- --------------------------------------------------------------------------------
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, 2000
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 of the Registrant's only class of common stock outstanding
as of November 6, 2000 was approximately 102,768,650.
- --------------------------------------------------------------------------------
WATSON PHARMACEUTICALS, INC.
INDEX TO FORM 10-Q
FOR THE
QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets as of September 30, 2000 and
December 31, 1999.......................................... 1
Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 2000 and 1999.... 2
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2000 and 1999.............. 3
Notes to Consolidated Financial Statements....................... 4
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.................. 9
Item 3. Quantitative and Qualitative Disclosure about Market Risk........ 13
PART II. OTHER INFORMATION AND SIGNATURES
Item 1. Legal Proceedings................................................ 14
Item 6. Exhibits and Reports on Form 8-K................................. 15
Signatures................................................................ 16
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(Unaudited; in thousands, except share amounts)
September 30, December 31,
2000 1999
---------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents.............................................. $ 103,334 $ 102,057
Marketable securities.................................................. 23,504 13,865
Accounts receivable, net............................................... 85,782 180,860
Inventories............................................................ 257,552 108,532
Assets held for disposition............................................ 129,877 ---
Prepaid expenses and other current assets.............................. 31,001 9,582
Deferred tax assets.................................................... 81,920 19,815
---------- ----------
Total current assets................................................. 712,970 434,711
Property and equipment, net................................................ 184,145 138,848
Investments and other assets............................................... 355,206 291,448
Product rights and other intangibles, net.................................. 1,439,336 573,743
---------- ----------
$2,691,657 $1,438,750
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses.................................. $ 148,366 $ 56,487
Income taxes payable................................................... 23,593 33,550
Current portion of long-term debt...................................... 37,733 1,691
Current liability from acquisitions of products and businesses......... 7,658 37,458
---------- ----------
Total current liabilities............................................ 217,350 129,186
Long-term debt............................................................. 499,213 149,503
Other long-term liabilities................................................ 17,088 18,449
Deferred income taxes...................................................... 339,519 87,060
---------- ----------
Total liabilities.................................................... 1,073,170 384,198
---------- ----------
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; 102,703,000,and 96,133,200 shares outstanding.......... 339 317
Additional paid-in capital................................................. 724,280 397,705
Retained earnings.......................................................... 733,796 549,000
Accumulated other comprehensive income..................................... 160,072 107,530
---------- ----------
Total stockholders' equity........................................... 1,618,487 1,054,552
---------- ----------
$2,691,657 $1,438,750
========== ==========
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,
---------------------- ----------------------
2000 1999 2000 1999
--------- --------- --------- ---------
Net revenues................................ $ 183,394 $ 171,217 $ 552,953 $ 500,702
Cost of sales............................... 98,606 60,727 229,245 166,151
--------- --------- --------- ---------
Gross profit....................... 84,788 110,490 323,708 334,551
--------- --------- --------- ---------
Operating expenses:
Research and development................. 12,672 12,073 36,792 35,788
Selling, general and administrative...... 46,232 32,390 109,194 88,401
Amortization............................. 18,210 7,701 35,646 21,741
Charge for acquired in-process
research and development (Note B)...... 115,000 --- 115,000 ---
Merger and related expenses (Note C)..... --- --- --- 20,467
--------- --------- --------- ---------
Total operating expenses........... 192,114 52,164 296,632 166,397
--------- --------- --------- ---------
Operating income (loss)..................... (107,326) 58,326 27,076 168,154
--------- --------- --------- ---------
Other income (expense):
Equity in earnings (losses)
of joint ventures...................... 2 (1,317) (3,709) (932)
Gains on sales of securities............. 93,766 --- 342,161 ---
Interest and other income................ 4,810 1,180 13,480 3,066
Interest expense......................... (10,589) (2,749) (15,898) (8,364)
--------- --------- --------- ---------
Total other income (expense), net.. 87,989 (2,886) 336,034 (6,230)
--------- --------- --------- ---------
Income (loss) before income taxes and
extraordinary item....................... (19,337) 55,440 363,110 161,924
Provision for income taxes.................. 34,372 18,738 177,098 56,085
--------- --------- --------- ---------
Income (loss) before extraordinary item..... (53,709) 36,702 186,012 105,839
Extraordinary loss on early retirement of
debt, net of tax of $730................. (1,216) --- (1,216) ---
--------- --------- --------- ---------
Net income (loss)........................... $ (54,925) $ 36,702 $ 184,796 $ 105,839
========= ========= ========= =========
Earnings (loss) per share:
Basic.............................. $ (0.56) $ 0.38 $ 1.90 $ 1.11
========= ========= ========= =========
Diluted............................ $ (0.56) $ 0.38 $ 1.86 $ 1.08
========= ========= ========= =========
Weighted average shares outstanding:
Basic.............................. 98,960 95,850 97,300 95,680
========= ========= ========= =========
Diluted............................ 98,960 97,510 99,325 97,865
========= ========= ========= =========
See accompanying Notes to Consolidated Financial Statements.
-2-
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
Nine Months Ended
September 30,
--------------------------------
2000 1999
------------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................... $ 184,796 $ 105,839
--------- ---------
Reconciliation to net cash provided (used) by operating activities:
Depreciation............................................................... 13,033 9,995
Amortization............................................................... 35,646 21,741
Charge for acquired in-process research and development.................... 115,000 ---
Extraordinary loss on early retirement of debt............................. 1,216 ---
Deferred income tax provision.............................................. 409 20,686
Equity in losses of joint ventures......................................... 3,998 1,260
Gain on sale of Andrx securities........................................... (342,161) ---
Tax benefits related to exercise of stock options.......................... 28,840 10,587
Other...................................................................... 10,586 2,396
Cash provided (used) by changes in
assets and liabilities (net of acquisitions):
Accounts receivable.................................................... 94,196 (34,732)
Inventories............................................................ (90,861) (24,306)
Prepaid expenses and other current assets.............................. (12,100) 10,784
Accounts payable and accrued expenses.................................. (33,347) (8,205)
Income taxes payable................................................... (17,241) 11,338
--------- ---------
Total adjustments................................................... (192,786) 21,544
--------- ---------
Net cash provided (used) by operating activities.................... (7,990) 127,383
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment.......................................... (21,592) (19,459)
Purchases of marketable securities........................................... (44,170) (55,005)
Proceeds from maturities of marketable securities............................ 34,531 59,874
Proceeds from sales of Andrx and other securities............................ 366,576 ---
Acquisition of Schein Pharmaceutical......................................... (518,183) ---
Contingent payment related to acquisition of The Rugby Group................. (23,407) ---
Issuance of note receivable.................................................. (12,400) ---
Acquisitions of product rights............................................... (6,553) (64,318)
Additions to investments in joint ventures and other......................... (437) (5,593)
--------- ---------
Net cash used by investing activities............................... (225,635) (84,501)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt..................................... 500,000 ---
Retirement of Schein Pharmaceutical debt..................................... (239,651) ---
Principal payments on long-term debt......................................... (118,363) (1,307)
Payments on liability for acquisition of product rights...................... (15,000) (30,380)
Proceeds from exercise of stock options and warrants......................... 107,916 14,714
--------- ---------
Net cash provided (used) by financing activities.................... 234,902 (16,973)
--------- ---------
Increase in cash and cash equivalents............................... 1,277 25,909
Cash and cash equivalents at beginning of period............................. 102,057 59,663
--------- ---------
Cash and cash equivalents at end of period................................... $ 103,334 $ 85,572
========= ========
See accompanying Notes to Consolidated Financial Statements.
-3-
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - GENERAL
The accompanying unaudited consolidated financial statements of Watson
Pharmaceuticals, Inc. and its subsidiaries ("Watson" or the "company") should be
read in conjunction with the company's Annual Report on Form 10-K for the year
ended December 31, 1999. In the opinion of management, the accompanying
financial statements contain all adjustments necessary to present fairly
Watson's consolidated financial position and results of operations for the
periods presented. Unless otherwise noted, all such adjustments are of a normal,
recurring nature. In addition, we have reclassified certain prior year amounts
in the consolidated financial statements to conform to the current year
presentation. The results of operations for any interim period are not
necessarily indicative of the results of operations that Watson may achieve for
the entire year.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements," which provides guidance on the recognition, presentation, and
disclosure of revenue in financial statements filed with the SEC. SAB 101
outlines the basic criteria that must be met to recognize revenue and provides
guidance for disclosures related to revenue recognition policies. Watson will
adopt SAB 101 as required in fourth quarter 2000. The adoption of SAB 101 is not
expected to have a material impact on the financial position or results of
operations of the company.
NOTE B - ACQUISITION OF SCHEIN PHARMACEUTICAL, INC.
On August 28, 2000, Watson completed its acquisition of Schein Pharmaceutical,
Inc. ("Schein"). Schein develops, manufactures and markets a broad line of
generic products and has a branded business focused in the area of nephrology
for the management of iron deficiency and anemia. The aggregate purchase price
of $825 million to acquire all of the outstanding Schein shares consisted of (1)
approximately $510 million in cash, (2) the issuance of approximately 5.4
million Watson common shares with a market value of $300 million, and (3)
estimated direct transaction costs of $15 million. In addition, short term
liabilities with a fair value of approximately $375 million (principally
long-term debt that was subsequently retired) and long-term liabilities with a
fair value of approximately $5 million were assumed by the company. Watson
accounted for this acquisition under the purchase method of accounting.
Accordingly, Schein's results of operations and the estimated fair value of the
assets acquired and liabilities assumed are included in Watson's financial
statements from the date of acquisition.
Watson completed the acquisition in two steps. In the first step, on July 6,
2000, following a cash tender offer, a Watson subsidiary purchased approximately
26,068,500 shares of Schein common stock, constituting 77.8% of Schein's
outstanding shares as of that date. Following the purchase of these shares,
Watson repaid approximately $190 million of Schein indebtedness. The share
purchase and debt retirement were financed utilizing $500 million borrowed under
a new term loan facility and cash on hand. During August 2000, Watson retired
the remaining $50 million of previous Schein indebtedness, utilizing cash on
hand.
In the second step of the acquisition, on August 28, 2000, following Schein's
stockholders' approval and adoption of the merger agreement, Watson converted
each remaining outstanding share of Schein not purchased by the company in the
cash tender, into the right to receive 0.42187 of a share of Watson common
stock. Accordingly, Watson issued approximately 5.4 million of its common
shares, with a market value of approximately $300 million, in exchange for all
of the remaining outstanding common shares of Schein.
Under the purchase method of accounting, the purchase price is generally
allocated to the acquired assets and liabilities based on their estimated fair
values at acquisition. Accordingly, these financial statements reflect a
preliminary allocation of the purchase price to the acquired assets and
liabilities based on Watson's estimates of fair values. With the assistance of
valuation consultants and based on discounted cash flow models,
-4-
approximately $600 million of the purchase price has been allocated to Schein's
existing product rights. These product rights will be amortized on a straight-
line basis over periods of two to twenty years, with the weighted average life
approximating 17.5 years. The remaining excess of the purchase consideration
over the fair value of the tangible net assets acquired of approximately $300
million has been recorded as goodwill, which is being amortized on a straight-
line basis over 25 years.
The company allocated a portion of the purchase price to in-process research and
development (IPR&D). IPR&D represents ongoing research and development projects
acquired by the company for products that have not been approved by the Food and
Drug Administration and would have no alternative future use. Under the purchase
method of accounting, IPR&D is not an asset and, accordingly, the $115 million
of the total purchase price of Schein that was determined to be IPR&D was
charged to expense at the date of acquisition. The company used independent
professional valuation consultants to assess and allocate values to IPR&D. The
IPR&D charge relates to 30 generic product development projects, the three most
significant of which were valued at $28.5 million, $16.8 million and $11.6
million. The value of each project was determined using discounted cash flow
models, with the forecasted net cash flows for each product discounted back to
its present value using discount factors (ranging from 30% to 65%) that take
into account the stage of completion and the risks surrounding the successful
commercial development of each purchased in-process development project. At the
date of acquisition, the company believes that the assumptions used in the
valuation process were reasonable. No assurance can be given, however, that the
underlying assumptions utilized in the valuation of these projects will be
realized.
The following selected unaudited pro forma condensed combined financial
information for the nine months ended September 30, 2000 and 1999 has been
derived from the unaudited financial statements of Watson, included herein, and
of Schein. It has been prepared to give effect to the merger using the purchase
method of accounting for business combinations and assumes the merger had been
effective as of the beginning of each period presented.
Nine Months Ended
September 30,
-------------------------
(in thousands, except per share data) 2000 1999
----------- -----------
Net revenues............................... $746,025 $861,425
Net income................................. 128,750 74,425
Diluted earnings per share................. $1.23 $0.71
In connection with the company's acquisition of Schein, the company acquired two
injectable pharmaceutical manufacturing facilities, Steris Laboratories, Inc.,
located in Phoenix, Arizona, and Marsam Pharmaceuticals, Inc., located in Cherry
Hill, New Jersey. The company has decided that these two facilities do not
contribute to its strategic long-term goals and is currently exploring strategic
alternatives and expects to dispose of these facilities by third quarter 2001.
Accordingly, these facilities were recorded at their estimated fair market
values at the time of the Schein acquisition, based on the reports of an
independent appraiser, and the net assets of the two facilities have been
classified as a current asset on the company's consolidated balance sheet. An
accrual for estimated future losses at these facilities through their
disposition is included in this balance. During the quarter ended September 30,
2000, these facilities operated at losses totaling $6.1 million, net of tax,
that were applied against the accrual for estimated future losses. In addition,
interest capitalized on these facilities aggregated $1.6 million, net of tax,
during the quarter ended September 30, 2000 and was added to the carrying amount
of these facilities.
A severance accrual of $33.5 million was established for termination costs
associated with approximately 80 duplicative Schein employees. As of September
30, 2000, this balance was reduced by payments to $28.6 million.
-5-
NOTE C - ACQUISITIONS OF OTHER BUSINESSES
Pending Acquisition of Makoff R & D Laboratories, Inc.
In October 2000, Watson entered into a definitive merger agreement under which
Watson will acquire Makoff, the sponsor of the New Drug Application for
Ferrlecit(R) (sodium ferric gluconate in sucrose injection). Schein markets
Ferrlecit(R) under exclusive marketing and distribution rights through a
sublicense from Makoff. Aventis is the manufacturer of Ferrlecit(R) and licenses
the marketing and distribution rights to Makoff. Under the terms of the
agreement, Watson will acquire all of Makoff's outstanding stock in a
transaction intended to qualify as a pooling of interests for accounting
purposes and a tax-free reorganization for federal income tax purposes. Watson
will issue 1.9555 shares of its common stock for each share of Makoff stock,
which will result in the issuance of approximately 2.8 million Watson common
shares. Watson expects the merger, which is subject to customary closing
conditions, to be non-dilutive to its earnings in 2001 and to close by the end
of 2000. Upon completion, Makoff will become a wholly owned subsidiary of
Watson. A one-time charge for merger-related costs in connection with this
transaction, in an amount not yet determinable, is anticipated at the time of
closing.
TheraTech, Inc.
In January 1999, the company completed its acquisition of TheraTech, a
developer, manufacturer and marketer of branded pharmaceutical products. This
acquisition was accounted for as a pooling of interests and, accordingly, the
accompanying consolidated financial statements include the results of TheraTech
for all periods presented. During the first quarter of 1999, the company
recorded a special charge of $20.5 million for certain TheraTech merger and
related expenses.
NOTE D - EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted
average common shares actually outstanding during a period. Diluted earnings per
share is computed by dividing net income by the weighted average common shares
that would have been outstanding during the period, assuming, among other
things, that all vested in-the-money stock options had been exercised at the
beginning of the period. The effect of such dilutive stock options was to
increase weighted average common shares outstanding, for diluted earnings per
share purposes, by 1,660,000 shares for the three months ended September 30,
1999, and by 2,025,000 and 2,185,000 shares for the nine months ended September
30, 2000 and 1999, respectively. Because inclusion of the effect of these stock
options would have been antidilutive, their effect (which would have been to
increase diluted weighted average shares outstanding by 2,615,000 shares) has
been excluded from earnings per share computations for the three months ended
September 30, 2000.
Basic and diluted earnings per share, giving effect to the extraordinary loss on
early retirement of debt recorded during the quarter ended September 30, 2000,
may be summarized as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
2000 1999 2000 1999
-------------- -------------- -------------- --------------
Basic earnings per share:
Income (loss) before extraordinary item................ $ (0.55) $ 0.38 $ 1.91 $ 1.11
Extraordinary loss on early retirement of debt......... (0.01) --- (0.01) ---
------- ------ ------ ------
Net income (loss)...................................... $ (0.56) $ 0.38 $ 1.90 $ 1.11
======= ====== ====== ======
Diluted earnings per share:
Income (loss) before extraordinary item................ $ (0.55) $ 0.38 $ 1.87 $ 1.08
Extraordinary loss on early retirement of debt.. (0.01) --- (0.01) ---
------- ------ ------ ------
Net income (loss)...................................... $ (0.56) $ 0.38 $ 1.86 $ 1.08
======= ====== ====== ======
-6-
NOTE E - INVENTORIES
Inventories consisted of the following (in thousands):
September 30, December 31,
2000 1999
------------- -------------
Raw materials................................ $ 80,310 $ 48,832
Work-in-progress............................. 37,795 13,472
Finished goods............................... 139,447 46,228
---------- ---------
$ 257,552 $ 108,532
========== =========
NOTE F - INVESTMENTS AND OTHER ASSETS
Long-term investments consist primarily of the company's investment in Andrx
Corporation, a drug-delivery company utilizing controlled-release technologies
to develop oral pharmaceutical products. Andrx' common stock trades on the
NASDAQ National Market System under the symbol ADRX. During the three months
ended September 30, 2000, and as adjusted to reflect Andrx' April 2000
two-for-one stock split, Watson sold 1.2 million shares of Andrx' stock for $97
million and recorded a pretax gain of $94 million. During the nine months ended
September 30, 2000,Watson sold 7.1 million shares of Andrx stock, as adjusted
for Andrx' April 2000 stock split, for $365 million and recorded a pretax gain
of $342 million.
As of September 30, 2000, Watson owned 2.9 million common shares of Andrx, or
approximately 4% of the total Andrx common shares outstanding. 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 $155
million and $110 million (net of income taxes of $105 million and $72 million),
at September 30, 2000 and December 31, 1999, respectively. This unrealized gain
was the primary component of accumulated other comprehensive income in the
stockholders' equity section of Watson's consolidated balance sheets.
NOTE G - LONG-TERM DEBT
Long-term debt consisted of the following:
September 30, December 31,
(in thousands) 2000 1999
------------- ------------
Senior unsecured notes, 7.125%,
face amount of $150 million, due 2008
(effective rate of 7.25%)...................... $ 148,704 $ 146,608
Term loan facility, due 2005....................... 385,000 ---
Other.............................................. 3,242 4,586
--------- ---------
536,946 151,194
Less current portion............................... 37,733 1,691
--------- ---------
$ 499,213 $ 149,503
========= =========
On July 5, 2000, the company entered into a credit agreement with a bank that
includes a $500 million term loan facility and a $200 million revolving credit
facility that is available for working capital and other needs. The $500 million
term loan was drawn upon in its entirety and, along with approximately $250
million in cash on hand, used to pay off certain existing Schein indebtedness
and to purchase approximately 26 million shares of Schein common stock through
the tender offer. The interest rate under this facility is fixed at the London
Interbank Offered Rate ("LIBOR") plus 1.375% (approximately 8.0% at September
30, 2000) for the first six months; thereafter, the margin over LIBOR will be
determined based on a leverage test.
In September 2000, the company prepaid $100 million of borrowings under the
facility in addition to a required payment of $15 million which was due
October 1, 2000. In connection with the $100 million prepayment, the
-7-
company incurred an extraordinary loss of $1.2 million, net of tax, representing
the write-off of deferred financing costs. As a result of the $100 million
prepayment, required quarterly payments under the term loan were reduced to $12
million for the next three quarters. The required quarterly payments will
increase by $4 million annually thereafter, with any outstanding borrowings
under the facility maturing in July 2005.
Under the terms of the facility, the company is subject to customary financial
and other operational covenants. The company canceled its previous $30 million
credit facility with another bank, which had never been utilized, before
entering into the current term loan agreement. As of October 31, 2000, the
company has not drawn any funds from the $200 million revolving credit facility.
NOTE H - COMPREHENSIVE INCOME
Comprehensive income (loss) includes all changes in equity during a period
except those resulting from investments by and distributions to our
stockholders. Watson's comprehensive income (loss) consisted of the following:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
(in thousands) 2000 1999 2000 1999
---------- ---------- ---------- ----------
Net income (loss)................................ $ (54,925) $ 36,702 $ 184,796 $ 105,839
--------- --------- --------- ---------
Other comprehensive income, net of tax:
Unrealized holding gains (losses)
on securities............................... 68,354 (68,159) 266,894 127,171
Reclassification for gains included
in net income............................... (58,605) --- (214,352) ---
--------- --------- --------- ---------
Other comprehensive income (loss)................ 9,749 (68,159) 52,542 127,171
--------- --------- --------- ---------
Comprehensive income (loss)...................... $ (45,176) $ (31,457) $ 237,338 $ 233,010
========= ========= ========= =========
NOTE I - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Nine Months Ended
September 30,
---------------------------
(in thousands) 2000 1999
------------ -----------
Cash paid during the periods for:
Income taxes............................... $ 155,500 $ 22,500
Interest................................... 15,450 5,595
Acquisition of business:
Fair value of assets acquired............ $ 1,200,612 $ ---
Less liabilities assumed................. (375,666) ---
Less common stock issued................. (300,300) ---
Less cash acquired....................... (6,463) ---
----------- ----------
Net cash paid for acquisition......... $ 518,183 $ ---
=========== ==========
-8-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations - Three Months Ended September 30, 2000 Compared to the
1999 Period
Net revenues for the three months ended September 30, 2000 were $183.4 million
compared to $171.2 million for the 1999 period, an increase of $12.2 million or
7%. Our third quarter 2000 revenue growth was primarily attributable to sales of
nicotine polacrilex gum (the generic equivalent of SmithKline Beecham's
Nicorette(R)) and sales of Ferrlecit(R) and INFeD(R), nephrology products we
obtained in the Schein acquisition. In addition, in the third quarter of 2000 we
recorded our initial sales of Schein generic products. For the products noted
above, we had no comparable prior year sales. In part due to our sales of the
Schein generic products, our total sales of generic products increased in the
third quarter of 2000, compared to the 1999 period. Our third quarter 2000 sales
of branded products decreased from the third quarter of 1999, primarily due to
aggressive generic price competition in the branded dermatology line. Our total
branded product sales accounted for 41% of our net product sales in the third
quarter of 2000, compared with 53% in the year-ago quarter.
In the third quarter of 2000, we continued to experience price competition in
the generic market. As noted above, we also experienced price competition from
generic products in our branded dermatology line. These competitive factors,
plus a larger generic mix during the quarter, resulted in overall gross margins
on product sales of 45% in the third quarter of 2000, down from 62% in the third
quarter 1999.
Research and development expenses increased to $12.7 million in the third
quarter of 2000, compared to $12.1 million in the same period of 1999.
Proprietary product development continued to be our focus, while spending on
certain generic projects declined. In this regard, spending on clinical studies
for proprietary products increased significantly in the third quarter 2000. At
the same time, administrative costs were lower due to efficiencies realized
resulting from the consolidation of our Utah-based proprietary development
program into the company-wide program in 1999.
Selling, general and administrative expenses increased to $46.2 million in the
third quarter of 2000, compared to $32.4 million in the prior year period, due
primarily to the addition of the sales, marketing and administrative personnel
of Schein. We expect these expenses to decrease significantly in fourth quarter
2000, when we will realize a full quarter's benefit of our integration plan
rather than the partial benefits realized in the third quarter. In addition,
general and administrative expenses were higher in the third quarter of 2000 as
the company continued to build its corporate quality assurance group and other
support areas.
Third quarter amortization expense increased to $18.2 million in 2000, compared
to $7.7 million in the 1999 period. This increase was due to amortization
expense associated with intangibles recorded in the Schein acquisition and to
amortization expense recorded on our 1999 product acquisitions.
In the third quarter of 2000, we accounted for the acquisition of Schein using
the purchase method of accounting. In recording this transaction, we determined
that a portion of the purchase price represented purchased, to-be-completed
research and development projects, referred to as in-process research and
development (IPR&D). We charged $115 million of the Schein purchase price to
IPR&D expense in the third quarter of 2000.
Our earnings from joint ventures were approximately breakeven in the third
quarter of 2000, compared with a loss of $1.3 million in the 1999 period. This
improvement resulted primarily from our 50% interest in Somerset
Pharmaceuticals, Inc., which reported a lower net loss in the 2000 period caused
primarily by reduced research and development costs.
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In the third quarter of 2000, we sold approximately 1.2 million shares of Andrx
common stock. The proceeds from these sales amounted to approximately $97
million and we recorded pre-tax gains on sales of securities in the third
quarter of 2000 of $93.8 million.
Interest and other income in the third quarter of 2000 increased to $4.8 million
from $1.2 million in 1999 due to higher 2000 cash balances, primarily as a
result of the proceeds received from the Andrx sales discussed above.
Interest expense in the third quarter of 2000 increased to $10.6 million from
$2.7 million in 1999 due to interest expense on debt acquired in connection with
the Schein acquisition. We obtained a $700 million senior credit facility, $500
million of which was borrowed in July 2000 in the form of a term loan facility.
In September 2000, we repaid $115 million of principal on this term loan. The
balance of the senior credit facility is a $200 million revolving credit
facility. To date, we have made no borrowings under the revolving facility.
Our income tax provision in the third quarter of 2000 reflected a 37% effective
tax rate on pre-tax income, compared to 34% in 1999. The lower effective tax
rate in 1999 was primarily attributable to June 1999 changes in income tax
regulations relating to the "separate return limitation year" limitations on the
use of acquired net operating loss carryforwards to reduce taxable income. As a
result of these changes, we recorded a one-time $4.1 million reduction in income
tax expense in third quarter 1999 and also recognized a reduction in our overall
effective tax rate during the final three quarters of 1999.
Nine months Ended September 30, 2000 Compared to the 1999 Period
Net revenues for the nine months ended September 30, 2000 were $553.0 million
compared to $500.7 million for the 1999 period, an increase of $52.3 million or
10%. The revenue growth was primarily attributable to increased sales of women's
health products, which have grown steadily since we expanded that group's sales
force in third quarter 1999. In total, branded product sales accounted for 52%
of our net product sales in the first nine months of both 2000 and 1999. Despite
continuing price competition in the generic market, our net sales of generic
products increased during the first nine months of 2000, with the April 2000
launch of our nicotine polacrilex gum contributing to this increase. In
addition, we recorded our initial sales of Schein generic products during the
third quarter of 2000.
Our overall gross profit margins on product sales decreased to 57% in the first
nine months of 2000 from 65% in the year ago period. The main factors
contributing to this decline were price competition in the generic market and
limited new generic product introductions, with the exception of our nicotine
gum. In addition, we also experienced generic competition in our branded
dermatology line.
Research and development expenses increased to $36.8 million in the 2000 period,
compared to $35.8 million in the same period of 1999. We continue to focus on
proprietary product development, while spending on certain generic projects
declined. In this regard, spending on clinical studies for proprietary products
increased significantly in the third quarter 2000, while administrative costs
were lower due to efficiencies realized resulting from the consolidation of our
Utah-based proprietary development program into the company-wide program in
1999.
Selling, general and administrative expenses increased to $109.2 million during
the first nine months of 2000 compared to $88.4 million in the prior year
period. The largest contributor to this increase was the additional selling,
general and administrative costs resulting from combining our operations with
those of Schein. We expect Schein's contribution to this balance to decrease in
the fourth quarter 2000 and beyond as the full synergistic benefits of our
integration plan are realized. In addition, during 2000 we expanded our sales
force in the women's health area and, overall, incurred higher advertising and
promotional expenses.
Amortization expense in the nine months ended September 30, 2000 increased to
$35.6 million compared to $21.7 million in the 1999 period. This increase was
primarily due to amortization expense associated with
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intangibles recorded in the Schein acquisition and to amortization expense
recorded on our 1999 product acquisitions.
We recorded a nonrecurring $20.5 million charge in the first quarter of 1999
relating to our acquisition of TheraTech. The charge consisted of transaction
fees for investment bankers, attorneys, accountants and financial printing costs
($11.1 million) and closure costs associated with the elimination of duplicate
or discontinued products, operations and facilities ($9.4 million).
In the first nine months of 2000, we sold approximately 7.1 million shares of
Andrx common stock. The proceeds from these sales amounted to approximately $365
million and we recorded pre-tax gains on these sales of $342.2 million.
We recorded a $3.7 million loss from joint ventures in the first nine months of
2000. The increase resulted primarily from our interest in Somerset
Pharmaceuticals, Inc., which reported a higher net loss in the 2000 period
caused by lower revenues and higher research and development costs.
Interest and other income in 2000 increased to $13.5 million from $3.1 million
in 1999 due to higher 2000 cash balances, primarily as a result of the proceeds
received from the Andrx sales discussed above.
The increase in interest expense from $8.4 million in 1999 to $15.9 million in
2000, was due to interest expense on debt acquired in July 2000 in connection
with the Schein acquisition.
Our income tax provision for the nine months ended September 30, 2000 reflected
a 36% effective tax rate on pre-tax income, compared to 35% for the same period
in 1999. The lower effective tax rate in 1999 was primarily attributable to June
1999 changes in income tax regulations relating to the "separate return
limitation year" limitations on the use of acquired net operating loss
carryforwards to reduce taxable income. As a result of these changes, we
recorded a one-time $4.1 million reduction in income tax expense in third
quarter 1999 and also recognized a reduction in our overall effective tax rate
during the final three quarters of 1999. Partially offsetting this decrease, a
portion of our first quarter 1999 charge related to the TheraTech acquisition
was not deductible for income tax purposes, which had the effect of increasing
the effective tax rate in 1999.
Liquidity and Capital Resources
The company's working capital increased to $495.6 million at September 30, 2000
from $305.5 million at December 31, 1999, primarily due to net income of
approximately $185 million during the nine-month period. The most significant
sources of cash during the first nine months of 2000 were proceeds from
borrowings related to the Schein acquisition ($500 million), proceeds from sales
of Andrx common stock (approximately $342 million) and proceeds from lower
accounts receivable balances (approximately $95 million), resulting from the
elimination of extended payment terms that had been offered in late 1999.
Significant uses of cash included the acquisition of Schein common stock and
related expenses ($525 million), retirement of Schein's indebtedness ($240
million), payments of federal and state income taxes (approximately $155
million), which were considerably higher in 2000 due to the Andrx stock sales,
the payments made on long-term debt ($115 million), and an increased investment
in inventories to help reduce the risk that certain intermittent future supply
interruptions would negatively impact revenues over the short term. Other
significant uses of cash in the first nine months of 2000 included acquisitions
of property and equipment and a final, contingent payment related to the 1998
acquisition of The Rugby Group, Inc.
On July 5, 2000, we entered into a credit agreement with a bank that included a
$500 million term loan facility and a $200 million revolving credit facility
that is available for working capital and other needs. The $500 million term
loan was drawn upon in its entirety, along with approximately $250 million in
cash on hand, to pay off certain existing Schein indebtedness and to purchase
approximately 26 million shares of Schein
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common stock through a cash tender offer. Quarterly prepayments of the term
borrowings, beginning at $15 million per quarter during the first four quarters
and increasing thereafter, were required, with any outstanding borrowings under
the facility maturing in July 2005. In September 2000, we paid the required $15
million, plus an additional $100 million of the term borrowings, which reduced
the required quarterly payment to $12 million for the next three quarters. The
interest rate under this facility is fixed at the London Interbank Offered Rate
("LIBOR") plus 1.375% (approximately 8.0%) for the first six months; thereafter,
the margin over LIBOR will be determined based on a leverage test. Under the
terms of the facility, we are subject to customary financial and other
operational covenants. We cancelled our $30 million credit facility with another
bank before we entered this credit agreement.
In April 1998, we filed a shelf registration statement with the Securities and
Exchange Commission that would allow us, from time to time, to raise up to $300
million from offerings of senior or subordinated debt securities, common stock,
preferred stock or a combination thereof. In May 1998, pursuant to this
registration statement, we issued $150 million of 7-1/8% senior unsecured notes
due May 2008, with interest payable semi-annually in May and November. Subject
to preparation of a supplement to the existing prospectus, the balance of this
registration statement remains available for issuance at the company's
discretion.
Our cash and marketable securities totaled approximately $125 million at
September 30, 2000. We believe that our cash and marketable securities balance,
our cash flow from operations and the financing sources discussed herein, will
be sufficient to meet our normal operating requirements during the next twelve
months. However, we continue to review opportunities to acquire or invest in
companies, technologies, product rights and other investments that are
compatible with our existing business. We could use cash and financing sources
discussed herein, or financing sources that subsequently become available, to
fund additional acquisitions or investments. If a material acquisition or
investment is completed, our operating results and financial condition could
change materially in future periods. However, no assurance can be given that
additional funds will be available on satisfactory terms, or at all.
FORWARD-LOOKING STATEMENTS
Certain statements made by the company in this report and in other reports and
statements released by the company constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995, such
as comments which express the company's opinions about trends and factors which
may impact future operating results. We caution the reader that certain
important factors may affect our actual results and could cause such results to
differ materially from any forward-looking statement which may have been deemed
to have been made in this report or which are otherwise made by us or on our
behalf. For this purpose any statements contained in this report that are not
statements of historical fact may be deemed to be forward-looking statements.
Without limiting the generality of the foregoing, words such as "may", "will",
"expect", "believe", "anticipate", "intend", "could", "would", "estimate", or
"continue", or the negative other variations thereof or comparable terminology
are intended to identify forward-looking statements. Such forward-looking
statements contained in this report reflect Watson's current analysis of
existing trends and information and represent Watson's judgment only as of the
date of this report. The company disclaims any intent or obligation to update
these forward-looking statements.
Forward-looking statements involve risks and uncertainties that cannot be
predicted or quantified and, consequently, actual results may differ materially
from those expressed or implied by such forward-looking statements. Such risks
and uncertainties include, among other things, the success of product
development efforts by Watson and its third party partners, uncertainties
related to the outcome and timing of such efforts, and the timeliness with which
regulatory authorizations and product roll-out may be achieved, if at all;
market acceptance of Watson's products and the impact of competitive products
and pricing; technological advances and patents or other intellectual property
rights held by competitors; health care and cost containment reforms; the timing
and availability on commercially reasonable terms of raw materials and other
third party sourced products; the company's ability to obtain and maintain a
sufficient supply of its products to meet market demand in a timely manner;
successful compliance with extensive, costly, complex and evolving governmental
regulations and restrictions; the uncertainty associated with the identification
of and successful consummation and execution of corporate development
transactions; the ability to timely and cost-effectively integrate acquisitions
and achieve the acquisition's intended benefits; exposure to product liability
and other lawsuits and contingencies and the outcome of litigation involving the
company and related costs and expenses and possible diversion of management's
time and attention arising from such litigation. Additional information
concerning the factors that affect Watson's business can be found in Watson's
periodic public filings with the Securities and Exchange Commission, including
but not limited to: Watson's Annual Report and Form 10-K for the year ended
December 31, 1999, Watson's Form 10-Qs for the quarters ended March 31, 2000 and
June 30, 2000 and Watson's Registration Statement on Form S-4 filed on July 14,
2000, as amended.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
As discussed in Note F to the accompanying Notes to Consolidated Financial
Statements, our investment in Andrx consisted of 2.9 million Andrx common shares
with a fair market value of approximately $270 million at September 30, 2000. 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. The following table sets forth the Andrx high and low market price per
share information, based on published financial sources, for 1999 and through
September 30, 2000 (adjusted for Andrx' two-for-one stock split distributed in
April 2000):
2000, by quarter High Low
---------------- ---- ---
First.......................... $65.50 $20.13
Second......................... 68.31 43.63
Third.......................... 93.50 63.94
1999, by quarter
----------------
First.......................... $23.13 $11.13
Second......................... 39.00 15.41
Third.......................... 39.00 28.57
Fourth......................... 29.00 19.25
Substantially all of our cash equivalents and marketable securities are at fixed
interest rates and, as such, changes in market interest rates will affect the
fair value of these instruments. However, all of these investments mature within
one year and we believe that the market risk arising from our holding of these
investments is minimal.
We believe that the fair value of our fixed-rate long-term debt approximates its
carrying value of approximately $150 million at September 30, 2000. While
changes in market interest rates may affect the fair value of our long-term
debt, 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.
Our exposure to interest rate risk increased in July 2000, when we borrowed $500
million (reduced to $385 million at September 30, 2000) under our new term
credit facility, which bears interest at a variable rate, at our option, based
on the lenders' base rate or LIBOR, plus in each case a specified percentage.
Until January 2001, the interest rate will be LIBOR plus 1.375% (approximately
8.0% at September 30, 2000); thereafter, the margin over LIBOR will be
determined based on a leverage test, with the margin increasing and decreasing
in 1/8% increments based on an interest rate grid. Beginning January 2001, the
interest rate is subject to adjustment each quarter, based on our leverage
ratio, and the LIBOR rate is also subject to market fluctuations. The annual
impact on the company's results of operations of a 100 basis point interest rate
change on the September 30, 2000 outstanding balance of the variable rate debt
would be approximately $2.5 million after tax.
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.
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PART II - OTHER INFORMATION AND SIGNATURES
ITEM 1. LEGAL PROCEEDINGS
Reference is made to the "Legal Proceedings" sections of our Annual Report on
Form 10-K for the year ended December 31, 1999 and our Form 10-Q for the
quarters ended March 31, 2000 and June 30, 2000 for background information on
certain litigation. The following provides updated information regarding certain
previously disclosed Legal Proceedings and certain actions recently served on
the company.
In the matter of SmithKline Beecham Consumer Healthcare LP v. Watson
Pharmaceuticals, et. al., on October 2, 2000, the U.S. Supreme Court denied
SmithKline Beecham Consumer Healthcare's petition seeking review of the U.S.
Court of Appeals' April 4, 2000 decision ordering the District Court to dismiss
the complaint.
With respect to the phentermine hydrochloride product liability suits filed
against a Watson subsidiary, Rugby Laboratories, Inc., and other Watson
entities, additional actions raising similar issues have been filed. As of
November 1, 2000, a total of approximately 1,700 cases have been filed against
Rugby and other Watson entities in a number of state and federal courts. The
company believes that it will be fully indemnified by Rugby'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.
Beginning on July 14, 2000, a number of suits have been filed against a Watson
subsidiary, The Rugby Group, Inc. ("Rugby"), and other Watson entities in
various state and federal courts alleging claims under various federal and state
competition and consumer protection laws. As of November 1, 2000, a total of
approximately 23 cases have been filed against Rugby and other Watson entities.
The actions generally allege that the defendants engaged in unlawful,
anticompetitive conduct in connection with alleged agreements, entered into
prior to Watson's acquisition of Rugby from Aventis, related to the development,
manufacture and sale of the drug substance ciprofloxacin hydrochloride, the
generic version of Bayer's brand drug, Cipro(R). The actions generally seek
declaratory judgment, damages, injunctive relief, restitution and other relief
on behalf of certain purported classes of individuals and other entities. The
company has not yet responded to the complaints. The company intends to
vigorously defend itself in these actions. The company also believes that to the
extent liability exists, if at all, the company is entitled to indemnification
from Aventis for the defense of such cases and for any liability that may arise
out of such cases.
Recently, there has been enhanced political attention and governmental scrutiny
at the federal and state levels of the prices paid or reimbursed for
pharmaceutical products under Medicaid, Medicare and other government programs.
In November 1999, the company's subsidiary, Schein Pharmaceutical, Inc.
("Schein"), was informed by the U.S. Department of Justice that it, along with
several other pharmaceutical companies, is a defendant in a qui tam action
brought in 1995 under the U.S. False Claims Act currently pending in the Federal
District Court for the Southern District of Florida. As of November 13, 2000,
Schein has not been served in this action. A qui tam action is a civil lawsuit
brought by an individual for an alleged violation of a federal statute, in which
the Department of Justice has the right to intervene and take over the
prosecution of the lawsuit at its option. The Department of Justice has not yet
intervened in that action. Pursuant to applicable federal law, the qui tam
action is under seal and no details are available concerning the name of the
plaintiff, the various theories of liability or the amount of damages sought
from any of the defendants. Schein believes that the matter relates to whether
allegedly improper price reporting by pharmaceutical manufacturers led to
increased payments by Medicare and/or Medicaid. The qui tam action may seek to
recover damages from Schein based on its price reporting practices and, if
successful, could adversely affect the company. Schein has also received
notices, subpoenas or civil investigative demands from the attorneys general of
various states including Florida, Nevada, New York and Texas, indicating
investigations and possible lawsuits relating to pharmaceutical pricing issues
and whether allegedly improper efforts by pharmaceutical manufacturers led to
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increased payments by Medicare and/or Medicaid. Other state and federal
inquiries regarding pricing and reimbursements issues are anticipated. Any
actions that may be instituted to recover damages from Schein based on its price
reporting practices, if successful, could adversely affect the company. Any
significant limitation in government or third party reimbursement practices
likewise could adversely affect the company.
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:
27.1 Financial Data Schedule (EDGAR version only)
(b) Reports on Form 8-K filed during the quarter ended September 30, 2000:
On July 7, 2000, we filed a Form 8-K report, dated July 5, 2000,
announcing the expiration of the cash tender offer for Schein common
stock and that approximately 78% of the total outstanding shares of
Schein had been tendered in that offer.
On September 11, 2000, we filed a Form 8-K report, dated August 28,
2000, announcing the completion of our acquisition of Schein
Pharmaceutical, Inc.
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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. CHATO ABAD
-----------------------------------------------
R. Chato Abad
Vice President - Finance
(Principal Accounting Officer)
Dated: November 13, 2000
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