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 JUNE 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 August 5, 1997 was 43,745,148 shares.
2
WATSON PHARMACEUTICALS, INC.
INDEX TO THE FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997
PART I FINANCIAL INFORMATION
PAGE NUMBER
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets
as of June 30, 1997 and
December 31, 1996 3
Consolidated Statements of
Income for the Three and Six Months Ended
June 30, 1997 and 1996 5
Consolidated Statements of Cash
Flows for the Six Months Ended
June 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 20
PART II OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
3
PART I FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
June 30, December 31,
1997 1996
-------- --------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $130,253 $158,221
Marketable securities 78,148 80,966
Accounts receivable, net of allowances for
doubtful accounts of $1,982 and $2,206 46,527 32,845
Royalty receivable 6,066 5,554
Inventories:
Raw materials 21,244 12,801
Work-in-process 6,519 7,150
Finished goods 16,725 12,478
Prepaid expenses and other current assets 3,301 6,381
Deferred tax assets 11,246 9,807
-------- --------
Total current assets 320,029 326,203
Property and equipment, net 79,259 78,429
Investments and other assets 135,454 66,051
Product rights, net 198,850 2,171
-------- --------
Total assets $733,592 $472,854
======== ========
See accompanying Notes to Consolidated Financial Statements.
3
4
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
June 30, December 31,
1997 1996
-------- ---------
(unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 34,302 $ 31,758
Income taxes payable 6,106 472
Current portion of long-term debt 817 1,025
Current liability from acquisition of product rights 100,000
--------- ---------
Total current liabilities 141,225 33,255
Long-term debt 2,848 3,864
Long-term liability from acquisition of product rights 50,000
Deferred tax liabilities 36,040 12,226
--------- ---------
Total liabilities 230,113 49,345
--------- ---------
Commitments and contingencies
Minority interest 586 401
--------- ---------
Stockholders' equity:
Preferred stock; no par; 2,500 shares
authorized; none outstanding
Common stock; par value of $.0033; 500,000
shares authorized; 43,566 and 42,745
shares issued and outstanding, respectively 144 141
Additional paid-in capital 245,713 231,653
Retained earnings 218,015 184,852
Unrealized holding gain on available-for-sale securities 39,339 7,189
Notes receivable from stockholders (318) (727)
--------- ---------
Total stockholders' equity 502,893 423,108
--------- ---------
Total liabilities and stockholders' equity $ 733,592 $ 472,854
========= =========
See accompanying Notes to Consolidated Financial Statements.
4
5
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Earnings Per Share)
(UNAUDITED)
Six Months Ended Three Months Ended
June 30, June 30,
1997 1996 1997 1996
-------- -------- -------- --------
Revenues:
Product sales $122,434 $108,574 $ 63,735 $ 55,003
Royalty income 14,249 12,602 7,208 6,616
-------- -------- -------- --------
Total revenues 136,683 121,176 70,943 61,619
-------- -------- -------- --------
Operating expenses:
Cost of revenues 52,500 49,684 26,812 25,057
Research and development 8,840 11,568 4,219 5,839
Selling, general and administrative 20,219 18,979 9,797 10,153
Merger expenses 14,718 5,821
-------- -------- -------- --------
Total operating expenses 96,277 80,231 46,649 41,049
-------- -------- -------- --------
Operating income 40,406 40,945 24,294 20,570
Other income:
Equity in earnings of joint ventures 7,895 9,353 3,760 4,709
Investment and other income 7,131 4,240 3,616 2,053
-------- -------- -------- --------
Other income, net 15,026 13,593 7,376 6,762
-------- -------- -------- --------
Income before provision
for income taxes 55,432 54,538 31,670 27,332
Provision for income taxes 22,269 16,143 12,558 8,513
-------- -------- -------- --------
Net income $ 33,163 $ 38,395 $ 19,112 $ 18,819
======== ======== ======== ========
Earnings per share $ 0.75 $ 0.87 $ 0.43 $ 0.43
======== ======== ======== ========
Weighted average
shares outstanding 44,271 44,080 44,352 44,097
======== ======== ======== ========
See accompanying Notes to Consolidated Financial Statements.
5
6
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(UNAUDITED)
Six Months Ended
June 30,
1997 1996
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 33,163 $ 38,395
--------- ---------
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 4,180 3,460
Amortization of unearned compensation-stock awards 501
Dividends received from Somerset 8,000 6,500
Equity in earnings of joint ventures (6,597) (7,497)
Provision for doubtful accounts (224) 1,034
Deferred income tax provision 675 7,751
Tax benefit related to stock option plan 7,342 3,427
Changes in assets and liabilities:
Accounts receivable (13,458) (1,937)
Royalty receivable (512) 2,080
Inventories (12,059) (8,069)
Prepaid expenses and other current assets 3,080 (602)
Other assets (752) 384
Accounts payable and accrued expenses 2,544 (6,185)
Income taxes payable 5,634 575
Other liabilities (477)
--------- ---------
Total adjustments (2,147) 945
--------- ---------
Net cash provided by operating activities 31,016 39,340
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (4,519) (7,613)
Purchases of marketable securities (82,799) (53,500)
Proceeds from maturities of marketable securities 85,565 43,935
Acquisition of product rights (46,922)
Investment in Andrx (15,300)
Increase in investment in joint ventures (915) (2,460)
--------- ---------
Net cash used in investing activities (64,890) (19,638)
--------- ---------
See accompanying Notes to Consolidated Financial Statements.
6
7
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(UNAUDITED)
Six Months Ended
June 30,
1997 1996
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Long-term debt paid in advance $ (752)
Principal payments on long-term debt (472) $ (351)
Proceeds from exercise of stock options 7,130 7,770
--------- ---------
Net cash provided by financing activities 5,906 7,419
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (27,968) 27,121
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD 158,221 97,507
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 130,253 $ 124,628
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the periods for:
Interest $ 194 $ 322
Income taxes $ 9,248 $ 4,360
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Acquisition of product rights:
Fair value of assets acquired $(196,922)
Fair value of liabilities assumed $ 150,000
---------
$ (46,922)
=========
See accompanying Notes to Consolidated Financial Statements.
7
8
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1997 AND 1996
(UNAUDITED)
NOTE A - GENERAL
The unaudited consolidated financial statements as of June 30, 1997 and for the
three and six months ended June 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.
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 June 30,
1997, and the results of operations for the three and six months ended June 30,
1997 and 1996 and cash flows for the six months ended June 30, 1997 and 1996.
The results of operations and cash flows for the three and six months ended June
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 six months ended June 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 - RECENT MERGERS
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.
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.
8
9
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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.
NOTE C - ACQUISITION OF PRODUCT RIGHTS
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(R)
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(R) to Watson no later than December 31, 1997. In addition, Watson
acquired the customer list for Dilacor XR(R) and the exclusive license to use
the Dilacor XR(R) trademark. Prior to the termination of the partnership
agreement, the Company earned royalties on RPR's sales of Dilacor XR(R). Watson
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 six months ended June 30, 1997,
respectively. RPR's sales of Dilacor XR(R) in 1996 were approximately $140.0
million.
Dilacor XR(R) (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. Watson is responsible for obtaining all regulatory approvals
required to market Dilacor XR(R) outside of the United States.
The Company expects to use available cash on hand and future operating cash
flows to fund this acquisition. Watson paid $40.0 million on the acquisition
date. The remaining scheduled payments, excluding royalties and future payments
under an inventory supply agreement, are due as follows:
Due Date Amount
- --------------- --------------
July 1, 1997 $ 55.0 million
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 $150.0 million
==============
9
10
WATSON PHARMACEUTICALS, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
These product rights will be amortized on a straight-line basis over 17 years.
In May 1995, patent exclusivity expired for Dilacor XR(R). To date, this loss
of exclusivity has not had a significant impact on sales of Dilacor XR(R).
The Company is aware of one competitor with a generic formulation of Dilacor
XR(R) under review by the U.S. Food and Drug Administration ("FDA"). The FDA
approval of a generic substitute is expected to occur during the second half of
1997. When a generic version of Dilacor XR(R) is available, sales of this
product are likely to decline.
10
11
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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 for $25.50 per
share. The total purchase price of $15.3 million was paid from Watson's
available cash on hand. 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 June 30,
1997, has appreciated by $66.0 million. This unrealized gain, net of applicable
income taxes of $26.5 million, is reflected as a separate component of
stockholders' equity.
NOTE E - JOINT VENTURES
Somerset Pharmaceuticals, Inc. ("Somerset")
The Company owns a 50% interest in the outstanding common stock of Somerset and
utilizes the equity method to account for this investment. Somerset manufactures
and markets the product Eldepryl(R), which is used in the treatment of
Parkinson's disease. Income recognized from Somerset was approximately $4.1
million and $5.3 million for the three months ended June 30, 1997 and 1996,
respectively. Income is comprised of Watson's 50% share of Somerset's earnings
and management fees, offset by amortization of goodwill. At June 30, 1997 and
December 31, 1996, the net excess cost of this investment over its net assets
was $6.9 million and $7.4 million, respectively. Goodwill is being amortized on
a straight-line basis over 15 years.
In June 1996, orphan drug exclusivity for Eldepryl(R) expired. In August
1996, the FDA approved three companies to market a generic tablet form of
Eldepryl(R) . Somerset has increased its research and development spending in
order to develop alternative indications for Eldepryl(R) and for the
development of other compounds. Due to generic competition and increased
research and development spending, management anticipates that the Company's
equity in earnings from Somerset in 1997 will decline by approximately 30% to
50% from 1996 earnings.
11
12
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Condensed income statements and balance sheets of Somerset are as follows (in
thousands):
CONDENSED INCOME STATEMENTS
Six Months Ended Three Months Ended
June 30, June 30,
1997 1996 1997 1996
-------- -------- ------- -------
Net revenues $ 39,545 $ 55,603 $17,273 $30,143
Costs and expenses 15,182 27,784 5,247 16,295
Income taxes 8,530 9,574 4,155 4,807
-------- -------- ------- -------
Net income $ 15,833 $ 18,245 $ 7,871 $ 9,041
======== ======== ======= =======
CONDENSED BALANCE SHEETS
June 30, December 31,
1997 1996
------- -----------
Current assets $45,746 $45,871
Other assets 6,490 7,006
------- -------
Total assets $52,236 $52,877
======= =======
Current liabilities $18,600 $19,075
Stockholders' equity 33,636 33,802
------- -------
Total liabilities and
stockholders' equity $52,236 $52,877
======= =======
13
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 $360,000 and $488,000
for the quarters ended June 30, 1997 and 1996, respectively.
Condensed statements of operations and balance sheets of ANCIRC are as follows
(in thousands):
CONDENSED STATEMENTS OF OPERATIONS
Six Months Ended Three Months Ended
June 30, June 30,
1997 1996 1997 1996
------- ------- ------- -------
Research and development
expenses $ 1,547 $ 2,066 $ 733 $ 976
======= ======= ======= =======
Net loss $(1,527) $(2,062) $ (721) $ (973)
======= ======= ======= =======
CONDENSED BALANCE SHEETS
June 30, December 31,
1997 1996
-------- ------------
Current assets $ 154 $ 701
Other assets 261 25
------- -------
Total assets $ 415 $ 726
======= =======
Current liabilities $ 863 $ 1,048
Partners' deficit (448) (322)
------- -------
Total liabilities and
partners' deficit $ 415 $ 726
======= =======
13
14
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
NOTE F - RECENT PRONOUNCEMENT
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 ("SFAS 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:
Six Months Ended Three Months Ended
June 30, June 30,
1997 1996 1997 1996
----- ----- ----- -----
Basic EPS $0.77 $0.93 $0.44 $0.46
===== ===== ===== =====
Diluted EPS $0.75 $0.87 $0.43 $0.43
===== ===== ===== =====
14
15
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company cautions readers that certain important factors may affect the
Company's actual results and could cause such results to differ materially from
forward-looking statements which may be deemed to have been made in this Report,
or which are otherwise made by or on behalf of the Company. Such factors
include, but are not limited to, changing market conditions; the availability
and cost of raw materials; the timely development, FDA approval and market
acceptance of the Company's products, the products producing royalties for the
Company and the products being developed and marketed by the Company's joint
ventures; risks associated with the potential acquisition of businesses,
technologies or products, including costs which may be incurred in connection
with such acquisitions; and other risks detailed herein or detailed from time to
time in the Company's Securities and Exchange Commission filings. In addition,
the U.S. drug industry is highly competitive, with pricing determined by many
factors including the number and timing of product introductions. Generally, the
price of a branded product will decline as off-patent products are introduced.
Likewise, the price of an off-patent product will generally decline as
competitors introduce additional versions of the product. The actual degree and
timing, however, of this price competition is not predictable.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS - SIX MONTHS ENDED JUNE 30, 1997 AND 1996
Revenues for the six months ended June 30, 1997 were $136.7 million compared to
$121.2 million for the six months ended June 30, 1996, an increase of $15.5
million or 12.8%. The increase in revenues consists of a $13.9 million increase
in product sales and a $1.6 million increase in royalty income. The increase in
product sales was due primarily to sales of new products introduced in 1997 and
increased sales of both off-patent and proprietary products. These increases
were partially offset by decreased sales of certain core products.
Royalty income from sales of Dilacor XR(R) by Rhone-Poulenc Rorer, Inc.
("RPR") was $14.2 million for the six months ended June 30, 1997 and represented
25.7% of pre-tax income compared to $12.6 million or 23.1% of pre-tax income for
the year-ago period. The 13.1% increase in royalty income for the six months
ended June 30, 1997 was primarily due to the increase in the royalty percentage
from 20% in 1996 to 22% in 1997. As discussed in Note C, on June 30, 1997, the
Company purchased certain rights to Dilacor XR(R) and terminated the prior
royalty arrangement with RPR .
Gross profit margins increased to 57.1% in 1997 from 54.2% in 1996. This
favorable increase was due to higher than average gross margins earned on sales
of the Company's proprietary products and new products introduced during the
first half of 1997.
Research and development expenses decreased from $11.6 million in the first half
of 1996 to $8.8 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 Watson as a result of
the mergers with these entities.
15
16
Selling, general and administrative expenses were $20.2 million for the first
half of 1997, compared to $19.0 million in the year-ago period. The increase
consists of a $3.3 million increase in sales and marketing expenses, offset by a
$2.1 million decrease in general and administrative costs. The increased sales
and marketing expenses were incurred by Watson in support of its expanded
proprietary products division. At June 30, 1997, the Company had approximately
160 sales and marketing personnel as compared to approximately 95 in the
year-ago period.
The decrease in general and administrative expenses of $2.1 million was
primarily the result of the consolidation of the acquired companies. In
addition, the 1997 period did not reflect deferred compensation expense that was
fully amortized during 1996. As a percentage of revenues, general and
administrative costs decreased from 7.4% in the first half of 1996 to 5.1% in
the first half of 1997.
In connection with the Oclassen and Royce mergers, the Company recorded
non-recurring charges of $14.7 million in the first half of 1997. These costs
included investment banking fees and other costs related to the consolidation of
the companies. No such expenses were incurred in 1996.
Equity in earnings from joint ventures decreased $1.5 million, or 16.0%, to $7.9
million in the first six months of 1997, compared to $9.4 million in the
comparable 1996 period. The significant ventures generating these earnings were
Somerset Pharmaceuticals, Inc. ("Somerset"), a 50% owned joint venture with
Mylan Laboratories, Inc. and ANCIRC, a 50% owned joint venture with Andrx
Corporation. Equity in earnings from Somerset decreased from $10.5 million in
the first half of 1996 to $8.7 million in the first half of 1997. The Company
believes the decreased earnings are due to the June 1996 loss of exclusivity for
Eldepryl(R) . During 1996, three competitors introduced generic tablets to
compete with Eldepryl(R) capsules. The introduction of additional competitive
products could have a material adverse effect on Somerset's contribution to
Watson's operating results. In addition, Somerset has increased its research and
development expenditures in support of Phase III clinical trials on a
transdermal Eldepryl(R) patch. Equity in earnings of Somerset represented
15.6% of pre-tax income in 1997 compared to 19.2% of pre-tax income for the
year-ago period. Management expects that Watson's total 1997 earnings from
Somerset will decline by approximately 30% to 50% compared to 1996. Watson's
equity in ANCIRC's losses for the first six months of 1997 decreased slightly
from $1.1 million in 1996 to $763,000 in 1997.
Investment and other income increased $2.9 million to $7.1 million in the first
half of 1997 from $4.2 million in the 1996 period. This increase was primarily
due to additional earnings generated from the Company's larger base of invested
cash.
The provision for income taxes increased to $22.3 million in 1997, compared to
$16.1 million in 1996. The effective income tax rate was 40.2% and 29.6% for the
six months ended June 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.
Net income decreased to $33.2 million in 1997 from $38.4 million in 1996, due to
one-time merger expenses incurred in connection with the acquisitions of
Oclassen and Royce. Exclusive of merger expenses of $14.7 million and related
income taxes, net income for the first six months of 1997 would have been $46.1
million, or $1.04 per share, an increase of 19.5% from the first half of 1996.
16
17
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 1997 AND 1996
Revenues for the three months ended June 30, 1997 were $70.9 million compared to
$61.6 million for the three months ended June 30, 1996, an increase of $9.3
million or 15.1%. The increase in revenues consists of an $8.7 million increase
in product sales and a $600,000 increase in royalty income. The increase in
product sales was due primarily to sales of new products introduced in 1997 and
increased sales of both off-patent and proprietary products. These increases
were partially offset by decreased sales of certain core products.
Royalty income from sales of Dilacor XR(R) by RPR was $7.2 million for the
three months ended June 30, 1997 and represented 22.8% of pre-tax income
compared to $6.6 million or 24.2% of pre-tax income for the year-ago period. The
9.0% increase in royalty income for second quarter of 1997 was primarily due to
the increase in the royalty percentage from 20% in 1996 to 22% in 1997. On June
30, 1997 Watson purchased certain rights to Dilacor XR(R) and the prior
royalty arrangement with RPR was terminated.
Gross profit margins increased to 57.9% in 1997 from 54.4% 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 during the second
quarter of 1997.
Research and development expenses decreased from $5.8 million in the three
months ended June 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,
Oclassen and Royce into Watson.
Selling, general and administrative expenses were $9.8 million for the second
quarter of 1997, compared to $10.2 million in the year-ago period. This net
decline consists of a $1.3 million decrease in general and administrative costs
offset by a $900,000 increase in sales and marketing expenses. The increased
sales and marketing expenses were incurred by Watson in support of its expanded
proprietary products division.
The decrease in general and administrative expenses of $1.3 million was
primarily the result of the consolidation of the companies. In addition, the
1997 period did not reflect deferred compensation expense that was fully
amortized during 1996. As a percentage of revenues, general and administrative
costs decreased from 7.6% in the second quarter of 1996 to 4.8% in the second
quarter of 1997.
In connection with the Royce merger, the Company recorded one-time charges of
$5.8 million in the second quarter of 1997. These costs included investment
banking fees and other costs related to the consolidation of the companies. No
such expenses were incurred in the 1996 period.
Equity in earnings from joint ventures decreased $900,000, or 20.0%, to $3.8
million in the second quarter of 1997 compared to $4.7 million in the comparable
1996 period. Equity in earnings from Somerset decreased from $5.3 million in the
second quarter of 1996 to $4.1 million in the second quarter of 1997. The
decreased earnings from Somerset are due to the June 1996 loss of exclusivity
for Eldepryl(R) and to Somerset's increased research and development
expenditures in support of the Phase III clinical trials on a transdermal
Eldepryl(R) patch. Equity in earnings of Somerset represented
17
18
13.0 % of pre-tax income in 1997 compared to 19.2% of pre-tax income for the
year-ago period. Watson's portion of ANCIRC's losses for the three months ended
June 30, 1997 decreased slightly from $488,000 in 1996 to $360,000 in 1997.
Investment and other income increased $1.5 million to $3.6 million in the second
quarter of 1997 from $2.1 million in the 1996 period. This increase was
primarily due to the additional earnings generated from the Company's larger
base of invested cash.
The provision for income taxes increased to $12.6 million in 1997, compared to
$8.5 million in 1996. The effective income tax rate was 39.7% and 31.1% for the
three months ended June 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 the second quarter of
1997.
Net income increased slightly to $19.1 million in 1997 from $18.8 million in
1996, principally due to the increased revenues generated in the second quarter
of 1997, offset by merger expenses and increased income tax expense. Exclusive
of merger expenses of $5.8 million and related income taxes, net income for the
three months ended June 30, 1997 would have been $24.7 million, or $0.56 per
share, an increase of 30.5% from the second quarter of 1996.
18
19
WATSON PHARMACEUTICALS, INC.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital decreased from $292.9 million at December 31, 1996
to $178.8 million at June 30, 1997. This $114.1 million decrease was primarily
due to the purchase of 600,000 additional shares of Andrx and the initial cash
payment and current liabilities incurred in connection with the purchase of
certain rights to Dilacor XR(R) . This was offset by cash flows from
operations and increased accounts receivable and inventory balances in support
of the Company's increased sales levels.
The growth in Watson's accounts receivable balances is the result of increased
product sales. The Company performs ongoing credit evaluations of its customers
and maintains reserves for potentially uncollectible accounts. Actual losses
have been within management's expectations.
The Company expects to invest approximately $13.0 million in capital
expenditures during 1997. In the six months ended June 30, 1997, Watson incurred
approximately $4.5 million of property and equipment expenditures.
At June 30, 1997, the Company had notes payable outstanding of approximately
$3.7 million. In addition, a credit facility of $36.0 million is currently
available to the Company, comprised of (i) a $20.0 million revolving, unsecured
line of credit, (ii) a $6.0 million revolving unsecured equipment line of credit
with a term repayment option and (iii) a $10.0 million non-revolving line of
credit with a term repayment option. The Company has made no borrowings against
this credit facility.
The Company's purchase of certain rights to Dilacor XR(R) was structured with
a $40.0 million cash payment in June 1997. The remaining scheduled payments,
excluding royalties and future payments under an inventory supply agreement, are
due as follows:
July 1, 1997 $ 55.0 million
January 1, 1998 45.0 million
January 1, 1999 30.0 million
January 1, 2000 15.0 million
January 1, 2001 5.0 million
------
$150.0 million
======
The Company expects to use available cash on hand and future operating cash
flows to fund this obligation.
19
20
The Company's cash and marketable securities totaled $208.4 million at June 30,
1997. The Company anticipates that its current cash and amounts available under
its bank financing agreement will be sufficient to fund its short-term working
capital requirements and enable the Company to continue its operations on a
long-term basis. To the extent that additional capital resources are required,
such capital may be raised through bank borrowings, equity offerings, or other
means.
The Company regularly reviews potential opportunities to acquire or invest in
technologies, products or product rights. The Company also regularly reviews
potential acquisitions, investments or combinations involving businesses
compatible with its existing business. The Company could use sources other than
cash, such as issuance of debt or equity securities, to finance any such
acquisition or investment. If such an acquisition or investment was completed,
the Company's operating results and financial condition could change materially
in future periods.
Management believes inflation does not have, and has not had, a significant
impact on the Company's revenues or operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
20
21
WATSON PHARMACEUTICALS, INC.
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 impact on
the Company'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 March 31, 1997, except as
noted below.
In August 1996, Somerset filed a complaint against the FDA entitled Somerset
Pharmaceuticals, Inc. v. Donna Shalala, et al. in the United States District
Court for the District of Delaware. See "Legal Proceedings" in Watson's Form
10-K for the fiscal year ended December 31, 1996. In June 1997, Somerset's
motion for a preliminary injunction in such action was denied by the court.
Somerset has filed an appeal of the court's decision.
21
22
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:
On July 14, 1997, the Company filed a Form 8-K Report to
disclose the acquisition of the marketing, sales and
distribution rights to Dilacor XR(R).
22
23
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 and Financial
Officer)
By: /s/ CHATO ABAD
----------------------------------
Chato Abad
Vice President - Finance
(Principal Accounting Officer)
Dated: August 13,1997
23