================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------
FORM 10-Q
-----------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to ________
Commission file number 0-20045
-----------------------
WATSON PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
-----------------------
Nevada 95-3872914
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
311 Bonnie Circle
Corona, CA 92880-2882
(Address of principal executive offices, including zip code)
(909) 270-1400
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes [X] No [ ]
The number of shares outstanding of the Registrant's only class of common stock
as of November 7, 2001 was approximately 106,468,000.
================================================================================
WATSON PHARMACEUTICALS, INC.
INDEX TO FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements: PAGE
----
Consolidated Balance Sheets as of September 30, 2001 and
December 31, 2000............................................... 1
Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2001 and 2000......... 2
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2001 and 2000................... 3
Notes to Consolidated Financial Statements......................... 5
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...................... 12
Item 3. Quantitative and Qualitative Disclosure about Market Risk............. 18
PART II. OTHER INFORMATION AND SIGNATURES
Item 1. Legal Proceedings..................................................... 20
Item 6. Exhibits and Reports on Form 8-K...................................... 21
Signatures..................................................................... 22
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited; in thousands, except share amounts)
September 30, December 31,
2001 2000
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents ................................................................. $ 131,500 $ 66,194
Marketable securities ..................................................................... 139,069 171,452
Accounts receivable, net .................................................................. 211,746 85,703
Assets held for disposition ............................................................... 23,432 142,067
Inventories ............................................................................... 247,299 248,945
Prepaid expenses and other current assets ................................................. 42,213 30,084
Deferred tax assets ....................................................................... 48,781 86,900
---------- ----------
Total current assets .................................................................... 844,040 831,345
Property and equipment, net ................................................................... 224,733 194,487
Investments and other assets .................................................................. 88,339 76,134
Deferred tax assets ........................................................................... 102,423 33,387
Product rights and other intangibles, net ..................................................... 826,105 1,000,788
Goodwill, net ................................................................................. 452,084 443,757
---------- ----------
$2,537,724 $2,579,898
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ..................................................... $ 168,973 $ 200,965
Income taxes payable ...................................................................... 37,684 18,935
Current portion of long-term debt ......................................................... 64,102 52,882
Current liability from acquisitions of products and businesses ............................ 1,708 7,658
---------- ----------
Total current liabilities ............................................................... 272,467 280,440
Long-term debt ................................................................................ 435,549 483,272
Long-term liability from acquisitions of products and businesses .............................. 10,637 12,249
Deferred tax liabilities ...................................................................... 195,468 255,968
---------- ----------
Total liabilities ....................................................................... 914,121 1,031,929
---------- ----------
Commitments and contingencies
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; 106,396,300 and 105,600,200 shares outstanding ................................. 351 348
Additional paid-in capital .................................................................... 789,625 758,760
Retained earnings ............................................................................. 776,761 706,693
Accumulated other comprehensive income ........................................................ 56,866 82,168
---------- ----------
Total stockholders' equity .............................................................. 1,623,603 1,547,969
---------- ----------
$2,537,724 $2,579,898
========== ==========
See accompanying Notes to Consolidated Financial Statements.
-1-
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Net revenues .................................................................. $ 270,942 $ 179,331 $ 866,766 $ 556,769
Cost of sales ................................................................. 140,398 96,917 383,136 230,983
--------- --------- --------- ---------
Gross profit ............................................................ 130,544 82,414 483,630 325,786
Operating expenses:
Research and development ................................................... 14,228 12,530 42,732 38,330
Selling, general and administrative ........................................ 48,409 49,106 153,118 116,011
Amortization ............................................................... 17,681 18,210 57,944 35,646
Charge for asset impairment ................................................ 147,596 -- 147,596 --
Loss on assets held for disposition ........................................ 50,705 -- 50,705 --
Charge for acquired in-process
research and development ................................................. -- 125,000 -- 125,000
--------- --------- --------- ---------
Total operating expenses ................................................ 278,619 204,846 452,095 314,987
--------- --------- --------- ---------
Operating (loss) income ....................................................... (148,075) (122,432) 31,535 10,799
--------- --------- --------- ---------
Other income (expense):
Equity in (loss) earnings of joint ventures................................. (1,170) 1 (2,950) (3,710)
Gain on sales of securities ................................................ 4,495 93,766 52,168 342,161
Gain from legal settlement ................................................. 60,517 -- 60,517 --
Interest and other income .................................................. 838 4,868 2,441 13,615
Interest expense ........................................................... (7,203) (11,335) (21,881) (16,642)
--------- --------- --------- ---------
Total other income, net ................................................. 57,477 87,300 90,295 335,424
--------- --------- --------- ---------
(Loss) income before income tax provision,
extraordinary item and cumulative effect
of change in accounting principle........................................... (90,598) (35,132) 121,830 346,223
(Benefit) provision for income taxes .......................................... (31,965) 31,190 51,762 173,588
--------- --------- --------- ---------
(Loss) income before extraordinary item
and cumulative effect of change
in accounting principle..................................................... (58,633) (66,322) 70,068 172,635
Extraordinary loss on early retirement of debt,
net of tax of $730 ......................................................... -- (1,216) -- (1,216)
Cumulative effect of change in accounting
principle, net of tax of $7,208 ............................................ -- -- -- (12,013)
--------- --------- --------- ---------
Net (loss) income ............................................................. $ (58,633) $ (67,538) $ 70,068 $ 159,406
========= ========= ========= =========
(Loss) earnings per share:
Basic ...................................................................... $ (0.55) $ (0.66) $ 0.66 $ 1.59
========= ========= ========= =========
Diluted .................................................................... (0.55) (0.66) $ 0.65 $ 1.56
========= ========= ========= =========
Weighted average shares outstanding:
Basic ...................................................................... 106,343 101,735 106,008 100,075
========= ========= ========= =========
Diluted .................................................................... 106,343 101,735 108,421 102,100
========= ========= ========= =========
See accompanying Notes to Consolidated Financial Statements.
-2-
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
Nine Months Ended
September 30,
----------------------
2001 2000
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................... $ 70,068 $ 159,406
--------- ---------
Reconciliation to net cash provided by (used in) operating activities:
Depreciation ........................................................... 17,642 13,242
Amortization ........................................................... 57,944 35,646
Asset impairment charge ................................................ 147,596 --
Loss on assets held for disposition .................................... 45,346 --
Charge for acquired in-process research and development ................ -- 125,000
Extraordinary loss on early retirement of debt ......................... -- 1,216
Cumulative effect of change in accounting principle .................... -- 12,013
Deferred income tax (benefit) provision ................................ (59,993) 409
Equity in loss of joint ventures ....................................... 3,317 3,998
Gain on sales of securities ............................................ (52,168) (342,161)
Tax benefits related to exercises of stock options ..................... 9,200 28,840
Other .................................................................. (3,308) (2,431)
Changes in assets and liabilities:
Accounts receivable ................................................ (126,043) 110,798
Assets held for disposition ........................................ (11,508) --
Inventories ........................................................ (2,145) (91,585)
Prepaid expenses and other current assets .......................... (13,832) (11,660)
Accounts payable and accrued expenses .............................. (55,147) (32,238)
Income taxes payable ............................................... 83,788 (17,241)
Other assets........................................................ (11,563) --
--------- ---------
Total adjustments ................................................ 29,126 (166,154)
--------- ---------
Net cash provided by (used in) operating activities ............. 99,194 (6,748)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment ...................................... (48,240) (21,835)
Purchases of marketable securities ....................................... -- (44,170)
Proceeds from maturities of marketable securities ........................ 251 34,531
Acquisition of Schein Pharmaceutical ..................................... -- (518,183)
Acquisitions of product rights ........................................... (15,709) (6,553)
Increase in investment in joint ventures ................................. -- (437)
Contingent payment related to acquisition of The Rugby Group ............. -- (23,407)
Issuance of note receivable .............................................. (3,500) (12,400)
Proceeds from sales of marketable equity securities ...................... 54,345 366,576
--------- ---------
Net cash used in investing activities ........................... (12,853) (225,878)
--------- ---------
See accompanying Notes to Consolidated Financial Statements.
-3-
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited, in thousands)
Nine Months Ended
September 30,
----------------------
2001 2000
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ........................................ -- 501,000
Principal payments on long-term debt and acquisition liabilities ................ (42,703) (373,332)
Distributions to stockholders ................................................... -- (2,430)
Proceeds from exercises of stock options ........................................ 21,668 108,178
--------- ---------
Net cash (used in) provided by financing activities .................... (21,035) 233,416
--------- ---------
Increase in cash and cash equivalents ........................................... 65,306 790
Cash and cash equivalents at beginning of period ................................ 66,194 108,172
--------- ---------
Cash and cash equivalents at end of period ...................................... $ 131,500 $ 108,962
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the periods for:
Income taxes ........................................................... $ 15,262 $ 155,500
Interest (including capitalized interest of $4,631 in 2001) ............ $ 24,005 $ 15,602
See accompanying Notes to Consolidated Financial Statements.
-4-
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - GENERAL
Watson Pharmaceuticals, Inc. (Watson or the company) is a diversified
specialty pharmaceutical company primarily engaged in the development,
production, marketing and distribution of both branded and generic (off-patent)
pharmaceutical products. Watson also develops advanced drug delivery systems
designed to enhance the therapeutic benefits of existing drugs.
The accompanying consolidated financial statements should be read in
conjunction with the company's Annual Report on Form 10-K for the year ended
December 31, 2000 and its Quarterly Reports on Form 10-Q for the quarters ended
March 31, 2001 and June 30, 2001. Certain information and footnote disclosures
normally included in annual financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted from the
accompanying consolidated financial statements. The accompanying interim
financial statements are unaudited, but reflect all adjustments which are, in
the opinion of management, necessary to present fairly Watson's consolidated
financial position, results of operations and cash flows for the periods
presented. Unless otherwise noted, all such adjustments are of a normal,
recurring nature. The results of operations and cash flows for the interim
periods are not necessarily indicative of the results of operations and cash
flows that Watson may achieve in future periods or for the full year.
Marketable securities
Marketable securities consist primarily of Watson's investment in the
common stock of Andrx Corporation - Andrx Group (Andrx). Andrx is primarily
engaged in the formulation and commercialization of controlled-release
pharmaceutical products using proprietary drug delivery technologies. Andrx'
common stock trades on the NASDAQ National Market System under the symbol ADRX.
As of September 30, 2001, Watson owned 1.7 million common shares of Andrx
(approximately 3% of the total Andrx common shares outstanding) with a market
value of approximately $112.0 million. The company accounts for this investment
at fair value as an available-for-sale security. The unrealized gain on the
company's investment in Andrx was approximately $64.2 million and $88.9 million
(net of income taxes of $42.8 million and $59.3 million), at September 30, 2001
and December 31, 2000, respectively. This unrealized gain was the primary
component of accumulated other comprehensive income in the stockholders' equity
section of Watson's consolidated balance sheets.
During the three months ended September 30, 2001, Watson sold 70,000 shares
of Andrx common stock for approximately $4.7 million and recorded a pre-tax gain
of $4.5 million. During the nine months ended September 30, 2001, Watson sold
approximately 958,000 shares of Andrx common stock for $54.3 million and
recorded a pre-tax gain of $52.2 million.
Recent accounting pronouncements
Effective January 1, 2000, the company adopted Staff Accounting Bulletin
101 (SAB 101) issued by the Securities and Exchange Commission in December 1999.
The adoption of SAB 101 required Watson to change the methods in which revenue
was recognized from product sales and research, development and licensing
agreements.
-5-
In accordance with SAB 101, the company records revenue from product sales
when title and risk of ownership have been transferred to the customer, which is
typically upon delivery to the customer. Revenues recognized from research,
development and licensing agreements (including milestone payments) are now
recorded on the "contingency-adjusted performance model," which requires
deferral of revenue until such time as contract milestone requirements, as
specified in the individual agreements, have been met and cash has been received
from the customer. Therefore, once contingencies for individual milestones (e.g.
government approval of a New Drug Application) have been eliminated, revenue is
recognized based on the percentage of completion method.
The cumulative effect of this change in accounting principle, through
December 31, 1999, was $12 million and was recorded in the first quarter of
2000. In addition, the retroactive effect of this change on the accompanying
consolidated statement of operations for the three months ended September 30,
2000 was to reduce net revenues and gross profit by $8.5 million and $5.8
million, respectively. The retroactive effect for the nine months ended
September 30, 2000, was to reduce net revenues and gross profit by $9.0 million
and $7.4 million, respectively.
In January 2001, Watson adopted Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS
No. 133), issued by the Financial Accounting Standards Board in June 1998. SFAS
No. 133 requires all derivative instruments on the balance sheet to be recorded
at their fair values. Gains and losses resulting from changes in the fair values
of those derivatives are accounted for depending on the use of the derivative
and other criteria. The adoption of SFAS No. 133 had no material impact on the
company's results of operations or financial position.
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting standards (SFAS) No. 141, "Business
Combinations" and SFAS No. 142, "Goodwill and Intangible Assets." SFAS No. 141
requires all business combinations to be accounted for using the purchase method
of accounting, establishes specific criteria for recognizing intangible assets
separately from goodwill and requires certain disclosures regarding reasons for
a business combination and the allocation of the purchase price paid. SFAS No.
141 is effective for all business combinations initiated after June 30, 2001.
SFAS No. 142 requires goodwill and indefinite lived intangible assets to be
tested for impairment under certain circumstances, and written off when
impaired, rather than being amortized as previous standards required. Separable
intangible assets that are not deemed to have an indefinite life will continue
to be amortized over their useful lives. Except for business combinations
initiated after June 30, 2001, the company is required to adopt the provisions
of SFAS No. 141 and SFAS No. 142 on January 1, 2002. The company is currently
evaluating the impact of these pronouncements on its operating results and
financial condition.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and or
-6-
Long-Lived Assets to be Disposed Of" and applies to all long lived assets,
including discontinued operations. This statement also amends Accounting
Principles Board Opinion No. 30, "Reporting Results of Operations --Reporting
the Effects of Disposal of a Segment of a Business." SFAS No. 144 develops one
accounting model, based on the framework established in SFAS No. 121, for long-
lived assets to be disposed of by sale as well as addresses the principle
implementation issues. The Company is required to adopt the provisions of SFAS
No. 144 no later than January 1, 2002. The Company is currently evaluating the
impact of this pronouncement on its consolidated financial statements.
(Loss) earnings per share (EPS)
Basic (loss) earnings per share is computed by dividing net (loss) income
by the weighted average common shares outstanding during a period. Diluted
earnings per share is based on the treasury stock method and is computed by
dividing net (loss) income by the weighted average number of common shares and
common share equivalents outstanding during the periods presented assuming the
exercise of all in-the-money stock options. A reconciliation of the numerators
and denominators of basic and diluted earnings per share for the three and nine
months ended September 30, 2001 and 2000 consisted of the following (in
thousands, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- ----------------------
2001 2000 2001 2000
----------- ----------- -------- -----------
Numerator:
(Loss) income before extraordinary item and cumulative
effect of change in accounting principle .............. $ (58,633) $ (66,322) $ 70,068 $ 172,635
Extraordinary loss on early retirement of debt, net of
tax ................................................... -- (1,216) -- (1,216)
Cumulative effect of change in accounting principle, net
of tax ................................................. -- -- -- (12,013)
----------- ----------- -------- -----------
Net (loss) income ......................................... $ (58,633) $ (67,538) $ 70,068 $ 159,406
=========== =========== ======== ===========
Denominator:
Basic weighted average common shares outstanding .......... 106,343 101,735 106,008 100,075
Effect of dilutive stock options .......................... -- -- 2,413 2,025
----------- ----------- -------- -----------
Diluted weighted average common shares
outstanding ........................................... 106,343 101,735 108,421 102,100
=========== =========== ======== ===========
Basic EPS:
(Loss) income before extraordinary item and cumulative
effect of change in accounting principle ............... $ (0.55) $ (0.65) $ 0.66 $ 1.72
Extraordinary loss on early retirement of debt, net of
tax .................................................... -- (0.01) -- (0.01)
Cumulative effect of change in accounting principle, net
of tax ................................................. -- -- -- (0.12)
----------- ----------- -------- -----------
Basic (loss) earnings per share ........................... $ (0.55) $ (0.66) $ 0.66 $ 1.59
=========== =========== ======== ===========
Diluted EPS:
(Loss) income before extraordinary item and cumulative
effect of change in accounting principle ............... $ (0.55) $ (0.65) $ 0.65 $ 1.69
Extraordinary loss on early retirement of debt, net of
tax .................................................... -- (0.01) -- (0.01)
Cumulative effect of change in accounting principle, net
of tax ................................................. -- -- -- (0.12)
----------- ----------- -------- -----------
Diluted (loss) earnings per share ......................... $ (0.55) $ (0.66) $ 0.65 $ 1.56
=========== =========== ======== ===========
-7-
NOTE B - ACQUISITIONS OF BUSINESSES
Schein Pharmaceutical, Inc.
Watson completed its acquisition of Schein Pharmaceutical, Inc. (Schein)
during the third quarter of 2000. Schein has a branded pharmaceutical business
focused in the area of nephrology for the management of iron deficiency and
anemia and also develops, manufactures and markets a broad line of generic
products. The aggregate purchase price of $825 million to acquire all the
outstanding Schein shares consisted of (a) approximately $510 million in cash,
(b) the issuance of approximately 5.4 million shares of Watson common stock,
having a market value on the date of acquisition of approximately $300 million,
and (c) direct transaction costs of approximately $15 million. In addition,
short-term liabilities with a fair value of approximately $375 million
(principally 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.
Accordingly, Schein's results of operations are included in the consolidated
financial statements from the date of acquisition.
Approximately $500 million of the purchase price was allocated to Schein's
existing product rights. These product rights are amortized on the straight-line
method over periods of two to 20 years, with the weighted average life of all
product rights approximating 19.5 years. The remaining excess of the purchase
consideration over the fair value of the tangible net assets acquired of
approximately $400 million was recorded as goodwill, which is amortized on the
straight-line method over 25 years. Following the adoption of SFAS No. 142, the
company will no longer amortize goodwill.
At the date of the Schein acquisition, Watson established a severance
accrual of $33.6 million for termination costs associated with approximately 80
duplicative Schein employees. As of September 30, 2001, substantially all
amounts had been paid.
In connection with the acquisition of Schein, the company acquired two
injectable pharmaceutical manufacturing facilities, Steris Laboratories, Inc.
(Steris), located in Phoenix, Arizona, and Marsam Pharmaceuticals, Inc.
(Marsam), located in Cherry Hill, New Jersey. At the completion of this
acquisition, the company decided to dispose of Steris and Marsam and reported
these facilities as "Assets Held for Disposition." Watson recorded these assets
at their estimated fair market values (based on the reports of an independent
appraiser), less an estimate of costs expected to be incurred through the
expected disposition date of each facility.
Following unsuccessful negotiations with several potential buyers, Watson
closed Marsam in the first quarter of 2001. The company wrote down the Marsam
assets to estimated liquidation value and recorded additional severance and
closure costs of $6.3 million, all of which have been paid through September 30,
2001. The company also realized a $65.0 million tax benefit associated with the
liquidation of Marsam, which was reclassified from Assets held for disposition
to current deferred tax assets.
During the first six months of 2001, the company incurred operating losses
from Steris and Marsam of $5.9 million and $1.6 million, respectively, which
were applied against the accrual for estimated future losses established at the
acquisition date. The company intends to continue its efforts to dispose of the
Steris and Marsan facilities through sale or otherwise.
Beginning in July 2001, Watson began to classify all operating expenses
relating to Steris as loss on assets held for disposition in its Consolidated
Statements of Operations. During the third quarter of 2001, Watson incurred $5.3
million of expenses related to Steris' operations, and recorded a write down of
$45.4 million to the carrying value of Steris assets to current estimated fair
market value. Such write down to current estimated fair market value is based
upon recent negotiations involving the sale or other disposition of the
facility.
-8-
Makoff R&D Laboratories, Inc.
In November 2000, Watson completed its acquisition of Makoff, a developer,
licensor and marketer of pharmaceutical products related principally to the
management of kidney disease. Watson issued approximately 2.8 million
shares of common stock, with a market value on the date of acquisition of
approximately $155.0 million, in exchange for all the outstanding shares of
Makoff. The company accounted for the acquisition as a pooling of interests for
accounting purposes and accordingly, Makoff's results of operations are included
in the accompanying Consolidated Statements of Operations, as if the two
companies had always operated as one.
During the fourth quarter of 2000, the company recorded a special charge of
$22.4 million for merger and related expenses associated with the Makoff
acquisition. This charge consisted of transaction costs for investment banking
fees, professional fees, printing and other costs of $13.6 million and closure
costs of $8.8 million. The $8.8 million consisted of employee termination costs
for approximately 50 employees (approximately $4.7 million) which were paid
pursuant to existing employment agreements, asset impairment costs
(approximately $2.5 million) and lease and contract termination costs
(approximately $1.6 million). As of September 30, 2001, the company had paid all
material transaction and closure costs and had written off the applicable
assets.
NOTE C - ASSET IMPAIRMENT CHARGE
In June 1997, Watson acquired from Rhone-Poulenc Rorer, Inc. and certain of
its affiliates (collectively, RPR) the exclusive U.S. and certain worldwide
marketing, sales and distribution rights to Dilacor XR(R) for $190 million in
cash and future royalties. The company and RPR entered into a supply agreement
whereby RPR was to provide Watson with all of its inventory of Dilacor XR(R) and
its generic equivalent through June 2000. Subsequently, Watson experienced
supply interruptions from this third party supplier and received only
intermittent releases of these products. These supply interruptions caused the
company's revenues and gross margins from Dilacor XR(R) and its generic
equivalent to deteriorate. In August 1999, Watson filed suit against RPR for
unfair competition and breach of contract, related to, among other things, RPR's
failure to fulfill its supply obligations to the company. Watson and RPR settled
this litigation in September 2001, resolving all outstanding disputes between
the companies related to Dilacor XR(R) and its generic equivalent, as further
discussed in Part II, Item 1. Legal Proceedings in this Quarterly Report.
During the third quarter of the current year, revenues and gross profit
from the company's Dilacor XR(R) product rights declined significantly from
prior year sales levels. Based upon this sales trend, the company performed an
evaluation in the third quarter 2001 of current market share and forecasted
sales for the product and determined that such declines were not a temporary
condition. Watson evaluated the recoverability of its Dilacor XR(R) product
rights in accordance with Statement of Financial Accounting Standard No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." The company determined that the future estimated undiscounted
cash flows of Dilacor XR(R) were below the carrying amount of the underlying
product rights. During the third quarter of 2001, Watson adjusted the carrying
value of the Dilacor XR(R) product rights to their estimated fair value of $11.5
million. This resulted in a noncash asset impairment charge of approximately
$147.6 million, or $0.87 per share, after tax. Watson estimated the fair value
of the Dilacor XR(R) product rights based on forecasted future net profits,
discounted by our investment hurdle rate used for evaluating product right
acquisitions.
NOTE D - OPERATING SEGMENTS
Watson has two operating segments: branded and generic pharmaceutical
products. The branded products segment includes the company's lines of women's
health, general products and nephrology products. Watson has aggregated its
branded product lines in a single segment because of similarities in regulatory
environment, manufacturing processes, methods of distribution and types of
customer. This segment includes patent-protected products and trademarked
generic products that Watson promotes directly to healthcare professionals as
branded pharmaceutical products. The generic products segment includes
off-patent pharmaceutical products that are therapeutically equivalent to
proprietary products. The company sells its products primarily to pharmaceutical
wholesalers, drug distributors and chain drug stores.
-9-
The accounting policies of the segments are the same as those described in
the company's Annual Report on Form 10-K for the year ended December 31, 2000.
Watson primarily evaluates the performance of its segments based on net revenues
and gross profit. The "other" classification includes revenues from research,
development and licensing agreements. The company does not report depreciation
expense, total assets, and capital expenditures by segment as such information
is not used by management, nor accounted for at the segment level. Net revenues
and gross profit information for the company's segments for the three and nine
months ended September 30, 2001 and 2000 consisted of the following (in
thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
Net revenues:
Branded pharmaceutical products ............................................. $127,097 $ 72,969 $403,162 $296,983
Generic pharmaceutical products ............................................. 141,530 105,500 457,316 244,700
Other........................................................................ 2,315 862 6,288 15,086
-------- -------- -------- --------
Total net revenues ................................................ $270,942 $179,331 $866,766 $556,769
======== ======== ======== ========
Gross profit:
Branded pharmaceutical products ............................................. $ 88,819 $ 56,002 $304,938 $238,200
Generic pharmaceutical products ............................................. 39,410 25,550 172,404 72,500
Other........................................................................ 2,315 862 6,288 15,086
-------- -------- -------- --------
Total gross profit ................................................ $130,544 $ 82,414 $483,630 $325,786
======== ======== ======== ========
NOTE E - INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or
market and consisted of the following (in thousands):
September 30, December 31,
2001 2000
------------------ ------------------
Raw materials...................................... $ 87,688 $100,859
Work-in-process.................................... 59,563 52,529
Finished goods..................................... 100,048 95,557
--------- --------
$ 247,299 $248,945
========= ========
NOTE F - LONG-TERM DEBT
Long-term debt consisted of the following (in thousands):
September 30, December 31,
2001 2000
------------- ------------
Term loan facility, due 2005 .................................... $349,278 $385,000
Senior unsecured notes, 7.125%,
face amount of $150 million, due 2008
(effective rate of 7.25%) .................................... 148,839 148,737
Other notes payable ............................................. 1,534 2,417
-------- --------
499,651 536,154
Less current portion ............................................ 64,102 52,882
-------- --------
$435,549 $483,272
======== ========
-10-
In July 2000, the company negotiated a credit agreement that provided for a
$500 million term loan facility and a $200 million revolving credit facility for
working capital and other needs. Concurrent with the acquisition of Schein, in
July 2000 the company borrowed $500 million through the term loan facility. The
interest rate under this credit agreement is based on a margin over the London
Interbank Offered Rate (LIBOR). The margin is determined based on a leverage
test, with the margin increasing and decreasing in 1/8% increments based on an
interest rate grid. The interest rate is subject to adjustment each quarter,
based on a leverage ratio. The LIBOR rate, which is subject to market
fluctuations, may also change. At September 30, 2001, the interest rate on this
credit agreement was approximately 4.7%. Through September 30, 2001, the company
had reduced the outstanding principal balance to approximately $349 million.
Watson is subject to customary financial and operational covenants. As of
September 30, 2001, the company had not drawn any funds from the $200 million
revolving credit facility.
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 May and November, but may be redeemed earlier under certain circumstances.
Pursuant to the indenture under which the notes were issued, the company is
subject to customary financial and operational covenants.
NOTE G - COMPREHENSIVE INCOME
Comprehensive income includes all changes in equity during a period except
those resulting from investments by and distributions to the company's
stockholders. Watson's comprehensive income, net of tax, consisted of the
following (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2001 2000 2001 2000
--------- --------- --------- ---------
Net (loss) income ......................................... $ (58,633) $ (67,538) $ 70,068 $ 159,406
--------- --------- --------- ---------
Other comprehensive (loss) income:
Unrealized holding (losses) gains
on securities ....................................... (12,082) 68,354 7,207 266,894
Reclassification for gains included
in net income ........................................ (2,809) (58,605) (32,509) (214,352)
--------- --------- --------- ---------
Other comprehensive (loss) income ......................... (14,891) 9,749 (25,302) 52,542
--------- --------- --------- ---------
Comprehensive (loss) income ............................... $ (73,524) $ (57,789) $ 44,766 $ 211,948
========= ========= ========= =========
-11-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our financial condition and the results of our
operations should be read in conjunction with the consolidated financial
statements and notes thereto included elsewhere in this Quarterly Report. This
discussion contains forward-looking statements that are subject to known and
unknown risks, uncertainties and other factors that may cause our actual results
to differ materially from those expressed or implied by such forward-looking
statements. These risks, uncertainties and other factors include, among others,
those identified under "Cautionary Note Regarding Forward-Looking Statements"
and elsewhere in this Quarterly Report.
Results of Operations - Three Months Ended September 30, 2001 Compared to the
2000 Period
Net revenues for the three months ended September 30, 2001 were $270.9
million, compared to $179.3 million for the 2000 period, an increase of $91.6
million or 51%. During the third quarter of 2001, branded product sales
increased by $54.1 million, generic product sales increased by $36.0 million and
research, development and licensing revenues increased by $1.5 million.
Increased sales of our branded products was primarily in our Nephrology and
Women's Health divisions, while the generic sales increase was largely due to
sales of buspirone (the generic equivalent to Bristol-Myers Squibb's BuSpar(R))
which we launched in April 2001.
Our 180-day market exclusivity for buspirone expired in late September
2001, at which time we expected to experience pricing and volume pressures due
to competition. However, due to pediatric labeling issues surrounding the
branded product BuSpar(R), the U.S. Food and Drug Administration (FDA) is
currently withholding additional approvals for generics. Additionally, there is
certain litigation pending between the maker of BuSpar(R) and another
manufacturer of generic buspirone which could affect the regulatory status of
generic buspirone products. We are not a party to that litigation. However, an
adverse outcome for the other generic manufacturer in this litigation could have
an adverse impact on us. Legislation is currently pending in the United States
Congress that may provide clarity and direction relating to these issues.
Assuming there is resolution of the pediatric labeling issues and approval of
additional generics, we expect to experience the pricing and volume pressures
mentioned above. Additional generic competition would result in a further
decline of buspirone sales in the fourth quarter of this year.
Our gross profit margin on product sales increased to 48% in the third
quarter 2001 from 46% in the prior year period. This increase was primarily due
to a higher proportion of branded product sales as compared to the prior year.
However, this increase was offset in part by a $21 million inventory charge
resulting from excess on-hand inventory primarily due to lower than forecasted
sales in our General Products division.
Research and development expenses increased to $14.2 million in the third
quarter of 2001, compared to $12.5 million in the same period of 2000. Branded
product development continued to be our focus, while spending on certain generic
projects declined. In this regard, spending on clinical studies for branded
products increased significantly in the third quarter 2001, while administrative
costs were lower due to efficiencies realized from the consolidation of our
branded product development program.
Selling, general and administrative expenses decreased slightly to $48.4
million in the third quarter of 2001, compared to $49.1 million in the prior
year period, due primarily to the reimbursement of legal expenses from our
settlement of certain legal matters. This was offset, however, by increases in
our sales and marketing expenses as we have continued to expand our sales force
for our Women's Health product line and, overall, incurred higher advertising
and promotional
-12-
expenses. In addition, we incurred higher professional fees in 2001, primarily
due to increased legal costs associated with certain patent-related and
litigation matters.
Amortization expense for the three months ended September 30, 2001 was
$17.7 million, compared to $18.2 million for the prior year period. The decrease
was due to a reduced carrying value of product rights due to an asset impairment
charge on Dilacor XR(R) in the third quarter of 2001.
In the third quarter of 2001, we recognized a charge for asset impairment
related to Dilacor XR(R) as a result of declines in revenue and gross profit
contribution from product sales. We adjusted the carrying value of the Dilacor
XR(R) product rights to reflect its estimated fair value, resulting in a charge
of $147.6 million. In addition, we recorded a loss on assets held for
disposition that included $5.3 million of expenses related to the operations of
Steris Laboratories, Inc. (Steris), and a write down of $45.4 million to the
carrying value of Steris assets to current estimated fair market value. The
write down to current estimated fair market value was based upon recent
negotiations involving the sale or other disposition of the facility.
In the third quarter of 2000, we completed the acquisition of Schein
Pharmaceutical, Inc. (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 $125
million of the Schein purchase price to IPR&D expense in the third quarter of
2000.
Our loss from joint ventures was approximately $1.2 million in the third
quarter of 2001, compared to roughly breakeven earnings in the 2000 period. The
third quarter 2001 loss was primarily attributable to a loss from our 50%-owned
joint venture, Somerset Pharmaceuticals, Inc. (Somerset). In the third quarter
of 2001, Somerset reported reduced sales and higher operating costs (primarily
general, administrative and marketing expenses) as compared to the third quarter
of 2000. For the fourth quarter of 2001, we expect to record a loss from the
Somerset joint venture of approximately $1.5 million.
In the third quarter of 2001, we sold 70,000 shares of Andrx common stock.
The proceeds from these sales totaled approximately $4.7 million. We recorded a
pre-tax gain on sales of securities in the third quarter of 2001 of $4.5
million, compared to a pre-tax gain of $93.8 million in the prior year period.
See Notes to Consolidated Financial Statements, "Note A - General - Marketable
securities" in this Quarterly Report.
In the third quarter of 2001, we recorded a gain from our litigation
settlement with Rhone-Poulenc Rouer, as further discussed in Part II, Item 1.
Legal Proceedings in this Quarterly Report.
Interest and other income in the third quarter of 2001 decreased to
$800,000 from $4.9 million in 2000. The decrease in interest and other income
was caused by lower average cash balances, which was primarily due to cash used
in the Schein acquisition.
Interest expense in the third quarter of 2001 decreased to $7.2 million
from $11.3 million in 2000 due to a lower average long-term debt balance in the
third quarter of 2001, compared to the third quarter of 2000. We borrowed $500
million in July 2000 in the form of a term loan facility and reduced the
outstanding principal balance to approximately $349 million at September 30,
2001. In addition, our effective interest rate on our long-term debt decreased
to 4.7%, from 8% in the same period in the prior year. No interest expense was
capitalized in the third quarter of 2001.
Our income tax provision in the third quarter of 2001 reflected a 35%
effective tax rate on a pre-tax loss. In the third quarter of 2000, income tax
expense of $31.2 million was recorded against a pre-tax loss of $35.1 million
due to the $125 million IPR&D charge that is non-deductible for tax purposes.
-13-
Nine Months Ended September 30, 2001 Compared to the 2000 Period
Net revenues for the nine months ended September 30, 2001 were $866.8
million, compared to $556.8 million for the 2000 period, an increase of $310.0
million or 56%. The revenue growth was primarily the result of increased sales
of generic products, due to sales of generic products acquired in the Schein
acquisition and the April 2001 launch of buspirone. Generic product sales
increased by $212.6 million during the nine months ended September 30, 2001.
Sales of branded products for the first nine months of 2001 increased by $106.2
million from the same period in 2000. The sales increases in branded and generic
products were offset by an $8.8 million decrease in research, development and
licensing revenues. These revenues are variable between periods, depending on
the terms and conditions of individual contracts. During the nine months ended
September 30, 2001, we experienced increased branded product sales in both our
Nephrology and Women's Health product lines. However, we recorded lower product
sales in our General Products division. The sales decrease in our General
Products line was primarily due to continuing generic competition in dermatology
and pain management products.
Our gross profit margin on product sales decreased to 55% in the first nine
months of 2001 from 57% in the year ago period primarily due to the change in
our product sales mix, which resulted in a higher proportion of lower-margin
generic product sales compared with the first nine months of 2000. During the
nine months ended September 30, 2001, generic products accounted for
approximately 53% of net product sales, compared with 44% in the year ago
period. In addition, we recorded a $21 million inventory charge resulting from
excess on-hand inventory primarily due to lower than forecasted sales in our
General Products division.
Research and development expenses increased slightly to $42.7 million in
the first nine months of 2001, compared to $38.3 million in the same period of
2000. We continued to focus on branded product development, while spending on
certain generic projects declined.
Selling, general and administrative expenses increased to $153.1 million in
the nine months ended September 30, 2001, compared to $116.0 million in the
prior year period, due primarily to higher selling and marketing costs. This
increase was primarily due to the expenses attributable to the addition of the
sales, marketing and administrative personnel of Schein. In addition, we
incurred higher professional fees in 2001, primarily due to increased legal
costs associated with certain patent-related and litigation matters.
Amortization expense in the nine months ended September 30, 2001 increased
to $57.9 million, compared to $35.6 million in the 2000 period. This increase
related to the amortization of intangible assets recorded in the Schein
acquisition.
In the third quarter of 2001, we recognized a charge for asset impairment
related to Dilacor XR(R) as a result of continued declines in revenue and gross
profit contribution from product sales. We adjusted the carrying value of the
Dilacor XR(R) product rights to reflect its estimated fair value, resulting in a
charge of $147.6 million. In addition, loss on assets held for disposition
related to the operating loss incurred from our Steris facility and an
adjustment of the carrying value of the Steris assets to fair market value.
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 $125 million of the Schein purchase
price to IPR&D expense in the third quarter of 2000.
Our $2.9 million loss from joint ventures in the first nine months of 2001
compared to a $3.7 million loss in the prior year period. Our joint venture loss
resulted primarily from our 50% interest in Somerset, which reported a higher
net loss in the 2000 period caused by higher research and development costs.
-14-
In the first nine months of 2001, we sold approximately 958,000 shares of
Andrx common stock. The proceeds from these sales totaled approximately $54.3
million. We recorded a pre-tax gain on sales of securities in the nine months
ended September 30, 2001 of $52.2 million, compared to a pre-tax gain of $342.2
million in the prior year period. See Notes to Consolidated Financial Statements
"Note A - General - Marketable securities" in this Quarterly Report.
In the first nine months of 2001, we recorded a gain from our litigation
settlement with Rhone-Poulenc Rouer, Inc. in September 2001, as further
discussed in Part II, Item 1. Legal Proceedings in this Quarterly Report.
Interest and other income in the first nine months of 2001 decreased to
$2.4 million from $13.6 million in 2000 due to lower 2001 cash balances,
primarily as a result of cash used in the Schein acquisition.
Interest expense in the first nine months of 2001 increased to $21.9
million from $16.6 million in 2000 due primarily to interest expense on debt
acquired in July 2000, related to the Schein acquisition. During the nine months
ended September 30, 2001, we capitalized interest expense of $4.6 million
related to the carrying value of Assets Held for Disposition and construction in
progress.
Our income tax provision for the nine months ended September 30, 2001
reflected a 43% effective tax rate on pre-tax income, compared to 50% for the
same period in 2000. The company's effective tax rate was impacted by goodwill
amortization in 2001 and an IPR&D charge in 2000, both of which were
non-deductible for tax purposes.
Liquidity and Capital Resources
The company's working capital increased to $571.6 million at September 30,
2001 from $550.9 million at December 31, 2000, primarily due to an increase in
accounts receivable balances and proceeds received from the Aventis litigation
settlement. See Part II, Item 1 "Legal Proceedings." The most significant
sources of non-operating cash during the first nine months of 2001 were proceeds
from sales of Andrx common stock ($54.3 million) and proceeds from the exercise
of stock options ($21.7 million). Significant uses of cash included the increase
in accounts receivable balances ($126 million) due to increased sales in the
first nine months of 2001, principal payments on long-term debt ($42.7 million)
and additions to property and equipment ($48.2 million). We expect to spend
approximately $55 to $65 million for property and equipment additions during
2001.
As discussed in Note B of the Notes to Consolidated Financial Statements in
this Quarterly Report, we acquired Marsam through our acquisition of Schein. At
the time of acquisition, we determined to dispose of the facility through a sale
or plant closure. Following unsuccessful negotiations with potential buyers, we
decided to close the Marsam facility and recorded estimated liabilities of $6.3
million for severance and other costs expected to be incurred in connection with
this closing. As of September 30, 2001, the company had paid all material
severance and closure costs related to the closure of the Marsam facility.
We continue to have discussions with potential purchasers of our Steris
facility. During the third quarter of 2001, Watson incurred $5.3 million of
expenses related to Steris' operations, and a write down of $45.4 million to the
carrying value of Steris assets to current estimated fair market value. Such
adjustment to fair market value is based upon recent negotiations involving the
sale or other disposition of the facility.
As discussed in Note F of the Notes to Consolidated Financial Statements in
this Quarterly Report, we entered into a credit agreement with a bank and a
consortium of lenders that included a $500 million term loan facility and a $200
million revolving credit facility. In connection with the Schein acquisition, in
July 2000 we borrowed the entire amount of the $500 million term loan. As of
September 30, 2001, approximately $349 million remained outstanding under this
term loan. As of September 30, 2001 no amounts had been drawn on the revolving
credit facility.
-15-
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 7.125% 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 and certain other
matters, the balance of this registration statement remains available for
issuance at our discretion.
Our cash and marketable securities, which included our ownership of Andrx
common stock, totaled approximately $271 million at September 30, 2001. The fair
value of the Andrx common stock may fluctuate significantly due to volatility of
the stock market and changes in general economic conditions. See Item 3 in this
Quarterly Report. We believe that our cash and marketable securities balance,
our cash flows 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. In addition, we may consider
issuing additional debt or equity securities in the future to fund potential
acquisitions or growth or to refinance existing debt. 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.
-16-
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Statements contained in this Quarterly Report that are not statements of
historical fact or that refer to estimated or anticipated future events are
forward-looking statements. Such forward-looking statements reflect our current
perspective of existing trends and information as of the date of this filing.
These include but are not limited to express or implied assumptions about
government regulatory action or inaction. Forward-looking statements involve
risks, uncertainties and other factors that we cannot predict or quantify with
precision. Without limiting the generality of the foregoing, words such as
"may", "will", "expect", "believe", "anticipate", "intend", "could", "would",
"estimate", "continue" or "pursue", or the negative other variations thereof or
comparable terminology are intended to identify forward-looking statements.
We caution the reader that certain important factors may affect our actual
operating results and could cause such results to differ materially from those
expressed or implied by forward-looking statements. We believe the following
important risks, uncertainties and other factors, among others, may affect our
actual results:
. the success of our product development activities and
uncertainties related to the timing or outcome of such
activities;
. the timing and unpredictability of regulatory authorizations
and product rollout, which is particularly sensitive in our
generic business;
. our ability to timely and cost effectively integrate the
companies that we acquire into our operations;
. the outcome of our litigation (including patent, trademark and
copyright litigation), and the costs, expenses and possible
diversion of management's time and attention arising from such
litigation;
. our ability to retain key personnel;
. our ability to adequately protect our technology and enforce our
intellectual property rights;
. our success in acquiring or licensing proprietary technologies
that are necessary for our product development activities;
. our ability to obtain and maintain a sufficient supply of
products to meet market demand in a timely manner;
. our dependence on sole source suppliers and the risks associated
with a production interruption or supply delays at such third
party suppliers;
. the scope, outcome and timeliness of any governmental, court or
other regulatory action that may involve us (including, without
limitation, the scope, outcome or timeliness of any inspection or
other action of the Food and Drug Administration);
. the availability to us, on commercially reasonable terms, of raw
materials and other third party sourced products;
. our exposure to product liability and other lawsuits and
contingencies;
. our mix of product sales between branded, which typically have
higher margins, and generic products;
-17-
. the ability of third parties to assert patents or other
intellectual property rights against us which, among other
things, could cause a delay or disruption in the manufacture,
marketing or sale of our products;
. our ability to license patents or other intellectual property
rights from third parties on commercially reasonable terms;
. the expiration of patent and regulatory exclusivity on certain of
our products that will result in competitive and pricing
pressures including but not limited to the outcome and timing of
FDA regulatory review involving buspirone discussed above;
. our successful compliance with extensive, costly, complex and
evolving governmental regulations and restrictions;
. market acceptance of and continued demand for our products and
the impact of competitive products and pricing;
. our ability to successfully compete in both the branded and
generic pharmaceutical product sectors;
. our timely and successful implementation of strategic
initiatives;
. the uncertainty associated with the identification of and
successful consummation and execution of our external business
and product development transactions; and
. other risks and uncertainties detailed herein and from time to
time in our Securities and Exchange Commission filings.
The information in this Quarterly Report is as of September 30, 2001 or,
where clearly indicated, as of the date of this filing. We undertake no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise. We also may make
additional disclosures in our Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q and Current Reports on Form 8-K that we may file from time to time
with the Securities and Exchange Commission. Please also note that we provided a
cautionary discussion of risks, uncertainties and other factors under the
section entitled "Risk Factors" in our Annual Report on Form 10-K for the year
ended December 31, 2000. These are factors that we think could cause our actual
results to differ materially from expected results. Other factors besides those
listed here could also adversely affect us. This discussion is provided as
permitted by the Private Securities Litigation Reform Act of 1995.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to market risk for the impact of interest rate changes and
changes in the market values of our investments. We have not used derivative
financial instruments in our investment portfolio. The quantitative and
qualitative disclosures about market risk are set forth below.
Investment Risk
As of September 30, 2001, our total holdings in equity securities of other
companies, including equity method investments and available-for-sale equity
securities, were $181.4 million. We regularly review the carrying value of our
investments and identify and record losses when events and circumstances
indicate that any declines in the fair values of such investments, below our
accounting basis, are other than temporary. At September 30, 2001, we had equity
method investments of $34.8 million and publicly traded equity securities
(available-for-sale securities) at fair value totaling $146.6 million ($138.6
million of which was included in
-18-
"Marketable securities" and $8.0 million of which was included in "Investments
and other long-term assets). The fair values of these investments are subject to
significant fluctuations due to volatility of the stock market and changes in
general economic conditions. Based on the fair value of the publicly traded
equity securities we held at September 30, 2001, an assumed 25%, 40% and 50%
adverse change in the market prices of these securities would result in a
corresponding decline in total fair value of approximately $36.7 million, $58.6
million and $73.3 million, respectively.
As discussed in Note A of the Notes to Consolidated Financial Statements in
this Quarterly Report, our investment in Andrx consisted of 1.7 million Andrx
common shares with a fair market value of approximately $112.0 million at
September 30, 2001. As a publicly traded equity security, this investment has
exposure to price risk. The market price of Andrx common shares has been, and
may continue to be, volatile. For example, on September 28, 2001, the last
trading day in the third quarter of 2001, the Andrx closing price was $64.92. On
November 13, 2001, before our filing of this Quarterly Report, the Andrx closing
price was $65.52. The following table sets forth the Andrx high and low market
price per share information, based on published financial sources, through
September 30, 2001 and for 2000:
2001, by quarter High Low
---------------- ----------- ------------
First....................... $72.25 $38.50
Second...................... $77.00 $44.94
Third....................... $77.39 $58.02
2000, by quarter
----------------
First....................... $65.50 $20.13
Second...................... $68.31 $43.63
Third....................... $95.88 $63.94
Fourth...................... $94.88 $50.82
In addition to Andrx, our marketable securities include common shares of
Dr. Reddy's Laboratories, Limited (Dr. Reddy). As of September 30, 2001, Watson
owned approximately 0.7 million common shares of Dr. Reddy (approximately 3% of
the total Dr. Reddy common shares outstanding) with a market value of
approximately $26.9 million. Dr. Reddy is a developer and manufacturer of active
pharmaceutical ingredients and products. Dr. Reddy's shares trade on the Bombay
Stock Exchange and on the New York Stock Exchange in the form of American
depositary shares. Other than our investments in Andrx and Dr. Reddy, we hold
substantially all of our cash equivalents and marketable securities in short-
term, variable interest rate instruments.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily
to our non-equity investment portfolio and our long-term debt. We have
designated all of our cash, cash equivalents and marketable fixed income
securities as available-for-sale and, accordingly, we have presented these
securities at fair value in our consolidated balance sheets. We generally invest
our excess cash in money market mutual funds and other short-term, variable
interest rate instruments. Under certain circumstances, we may invest in A-rated
or higher fixed income securities. The fair value of fixed rate securities may
be adversely impacted due to a rise in interest rates. We may suffer losses in
principal if we sell securities that have declined in market value due to
changes in interest rates.
As discussed in Note F of the Notes to Consolidated Financial Statements in
this Quarterly Report, as of September 30, 2001 we had approximately $349.0
million outstanding under a LIBOR-based, variable interest rate term loan. A
hypothetical 100 basis point increase in interest rates, based on the September
30, 2001 term loan balance, would reduce our annual net income by approximately
$2.0 million. Any future gains or losses may differ materially from this
hypothetical amount based on the timing and amount of actual interest rate
changes and the actual term loan balance.
-19-
We estimate that the fair value of our fixed-rate senior unsecured
notes approximated its carrying value of $150.0 million at September 30, 2001.
While changes in market interest rates may affect the fair value of our fixed-
rate long-term notes, we believe the effect, if any, of reasonably possible
near-term changes in the fair value of such debt on our financial condition,
results of operations or cash flows will not be material.
At this time, we are not party to any interest rate or derivative hedging
contracts and have no material foreign exchange or commodity price risks.
PART II OTHER INFORMATION AND SIGNATURES
ITEM 1. LEGAL PROCEEDINGS
The company is party to certain lawsuits and legal proceedings, which are
described in "Part I, Item 3. Legal Proceedings," of our Annual Report on Form
10-K for the year ended December 31, 2000, and in "Part II, Item 1. Legal
Proceedings," of our Quarterly Reports on Form 10-Q for the periods ended March
31, 2001 and June 30, 2001. The following is a description of significant
developments during the period covered by this Quarterly Report and should be
read in conjunction with the Annual Report and Quarterly Reports referenced
above.
Phentermine hydrochloride lawsuits. With respect to the phentermine
- ----------------------------------
hydrochloride product liability lawsuits filed against the company, certain of
its subsidiaries, and others, additional actions raising similar issues have
been filed, and a number of actions have been settled and/or otherwise
dismissed. As of November 1, 2001, approximately 625 actions were pending
against the company and other company entities in a number of state and federal
courts. The company believes that it will be fully indemnified by The Rugby
Group's former owner, Aventis Pharmaceuticals (Aventis, formerly known as
Hoechst Marion Roussel, Inc.) for the defense of all such cases and for any
liability that may arise out of these cases. Aventis is currently controlling
the defense of all these cases as the indemnifying party under its agreements
with the company.
Watson Laboratories, Inc. v. Rhone-Poulenc Rorer, Inc. et. al. (RPR). In
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September 2001, the company reached a settlement with Aventis Pharma AG,
successor to RPR, resolving all outstanding disputes between the companies
related to Dilacor XR(R)(diltiazem) and its generic equivalent. As a result of
the settlement, the company recorded a non-recurring gain of approximately $60
million in the third quarter of 2001.
Higuchi v. Watson Pharmaceuticals, Inc. On September 5, 2001, the United States
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District Court for the District of Utah entered judgment for plaintiffs in this
matter, in the amount of $662,500. The case as tried asserted that the company
was negligent in allowing there to be, or in not removing soon enough,
restrictive legends on shares of company stock plaintiffs received following a
merger and exchange. These restrictions purportedly prevented plaintiffs from
selling their shares for some period of time, causing them damage. The judgment
is not expected to have a material effect on the company. On October 2, 2001,
the plaintiffs filed a Notice of Appeal to the United States Court of Appeals
for the Tenth Circuit. On October 16, 2001, the company filed its Notice of
Cross-Appeal, appealing the amount of the judgment.
Cipro lawsuits. In September 2001, Aventis, the former owner of The Rugby Group,
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accepted the company's tender for defense and indemnification of the company
and its affiliates in connection with the claims and investigations arising from
conduct and agreements allegedly undertaken by The Rugby Group and its
affiliates prior to the company's acquisition of The Rugby Group.
In re: Buspirone Patent Litigation; In re: Buspirone Antitrust Litigation, MDL
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Docket No. 1410.
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In August 2001, the Judicial Panel on Multi-District Litigation ordered that the
company's antitrust action against Bristol-Myers Squibb (BMS), similar antitrust
actions filed against BMS by other third parties, BMS' patent infringement
action against the company and certain company subsidiaries seeking damages and
injunctive relief, and similar patent infringement actions filed by BMS against
other third parties, all be consolidated for pretrial purposes in the United
Stated District Court for the Southern District of New York. Discovery is
ongoing.
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The company and its affiliates are involved in various other disputes,
governmental and/or regulatory inspections, investigations and proceedings, and
litigation matters that arise from time to time in the ordinary course of
business. The process of resolving matters through litigation or other means is
inherently uncertain and it is possible that the resolution of these matters
will adversely affect the company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Reference is hereby made to the Exhibit Index on page 23.
(b) Reports on Form 8-K filed during the quarter ended September 30, 2001:
On July 12, 2001, we filed a Form 8-K report dated July 11, 2001.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
WATSON PHARMACEUTICALS, INC.
(Registrant)
By: /s/ MICHAEL E. BOXER
-------------------------------------------------
Michael E. Boxer
Senior Vice President - Chief Financial Officer
(Principal Financial Officer)
By: /s/ R. TODD JOYCE
------------------------------------------------
R. Todd Joyce
Vice President - Corporate Controller and
Treasurer
(Principal Accounting Officer)
Dated: November 14, 2001
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WATSON PHARMACEUTICALS, INC.
EXHIBIT INDEX TO FORM 10-Q
For the Quarterly Period Ended September 30, 2001
Exhibit
No. Description
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3.2 The company's By-laws, as amended and restated as of July 27,
2001, filed with the Form 10-Q for the quarterly period ended
June 30, 2001.
*10.1 Watson Pharmaceuticals, Inc. Employee Stock Purchase Plan
effective as of February 12, 2001, filed with the Form 10-Q for
the quarterly period ended March 31, 2001.
First Amendment to the Employee Stock Purchase Plan of Watson,
filed with the Form 10-Q for the quarterly period ended June 30,
2001.
*10.2 Watson Pharmaceuticals, Inc. 2001 Incentive Award Plan effective
as of February 12, 2001, filed with the Form 10-Q for the
quarterly period ended March 31, 2001.
First Amendment to the 2001 Incentive Award Plan of Watson, filed
as Exhibit 10.2 to the company's Form S-8 (Reg. No. 333-61844)
filed on May 30, 2001 and hereby incorporated by reference.
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* Compensation Plan or Agreement
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