutive stock
options and warrants .................. 2,020 2,680 2,590
-------- -------- --------
Denominator for diluted EPS .............. 100,520 100,140 97,830
======== ======== ========
Basic EPS ................................... $ 1.85 $ 1.25 $ 0.99
======== ======== ========
Diluted EPS ................................. $ 1.82 $ 1.22 $ 0.97
======== ======== ========
</TABLE>
Concentration of credit risk
Watson 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.
Watson 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 -- ACQUISTIONS OF PRODUCTS AND BUSINESSES
Subsequent event - 2000 acquisition of Makoff
On November 15, 2000, Watson completed its acquisition of Makoff R&D
Laboratories, Inc., ("Makoff") a developer, licensor and marketer of
pharmaceutical products and medical foods related to the management of kidney
disease. Under the terms of the merger agreement, each share of Makoff common
stock was converted into the right to receive 1.9555 of a share of Watson's
common stock. Accordingly, Watson issued approximately 2.8 million common
shares, having a market value of approximately $155 million on the date of
acquisition, in exchange for all the outstanding common shares of Makoff. The
acquisition qualified as a pooling of interests for accounting purposes and a
tax-free reorganization under Section 368(a) of the Internal Revenue Code. In
connection with this acquisition, Watson expects to record a special, one-time
charge during the fourth quarter of 2000, in an amount not yet determinable, for
certain merger-related expenses.
1999 acquisition of TheraTech
In January 1999, Watson completed its acquisition of TheraTech. 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 Watson's common stock.
Accordingly, Watson 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 under Section 368(a) of the Internal Revenue Code
and was accounted for as a pooling of interests.
In connection with this acquisition, during the first quarter of 1999, Watson
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 Watson. 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, Watson had paid all material merger-related
costs and charged-off the impaired assets and shutdown facilities.
F-14
<PAGE> 43
Combined and separate selected financial data of Watson, Makoff and TheraTech
for the three years in the period ended December 31, 1999 are summarized as
follows (in thousands):
<TABLE>
<CAPTION>
Adjust-
Watson Makoff TheraTech ments Combined
-------- ------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
1999
Net revenues .......... $689,232 $ 15,658 $ -- $ -- $704,890
======== ======== ======== ======== ========
Net income ............ $178,881 $ 3,780 $ -- $ -- $182,661
======== ======== ======== ======== ========
1998
Net revenues .......... $556,148 $ 10,992 $ 40,045 $ -- $607,185
======== ======== ======== ======== ========
Net income (loss) ..... $120,829 $ 3,092 $ (2,147) $ -- $121,774
======== ======== ======== ======== ========
1997
Net revenues .......... $324,015 $ 7,039 $ 38,206 $ -- $369,260
======== ======== ======== ======== ========
Net income (loss) ..... $ 90,184 $ (995) $ 5,851 $ (385) $ 94,655
======== ======== ======== ======== ========
</TABLE>
Prior to its merger with Watson, Makoff was taxed as an "S" Corporation. All
Makoff income, losses, gains and credits were passed through to the Makoff
stockholders. Accordingly, no income tax provision is included in the
accompanying supplemental financial statements related to Makoff's income. The
pro forma diluted earnings per share amount presented in the statement of income
for 1999 reflects the company's results of operations as if Makoff's pretax
earnings were taxed at Watson's historic effective tax rate. Also prior to its
merger with Watson, Makoff made distributions to its stockholders totaling $2.8
million and $48,000 in 1999 and 1997, respectively. Watson has not made
distributions to its stockholders since its initial public offering in 1993 and
does not anticipate doing so in the foreseeable future.
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 Watson, Makoff 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.
F-15
<PAGE> 44
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, Watson 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, Watson 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 Watson 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.
Watson 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, Watson
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, Watson 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 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 Watson'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. Watson 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, Watson 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 for treatment of chronic stable angina since
March 1995.
Watson and RPR entered into a supply agreement whereby RPR agreed to supply
Watson with all of its requirements for Dilacor XR 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 or its generic equivalent since that time. During 1999, Watson
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).
F-16
<PAGE> 45
1997 acquisition of Royce Laboratories, Inc.
In April 1997, Watson 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, Watson 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 under
Section 368(a) of the Internal Revenue Code. Oclassen marketed dermatology
products used to prevent and treat skin diseases.
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 .......................... $ 48,952 $ 26,109
Work-in-progress ....................... 13,897 12,980
Finished goods ......................... 46,228 43,218
--------- ---------
$ 109,077 $ 82,307
========= =========
Property and equipment:
Buildings and improvements ............. $ 64,114 $ 58,682
Leasehold improvements ................. 14,773 14,467
Land and land improvements ............. 10,633 9,674
Machinery and equipment ................ 90,670 72,499
Research and laboratory equipment ...... 24,571 20,778
Furniture and fixtures ................. 6,895 4,753
--------- ---------
211,656 180,853
Less accumulated depreciation and
amortization ...................... (83,624) (67,153)
--------- ---------
128,032 113,700
Construction in progress ............... 11,571 12,640
--------- ---------
$ 139,603 $ 126,340
========= =========
Accounts payable and accrued expenses:
Trade accounts payable ................. $ 37,321 $ 37,482
Royalties payable ...................... 8,061 8,227
Accrued payroll and benefits ........... 6,827 8,170
Other accrued liabilities .............. 9,103 19,699
--------- ---------
$ 61,312 $ 73,578
========= =========
</TABLE>
F-17
<PAGE> 46
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 ...................... 13,270 12,944
-------- --------
$291,642 $201,300
======== ========
</TABLE>
Long-term investments
Long-term investments consisted primarily of Watson'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, Watson
owned 5.4 million Andrx common shares (adjusted for a June 1999 two-for-one
stock split). In June 1999, Watson 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, Watson owned
approximately 5 million of Andrx' common shares, or 15.8% of the total shares
outstanding. Watson'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
Watson 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.
Watson 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.
F-18
<PAGE> 47
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 ...................... 2,488 2,730
--------- ---------
152,479 153,393
Less current portion ..................... (2,114) (2,012)
--------- ---------
$ 150,365 $ 151,381
========= =========
</TABLE>
In May 1998, Watson 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. Watson 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: $2.1 million in 2000, $1.2 million in 2001 and $0.6 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 .......................... 9,785 9,341 9,373
-------- -------- --------
96,777 76,693 56,486
-------- -------- --------
Deferred provision (benefit):
Federal ........................ (2,869) 920 (1,966)
State .......................... (157) 635 280
-------- -------- --------
(3,026) 1,555 (1,686)
-------- -------- --------
Provision for income taxes ........ $ 93,751 $ 78,248 $ 54,800
======== ======== ========
</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
Watson's investments in joint ventures.
F-19
<PAGE> 48
Reconciliations between the statutory federal income tax rate and Watson'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>
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 Watson'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>
Watson 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, Watson 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. Watson's NOL
carryforwards will begin to expire at various dates beginning in year 2003, if
not utilized.
Watson 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 Watson's 1999 income tax provision, and a corresponding
increase in Watson'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 Watson's effective tax rate
during the final three quarters of 1999.
F-20
<PAGE> 49
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
Watson determined that the deferred tax assets to which it had related would be
realized.
NOTE 7 - STOCKHOLDERS' EQUITY
Preferred stock
In 1992, Watson 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.
Stock option plans
Watson has adopted several stock option plans that authorize the granting of
options to purchase Watson's common stock subject to certain conditions. At
December 31, 1999, Watson 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
Watson'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.
Watson 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, Watson'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 ........................ $ 165,250 $ 108,525 $ 85,775
========== ========== ==========
Pro forma basic EPS ......................... $ 1.68 $ 1.11 $ 0.90
========== ========== ==========
Pro forma diluted EPS ....................... $ 1.64 $ 1.08 $ 0.88
========== ========== ==========
</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.
F-21
<PAGE> 50
A summary of Watson'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>
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
Watson 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, Watson made a $2 million equity investment in Palatin, a
publicly traded company. Also, in 1998, Watson 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, Watson earned
research and development revenues of $250,000 and $860,000, respectively.
Watson had notes receivable due from executive officers aggregating $920,000 at
December 31, 1998. The notes were repaid to Watson in 1999.
F-22
<PAGE> 51
NOTE 9 - COMMITMENTS AND CONTINGENCIES
Facility and equipment leases
Watson has entered into operating leases for certain facilities and equipment.
The terms of the operating leases for Watson's facilities require Watson 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 $7.2 million, $6.8 million and $3.9
million, respectively.
At December 31, 1999, future minimum lease payments under all non-cancelable
operating leases consisted of $6.7 million in 2000, $5.7 million in 2001, $4.9
million in 2002, $1.3 million in 2003, $0.6 million in 2004, and $3.3 million
thereafter.
Employee retirement plans
Watson maintains 401(k) retirement plans covering substantially all employees.
Watson contributes to the plans based upon the employee contributions. Watson
contributed $1.8 million, $1.4 million and $1.0 million to these retirement
plans for the years ended December 31, 1999, 1998, and 1997, respectively.
Legal matters
Watson 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 Watson. Management believes, however, that the ultimate resolution of
such matters will not have a material adverse impact on Watson's consolidated
financial position or results of operations.
F-23
<PAGE> 52
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>
Net revenues ........................... $ 193,161 $ 173,025 $ 172,819 $ 165,885
Cost of sales .......................... 65,855 61,837 56,219 50,429
--------- --------- --------- ---------
Gross profit ........................ 127,306 111,188 116,600 115,456
--------- --------- --------- ---------
Operating expenses ..................... 57,602 53,998 51,212 66,663
Gain on sales of Andrx securities ...... 44,275 -- -- --
Other expense, net ..................... 2,870 2,815 1,428 1,825
Provision for income taxes ............. 37,600 18,760 17,693 19,698
--------- --------- --------- ---------
Net income .......................... $ 73,509 $ 35,615 $ 46,267 $ 27,270
========= ========= ========= =========
Basic earnings per share ............ $ 0.75 $ 0.36 $ 0.47 $ 0.28
========= ========= ========= =========
Diluted earnings per share .......... $ 0.73 $ 0.35 $ 0.46 $ 0.27
========= ========= ========= =========
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>
Net revenues ........................... $ 154,174 $ 160,372 $ 153,983 $ 138,656
Cost of sales .......................... 53,951 57,600 54,478 46,012
--------- --------- --------- ---------
Gross profit ........................ 100,223 102,772 99,505 92,644
--------- --------- --------- ---------
Operating expenses ..................... 49,701 48,645 48,989 54,555
Other income (expense), net ............ (575) 1,923 2,605 2,815
Provision for income taxes ............. 21,053 20,037 19,407 17,751
--------- --------- --------- ---------
Net income .......................... $ 28,894 $ 36,013 $ 33,714 $ 23,153
========= ========= ========= =========
Basic earnings per share ............ $ 0.30 $ 0.37 $ 0.35 $ 0.24
========= ========= ========= =========
Diluted earnings per share .......... $ 0.29 $ 0.36 $ 0.34 $ 0.23
========= ========= ========= =========
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 acquisitions of
TheraTech in January 1999 and Makoff in November 2000. Both acquisitions were
accounted for under the pooling of interests method as further discussed in Note
2.
F-24
<PAGE> 53
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
(Unaudited; in thousands, except share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ..................................... $ 108,962 $ 108,172
Marketable securities ......................................... 23,504 13,865
Accounts receivable, net ...................................... 87,598 182,616
Inventories ................................................... 258,821 109,077
Assets held for disposition ................................... 129,877 --
Prepaid expenses and other current assets ..................... 31,005 10,026
Deferred tax assets ........................................... 81,920 19,815
---------- ----------
Total current assets ........................................ 721,687 443,571
Property and equipment, net ...................................... 184,945 139,603
Investments and other assets ..................................... 356,470 291,642
Product rights and other intangibles, net ........................ 1,439,936 574,418
---------- ----------
$2,703,038 $1,449,234
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ......................... $ 154,300 $ 61,312
Income taxes payable .......................................... 23,593 33,550
Current portion of long-term debt ............................. 38,157 2,114
Current liability from acquisitions of products and
businesses ................................................... 7,658 37,458
---------- ----------
Total current liabilities ................................... 223,708 134,434
Long-term debt ................................................... 500,776 150,365
Other long-term liabilities ...................................... 17,088 18,067
Deferred income taxes ............................................ 339,519 87,060
---------- ----------
Total liabilities ........................................... 1,081,091 389,926
---------- ----------
Commitments and contingencies ....................................
Minority interest ................................................ -- 400
---------- ----------
Stockholders' equity:
Preferred stock; no par value per share;
2,500,000 shares authorized; none outstanding .................. -- --
Common stock; $0.0033 par value per share; 500,000,000
shares authorized; 105,479,500,and 98,853,000 shares ............ 348 326
outstanding
Additional paid-in capital ....................................... 726,261 399,424
Retained earnings ................................................ 735,266 551,628
Accumulated other comprehensive income ........................... 160,072 107,530
---------- ----------
Total stockholders' equity .................................. 1,621,947 1,058,908
---------- ----------
$2,703,038 $1,449,234
========== ==========
</TABLE>
See accompanying Notes to Supplemental Consolidated Financial Statements.
F-25
<PAGE> 54
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Net revenues ................................. $ 187,854 $ 173,025 $ 565,750 $ 511,729
Cost of sales ................................ 99,631 61,837 232,524 168,485
--------- --------- --------- ---------
Gross profit ............................ 88,223 111,188 333,226 343,244
--------- --------- --------- ---------
Operating expenses:
Research and development .................. 12,927 12,578 38,330 36,665
Selling, general and administrative ....... 49,107 33,719 116,012 93,000
Amortization .............................. 18,210 7,701 35,646 21,741
Charge for acquired in-process
research and development (Note B) ....... 115,000 -- 115,000 --
Merger and related expenses (Note C) ...... -- -- -- 20,467
--------- --------- --------- ---------
Total operating expenses ................ 195,244 53,998 304,988 171,873
--------- --------- --------- ---------
Operating income (loss) ...................... (107,021) 57,190 28,238 171,371
--------- --------- --------- ---------
Other income (expense):
Equity in earnings (losses)
of joint ventures ....................... 2 (1,317) (3,709) (932)
Gains on sales of securities .............. 93,766 -- 342,161 --
Interest and other income ................. 5,249 1,251 13,601 3,228
Interest expense .......................... (10,589) (2,749) (15,898) (8,364)
--------- --------- --------- ---------
Total other income (expense), net ....... 88,428 (2,815) 336,155 (6,068)
--------- --------- --------- ---------
Income (loss) before income taxes and
extraordinary item ........................ (18,593) 54,375 364,393 165,303
Provision for income taxes ................... 34,099 18,760 177,109 56,151
--------- --------- --------- ---------
Income (loss) before extraordinary item ...... (52,692) 35,615 187,284 109,152
Extraordinary loss on early retirement of
debt, net of tax of $730 .................. (1,216) -- (1,216) --
--------- --------- --------- ---------
Net income (loss) ............................ $ (53,908) $ 35,615 $ 186,068 $ 109,152
========= ========= ========= =========
Earnings (loss) per share:
Basic ..................................... $ (0.53) $ 0.36 $ 1.86 $ 1.11
========= ========= ========= =========
Diluted ................................... $ (0.53) $ 0.36 $ 1.82 $ 1.09
========= ========= ========= =========
Weighted average shares outstanding:
Basic ..................................... 101,735 98,583 100,075 98,413
========= ========= ========= =========
Diluted ................................... 101,735 100,243 102,100 100,598
========= ========= ========= =========
</TABLE>
See accompanying Notes to Supplemental Consolidated Financial Statements.
F-26
<PAGE> 55
WATSON PHARMACEUTICALS, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------
2000 1999
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................................. $ 186,068 $ 109,152
--------- ---------
Reconciliation to net cash provided (used) by operating activities:
Depreciation ............................................................. 13,242 10,050
Amortization ............................................................. 35,646 21,807
Charge for acquired in-process research and development .................. 115,000 --
Extraordinary loss on early retirement of debt ........................... 1,216 --
Deferred income tax provision ............................................ 409 20,686
Equity in losses of joint ventures ....................................... 3,998 1,260
Gain on sale of Andrx securities ......................................... (342,161) --
Tax benefits related to exercise of stock options ........................ 28,840 10,587
Other .................................................................... 10,652 2,309
Cash provided (used) by changes in
assets and liabilities (net of acquisitions):
Accounts receivable ................................................... 94,136 (35,600)
Inventories ........................................................... (91,585) (24,293)
Prepaid expenses and other current assets ............................. (11,660) 10,707
Accounts payable and accrued expenses ................................. (32,238) (7,477)
Income taxes payable .................................................. (17,241) 11,501
--------- ---------
Total adjustments .................................................. (191,746) 21,537
--------- ---------
Net cash provided (used) by operating activities ................... (5,678) 130,689
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment ........................................ (21,835) (19,733)
Purchases of marketable securities ......................................... (45,240) (57,806)
Proceeds from maturities of marketable securities .......................... 34,531 59,874
Proceeds from sales of Andrx and other securities .......................... 366,576 --
Acquisition of Schein Pharmaceutical ....................................... (518,183) --
Contingent payment related to acquisition of The Rugby Group ............... (23,407) --
Issuance of note receivable ................................................ (12,400) --
Acquisitions of product rights ............................................. (6,553) (64,318)
Additions to investments in joint ventures and other ....................... (437) (5,593)
--------- ---------
Net cash used by investing activities .............................. (226,948) (87,576)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ................................... 501,000 --
Retirement of Schein Pharmaceutical debt ................................... (239,651) --
Principal payments on long-term debt ....................................... (118,681) (1,455)
Payments on liability for acquisition of product rights .................... (15,000) (30,380)
Distributions to stockholders .............................................. (2,430) (2,821)
Proceeds from exercise of stock options and warrants ....................... 108,178 14,558
--------- ---------
Net cash provided (used) by financing activities ................... 233,416 (20,098)
--------- ---------
Increase in cash and cash equivalents .............................. 790 23,015
Cash and cash equivalents at beginning of period ........................... 108,172 63,576
--------- ---------
Cash and cash equivalents at end of period ................................. $ 108,962 $ 86,591
========= =========
</TABLE>
See accompanying Notes to Supplemental Consolidated Financial Statements.
F-27
<PAGE> 56
WATSON PHARMACEUTICALS, INC.
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- GENERAL
The accompanying unaudited consolidated financial statements of Watson
Pharmaceuticals, Inc. and its subsidiaries ("Watson" or the "company") should be
read in conjunction with Watson's Annual Report on Form 10-K for the year ended
December 31, 1999. In the opinion of management, the accompanying financial
statements contain all adjustments necessary to present fairly Watson's
consolidated financial position and results of operations for the periods
presented. Unless otherwise noted, all such adjustments are of a normal,
recurring nature. In addition, we have reclassified certain prior year amounts
in the consolidated financial statements to conform to the current year
presentation. The results of operations for any interim period are not
necessarily indicative of the results of operations that Watson may achieve for
the entire year.
The supplemental consolidated financial statements of Watson have been prepared
to give retroactive effect to the merger with Makoff R&D Laboratories, Inc. on
November 15, 2000, as further discussed in Note C. Generally accepted accounting
principles proscribe giving effect to a consummated business combination
accounted for by the pooling of interests method in financial statements that do
not include the date of consummation. These financial statements do not extend
through the date of the consummation; however, they will become the historical
consolidated financial statements of Watson after financial statements covering
the date of consummation of the business combination are issued.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements," which provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements filed with the SEC. SAB
101 outlines the basic criteria that must be met to recognize revenue and
provides guidance for disclosures related to revenue recognition policies.
Watson will adopt SAB 101 as required in fourth quarter 2000. The adoption of
SAB 101 is not expected to have a material impact on the financial position or
results of operations of Watson.
NOTE B -- ACQUISITION OF SCHEIN PHARMACEUTICAL, INC.
On August 28, 2000, Watson completed its acquisition of Schein Pharmaceutical,
Inc. ("Schein"). Schein develops, manufactures and markets a broad line of
generic products and has a branded business focused in the area of nephrology
for the management of iron deficiency and anemia. The aggregate purchase price
of $825 million to acquire all of the outstanding Schein shares consisted of (1)
approximately $510 million in cash, (2) the issuance of approximately 5.4
million Watson common shares with a market value of $300 million, and (3)
estimated direct transaction costs of $15 million. In addition, short term
liabilities with a fair value of approximately $375 million (principally
long-term debt that was subsequently retired) and long-term liabilities with a
fair value of approximately $5 million were assumed by Watson. Watson accounted
for this acquisition under the purchase method of accounting. Accordingly,
Schein's results of operations and the estimated fair value of the assets
acquired and liabilities assumed are included in Watson's financial statements
from the date of acquisition.
Watson completed the acquisition in two steps. In the first step, on July 6,
2000, following a cash tender offer, a Watson subsidiary purchased approximately
26,068,500 shares of Schein common stock, constituting 77.8% of Schein's
outstanding shares as of that date. Following the purchase of these shares,
Watson repaid approximately $190 million of Schein indebtedness. The share
purchase and debt retirement were financed utilizing $500 million borrowed under
a new term loan facility and cash on hand. During August 2000, Watson retired
the remaining $50 million of previous Schein indebtedness, utilizing cash on
hand.
In the second step of the acquisition, on August 28, 2000, following Schein's
stockholders' approval and adoption of the merger agreement, Watson converted
each remaining outstanding share of Schein not purchased by Watson in the cash
tender, into the right to receive 0.42187 of a share of Watson common stock.
Accordingly, Watson issued approximately 5.4 million of its common shares, with
a market value of approximately $300 million, in exchange for all of the
remaining outstanding common shares of Schein.
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 acquisition. Accordingly, these financial statements reflect a
preliminary allocation of the purchase price to the acquired assets and
liabilities based on Watson's estimates of fair values. Based on discounted cash
flow models, approximately $600 million of the purchase price has been allocated
to Schein's existing product rights. These product rights will be amortized on a
straight-line basis over periods of two to 20 years, with the weighted average
life approximating 17.5 years. The remaining excess of the purchase
consideration over the fair value of the tangible net assets acquired of
approximately $300 million has been recorded as goodwill, which is being
amortized on a straight-line basis over 25 years.
F-28
<PAGE> 57
Watson allocated a portion of the purchase price to in-process research and
development (IPR&D). IPR&D represents ongoing research and development projects
acquired by Watson for products that have not been approved by the Food and Drug
Administration and would have no alternative future use. Under the purchase
method of accounting, IPR&D is not an asset and, accordingly, the $115 million
of the total purchase price of Schein that was determined to be IPR&D was
charged to expense at the date of acquisition. The IPR&D charge relates to 30
generic product development projects, the three most significant of which were
valued at$28.5 million, $16.8 million and $11.6 million. The value of each
project was determined using discounted cash flow models, with the forecasted
net cash flows for each product discounted back to its present value using
discount factors (ranging from 30% to 65%) that take into account the stage of
completion and the risks surrounding the successful commercial development of
each purchased in-process development project. At the date of acquisition,
Watson believes that the assumptions used in the valuation process were
reasonable. No assurance can be given, however, that the underlying assumptions
utilized in the valuation of these projects will be realized.
The following selected unaudited pro forma condensed combined financial
information for the nine months ended September 30, 2000 and 1999 has been
derived from the unaudited financial statements of Watson, included herein, and
of Schein. It has been prepared to give effect to the merger using the purchase
method of accounting for business combinations and assumes the merger had been
effective as of the beginning of each period presented. This pro forma
information has also been restated to include the operations of Makoff.
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------
2000 1999
-------- --------
(in thousands, except
per share data)
<S> <C> <C>
Net revenues ..................... $758,825 $872,450
Net income ....................... 138,950 77,875
Diluted earnings per share ....... $ 1.30 $ 0.73
</TABLE>
In connection with Watson's acquisition of Schein, Watson acquired two
injectable pharmaceutical manufacturing facilities, Steris Laboratories, Inc.,
located in Phoenix, Arizona, and Marsam Pharmaceuticals, Inc., located in Cherry
Hill, New Jersey. Watson has decided that these two facilities do not contribute
to its strategic long--term goals and is currently exploring strategic
alternatives and expects to dispose of these facilities by third quarter 2001.
Accordingly, these facilities were recorded at their estimated fair market
values at the time of the Schein acquisition, based on the reports of an
independent appraiser, and the net assets of the two facilities have been
classified as a current asset on Watson's consolidated balance sheet. An accrual
for estimated future losses at these facilities through their disposition is
included in this balance. During the quarter ended September 30, 2000, these
facilities operated at losses totaling $6.1 million, net of tax, that were
applied against the accrual for estimated future losses. In addition, interest
capitalized on these facilities aggregated $1.6 million, net of tax, during the
quarter ended September 30, 2000 and was added to the carrying amount of these
facilities.
A severance accrual of $33.5 million was established for termination costs
associated with approximately 80 duplicative Schein employees. As of September
30, 2000, this balance was reduced by payments to $28.6 million.
F-29
<PAGE> 58
NOTE C -- ACQUISITIONS OF OTHER BUSINESSES
Subsequent event -- 2000 acquisition of Makoff
On November 15, 2000, Watson completed its acquisition of Makoff, the sponsor of
the New Drug Application for Ferrlecit(R) (sodium ferric gluconate in sucrose
injection). Schein markets Ferrlecit(R) under exclusive marketing and
distribution rights through a sublicense from Makoff. Aventis is the
manufacturer of Ferrlecit(R) and licenses the marketing and distribution rights
to Makoff. Under the terms of the agreement, Watson acquired all of Makoff's
outstanding stock in a transaction that qualified as a pooling of interests for
accounting purposes and a tax-free reorganization under Section 368(a) of the
Internal Revenue Code. Watson issued 1.9555 shares of its common stock for each
share of Makoff stock, which resulted in the issuance of approximately 2.8
million Watson common shares. In connection with this acquisition, during the
fourth quarter of 2000, Watson expects to record a special, one-time charge, in
an amount not yet determinable, for certain merger-related costs.
TheraTech, Inc.
In January 1999, Watson completed its acquisition of TheraTech, a developer,
manufacturer and marketer of branded pharmaceutical products. This acquisition
was accounted for as a pooling of interests and, accordingly, the accompanying
consolidated financial statements include the results of TheraTech for all
periods presented. During the first quarter of 1999, Watson recorded a special
charge of $20.5 million for certain TheraTech merger and related expenses.
NOTE D -- EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted
average common shares actually outstanding during a period. Diluted earnings per
share is computed by dividing net income by the weighted average common shares
that would have been outstanding during the period, assuming, among other
things, that all vested in-the-money stock options had been exercised at the
beginning of the period. The effect of such dilutive stock options was to
increase weighted average common shares outstanding, for diluted earnings per
share purposes, by 1,660,000 shares for the three months ended September 30,
1999, and by 2,025,000 and 2,185,000 shares for the nine months ended September
30, 2000 and 1999, respectively. Because inclusion of the effect of these stock
options would have been antidilutive, their effect (which would have been to
increase diluted weighted average shares outstanding by 2,615,000 shares) has
been excluded from earnings per share computations for the three months ended
September 30, 2000.
Basic and diluted earnings per share, giving effect to the extraordinary loss on
early retirement of debt recorded during the quarter ended September 30, 2000,
may be summarized as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
BASIC EARNINGS PER SHARE:
Income (loss) before extraordinary item ........... $ (0.52) $ 0.36 $ 1.87 $ 1.11
Extraordinary loss on early retirement of debt .... (0.01) -- (0.01) --
-------- -------- -------- --------
Net income (loss) ................................. $ (0.53) $ 0.36 $ 1.86 $ 1.11
======== ======== ======== ========
DILUTED EARNINGS PER SHARE:
Income (loss) before extraordinary item ........... $ (0.52) $ 0.36 $ 1.83 $ 1.09
Extraordinary loss on early retirement of debt .... (0.01) -- (0.01) --
-------- -------- -------- --------
Net income (loss) ................................. $ (0.53) $ 0.36 $ 1.82 $ 1.09
======== ======== ======== ========
</TABLE>
Prior to its merger with Watson, Makoff was taxed as an "S" Corporation. All
Makoff income, losses, gains and credits were passed through to the Makoff
stockholders. Accordingly, no income tax provision is included in the
accompanying supplemental financial statements related to Makoff's income. The
company's results of operations would not have differed materially had Makoff
been taxed as a "C" Corporation. Also, prior to its merger with Watson, Makoff
made distributions to its stockholders. Watson has not made distributions to its
stockholders since its initial public offering in 1993 and does not anticipate
doing so in the foreseeable future.
F-30
<PAGE> 59
NOTE E -- INVENTORIES
Inventories consisted of the following (in thousands):
September 30, December 31,
2000 1999
------------ -----------
Raw materials .............. $ 80,404 $ 48,952
Work-in-progress ........... 37,795 13,897
Finished goods ............. 140,622 46,228
-------- --------
$258,821 $109,077
======== ========
NOTE F -- INVESTMENTS AND OTHER ASSETS
Long-term investments consist primarily of Watson's investment in Andrx
Corporation, a drug-delivery company utilizing controlled-release technologies
to develop oral pharmaceutical products. Andrx' common stock trades on the
NASDAQ National Market System under the symbol ADRX. During the three months
ended September 30, 2000, and as adjusted to reflect Andrx' April 2000
two-for-one stock split, Watson sold 1.2 million shares of Andrx' stock for $97
million and recorded a pretax gain of $94 million. During the nine months ended
September 30, 2000,Watson sold 7.1 million shares of Andrx stock, as adjusted
for Andrx' April 2000 stock split, for $365 million and recorded a pretax gain
of $342 million.
As of September 30, 2000, Watson owned 2.9 million common shares of Andrx, or
approximately 4% of the total Andrx common shares outstanding. Watson accounts
for this investment at fair value as an available-for-sale security. The
unrealized gain on Watson's investment in Andrx was approximately $155 million
and $110 million (net of income taxes of $105 million and $72 million), at
September 30, 2000 and December 31, 1999, respectively. This unrealized gain was
the primary component of accumulated other comprehensive income in the
stockholders' equity section of Watson's consolidated balance sheets.
NOTE G -- LONG-TERM DEBT
Long-term debt consisted of the following:
September 30, December 31,
2000 1999
------------ ------------
(in thousands)
Senior unsecured notes, 7.125%,
face amount of $150 million, due 2008
(effective rate of 7.25%) .................. $148,704 $148,608
Term loan facility, due 2005 .................. 385,000 --
Unsecured note, 8.1% due August 2001 .......... -- 1,383
Other ......................................... 5,229 2,488
-------- --------
538,933 152,479
Less current portion .......................... 38,157 2,114
-------- --------
$500,776 $150,365
======== ========
On July 5, 2000, Watson entered into a credit agreement with a bank that
includes a $500 million term loan facility and a $200 million revolving credit
facility that is available for working capital and other needs. The $500 million
term loan was drawn upon in its entirety and, along with approximately $250
million in cash on hand, used to pay off certain existing Schein indebtedness
and to purchase approximately 26 million shares of Schein common stock through
the tender offer. The interest rate under this facility is fixed at the London
Interbank Offered Rate ("LIBOR") plus 1.375% (approximately 8.0% at September
30, 2000) for the first six months; thereafter, the margin over LIBOR will be
determined based on a leverage test.
In September 2000, Watson prepaid $100 million of borrowings under the facility
in addition to a required payment of $15 million that was due October 1, 2000.
In connection with the $100 million prepayment, Watson incurred an extraordinary
loss of $1.2 million, net of tax, representing the write-off of deferred
financing costs. As a result of the $100 million prepayment, required quarterly
payments under the term loan were reduced to $12 million for the next three
quarters. The required quarterly payments will increase by $4 million annually
thereafter, with any outstanding borrowings under the facility maturing in July
2005.
F-31
<PAGE> 60
Under the terms of the facility, Watson is subject to customary financial and
other operational covenants. Watson canceled its previous $30 million credit
facility with another bank, which had never been utilized, before entering into
the current term loan agreement. As of October 31, 2000, Watson has not drawn
any funds from the $200 million revolving credit facility.
NOTE H -- COMPREHENSIVE INCOME
Comprehensive income (loss) includes all changes in equity during a period
except those resulting from investments by and distributions to our
stockholders. Watson's comprehensive income (loss) consisted of the following:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
(in thousands)
<S> <C> <C> <C> <C>
Net income (loss) ........................... $ (53,908) $ 35,615 $ 186,068 $ 109,152
--------- --------- --------- ---------
Other comprehensive income, net of tax:
Unrealized holding gains (losses)
on securities .......................... 68,354 (68,159) 266,894 127,171
Reclassification for gains included
in net income ......................... (58,605) -- (214,352) --
--------- --------- --------- ---------
Other comprehensive income (loss) ........... 9,749 (68,159) 52,542 127,171
--------- --------- --------- ---------
Comprehensive income (loss) ................. $ (44,159) $ (32,544) $ 238,610 $ 236,323
========= ========= ========= =========
</TABLE>
NOTE I -- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------
2000 1999
----------- -----------
(in thousands)
<S> <C> <C>
Cash paid during the periods for:
Income taxes ............................ $ 155,500 $ 22,500
Interest ................................ 15,602 5,653
Acquisition of business:
Fair value of assets acquired ......... $ 1,200,612 $ --
Less liabilities assumed .............. (375,666) --
Less common stock issued .............. (300,300) --
Less cash acquired .................... (6,463) --
----------- -----------
Net cash paid for acquisition ...... $ 518,183 $ --
=========== ===========
</TABLE>
F-32
<PAGE> 61
WATSON PHARMACEUTICALS, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
On November 15, 2000, Watson merged with Makoff R&D Laboratories, Inc. (Makoff)
in a transaction accounted for as a pooling of interests. As discussed below, in
July 2000, Watson acquired 77.8% of Schein following the completion of a cash
tender offer and, in August 2000, Watson completed its acquisition of Schein in
a transaction accounted for as a purchase. The following unaudited pro forma
condensed combined statement of operations for the nine months ended September
30, 2000 has been derived from the unaudited supplemental financial statements
of Watson and the unaudited historical financial statements of Schein. In the
unaudited pro forma condensed combined statement of operations, the "Historical
Watson" amounts include the results of operations of Watson and Makoff for the
entire period and the results of Schein from the acquisition date.
Schein develops, manufactures and markets a broad line of generic products and
has a branded business focused in the area of nephrology for the management of
iron deficiency and anemia. The aggregate purchase price of $825 million to
acquire all of the outstanding Schein shares consisted of (1) approximately $510
million in cash, (2) the issuance of approximately 5.4 million Watson common
shares with a market value of $300 million, and (3) estimated direct transaction
costs of $15 million. In addition, short term liabilities with a fair value of
approximately $375 million (principally long-term debt that was subsequently
retired) and long-term liabilities with a fair value of approximately $5 million
were assumed by the company. Watson accounted for this acquisition under the
purchase method of accounting.
Watson completed the acquisition in two steps. In the first step, on July 6,
2000, following a cash tender offer, a Watson subsidiary purchased approximately
26,068,500 shares of Schein common stock, constituting 77.8% of Schein's
outstanding shares as of that date. Following the purchase of these shares,
Watson repaid approximately $190 million of Schein indebtedness. The share
purchase and debt retirement were financed utilizing $500 million borrowed under
a new term loan facility and cash on hand. During August 2000, Watson retired
the remaining $50 million of previous Schein indebtedness, utilizing cash on
hand.
In the second step of the acquisition, on August 28, 2000, following Schein's
stockholders' approval and adoption of the merger agreement, Watson converted
each remaining outstanding share of Schein not purchased by the company in the
cash tender, into the right to receive 0.42187 of a share of Watson common
stock. Accordingly, Watson issued approximately 5.4 million of its common
shares, with a market value of approximately $300 million, in exchange for all
of the remaining outstanding common shares of Schein.
Under the purchase method of accounting, Watson allocated the Schein purchase
price to the acquired assets and liabilities based on the company's estimates of
their fair values at the acquisition date. Based primarily on discounted cash
flow models, approximately $600 million of the purchase price was allocated to
Schein's existing product rights. These product rights will be amortized on a
straight-line basis over periods of two to 20 years, with the weighted average
life approximating 17.5 years. The remaining excess of the purchase
consideration over the fair value of the tangible net assets acquired of
approximately $300 million has been recorded as goodwill, which is being
amortized on a straight-line basis over 25 years.
The company allocated a portion of the purchase price to in-process research and
development (IPR&D). IPR&D represents ongoing research and development projects
acquired by the company for products that have not been approved by the Food and
Drug Administration and would have no alternative future use. Under the purchase
method of accounting, IPR&D is not an asset and, accordingly, the $115 million
of the total purchase price of Schein that was determined to be IPR&D was
charged to expense at the date of acquisition. The IPR&D charge relates to 30
generic product development projects, the three most significant of which were
valued at $28.5 million, $16.8 million and $11.6 million. The value of each
project was determined using discounted cash flow models, with the forecasted
net cash
F-33
<PAGE> 62
flows for each product discounted back to its present value using discount
factors (ranging from 30% to 65%) that take into account the stage of completion
and the risks surrounding the successful commercial development of each
purchased in-process development project. At the date of acquisition, the
company believes that the assumptions used in the valuation process were
reasonable. No assurance can be given that the underlying assumptions utilized
in the valuation of these projects will be realized.
This unaudited pro forma condensed combined statement of operations should be
read in conjunction with the supplemental financial statements of Watson,
included in this prospectus, and with Watson and Schein audited consolidated
financial statements and unaudited interim consolidated financial statements,
including the notes thereto, which are included in Watson's Annual Report on
Form 10-K for the year ended December 31, 1999, Watson's Quarterly Reports on
Form 10-Q for the quarters ended March 31, June 30, and September 30, 2000,
Schein's Annual Report on Form 10-K for the year ended December 25, 1999 and
Schein's Quarterly Reports on Form 10-Q for the quarters ended March 25 and June
24, 2000, which are incorporated by reference in this registration statement.
The unaudited pro forma adjustments are based upon certain assumptions as
described in the notes to the unaudited pro forma condensed combined statement
of income. Watson's management believes that the pro forma assumptions are
reasonable under the circumstances.
The unaudited pro forma condensed combined statement of operations does not
reflect any incremental direct costs, including a significant restructuring
charge management expects to record in connection with the acquisition, or
potential cost savings which are expected to result from the consolidation of
certain operations of Watson and Schein. Accordingly, the unaudited pro forma
condensed combined statement of income is not necessarily indicative of the
results of operations of the combined company that would have occurred had the
acquisition occurred at the beginning of 2000, nor are they necessarily
indicative of future operating results.
F-34
<PAGE> 63
WATSON PHARMACEUTICALS, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS(e)
NINE MONTHS ENDED SEPTEMBER 30, 2000
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL PRO FORMA
WATSON SCHEIN ADJUSTMENTS COMBINED
---------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net revenues......................................... $565,750 $193,075 $ $758,825
Cost of sales........................................ 232,524 152,702 385,226
-------- -------- -------- --------
Gross profit.................................... 333,226 40,373 373,599
-------- -------- -------- --------
Operating expenses:
Research and development........................ 38,330 15,436 53,766
Selling, general and administrative............. 116,012 33,724 149,736
Amortization.................................... 35,646 663 25,095 (a) 61,404
Charge for acquired in-process
research and development.................... 115,000 115,000
Severance charge................................ 3,500 3,500
-------- -------- -------- --------
Total operating expenses.................... 304,988 53,323 25,095 383,406
-------- -------- -------- --------
Operating income (loss)..................... 28,238 (12,950) (25,095) (9,807)
-------- -------- -------- --------
Other income (expense):
Equity in loss of joint ventures............... (3,709) (603) (4,312)
Gain on sales of Andrx securities............... 342,161 342,161
Interest income and other income................ 13,601 1,164 14,765
Interest expense................................ (15,898) (10,170) (23,684)(b) (49,752)
-------- -------- -------- --------
Total other income (expense), net........... 336,155 (9,609) (23,684) 302,862
-------- -------- -------- --------
Income (loss) before income taxes and
extraordinary item............................... 364,393 (22,559) (48,779) 293,055
Income tax provision (benefit)....................... 177,109 (9,024) (15,200)(c) 152,885
-------- -------- -------- --------
Income (loss) before extraordinary item.............. 187,284 (13,535) (33,579) 140,170
Extraordinary loss on early retirement of
debt, net of taxes of $730....................... (1,216) (1,216)
-------- -------- -------- --------
Net income (loss)................................ $186,068 $(13,535) $(33,579) $138,954
======== ======== ======== ========
Per share data(d):
Basic earnings per share............................. $ 1.86 $ 1.32
======== ========
Diluted earnings per share........................... $ 1.82 $ 1.30
======== ========
Weighted average shares outstanding, basic........... 100,075 105,220
Common stock equivalents............................. 2,025 2,025
-------- --------
Weighted average shares outstanding, diluted......... 102,100 107,245
======== ========
</TABLE>
See accompanying notes to the unaudited pro forma condensed
combined statement of operations.
F-35
<PAGE> 64
WATSON PHARMACEUTICALS, INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED
COMBINED STATEMENT OF OPERATIONS
As further described in the supplemental financial statements of Watson
included in this Prospectus, Watson acquired Makoff R&D Laboratories, Inc.
(Makoff), in a transaction accounted for as a pooling of interests, on November
15, 2000. The accompanying pro forma financial statements have been prepared to
give retroactive effect to that acquisition, as if it had occurred on January 1,
2000.
Certain amounts in the historical and supplemental consolidated
financial statements of Watson and Schein have been reclassified to conform to
the presentation in the unaudited pro forma condensed combined statement of
operations. Intercompany transactions and balances, which were not material,
have been eliminated.
Pro forma adjustments giving effect to the acquisition in the unaudited
pro forma condensed combined statement of operations include the following:
(a) This pro forma statement of operations reflects amortization expense for the
nine months ended September 30, 2000 and was derived from an allocation of
the purchase price to the acquired assets and liabilities of Schein based on
Watson's estimates of fair values. Based primarily on discounted cash flow
models, approximately $600 million of the purchase price was allocated to
Schein's existing product rights. These product rights are being amortized
on a straight-line basis over periods of two to 20 years, with the weighted
average life approximating 17.5 years. The remaining excess of the purchase
consideration over the fair value of the tangible net assets acquired of
approximately $300 million has been recorded as goodwill, and is being
amortized on a straight-line basis over 25 years.
(b) This pro forma statement of operations reflects interest expense for the
nine months ended September 30, 2000 based on Watson's credit agreement with
a bank that includes a $500 million term loan facility. The term loan was
drawn upon in its entirety and, along with approximately $250 million in
cash on hand, used to pay off certain existing Schein indebtedness and to
purchase approximately 26 million shares of Schein common stock through the
tender offer. The interest rate under this facility is fixed at the London
Interbank Offered Rate ("LIBOR") plus 1.375% for the first six months;
thereafter, the margin over LIBOR will be determined based on a leverage
test. The incremental interest expense that resulted from the new
borrowings, in excess of that reflected in Watson's historical balances from
the date of Schein's acquisition forward, is as follows (in thousands):
Incremental interest on acquisition-related borrowings..... $ 22,328
Less: Schein historical interest expense................... (10,170)
Amortization of deferred financing costs................... 1,575
Reduction in interest income from use of cash on hand
to fund portion of purchase consideration.............. 9,387
Commitment fee on unused bank facility..................... 564
--------
Incremental net interest expense........................... $ 23,684
========
For purposes of preparing the unaudited pro forma condensed combined
statement of operations, deferred financing costs of $10.5 million are being
amortized using a method which approximates the effective interest method over
the expected average term of the associated financing agreements or five years.
The incremental interest expense has been calculated based on an assumed
interest rate of 8.0%, which approximates the actual borrowing rate as of
September 30, 2000. The annual impact on the company's results of operations of
a 100 basis point interest rate change, on the assumed outstanding balance of
$500 million, would be approximately $2.5 million after tax.
F-36
<PAGE> 65
(c) Income tax effect of the pro forma adjustments.
(d) Earnings per share calculations are based on the weighted average number of
shares of Watson common stock and common equivalent shares outstanding for
each period presented, including approximately 5.4 million Watson common
shares issued in connection with the acquisition as if they had been issued
at the beginning of 2000. In addition, options to purchase approximately 0.7
million Watson common shares were converted from Schein options and have
been included in the calculation of the diluted weighted average number of
shares as if they had been outstanding at the beginning of 2000 for purposes
of calculating the pro forma earnings per share.
(e) The historical financial statements of Watson include the following
significant non-recurring items:
o During the nine months ended September 30, 2000, Watson sold
approximately 7.1 million shares of Andrx Corporation common stock
(adjusted to reflect Andrx' April 2000 two-for-one stock split). Proceeds
from these sales amounted to $365 million and the company recorded
pre-tax gains of $342 million.
o The company allocated a portion of the Schein purchase price to
in-process research and development (IPR&D). IPR&D represents ongoing
research and development projects acquired by the company for products
that have not been approved by the Food and Drug Administration and would
have no alternative future use. Under the purchase method of accounting,
IPR&D is not an asset and, accordingly, the $115 million of the total
purchase price of Schein that was determined to be IPR&D was charged to
expense at the date of acquisition.
F-37
<PAGE> 66
2,839,306 SHARES
WATSON PHARMACEUTICALS, INC.
COMMON STOCK
PROSPECTUS
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED OR INCORPORATED BY REFERENCE
IN THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH DIFFERENT
INFORMATION. YOU SHOULD NOT ASSUME THAT THE INFORMATION CONTAINED OR
INCORPORATED BY REFERENCE IN THIS PROSPECTUS IS ACCURATE AS OF ANY DATE OTHER
THAN THE DATE OF THIS PROSPECTUS. WE ARE NOT MAKING AN OFFER OF THESE SECURITIES
IN ANY STATE WHERE THE OFFER IS NOT PERMITTED.
