-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LSeEGzjn0sr1TQg2SMYuIz0/KQkIhOnonO9wybqFHlnEfFJzUBNRh9phtV9fl1hF JhVmNIJReRd6Qri/h7ya8A== 0000950170-97-001433.txt : 19971117 0000950170-97-001433.hdr.sgml : 19971117 ACCESSION NUMBER: 0000950170-97-001433 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971114 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: WATSON PHARMACEUTICALS INC CENTRAL INDEX KEY: 0000884629 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 953872914 STATE OF INCORPORATION: NV FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13305 FILM NUMBER: 97720964 BUSINESS ADDRESS: STREET 1: 311 BONNIE CIRCLE CITY: CORONA STATE: CA ZIP: 91720 BUSINESS PHONE: 9092701400 MAIL ADDRESS: STREET 1: 311 BONNIE CIRCLE CITY: CORONA STATE: CA ZIP: 91720 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997 COMMISSION FILE NUMBER 0-20045 WATSON PHARMACEUTICALS, INC. (Exact name of registrant as specified in its charter) NEVADA 95-3872914 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 311 BONNIE CIRCLE CORONA, CA 91720 (Address of principal executive offices) (Zip Code) 909-270-1400 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: YES [X] NO [ ] The number of shares outstanding of the Registrant's only class of common stock as of November 4, 1997 was 87,840,934 shares. WATSON PHARMACEUTICALS, INC. INDEX TO THE FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997 PART I FINANCIAL INFORMATION PAGE NUMBER Item 1. Consolidated Financial Statements Consolidated Balance Sheets as of September 30, 1997 and December 31, 1996 3 Consolidated Statements of Income for the Three and Nine Months Ended September 30, 1997 and 1996 5 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1997 and 1996 6 Notes to Consolidated Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 3. Quantitative and Qualitative Disclosure About Market Risk 18 PART II OTHER INFORMATION Item 1. Legal Proceedings 19 Item 6. Exhibits and Reports on Form 8-K 19 SIGNATURES 20 PART I - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
WATSON PHARMACEUTICALS, INC. CONSOLIDATED BALANCE SHEETS (In Thousands) SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------ (unaudited) ASSETS Current assets: Cash and cash equivalents $100,673 $158,221 Marketable securities 82,013 80,966 Accounts receivable, net of allowances for doubtful accounts of $2,130 and $2,206 64,809 32,845 Royalty receivable 5,554 Inventories: Raw materials 17,705 12,801 Work-in-process 9,684 7,150 Finished goods 17,310 12,478 Prepaid expenses and other current assets 1,024 6,381 Deferred tax assets 9,146 9,807 -------- -------- Total current assets 302,364 326,203 Property and equipment, net 81,821 78,429 Investments and other assets 160,447 66,051 Product rights, net 197,369 2,171 -------- -------- $742,001 $472,854 ======== ========
See accompanying Notes to Consolidated Financial Statements. 3
WATSON PHARMACEUTICALS, INC. CONSOLIDATED BALANCE SHEETS (In Thousands) SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------ (unaudited) LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued expenses $ 39,770 $ 31,758 Income taxes payable 6,671 472 Current portion of long-term debt 812 1,025 Current liability from acquisition of product rights 45,000 --------- --------- Total current liabilities 92,253 33,255 Long-term debt 2,648 3,864 Long-term liability from acquisition of product rights 50,000 Deferred tax liabilities 43,730 12,226 --------- --------- Total liabilities 188,631 49,345 --------- --------- Commitments and contingencies Minority interest 767 401 --------- --------- Stockholders' equity: Preferred stock; no par; 2,500 shares authorized; none outstanding Common stock; par value of $.0033; 500,000 shares authorized; 87,764 and 85,439 shares issued and outstanding, respectively 290 282 Additional paid-in capital 255,451 231,512 Retained earnings 245,613 184,852 Unrealized holding gain on available-for-sale securities 51,321 7,189 Notes receivable from stockholders (72) (727) --------- --------- Total stockholders' equity 552,603 423,108 --------- --------- $ 742,001 $ 472,854 ========= =========
See accompanying Notes to Consolidated Financial Statements. 4
WATSON PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF INCOME (In Thousands, Except Earnings Per Share) (UNAUDITED) THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 1997 1996 1997 1996 ----------- ---------- ----------- ---------- Revenues: Product sales $ 91,817 $ 55,074 $ 214,251 $ 163,648 Royalty income 7,260 14,249 19,862 ----------- ---------- ----------- ---------- Total revenues 91,817 62,334 228,500 183,510 ----------- ---------- ----------- ---------- Operating expenses: Cost of revenues 34,525 25,457 87,025 75,141 Research and development 4,201 5,706 13,041 17,274 Selling, general and administrative 11,606 9,752 31,825 28,731 Amortization of intangibles 3,280 3,280 Merger expenses 14,718 ----------- ---------- ----------- ---------- Total operating expenses 53,612 40,915 149,889 121,146 ----------- ---------- ----------- ---------- Operating income 38,205 21,419 78,611 62,364 Other income: Equity in earnings of joint ventures 1,818 4,803 9,713 14,156 Investment and other income, net 2,412 2,582 9,543 6,822 ----------- ---------- ----------- ---------- Total other income 4,230 7,385 19,256 20,978 ----------- ---------- ----------- ---------- Income before provision for income taxes 42,435 28,804 97,867 83,342 Provision for income taxes 14,837 9,609 37,106 25,752 ----------- ---------- ----------- ---------- Net income $ 27,598 $ 19,195 $ 60,761 $ 57,590 =========== ========== =========== ========== Earnings per share $ 0.31 $ 0.22 $ 0.68 $ 0.65 =========== ========== =========== ========== Weighted average shares outstanding 90,013 87,790 89,037 88,036 =========== ========== =========== ==========
See accompanying Notes to Consolidated Financial Statements. 5
WATSON PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) (UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30, 1997 1996 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 60,761 $ 57,590 --------- --------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 9,265 5,298 Amortization of unearned compensation-stock awards 716 Dividends received from Somerset 8,000 10,500 Equity in earnings of joint ventures (8,832) (11,415) Provision for doubtful accounts (76) 918 Deferred income tax provision 2,775 10,009 Tax benefit related to stock option plan 10,993 3,765 Changes in assets and liabilities: Accounts receivable (31,888) (1,960) Royalty receivable 5,554 950 Inventories (12,270) (5,980) Prepaid expenses and other current assets 5,357 (1,486) Other assets (2,355) 12 Accounts payable and accrued expenses 8,012 (1,548) Income taxes payable 6,199 6,999 Other liabilities (714) --------- --------- Total adjustments 734 16,064 --------- --------- Net cash provided by operating activities 61,495 73,654 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (8,880) (9,491) Purchases of marketable securities (101,825) (84,885) Proceeds from maturities of marketable securities 100,857 39,516 Acquisition of product rights (48,478) Investment in Andrx (15,307) Investments in joint ventures (2,590) (3,857) --------- --------- Net cash used in investing activities (76,223) (58,717) --------- ---------
See accompanying Notes to Consolidated Financial Statements. 6
WATSON PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30, 1997 1996 ----------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Principal payment on liability from acquisition of product rights $ (55,000) Proceeds from long-term debt $ 743 Long-term debt paid in advance (752) Principal payments on long-term debt (677) (597) Proceeds from exercise of stock options 13,609 8,851 ----------- -------- Net cash (used) provided by financing activities (42,820) 8,997 ----------- -------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (57,548) 23,934 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 158,221 97,507 ----------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 100,673 $121,441 =========== ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the periods for: Interest $ 264 $ 293 Income taxes $ 17,484 $ 4,962 SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES: Acquisition of product rights: Fair value of assets acquired $ (198,478) Fair value of liabilities assumed $ 150,000 ----------- $ (48,478)
See accompanying Notes to Consolidated Financial Statements. 7 WATSON PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED) NOTE A - GENERAL The unaudited consolidated financial statements as of September 30, 1997 and for the three and nine months ended September 30, 1997 and 1996, as well as related notes, should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 1996. As discussed in Note B to the Consolidated Financial Statements, in 1997 the Company entered into two mergers that were accounted for as poolings of interests. These financial statements have been restated to include the results of operations of the pooled companies for all periods presented. In the opinion of management, the accompanying consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments), necessary to present fairly the Company's financial position as of September 30, 1997, and the results of operations for the three and nine months ended September 30, 1997 and 1996 and cash flows for the nine months ended September 30, 1997 and 1996. The results of operations and cash flows for the three and nine months ended September 30, 1997 are not necessarily indicative of the results of operations or cash flows which may be reported for the remainder of 1997. The accounting policies followed during the three and nine months ended September 30, 1997 were the same as those disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. NOTE B - ACQUISITIONS In 1997, the Company entered into several acquisitions which will require the payment of future scheduled amounts and the possible payment of certain contingent amounts. In addition, the Company continues to review additional acquisition and investment opportunities. The Company expects to use a combination of available cash, future debt or equity financing and future operating cash flows to fund its future acquisition costs and contingent payments. Please refer to the Liquidity and Capital Resources section of this Form 10-Q for further discussion of financing alternatives under consideration. 8 WATSON PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED SUBSEQUENT EVENT - ACQUISITION OF PRODUCTS FROM G. D. SEARLE & CO. ("SEARLE") In October 1997, the Company acquired the U.S. rights to three Searle branded off-patent oral contraceptive products: Genora, Levora and Nor QD. Cash of $80.0 million was paid at closing from available cash on hand. This amount includes a $5.0 million payment related to the achievement of certain events between the signing and the closing of the transaction. The Company also agreed to acquire the U.S. rights to certain additional generic oral contraceptive products from Searle (the "Future Products"), upon achievement of certain events, which include in certain instances, approval by the U.S. Food and Drug Administration. If the Future Products are acquired before July 1, 1999, the aggregate acquisition cost for the Future Products will be $93.5 million. In addition to the acquisition cost of the Future Products, Watson also agreed to make contingent payments to Searle based on the achievement of certain events, including but not limited to, future net sales of certain products during the period from January 1, 2000 to December 31, 2004. SUBSEQUENT EVENT - ACQUISITION OF CERTAIN ASSETS FROM COCENSYS, INC. ("COCENSYS") In October 1997, the Company acquired the Pharmaceutical Sales and Marketing Division, two products and two co-promotion agreements from CoCensys. A total of $8.0 million was paid. A contingent payment of $1.0 million may be required, based upon the achievement of certain future events. The Company used available cash to fund this acquisition. AGREEMENT TO ACQUIRE THE RUGBY GROUP, INC. ("RUGBY") During the third quarter, the Company entered into an agreement with Hoechst Marion Roussel, Inc., to acquire all of the ouststanding stock of Rugby for $70.0 million in cash and contingent payments based on future sales and future operating results. Rugby develops, manufactures and markets a wide array of generic pharmaceutical products. The acquisition is expected to be completed upon receipt of federal regulatory approval. Under the terms of the agreement, the Company will acquire Rugby and its abbreviated new drug applications which include several licensed products, plus Rugby's sales and marketing capabilities for U.S. generic pharmaceuticals. Watson will also acquire Rugby's product development group and product pipeline. ACQUISITION OF PRODUCT RIGHTS TO DILACOR XR/Registered trademark/ On June 30, 1997, in connection with the termination of a partnership agreement with Rhone-Poulenc Rorer, Inc. ("RPR"), the Company obtained the exclusive U.S. and certain worldwide marketing, sales and distribution rights to Dilacor XR/Registered trademark/ for $190.0 million in cash (payable as set forth below), future royalties and an inventory supply agreement. RPR agreed to transfer the new drug application for Dilacor XR/Registered trademark/ to the Company no later than December 31, 1997. In addition, Watson acquired the customer list for Dilacor XR/Registered trademark/ and the exclusive license to use the Dilacor XR/Registered trademark/ trademark. These product rights are being amortized on a straight-line basis over 17 years. Prior to the termination of the partnership agreement, the Company earned royalties on RPR's sales of Dilacor XR/Registered trademark/. The Company earned royalties from such RPR sales in the amount of $27.2 million and $14.2 million for the year ended December 31, 1996 and nine months ended September 30, 1997, respectively. RPR's sales of Dilacor XR/Registered trademark/ in 1996 were approximately $140.0 million. Dilacor XR/Registered trademark/ (diltiazem hydrochloride) has been available in the United States for the treatment of hypertension since June 1992 and was approved for the treatment of chronic stable angina in March 1995. The Company obtained all worldwide rights with the exception of New Zealand, The Republic of Korea and North Korea. The Company is responsible for obtaining all regulatory approvals required to market Dilacor XR/Registered trademark/ outside of the United States. 9 WATSON PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED To date, the Company has made scheduled payments to RPR of $95.0 million from its available cash on hand. The remaining scheduled payments are due as follows: DUE DATE AMOUNT -------- ------ January 1, 1998 $ 45.0 million January 1, 1999 30.0 million January 1, 2000 15.0 million January 1, 2001 5.0 million ------------ Total $ 95.0 million ============ In October 1997, Andrx Corporation received regulatory approval and began to market a generic form of Dilacor XR/Registered trademark/. In response, the Company has introduced its own off-patent alternative. Due to this recent generic competition, the Company's product sales and gross profits from Dilacor XR/Registered trademark/ are likely to decline in future periods. MERGER WITH ROYCE LABORATORIES, INC. ("ROYCE") On April 16, 1997, the stockholders of Royce approved the merger which resulted in Royce becoming a wholly owned subsidiary of the Company. Under the terms of the Royce merger agreement, Royce stockholders received approximately 0.19 of a share of the Company's common stock for each Royce share. In the merger, Watson issued approximately 2.6 million shares of common stock for all of the outstanding common shares of Royce. Royce develops, manufactures and markets off-patent prescription drugs in solid dosage forms (tablets and capsules). The merger qualified as a tax-free reorganization for federal income tax purposes and was accounted for as a pooling of interests. During the second quarter of 1997, the Company recorded a one-time charge of $5.8 million for investment banking fees and other merger related expenses incurred in connection with the Royce acquisition. The Company's financial statements have been restated to include the results of Royce for all periods presented. MERGER WITH OCLASSEN PHARMACEUTICALS, INC. ("OCLASSEN") On February 26, 1997, the stockholders of Oclassen approved the merger which resulted in Oclassen becoming a wholly owned subsidiary of the Company. Under the terms of the Oclassen merger agreement, Oclassen stockholders received approximately 0.37 of a share of the Company's common stock for each Oclassen share. In the merger, Watson issued approximately 3.3 million shares of common stock for all of the outstanding common shares of Oclassen. 10 WATSON PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED Oclassen develops specialty prescription pharmaceuticals to prevent and treat skin diseases and markets these products to dermatologists. The merger qualified as a tax-free reorganization for federal income tax purposes and was accounted for as a pooling of interests. During the first quarter of 1997, the Company recorded a one-time charge of $8.9 million for investment banking fees and other merger related expenses incurred in connection with the Oclassen acquisition. The Company's financial statements have been restated to include the results of Oclassen for all periods presented. NOTE C - STOCK SPLIT On October 13, 1997, the Company announced that its board of directors approved a two-for-one stock split in the form of a 100% stock dividend to all stockholders who owned shares on October 22, 1997. The par value of the Company's common stock will remain at $0.0033 per share. The Company issued the additional shares effective October 29, 1997. All share and per share amounts reflect the stock split. NOTE D - INCREASE IN INVESTMENT IN ANDRX CORPORATION ("ANDRX") On June 16, 1997, the Company purchased a total of 600,000 shares of Andrx common stock from Andrx and its founders. The stock was purchased at $25.50 per share. The total purchase price of $15.3 million was paid from available cash. The Company now owns 2.7 million common shares of Andrx, which represents approximately 18.5% of the total Andrx common shares outstanding. Watson continues to account for this investment using the cost method, which requires that the investment be adjusted to fair value. The fair value of the Andrx investment, based on the Andrx closing price at September 30, 1997 of $45.50 per share, has appreciated by $85.5 million from its original cost. This unrealized gain, net of applicable income taxes of $34.2 million, is reflected as a separate component of stockholders' equity. NOTE E - JOINT VENTURES SOMERSET PHARMACEUTICALS, INC. ("SOMERSET") The Company owns 50% of the outstanding common stock of Somerset and utilizes the equity method to account for this investment. Somerset manufactures and markets the product Eldepryl/Registered trademark/, which is used in the treatment of Parkinson's disease. Income recognized from Somerset was approximately $2.3 million and $5.2 million for the three months ended September 30, 1997 and 1996, respectively. Income is comprised of the Company's 50% share of Somerset's earnings and management fees, offset by amortization of goodwill. At September 30, 1997 and December 31, 1996, the net excess cost of this investment over its net assets was $6.7 million and $7.4 million, respectively. Goodwill is being amortized on a straight-line basis over 15 years. 11 WATSON PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED In recent years, Somerset has increased its research and development spending in order to 1) develop additional indications for selegiline (the parent compound of Eldepryl/Registered trademark/), using a transdermal delivery system and 2) develop and evaluate different therapeutic areas using selegiline and other compounds. In November 1997, Somerset announced completion of the Phase III clinical trials of its selegiline transdermal system for the treatment of Alzheimer's disease. Somerset reported that the preliminary analyses of the efficacy data did not yield statistically significant differences between the placebo and the selegiline treatment group. In light of these results, Somerset is reviewing its current research projects and is considering alternatives that include third party contract research and other options. Watson's equity in earnings from Somerset is expected to continue to decline from current levels. Somerset has been notified by the Internal Revenue Service ("IRS") that it may be subject to additional income taxes and interest for its 1993, 1994 and 1995 tax years. The IRS has proposed adjustments relating to credits claimed under Internal Revenue Code Section 936. These proposed adjustments amount to approximately $12.5 million plus interest, 50% of which would be Watson's share. Management of Somerset believes that it has complied with all relevant tax laws and intends to vigorously defend its position on this matter. Condensed income statements and balance sheets of Somerset are as follows (in thousands): CONDENSED INCOME STATEMENTS THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 1997 1996 1997 1996 ------- ------- ------- ------- Net revenues $15,110 $26,224 $54,655 $81,826 Costs and expenses 8,007 11,734 23,191 39,516 Income taxes 2,485 5,336 11,014 14,911 ------- ------- ------- ------- Net income $ 4,618 $ 9,154 $20,450 $27,399 ======= ======= ======= ======= CONDENSED BALANCE SHEETS SEPTEMBER 30, DECEMBER 31, 1997 1996 ------- ------- Current assets $47,043 $45,871 Other assets 6,223 7,006 ------- ------- Total assets $53,266 $52,877 ======= ======= Current liabilities $15,013 $19,075 Stockholders' equity 38,253 33,802 ------- ------- Total liabilities and stockholders' equity $53,266 $52,877 ======= ======= 12 WATSON PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED ANCIRC In July 1994, the Company and Andrx formed a joint venture, ANCIRC, to develop off-patent pharmaceutical products utilizing Andrx's controlled-release technology. The Company utilizes the equity method to account for this joint venture and recognized losses from ANCIRC of approximately $498,000 and $353,000 for the quarters ended September 30, 1997 and 1996, respectively. Condensed statements of operations and balance sheets of ANCIRC are as follows (in thousands): CONDENSED STATEMENTS OF OPERATIONS Three Months Ended Nine Months Ended September 30, September 30, 1997 1996 1997 1996 ----- ----- ------- ------- Research and development expenses $ 998 $ 711 $ 2,545 $ 2,776 ===== ===== ======= ======= Net (loss) $(995) $(706) $(2,522) $(2,768) ===== ===== ======= ======= CONDENSED BALANCE SHEETS September 30, December 31, 1997 1996 ----- ------ Current assets $ 2 $ 701 Other assets 251 25 ----- ------ Total assets $ 253 $ 726 ===== ====== Current liabilities $ 697 $1,048 Partners' deficit (444) (322) ----- ------ Total liabilities and partners' deficit $ 253 $ 726 ===== ====== 13 WATSON PHARMACEUTICALS, INC. NOTE F - RECENT ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 128 , "Earnings per Share". SFAS 128 specifies the computation, presentation and disclosure requirements for earnings per share ("EPS") and will become effective for both interim and annual periods ending after December 15, 1997. Earlier application to the Company's financial statements is prohibited. However, disclosure of pro forma EPS computed using SFAS 128 is permitted in the notes to the financial statements. The following table sets forth unaudited pro forma EPS data computed under the provisions of SFAS 128: Three Months Ended Nine Months Ended September 30, September 30, 1997 1996 1997 1996 ----- ----- ----- ----- Basic EPS $0.32 $0.23 $0.70 $0.70 ===== ===== ===== ===== Diluted EPS $0.31 $0.22 $0.68 $0.65 ===== ===== ===== ===== In June 1997, SFAS No. 130, "Reporting Comprehensive Income," was issued and established standards for the reporting and disclosure of components of comprehensive income (revenues, expenses, gains and losses). Also in June 1997, SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," was issued. This statement requires that certain financial information regarding operating segments be publicly reported on the same basis used internally by management to evaluate segment performance. These statements are effective for fiscal years beginning after December 15, 1997. SFAS No.'s 130 and 131 both address disclosure matters and, therefore, will not have any effect on the Company's financial position, cash flows or results of operations. 14 WATSON PHARMACEUTICALS, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 Revenues for the three months ended September 30, 1997 were $91.8 million compared to $62.3 million for the three months ended September 30, 1996, an increase of $29.5 million or 47.3%. The increase in revenues was largely due to sales of Dilacor XR/Registered trademark/, the rights to which were purchased from RPR on June 30, 1997. Simultaneous with the purchase of these product rights, a partnership and royalty agreement with RPR was terminated. As a result, the Company reported no royalty income in the third quarter of 1997, as compared to royalties of $7.3 million in the third quarter of 1996. In the third quarter of 1997, the Company also experienced an increase in sales of both off-patent and proprietary products, offset by decreased sales of certain established products. In October 1997, a competitor received regulatory approval and began to market a generic form of Dilacor XR/Registered trademark/. In response, the Company has introduced its own off-patent alternative. Due to this recent generic competition, the Company's product sales and gross profits from Dilacor XR/Registered trademark/ are likely to decline in future periods. Gross profit margins increased to 62.4% in 1997 from 53.8% in 1996. This favorable increase was due to higher than average gross margins earned on sales of the Company's brand products and new products introduced in 1997. Research and development expenses decreased from $5.7 million in the three months ended September 30, 1996 to $4.2 million in the 1997 period. The decrease is due to the consolidation of certain research and development functions of Circa Pharmaceuticals, Inc. ("Circa"), Oclassen and Royce into the Company. Selling, general and administrative expenses were $11.6 million for the third quarter of 1997, compared to $9.8 million in the year-ago period. This net increase consists of a $2.1 million decrease in general and administrative costs, offset by a $4.0 million increase in sales and marketing expenses. The increased sales and marketing expenses were incurred by the Company in support of the increased sales of its proprietary products. At September 30, 1997, the Company had approximately 200 sales and marketing personnel as compared to approximately 100 in the year-ago period. The decrease in general and administrative expenses was primarily the result of the consolidation of the acquired companies. See Note B, Acquisitions, of the Notes to Consolidated Financial Statements. In addition, the 1997 period did not reflect deferred compensation expense that was fully amortized during 1996. 15 WATSON PHARMACEUTICALS, INC. Equity in earnings from joint ventures decreased $3.0 million, or 62.6%, to $1.8 million in the third quarter of 1997 compared to $4.8 million in the comparable 1996 period. The significant ventures generating these earnings were Somerset, a 50% owned joint venture with Mylan Laboratories, Inc. and ANCIRC, a 50% owned joint venture with Andrx. Equity in earnings from Somerset decreased from $5.2 million in the third quarter of 1996 to $2.3 million in the third quarter of 1997. The decreased earnings are due in part to the June 1996 loss of exclusivity for Eldepryl/Registered trademark/. During 1996, three competitors introduced generic tablets to compete with Eldepryl/Registered trademark/ capsules. The introduction of generic competition and increased research and development spending in support of various clinical trials has significantly reduced Somerset's contribution to the Company's operating results. Equity in earnings of Somerset represented 5.5% of pre-tax income in the third quarter of 1997 compared to 18.1% of pre-tax income for the year-ago period. Management expects the Company's earnings from Somerset will continue to decline. See Note E, Joint Ventures, of the Notes to Consolidated Financial Statements. Watson's equity in ANCIRC's losses for the three months ended September 30, 1997 increased slightly from $353,000 in 1996 to $498,000 in 1997. The provision for income taxes increased to $14.8 million in 1997, compared to $9.6 million in 1996. The effective income tax rate was 35.0% and 33.4% for the three months ended September 30, 1997 and 1996, respectively. The increase in the Company's effective income tax rate in 1997 as compared to 1996 was due to higher tax credit utilization in 1996. RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 Revenues for the nine months ended September 30, 1997 were $228.5 million compared to $183.5 million for the nine months ended September 30, 1996, an increase of $45.0 million or 24.5%. The increase was largely due to sales of Dilacor XR/Registered trademark/, the rights to which were purchased in June 1997. However, the recent introduction of generic competition for Dilacor XR/Registered trademark/ will likely cause the Company's future sales and gross profits of this product to decline. The Company also experienced increased sales of both off-patent and proprietary products, partially offset by decreased sales of certain established products. Royalty income for the nine months ended September 30, 1997 decreased $5.6 million from 1996 levels to $14.2 million. This decrease is due to the termination of a partnership and royalty agreement with RPR simultaneous with the purchase of Dilacor XR/Registered trademark/. Gross profit margins increased to 59.4% in 1997 from 54.1% in 1996. This favorable increase was due to higher than average gross margins earned on sales of Watson's proprietary products and new products introduced during the first nine months of 1997. Research and development expenses decreased from $17.3 million in the nine months ended September 30, 1996 to $13.0 million in the 1997 period. The decrease is due to the consolidation of certain Circa, Oclassen and Royce research and development functions into the Company, as a result of the mergers with these entities. Selling, general and administrative expenses were $31.8 million for the first nine months of 1997, compared to $28.7 million in the comparable period of 1996. The increase consists of a $7.3 million increase in sales and marketing expenses, offset by a $4.2 million decrease in general and administrative costs. The increased sales and marketing expenses were incurred by the Company in support of the increased sales of its proprietary products. At September 30, 1997, the Company had 16 WATSON PHARMACEUTICALS, INC. approximately 200 sales and marketing personnel as compared to approximately 100 in the year-ago period. The decrease in general and administrative expenses was primarily the result of the consolidation of the acquired companies. See Note B, Acquisitions, of the Notes to Consolidated Financial Statements. In addition, the 1997 period did not reflect deferred compensation expense that was fully amortized during 1996. In connection with the Oclassen and Royce mergers, the Company recorded non-recurring charges of $14.7 million in the nine months ended September 30, 1997. All such merger costs were incurred prior to the third quarter of 1997. These costs included investment banking fees and other costs related to the consolidation of the companies. Equity in earnings from joint ventures decreased $4.5 million, or 31.7%, to $9.7 million in the first nine months of 1997, compared to $14.2 million in the comparable 1996 period. The decreased earnings from Somerset are due to the June 1996 loss of exclusivity for Eldepryl/Registered trademark/ and to Somerset's increased research and development expenditures in support of various clinical trials. Equity in earnings of Somerset represented 11.2% of pre-tax income in the first nine months of 1997 compared to 18.8% of pre-tax income for the year-ago period. See Note E, Joint Ventures, of the Notes to Consolidated Financial Statements. The Company's portion of ANCIRC's losses for the nine months ended September 30, 1997 decreased slightly from $1.5 million in 1996 to $1.3 million in 1997. Investment and other income increased $2.7 million to $9.5 million in the first nine months of 1997 from $6.8 million in the 1996 period. This increase was primarily due to earnings on the Company's increased cash and marketable securities balances in 1997. The provision for income taxes increased to $37.1 million in 1997, compared to $25.8 million in 1996. The effective income tax rate was 37.9% and 30.9% for the nine months ended September 30, 1997 and 1996, respectively. The increase in the Company's effective income tax rate was due primarily to the non-deductibility of a significant portion of merger expenses incurred in 1997. Exclusive of merger expenses of $14.7 million and related income taxes, net income for the first nine months of 1997 would have been $73.7 million, or $0.83 per share, an increase of 27.7% over the first nine months of 1996. LIQUIDITY AND CAPITAL RESOURCES The Company's working capital decreased from $292.9 million at December 31, 1996 to $210.1 million at September 30, 1997. This $82.8 million decrease was primarily due to the purchase of certain rights to Dilacor XR/Registered trademark/ from RPR and the purchase of 600,000 additional shares of Andrx common stock. See Note D, Increase in Investment in Andrx Corporation, of the Notes to Consolidated Financial Statements. These decreases to working capital were partially offset by cash flow from operations and increased accounts receivable and inventory balances. The growth in the Company's accounts receivable and inventory balances is the result of increased product sales. The Company performs ongoing credit evaluations of its customers and maintains reserves for potentially uncollectible accounts and obsolete inventory. Actual losses have not exceeded management's expectations. 17 WATSON PHARMACEUTICALS, INC. At September 30, 1997, the Company had notes payable outstanding of approximately $3.5 million. In addition, a $20.0 million line of credit is available to the Company. Watson has made no borrowings against this line of credit. The Company's purchase of the rights to Dilacor XR/Registered trademark/ was structured with a $40.0 million cash payment in June 1997 and a $55.0 million payment in July 1997. The remaining scheduled payments, excluding royalties and future payments under an inventory supply agreement, are due as follows: January 1, 1998 $45.0 million January 1, 1999 30.0 million January 1, 2000 15.0 million January 1, 2001 5.0 million ----- $95.0 million ===== Management believes that cash provided from operations will be sufficient to meet its normal operating requirements during the coming year. However, as previously noted, the Company has entered into several acquisitions, all but one of which has been closed, that are expected to require significant future cash payments. Certain of these transactions also provide for the payment of certain future contingent amounts. To date, the Company has used existing cash to fund its acquisitions. However, Watson will require additional funding in order to meet its remaining acquisition commitments. At the present time, the Company is pursuing financing alternatives which include an increase to its existing line of credit, a public or private debt offering, equity financing or some combination of these alternatives. Management expects to complete acceptable financing arrangements in the near future. The Company continues to review additional opportunities to acquire or invest in companies, technologies, product rights and other investments that are compatible with its existing business. Watson could use sources other than cash, such as financing alternatives discussed herein, to fund additional acquisitions or investments. If such an acquisition or investment was completed, the Company's operating results and financial condition could change materially in future periods. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Not applicable. 18 WATSON PHARMACEUTICALS, INC. CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS The Securities and Exchange Commission (SEC) encourages companies to disclose forward-looking information so investors may better understand a company's future prospects and make informed investment decisions. This report contains such forward-looking statements made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995. You must carefully consider all such statements as they inherently involve certain risks and uncertainties that could cause actual results to differ materially from the Company's forward-looking statements. You should carefully evaluate such statements in light of risk factors described herein or described in the Company's SEC filings. In particular, you should refer to Watson's 1996 Annual Report on Form 10-K and all Form 8-K's filed in 1997. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is involved in various disputes and litigation matters which arise in the ordinary course of business. The litigation process is inherently uncertain and it is possible that the resolution of these disputes and lawsuits may adversely affect the Company. Management believes, however, that the ultimate resolution of such matters will not have a material adverse effect on Watson's financial position or results of operations. There have been no material developments in any such matters since the filing of the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1997. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 27.1 Financial Data Schedule (EDGAR version only) (b) Reports on Form 8-K: Subsequent to the end of the period, on October 31, 1997, the Company filed a Form 8-K Report to disclose the acquisition of certain products from G. D. Searle & Co. 19 WATSON PHARMACEUTICALS, INC. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. WATSON PHARMACEUTICALS, INC. (Registrant) By: /S/ ALLEN CHAO ------------------------------------------------- Allen Chao, Ph.D. Chairman and Chief Executive Officer (Principal Executive Officer) By: /S/ CHATO ABAD ------------------------------------------------- Chato Abad Vice President - Finance (Principal Financial and Accounting Officer) Dated: November 13,1997 20 EXHIBIT INDEX EXHIBIT DESCRIPTION - ------- ----------- 27.1 Financial Data Schedule EX-27.1 2
5 1,000 3-MOS DEC-31-1997 JUL-01-1997 SEP-30-1997 100,673 82,013 66,939 2,130 44,699 302,364 127,039 45,218 742,001 92,253 0 0 0 290 552,313 742,001 91,817 91,817 34,525 53,612 (4,230) (76) 0 42,435 14,837 27,598 0 0 0 27,598 0.31 0.31
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