<PAGE>
 
                                              Commission File Number 1-10827



                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549



                               ________________



                                  FORM 10--Q



               QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
                    OF THE SECURITIES EXCHANGE ACT OF 1934



                 For the quarterly period ended June 27, 1998



                        PHARMACEUTICAL RESOURCES, INC.

            (Exact name of registrant as specified in its charter)



  NEW JERSEY                                                 22-3122182

 (State or other jurisdiction of                           (I.R.S. Employer
 incorporation or organization)                         Identification Number)



  ONE RAM RIDGE ROAD, SPRING VALLEY, NEW YORK                   10977

    (Address of principal executive offices)                  (Zip Code)



       Registrant's telephone number, including area code: (914) 425-7100



          Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding twelve months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.  Yes X  No
                                                                 



                                 29,311,245

       Number of shares of Common Stock outstanding as of August 5, 1998.



         This is page 1 of 18 pages.  The exhibit index is on page 17.
<PAGE>
 
                         PART I. FINANCIAL INFORMATION
                                        
                         ITEM 1. FINANCIAL STATEMENTS
                                        
                         PHARMACEUTICAL RESOURCES, INC.
                          CONSOLIDATED BALANCE SHEETS
                       (In Thousands, Except Share Data)
<TABLE>
<CAPTION>
 
 
                                                                        JUNE 27,   SEPTEMBER 30,
<S>                                                                        <C>        <C>
 
     ASSETS                                                              1998            1997
     ------                                                             -------         -------
                                                                      (Unaudited)      (Audited)
 
Current assets:
 
  Cash and cash equivalents                                             $   87         $   181
  Accounts receivable, net of allowances of
   $4,058 and $5,109                                                    11,991          11,414
  Inventories                                                           11,518          13,239
  Prepaid expenses and other current assets                              1,170           3,321
                                                                        -------         -------
    Total current assets                                                24,766          28,155
 
Property, plant and equipment, at cost less
accumulated depreciation and amortization                               26,575          27,832
 
Deferred charges and other assets                                        3,069           2,102
 
Non-current deferred tax benefit                                        14,608          14,608
                                                                        -------         -------
 

 Total assets                                                          $69,018         $72,697
                                                                        ======          ======
</TABLE> 

      LIABILITIES AND SHAREHOLDERS' EQUITY
      ------------------------------------
<TABLE>
<CAPTION>
 
Current liabilities:
<S>                                                                     <C>             <C>
  Current portion of long-term debt                                    $   272         $   218
  Short-term debt                                                        4,674           3,947
  Accounts payable                                                       4,505           5,120
  Accrued salaries and employee benefits                                 1,796           1,755
  Accrued expenses and other current liabilities                         1,108           1,156
                                                                        -------         -------
     Total current liabilities                                          12,355          12,196
 


Long-term debt, less current portion                                     2,689           2,651

 

Accrued pension liability                                                  582             582
</TABLE>
<TABLE>
<CAPTION>
 
 
Shareholders' equity:
<S>                                                                        <C>       <C>
  Common Stock, par value $.01 per share; authorized 90,000,000 shares; 
    issued and outstanding 18,909,381 and  18,874,216 shares               189             189
  Additional paid in capital                                            67,599          67,520
  Accumulated deficit                                                  (14,365)        (10,410)
  Additional minimum liability related to defined benefit pension plan     (31)            (31)
    Total shareholders' equity                                          53,392          57,268
                                                                        -------        -------
 


 Total liabilities and shareholders' equity                            $69,018         $72,697
                                                                        ======          ======

</TABLE>

        The accompanying notes are an integral part of these statements.

                                      -2-
<PAGE>
 
                         PHARMACEUTICAL RESOURCES, INC.
         CONSOLIDATED STATEMENTS OF OPERATIONS AND ACCUMULATED DEFICIT


                    (In Thousands, Except Per Share Amounts)
                                  (Unaudited)


<TABLE>
<CAPTION>
                                        
                                                   NINE MONTHS ENDED       THREE MONTHS ENDED
                                                -----------------------   ----------------------

                                                   JUNE 27,   JUNE 28,   JUNE 27,   JUNE 28,
                                                     1998       1997       1998       1997
                                                   ---------  ---------  ---------  ---------
<S>                                                <C>        <C>        <C>        <C>
Net sales                                          $ 43,594   $ 36,001   $ 17,886   $ 11,749
Cost of goods sold                                   39,425     34,626     15,850     11,132
                                                   --------   --------   --------   --------

   Gross margin                                       4,169      1,375      2,036        617
 
Operating expenses:
 Research and development                             2,669      4,627        900        850
 Selling, general and administrative                  8,559      9,478      3,247      3,132
                                                   --------   --------   --------   --------
 
   Total operating expenses                          11,228     14,105      4,147      3,982
                                                   --------   --------   --------   --------
   Operating loss                                    (7,059)   (12,730)    (2,111)    (3,365)
 
Other income (expense)                                3,778        (28)     3,632       (277)
Interest expense                                       (674)      (411)      (221)      (193)
                                                   --------   --------   --------   --------     
(Loss) income before provision for income taxes      (3,955)   (13,169)     1,300     (3,835)
Provision for income taxes                                -        410          -          -
                                                   --------   --------   --------   --------
NET (LOSS) INCOME                                    (3,955)   (13,579)     1,300     (3,835)

Accumulated deficit, beginning of period            (10,410)    (1,509)   (15,665)   (11,253)
                                                   --------   --------   --------   -------- 
Accumulated deficit, end of period                 $(14,365)  $(15,088)  $(14,365)  $(15,088)
 

NET (LOSS) INCOME PER SHARE OF COMMON STOCK:

   BASIC                                              $(.21)     $(.73)      $.07      $(.21)
                                                        ===        ===        ===        === 
   DILUTED (1)                                        $(.21)     $(.73)      $.06      $(.21)
                                                        ===        ===        ===        === 


WEIGHTED AVERAGE NUMBER OF COMMON AND
 COMMON EQUIVALENT SHARES OUTSTANDING:

   BASIC                                             18,886     18,669     18,896    18,676
                                                     ======     ======     ======    ======
   DILUTED (1)                                       18,886     18,669     20,732    18,676
                                                     ======     ======     ======    ======

</TABLE>


(1) There were no effects of dilutive options in the nine-month period ended
    June 27, 1998 and the nine and three-month periods ended  June 28, 1997.



       The accompanying notes are an integral part of these statements.

                                      -3-
<PAGE>
 
                        PHARMACEUTICAL RESOURCES, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                (In Thousands)
                                  (Unaudited)
<TABLE>
<CAPTION>
                                                                  NINE MONTHS ENDED
                                                              -------------------------

                                                                   JUNE 27,  JUNE 28,
                                                                    1998      1997
                                                                  --------  --------


<S>                                                                 <C>       <C>
Cash flows from operating activities:
 Net loss                                                           $(3,955) $(13,579)

 Adjustments to reconcile net loss to net
  cash used in operating activities:
     Joint venture research and development                               -       610
     Depreciation and amortization                                    2,062     2,059
     Allowances against accounts receivable                           1,051    (1,677)
     Write-off of inventories                                         1,372     1,148
     Loss on sale of marketable securities                                -       197
     Loss (gain) on sale of fixed assets                                 22       (98)
 
 
 Changes in assets and liabilities:
      (Increase) decrease in accounts receivable                     (1,628)    1,997
 
    Decrease in inventories                                             349     2,094
    Decrease in prepaid expenses and other assets                     1,187     1,856
    Decrease in accounts payable                                       (615)     (848)
    Decrease in accrued expenses and other liabilities                   (7)     (674)
                                                                    -------   ------- 
        Net cash used in operating activities                          (162)   (6,915)
 
Cash flows from investing activities:
      Capital expenditures                                             (899)     (716)
      Proceeds from sale of fixed assets                                 69       453
      Proceeds from sale of marketable securities                         -     1,115
                                                                    -------   -------
 
        Net cash (used in) provided by investing activities            (830)      852
 
 Cash flows from financing activities:
    Proceeds from issuances of Common Stock                              79        57
    Net proceeds from revolving credit line and proceeds
     from issuances of other debt                                     1,008     9,415
    Principal payments under long-term debt and other borrowings       (189)   (3,708)
        Net cash provided by financing activities                       898     5,764
 
Net decrease in cash and cash equivalents                               (94)     (299)
Cash and cash equivalents at beginning of period                        181   $   299
                                                                    -------   -------
Cash and cash equivalents at end of period                          $    87         -
                                                                    =======   =======
 
</TABLE>



        The accompanying notes are an integral part of these statements.

                                      -4-
<PAGE>
 
                         PHARMACEUTICAL RESOURCES, INC.
                         NOTES TO FINANCIAL STATEMENTS
                                 JUNE 27, 1998
                                  (UNAUDITED)
                                        



   Pharmaceutical Resources, Inc. (the "Company" or "PRI") operates in one
business segment, the manufacture and distribution of generic pharmaceuticals.
Marketed products are principally in solid oral dosage form (tablet, caplet and
capsule), with one product in the semi-solid form of a cream and one transdermal
patch.


BASIS OF PREPARATION:


   The accompanying financial statements at June 27, 1998 and for the nine-month
and three-month periods ended June 27, 1998 and June 28, 1997 are unaudited;
however, in the opinion of management of PRI, such statements include all
adjustments (consisting of normal recurring accruals) necessary to a fair
statement of the information presented therein.  The balance sheet at September
30, 1997 was derived from the Company's audited financial statements at such
date.


   Pursuant to accounting requirements of the Securities and Exchange Commission
applicable to quarterly reports on Form 10-Q, the accompanying financial
statements and these notes do not include all disclosures required by generally
accepted accounting principles for audited financial statements.  Accordingly,
these statements should be read in conjunction with PRI's most recent annual
financial statements.


   Results of operations for interim periods are not necessarily indicative of
those to be achieved for full fiscal years.  Certain items on the consolidated
financial statements of the prior year have been reclassified to conform to the
current year financial statement presentation.


ACCOUNTS RECEIVABLE:


   A significant portion of the accounts receivable allowances were comprised of
provisions for chargebacks.  Chargebacks are price adjustments generated from
the differential between the invoice or list price and a separate price agreed
to in a contract with a customer.  In fiscal 1997, the Company began to expand
the number of contracts with drug wholesalers as distribution channels
constricted.


SHORT-TERM DEBT:


   In December 1996, Par Pharmaceutical, Inc. ("Par"), the Company's principal
operating subsidiary, entered into a Loan and Security Agreement (the "Loan
Agreement") with General Electric Capital Corporation ("GECC") which provided
Par with a three-year revolving line of credit.  On May 22, 1998, the Company
and GECC amended the Loan Agreement in connection with an equity investment in
the Company by Merck KGaA, Darmstadt, Germany ("Merck KGaA") (see "--Subsequent
Events-Equity Investment").  Pursuant to the Loan Agreement, as amended, Par is
permitted to borrow up to the lesser of (i) the borrowing base established under
the Loan Agreement or (ii) $20,000,000.  The borrowing base is limited to 85% of
eligible accounts receivable plus 50% of eligible inventory of Par, each as
determined from time to time by GECC.  The interest rate charge on the line of
credit is based upon a per annum rate of 3.50% above the 30-day commercial paper
rate for high-grade unsecured notes adjusted monthly.  The line of credit with
GECC is secured by the assets of Par and PRI other than real property and is
guaranteed by PRI.  In connection with such facility, Par, PRI, and their
affiliates established a cash management system pursuant to which all cash and
cash equivalents received by any of such entities are deposited into a lockbox
account over which GECC has sole operating control and which are applied on a
daily basis to reduce amounts outstanding under the line of credit.  The
revolving credit facility is subject to covenants based on various financial
benchmarks.


                         PHARMACEUTICAL RESOURCES, INC.

                                      -5-
<PAGE>
 
                    NOTES TO FINANCIAL STATEMENTS--CONTINUED
                                 JUNE 27, 1998


                                  (UNAUDITED)


LONG-TERM DEBT:


   As a result of PRI's August 1997 acquisition of Clal Pharmaceutical
Industries Ltd. ("Clal") 51% ownership interest in their research and
development joint venture, the Company issued a non-recourse secured promissory
note in the principal amount of $1,500,000 bearing interest at 7% per annum and
payable in eight equal installments to Clal starting in July 1999.  The Company
and  Clal had formed the joint venture located in Israel to research and develop
generic pharmaceutical products.  The joint venture was renamed Israel
Pharmaceutical Resources L.P. ("IPR") following the acquisition.  The Company is
obligated to invest not less than $1,500,000 each year in IPR until the note is
repaid.  The Company intends to prepay the note in full with a payment of
$600,000 before August 13, 1998.


INCOME TAXES:


   Based on the Company's recent performance and the uncertainty of the generic
drug business in which it operates, management believes that future operating
income might not be sufficient to recognize fully the net operating loss
carryforwards of the Company.  Therefore, the Company did not recognize a
benefit for its operating losses in any of the nine-month and three-month
periods ended June 27, 1998 or June 28, 1997.  If the Company is unable to
generate sufficient taxable income in the future, increases in the valuation
allowance will be required through a charge to expense.  The Company incurred
income tax expense of $410,000 in the first quarter of fiscal 1997 due to
interest relating to a settlement with the Internal Revenue Service in fiscal
1995 for the disallowance of tax credits taken by the Company in prior periods
with respect to certain research and development costs.


EARNINGS PER SHARE:


   In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share" ("SFAS
128"), which is effective for financial statements for periods ending after
December 15, 1997, and requires replacement of primary and fully diluted
earnings per share with basic and diluted earnings per share including
retroactive restatement of all prior earnings per share data.  Under SFAS 128,
the dilutive effect of stock options is excluded from the calculation of basic
earnings per share but included in diluted earnings per share.  The Company
adopted the new accounting standard during the first quarter of fiscal 1998 and,
accordingly, has presented or restated all earnings per share data to conform to
the requirements of SFAS 128.  The following table is a reconciliation of the
numerators and denominators used to calculate basic and diluted earnings per
share:

<TABLE>
<CAPTION>
                                                 NINE MONTHS ENDED      THREE MONTHS ENDED
                                              -----------------------   -------------------
                                                 JUNE 27,   JUNE 28,    JUNE 27,  JUNE 28,
                                                   1998       1997       1998      1997
                                                 ---------  ---------  --------  ---------
<S>                                              <C>        <C>        <C>       <C>
                                                  (In Thousands, Except Per Share Amounts)
NET (LOSS) INCOME (NUMERATOR)                     $(3,955)  $(13,579)   $ 1,300   $(3,835)
 
BASIC:
Weighted average number of common
 shares outstanding (denominator)                  18,886     18,669     18,896    18,676

NET (LOSS) INCOME PER SHARE OF COMMON STOCK       $  (.21)  $   (.73)   $   .07   $  (.21)
                                                      ===        ===        ===       ===
 
ASSUMING DILUTION:
Weighted average number of common
 shares outstanding                                18,886     18,669     18,896    18,676
Effect of dilutive options                              -          -      1,836         -
                                                  -------   --------    -------   -------
Weighted average number of common and common
  equivalent shares outstanding (denominator)      18,886     18,669     20,732    18,676

NET (LOSS) INCOME PER SHARE OF COMMON STOCK       $  (.21)  $   (.73)   $   .06   $  (.21)
                                                      ===        ===        ===       ===
</TABLE>
                         PHARMACEUTICAL RESOURCES, INC.
                    NOTES TO FINANCIAL STATEMENTS--CONTINUED
                                 JUNE 27, 1998
                                  

                                      -6-
<PAGE>
 
                                  (UNAUDITED)

   Outstanding options and warrants of 794,700 and 548,700 at the end of the
current nine-month and three-month periods, respectively, and 3,652,307 and
3,713,307 in the corresponding periods of the prior year were not included in
the computation of diluted earnings per share because the exercise prices were
greater than the average market price of the Common Stock in the respective
periods.  In addition, incremental shares from assumed conversions of 771,373
for the current nine-month period and 9,562 and 918 for the nine-month and
three-month periods of last year, respectively, were excluded from diluted
earnings per share because they were antidilutive.


STRATEGIC ALLIANCE:


   In March 1998, the Company entered into a strategic alliance with Merck KGaA,
a multinational pharmaceutical, laboratory and chemical company located in
Darmstadt, Germany.  At the Company's Annual Meeting of Shareholders on June 26,
1998, certain terms of the alliance were approved and the transactions were
subsequently completed on June 30, 1998.  Pursuant to a Stock Purchase Agreement
(the "Stock Purchase Agreement"), dated March 25, 1998, between the Company and
Lipha Americas, Inc. ("Lipha"), a subsidiary of Merck KGaA, the Company agreed
to sell 10,400,000 newly-issued shares of PRI's Common Stock to Lipha, at $2.00
per share.  In addition, the Company agreed to issue to Merck KGaA and Genpharm,
Inc. ("Genpharm"), a subsidiary of Merck KGaA, five-year options to purchase up
to 1,171,040 additional shares of the Company's Common Stock at an exercise
price of $2.00 per share, in exchange for consulting services to be provided to
the Company (see "--Subsequent Events-Equity Investment").


DISTRIBUTION AGREEMENTS:


Genpharm, Inc.

   In connection with the Stock Purchase Agreement, Genpharm and the Company
have entered into a Distribution Agreement, dated March 25, 1998 (the
"Distribution Agreement"), pursuant to which Genpharm granted exclusive
distribution rights to the Company within the United States and certain other
United States territories with respect to approximately 40 generic
pharmaceutical products currently being developed or identified for development,
some of which have obtained FDA approval and others of which have been or will
be submitted to the FDA for approval.  Products may be added to or removed from
the Distribution Agreement by mutual agreement of the parties.  Genpharm is
required to use commercially reasonable efforts to develop the products which
are subject to the Distribution Agreement and is responsible for the completion
of product development and for obtaining all applicable regulatory approvals.
The Company will pay Genpharm a percentage of the gross profits attributable to
the sales of such products.


BASF Corporation


   In April 1997, Par entered into a Manufacturing and Supply Agreement (the
"Supply Agreement") with BASF Corporation ("BASF"), a manufacturer of
pharmaceutical products.  Under the Supply Agreement, Par agreed to purchase
certain minimum quantities of certain products manufactured by BASF at one of
its facilities, and phase out Par's manufacturing of those products.  BASF
agreed to discontinue its direct sale of those products.  The agreement has an
initial term of three years (subject to earlier termination upon the occurrence
of certain events as provided therein) and thereafter renews automatically for
successive two-year periods to December 31, 2005, if Par has met certain
purchase thresholds.  Under the first three years of the initial term of the
Supply Agreement, Par agreed to purchase minimum quantities of certain products
valued at $24,500,000.  Further, if Par does not purchase one of those products
valued at $29,000,000 in the third and final year of the agreement, BASF has the
right to terminate the agreement with a notice period of one year.  The Company
currently believes it will meet the minimum purchase requirements of calendar
year 1998, however, there can be no assurance that the Company will meet such
requirements.   The Company began selling drugs manufactured by BASF and BASF
transferred to Par the marketing and sales of certain products covered by the
Supply Agreement in June 1997 and the agreement became fully implemented in
August 1997.



                         PHARMACEUTICAL RESOURCES, INC.
                    NOTES TO FINANCIAL STATEMENTS--CONTINUED
                                 JUNE 27, 1998
                                  (UNAUDITED)

                                      -7-
<PAGE>
 
Sano Corporation

   The Company has a distribution agreement, as amended, with Sano Corporation
("Sano") which gives Par the right to exclusively distribute Sano's nicotine
transdermal patch and an option to distribute, when approved, a nitroglycerin
transdermal patch developed by Sano, in the United States. Sano develops
transdermal delivery systems utilizing a patch that incorporates the appropriate
drug dosage into an adhesive that attaches the patch to the skin. Pursuant to an
amendment in May 1998 in which the Company ceded its distribution rights to two
nitroglycerin transdermal patches, one unconditionally and one conditionally,
currently filed with the FDA and awaiting approval, PRI received cash payments
of approximately $5,700,000. The payments included approximately $2,100,000 as a
prepayment, with accrued interest, of a promissory note which was due from Sano
in September 1998. PRI will also receive a royalty on all future net sales of
one of the nitroglycerin transdermal patches by Sano or any transferee of rights
by Sano, and any distributors and licensees of the product, as defined in the
agreement, in the United States and Israel. In addition, Sano has increased the
Company's share of the gross profit on sales of the nicotine patch whose United
States distribution rights remain covered by the agreement. Sano received U.S.
Food and Drug Administration ("FDA") approval for its nicotine patch in October
1997 and the Company began selling the patch in January 1998. The Company is
purchasing the manufactured product from Sano at cost and sharing in the gross
profits from the sales.


COMMITMENTS, CONTINGENCIES AND OTHER MATTERS:


Retirement Plans:

   The Company has a defined contribution, social security integrated Retirement
Plan providing retirement benefits to eligible employees as defined in the
Retirement Plan.  The Board of Directors of Par directed the cessation of
employer contributions effective December 30, 1996.  Consequently, participants
in the Retirement Plan will no longer be entitled to any employer contributions
under such plan for 1996 or subsequent years.  The Company also maintains a
Retirement Savings Plan whereby eligible employees are permitted to contribute
from 1% to 12% of pay to this Plan.  The Company contributes an amount equal to
50% of the first 6% of the pay contributed by the employee.  In fiscal 1998, the
Company merged the Retirement Plan into the Retirement Savings Plan.


Legal Proceedings:


   The Company is involved in certain litigation matters, including certain
product liability actions and actions by a former officer for, among other
things, breach of contract.  Such actions seek damages from the Company,
including compensatory and punitive damages.  The Company intends to defend
these actions vigorously.  The Company believes that these actions are
incidental to the conduct of its business and that the ultimate resolution
thereof will not have a material adverse effect on its financial condition or
results of operations.


Restructuring and Cost Reductions:


   The Company implemented measures beginning in the fourth quarter of fiscal
1996, which continued throughout fiscal 1997, to reduce costs and increase
operating efficiencies.  Such measures have provided for a reduction of the work
force, changes in various senior management, a reorganization of certain
existing personnel and reductions in certain expenses.


Other Matters:


   Through March 1998, the Company loaned $875,000 to another generic drug
manufacturer for working capital purposes.  In March and April 1998, the loan
plus interest, was repaid in full.



                         PHARMACEUTICAL RESOURCES, INC.
                    NOTES TO FINANCIAL STATEMENTS--CONTINUED
                                 JUNE 27, 1998
                                  (UNAUDITED)


SUBSEQUENT EVENTS:

                                      -8-
<PAGE>
 
Equity Investment:

   On June 30, 1998, the Company and Merck KGaA completed the transactions
resulting from the strategic alliance discussed above. Merck KGaA, through its
subsidiary Lipha, purchased 10,400,000 newly-issued shares of the Company's
Common Stock for $20,800,000. In addition, the Company issued to Merck KGaA and
Genpharm five-year options to purchase an aggregate of 1,171,040 shares of the
Company's Common Stock at an exercise price of $2.00 per share in exchange for
consulting services to be provided to the Company. Merck KGaA also purchased
1,813,272 shares of the Company's Common Stock from Clal, PRI's largest
shareholder prior to the transaction and Clal has the right to cause Merck KGaA
and/or the Company to purchase an additional 500,000 shares of Common Stock from
Clal in three years. After giving effect to such transactions, Merck KGaA and
its affiliates currently have a 42% stake in the Company and have the right to
purchase up to an aggregate of approximately 46% of the Company's Common Stock.


   Under the Stock Purchase Agreement, Lipha has the right to designate a
majority of the Company's directors.  Lipha and its affiliates have agreed to
not engage in certain business combinations including the Company for a period
of three years, unless a majority of the three directors designated by the
Company's former Board of Directors consents.  Lipha will have certain rights of
first refusal to acquire equity stock of the Company in the event of future
equity offerings.


   On June 30, 1998, the Company paid all outstanding revolving credit advances
pursuant to the Loan Agreement with GECC with a portion of the proceeds from the
equity investment and GECC relinquished operating control over the Company's
cash receipts.  As of July 31, 1998, the borrowing base was approximately
$12,300,000 and no amounts were outstanding under the line of credit.  PRI and
GECC are currently negotiating new terms for the credit facility.  The remainder
of the proceeds from the equity investment is planned to be used for working
capital, including possible business expansion.

                                      -9-
<PAGE>
 
                ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
                 FINANCIAL CONDITION AND RESULTS OF OPERATIONS


   CERTAIN STATEMENTS IN THIS FORM 10-Q CONSTITUTE "FORWARD-LOOKING STATEMENTS"
WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995,
INCLUDING THOSE CONCERNING MANAGEMENT'S EXPECTATIONS WITH RESPECT TO FUTURE
FINANCIAL PERFORMANCE AND FUTURE EVENTS, PARTICULARLY RELATING TO SALES OF
CURRENT PRODUCTS AS WELL AS THE INTRODUCTION OF NEW MANUFACTURED AND DISTRIBUTED
PRODUCTS.  SUCH STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND
CONTINGENCIES, MANY OF WHICH ARE BEYOND THE CONTROL OF THE COMPANY, WHICH COULD
CAUSE ACTUAL RESULTS AND OUTCOMES TO DIFFER MATERIALLY FROM THOSE EXPRESSED
HEREIN.  FACTORS THAT MIGHT AFFECT SUCH FORWARD-LOOKING STATEMENTS SET FORTH IN
THIS FORM 10-Q INCLUDE, AMONG OTHERS; (I) INCREASED COMPETITION FROM NEW AND
EXISTING COMPETITORS AND PRICING PRACTICES FROM SUCH COMPETITORS, (II) PRICING
PRESSURES RESULTING FROM THE CONTINUED CONSOLIDATION OF  THE COMPANY'S
DISTRIBUTION CHANNELS, (III) THE AMOUNT OF FUNDS CONTINUING TO BE AVAILABLE FOR
INTERNAL RESEARCH AND DEVELOPMENT AND RESEARCH AND DEVELOPMENT JOINT VENTURES,
(IV) RESEARCH AND DEVELOPMENT PROJECT DELAYS OR DELAYS IN OBTAINING REGULATORY
APPROVALS, AND (V)  CONTINUATION OF DISTRIBUTION RIGHTS UNDER CURRENT
SIGNIFICANT AGREEMENTS.


RESULTS OF OPERATIONS

GENERAL


   The Company's operating losses for the nine-month and three-month periods
ended June 27, 1998 of $7,059,000 and $2,111,000, respectively, decreased from
operating losses of $12,730,000 and $3,365,000 in the corresponding periods of
the prior fiscal year.  The improvement in both periods was due primarily to
increased sales and gross margins, as described below, and lower operating
expenses in the nine-month period.  The Company's net loss of $3,955,000 and net
income of $1,300,000 for the current nine-month and three-month periods,
respectively, improved from net losses of $13,579,000 and $3,835,000 in the
corresponding periods of the prior fiscal year.  Current year results included
non-recurring income of approximately $3,600,000 in both periods pursuant to an
amendment to the distribution agreement between Par and Sano (see "Notes to
Financial Statements-Distribution Agreements-Sano Corporation").  If current
sales and gross margin levels are not increased from additional sales of new
distributed or manufactured products, the Company will continue to experience
losses.


   In an effort to position the Company for future growth while strengthening
its current financial condition and near and long-term product line, PRI entered
into a strategic alliance on March 25, 1998 with Merck KGaA, a pharmaceutical,
laboratory and chemical company located in Darmstadt, Germany.  Under the
agreement, which was completed on June 30, 1998, Merck KGaA, through its
subsidiary Lipha, paid the Company $20,800,000, or $2.00 per share, for
10,400,000 newly-issued shares of PRI's Common Stock.  The Company also issued
to Merck KGaA and Genpharm five-year options to purchase an aggregate of
1,171,040 shares of the Company's Common Stock at an exercise price of $2.00 per
share in exchange for consulting services to be provided to the Company.  A
portion of  the proceeds from the stock sale were used to repay advances made to
the Company under its existing line of credit and the remainder is planned to be
used for working capital, including possible business expansion.  In addition,
the Company received the sole rights to the portfolio of products covered by a
distribution agreement with Merck KGaA's Canadian subsidiary Genpharm, granting
the Company exclusive United States distribution rights for up to approximately
40 generic pharmaceutical products currently being developed or identified for
development, some of which have obtained FDA approval and others of which have
been or will be submitted to the FDA for approval.  Genpharm will pay all of the
research and development costs associated with the products and PRI will pay
Genpharm a certain percentage of the gross margin on sales of the products
(see "Notes to Financial Statements-Strategic Alliance", -Distribution
Agreements-Genpharm, Inc." and "-Subsequent Events-Equity Investment").


    The generic drug industry in the United States continues to be highly
competitive. The factors contributing to the intense competition and affecting
both the introduction of new products and the pricing and profit margins of the
Company, include, among other things; (i) introduction of other generic drug
manufacturer's products in direct competition with the Company's significant
products, (ii) consolidation among distribution outlets, (iii) increased ability
of generic competitors to enter the market after patent expiration, diminishing
the amount and duration of significant profits, (iv) willingness of generic drug
customers, including wholesale and retail customers, to switch among
pharmaceutical manufacturers, and (v) 

                                      -10-
<PAGE>
 
competition from brand name drug manufacturers selling generic versions of their
drugs. In an attempt to improve eroding margins, a recent trend developing in
the industry is the raising of prices on products that do not generate an
adequate profit or discontinuing them. Consequently, the Company increased
pricing on a limited number of products while discontinuing certain unprofitable
products. In an effort to further lessen the unfavorable impact of the continued
price and profit margin erosion on certain significant manufactured products,
the Company has reduced operating costs and entered into several significant
agreements, as described elsewhere in this Form 10-Q (see "Notes to Financial
Statements-Strategic Alliance", "-Distribution Agreements" and "-Commitments,
Contingencies and Other Matters-Restructuring and Cost Reductions").


   Critical to any significant improvement in the Company's financial condition
is the introduction and acquisition of new manufactured and distributed products
at selling prices that generate significant gross margin.  The strategic
alliance with Merck KGaA is expected to provide the Company with a significant
number of additional products for its product development pipeline without the
substantial resource commitment, including financial, it would normally take to
develop such a pipeline.  The Company plans to continue to invest in research
and development efforts in addition to pursuing additional products for sale
through new and existing distribution agreements.  The Company is engaged in
efforts, subject to FDA approval and other factors, to introduce new products as
a result of its research and development efforts and distribution agreements.
No assurance can be given that any additional products for sale by the Company
will occur or that sales of additional products will reduce losses or return the
Company to profitability.  Continuing losses will adversely affect the Company's
liquidity and, accordingly, its ability to fund research and development or
ventures relating to the sale of new products (see "--Financial Condition-
Liquidity and Capital Resources").


NET SALES


   Net sales for the nine-month period ended June 27, 1998 of $43,594,000
increased $7,593,000, or 21%, from $36,001,000 for the nine-month period ended
June 28, 1997.  The sales growth was primarily attributable to significantly
higher volumes of a lower margin manufactured product due to increased demand
from two customers.  The manufacturing of this product was transferred to BASF
in June 1998.  Also contributing to the sales improvement was the continuing
increase in sales of two distributed products manufactured by BASF under the
Supply Agreement and the introduction of three new products, the nicotine patch
manufactured by Sano, Zorprin(R) manufactured by BASF and the first product
distributed by the Company under the Distribution Agreement (see "Notes to
Financial Statements-Distribution Agreements-Genpharm, Inc.").  Net sales of
these six products, and to a lesser extent, price and volume increases on
several other manufactured products more than offset the discontinuance of
certain unprofitable products and the continuing decreases in pricing and volume
of three of the Company's products, which had historically accounted for a
significant percentage of the Company's sales and gross margins.  The reductions
in pricing and volume of these three products resulted principally from the
introduction of other generic drug manufacturers' products in direct competition
with the Company's significant products.  Net sales of distributed product for
the nine-month period increased to approximately 40% of the Company's total net
sales compared to approximately 20% of the total in the same period of the prior
year.


   Net sales of $17,886,000 for the third quarter of fiscal 1998 increased
$6,137,000, or 52%, compared to sales of $11,749,000 for the corresponding
quarter of fiscal 1997.  The increase is principally attributable to a higher
volume of a lower margin manufactured product, the introduction of three new
distributed products and higher sales of two other distributed products.  Price
and sales volume increases during the current quarter on several manufactured
products offset the continuing lower sales of certain significant products, as
described above, in addition to the discontinuance of some unprofitable
products.  Net sales of distributed product for the third quarter increased to
approximately 50% of the Company's total net sales versus approximately 25% of
the total for the same quarter of last year.


   Levels of sales are principally dependent upon, among other things, (i)
pricing levels and competition, (ii) market penetration for the existing product
line, (iii) approval of Abbreviated New Drug Applications ("ANDAs") and
introduction of new manufactured products, (iv) introduction of new distributed
products, and (v) the level of customer service.


GROSS MARGIN


   The gross margin of $4,169,000 (10% of net sales) for the nine-month period
ended June 27, 1998 increased $2,794,000 from $1,375,000 (4% of net sales) in
the corresponding period of the prior fiscal year.  The gross margin improvement
was principally due to higher volumes of a lower margin manufactured product
together with more favorable raw material pricing, increased margin
contributions from higher margin products manufactured by BASF under the Supply

                                      -11-
<PAGE>
 
Agreement, and the introduction of three new products. These improvements along
with reduced manufacturing costs, and to a lesser extent, price increases on
certain products, more than offset the continuing lower selling prices and
decreased volumes of certain significant manufactured products resulting from
increased competition from other generic drug manufacturers.


   The Company's gross margin for the three-month period ended June 27, 1998 of
$2,036,000 (11% of net sales) increased $1,419,000 from $617,000 (5% of net
sales) in the corresponding three-month period of the prior year.  The
improvement is primarily attributable to a higher volume of a lower margin
manufactured product, increased margin contributions from products manufactured
by BASF, and the introduction of three new products in the current year.  These
factors along with price increases on several products and reduced manufacturing
costs more than offset the continuing lower sales of certain significant
products, as described above.


   Inventory write-offs amounted to $1,372,000 and $877,000 for the nine-month
and three-month periods ended June 27, 1998, respectively, compared to
$1,148,000 and $514,000 in the corresponding periods of the prior year.  The
increase in both periods was primarily attributable to the write-off of obsolete
inventory due to the discontinuance of certain products.  Inventory write-offs
taken in the normal course of business are related primarily to the disposal of
finished products due to short shelf life.


OPERATING EXPENSES

Research and Development

   Research and development expenses were $2,669,000 for the nine-month period
ended June 27, 1998 compared to $4,627,000 for the corresponding period of the
prior fiscal year.  The lower cost in the current year is due to advances of
$1,957,000 paid to Sano in the prior year.  In August 1997, the Company acquired
Clal's 51% ownership interest in IPR in which PRI previously had owned 49% (see
"Notes to Financial Statements-Long-Term Debt").  The Company recorded an
aggregate of $1,214,000 in research and development expenses for IPR for the
current nine-month period compared to $610,000 in the corresponding period of
the prior year.  The higher costs of IPR, due to the Company absorbing 100% of
the expenses in the current year compared to 49% in the prior year, were offset
by reduced spending in the Company's domestic research and development operation
as IPR assumed responsibility for certain functions previously performed in the
United States.


   In the three-month period ended June 27, 1998 research and development
expenses of $900,000 were comparable to $850,000 for the same period of last
year.  Research and development expenses for IPR in the current fiscal quarter
were $485,000 versus $231,000 in the corresponding quarter of the prior year.
The higher costs of IPR were partially offset by lower domestic research and
development spending.


   During fiscal 1997, the Company's domestic research and development program
was fully integrated with the research operations in Israel.  The Company has
ANDAs for two potential products pending with the FDA and awaiting approval.
The Company expects to complete three additional product submissions by the end
of the current calendar year.  Recently, PRI received FDA approval of its ANDAs
for two products which the Company expects to begin marketing shortly.


   As part of the Distribution Agreement entered into with Genpharm, Genpharm is
required to pay all of the research and development costs associated with a
portfolio of products covered by the Distribution Agreement.  The Distribution
Agreement will grant the Company exclusive United States distribution rights for
up to approximately 40 generic pharmaceutical products currently being developed
or identified for development, some of which have obtained FDA approval and
others of which have been or will be submitted to the FDA for approval.  The
Company will pay Genpharm a certain percentage of the gross margin on sales of
those products  (see "Notes to Financial Statements-Distribution Agreements-
Genpharm, Inc.").

Selling, General and Administrative

   Selling, general and administrative costs of $8,559,000 (20% of net sales)
for the nine months ended June 27, 1998 were reduced $919,000 from $9,478,000
(26% of net sales) in the corresponding period ended June 28, 1997.  The lower
expenses in the current period were primarily attributable to a decline in
personnel costs resulting from head count reductions (see "Notes to Financial
Statements -Commitments, Contingencies and Other Matters-Restructuring and Cost
Reductions").

                                      -12-
<PAGE>
 
   For the three months ended June 27, 1998, selling, general and administrative
costs of $3,247,000 (18% of net sales) were moderately higher than $3,132,000
(27% of net sales) for the corresponding three-month period of last year. The
increase reflects higher costs incurred in connection with an equity investment
in the Company (see "Notes to Financial Statements -Subsequent Events-Equity
Investment") and additional selling costs associated with a new product
introduction.


   The Company's previous trend of decreasing selling, general and
administrative costs is expected to end in subsequent periods as the Company
plans to increase and strengthen its sales force and expand marketing efforts in
anticipation of product introductions.


OTHER INCOME (EXPENSE)

   Other income of  $3,778,000 and $3,632,000 for the nine-month and three-month
periods ended June 27, 1998, respectively, included approximately $3,600,000
from the sale of product rights pursuant to an amendment to the distribution
agreement between the Company and Sano (see "Notes to Financial Statements-
Distribution Agreements-Sano Corporation" and  "--Liquidity and Capital
Resources").   Prior year expenses of $28,000 and $277,000 for the corresponding
nine-month and three-month periods, respectively, included a loss on the sale of
Fine-Tech Ltd. ("Fine-Tech") stock partially offset by gains on the sale of Sano
stock.


INCOME TAXES


   Management has determined, based on the Company's recent performance and the
uncertainty of the generic drug business in which the Company operates, that
future operating income might not be sufficient to recognize fully the net
operating loss carryforwards of the Company.  Therefore, the Company did not
recognize a benefit for its operating losses in any of the nine-month and three-
month periods ended June 27, 1998 or June 28, 1997 (see "Notes to Financial
Statements-Income Taxes").  The Company incurred income tax expense of $410,000
in the first quarter of fiscal year 1997 due to interest relating to a
settlement with the Internal Revenue Service in fiscal year 1995 for the
disallowance of tax credits taken by the Company in prior periods with respect
to certain research and development costs.


FINANCIAL CONDITION

LIQUIDITY AND CAPITAL RESOURCES


   Working capital of $12,411,000 at June 27, 1998 decreased $3,548,000 from
$15,959,000 at September 30, 1997.  The decrease is principally due to the use
of funds to finance operating losses.  As a result of a cash management system
pursuant to the financing agreement that the Company entered into with GECC, the
only remaining cash balance at June 27, 1998 was cash at IPR (see "--
Financing").  The working capital ratio of 2.0x in the current period declined
from 2.3x at fiscal 1997 year end.


   In August 1997, the Company, through one of its subsidiaries, acquired Clal's
51% ownership interest in their research and development joint venture in Israel
for $447,000 in cash obtained from the sale of Fine-Tech stock and a non-
recourse secured promissory note for $1,500,000 bearing interest at 7% per
annum.  The Company is obligated to invest not less than $1,500,000 each year in
IPR until the note is repaid.  The Company intends to prepay the note in full
with a payment of $600,000 before August 13, 1998.  Merck KGaA and the Company
are negotiating an agreement where Merck KGaA would advance the Company the
funds to prepay the note in exchange for consideration relating to IPR to be
agreed upon in the future.


   Through March 1998, the Company loaned $875,000 to another generic drug
manufacturer for working capital purposes.  In March and April 1998, the loan,
plus interest, was repaid in full (see "Notes to Financial Statements-
Commitments, Contingencies and Other Matters-Other Matters").


   In May 1998, the Company amended its existing distribution agreement with
Sano ceding its distribution rights to two products, one unconditionally and one
conditionally, covered under the agreement.  In return for relinquishing these
rights, PRI received cash payments of approximately $5,700,000 in May 1998,
which included approximately $2,100,000 as a prepayment, with accrued interest,
of a promissory note which was due from Sano in September 1998.  The proceeds
from this transaction were used to reduce the revolving credit line balance (see
"Notes to Financial Statements-Distribution Agreement-Sano Corporation").

                                      -13-
<PAGE>
 
   Under the terms of a strategic alliance formed on March 25, 1998, Merck KGaA,
through its subsidiary Lipha, paid the Company $20,800,000, or $2.00 per share,
on June 30 1998 for 10,400,000 newly-issued shares of  PRI's Common Stock.  The
Company used approximately $3,600,000 of the net proceeds from the stock sale to
repay advances made to it under its existing line of credit and the remainder is
planned to be used for working capital, including possible business expansion
(see "Notes to Financial Statements-Subsequent Events-Equity Investment").


   The Company expects to fund its operations, including research and
development activities and its obligations under the existing distribution and
development arrangements discussed above, out of its working capital, (including
proceeds from the stock sale to Lipha) and if necessary with borrowings against
its line of credit, to the extent then available (see "--Financing").  If,
however, the Company continues to experience significant losses over the next
year, its liquidity and, accordingly, its ability to fund research and
development or ventures relating to the distribution of new products would
likely be materially and adversely affected.


FINANCING


   The Company's total outstanding short-term and long-term debt at June 27,
1998 amounted to $4,674,000 and $2,961,000, respectively.  The short-term debt
consists of the outstanding amount under the Company's line of credit with GECC,
which was repaid in full on June 30, 1998, and the long-term debt consists
primarily of capital leases, an outstanding mortgage loan with a bank and a non-
recourse secured promissory note resulting from the acquisition of Clal's
interest in IPR in fiscal 1997 (see "Notes to Financial Statements-Short-Term
Debt" and "-Long-Term Debt").


   In December 1996, Par entered into the Loan Agreement with GECC which
provided Par with a three-year revolving line of credit.  On May 22, 1998, the
Company and GECC amended the Loan Agreement in connection with  Merck KGaA's
equity investment in the Company  (see "Notes to Financial Statements-Subsequent
Events-Equity Investment").  Pursuant to the Loan Agreement, as amended, Par is
permitted to borrow up to the lesser of (i) the borrowing base established under
the Loan Agreement or (ii) $20,000,000.  The borrowing base is limited to 85% of
eligible accounts receivable plus 50% of eligible inventory of Par, each as
determined from time to time by GECC.  The interest rate charge on the line of
credit is based upon a per annum rate of 3.50% above the 30-day commercial paper
rate for high-grade unsecured notes adjusted monthly.  The line of credit with
GECC is secured by the assets of Par and PRI other than real property and is
guaranteed by PRI.  In connection with such facility, Par, PRI, and their
affiliates established a cash management system pursuant to which all cash and
cash equivalents received by any of such entities are deposited into a lockbox
account over which GECC has sole operating control and which are applied on a
daily basis to reduce amounts outstanding under the line of credit.  The
revolving credit facility is subject to covenants based on various financial
benchmarks.


   On June 30, 1998, the Company paid all outstanding revolving credit advances
pursuant to the Loan Agreement with a portion of the proceeds from the equity
investment by Merck KGaA and GECC relinquished operating control over the
Company's cash receipts.  As of July 31, 1998, the borrowing base was
approximately $12,300,000 with no amounts outstanding under the line of credit.
PRI and GECC are currently negotiating new terms for the credit facility.

                                      -14-
<PAGE>
 
                          PART II. OTHER INFORMATION



ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
-------  --------------------------------------------------- 


   An Annual Meeting of Shareholders of the Company was held on June 26, 1998.
The following matters were voted on and approved by the holders of shares of the
Company's Common Stock:


   The first proposal presented to the shareholders was to elect seven members
   of the Company's Board of Directors, divided into three classes, Class I to
   serve until 2000, Class II to serve until 2001 and Class III to serve until
   1999, and until their respective successors are duly elected and qualified.
   There were 11,541,739 and 11,544,774 shares of Common Stock cast in favor of
   electing Anthony S. Tabatznik and J. Neil Tabatznik, respectively, Class I
   Directors which represented a plurality of the shares of the Company's Common
   Stock cast for such proposal, and 537,240 and 534,205, shares were withheld,
   respectively.  There were 11,464,072, 11,519,932 and 11,515,375 shares of
   Common Stock cast in favor of electing Kenneth I. Sawyer, Mark Auerbach and
   Stephen A. Ollendorff, respectively, Class II Directors which represented a
   plurality of the shares of the Company's Common Stock cast for such proposal,
   and 614,907, 559,047 and 563,604, shares were withheld, respectively.  There
   were 11,542,223 and 11,543,935 shares of Common Stock cast in favor of
   electing Bernhard Scheuble and Klaus H. Jander, respectively, Class III
   Directors which represented a plurality of the shares of the Company's Common
   Stock cast for such proposal, and 536,756 and 535,044, shares were withheld,
   respectively.  There were no broker non-votes.


   The second proposal presented to the shareholders was to approve the sale of
   10,400,000 shares of the Company's Common Stock to Lipha Americas, Inc. at a
   price of $2.00 per share and grant the issuance of stock options to Merck
   KGaA, Darmstadt, Germany, and Genpharm Inc. to purchase an aggregate of
   1,171,040 shares of the Company's Common Stock at an exercise price of $2.00
   per share.  There were 11,734,992 shares of Common Stock cast in favor of
   such proposal which represented a majority of the outstanding shares of the
   Company's Common Stock, and 5,057,781 shares of Common Stock voted against
   such proposal, including 4,775,130 abstentions and non-voted Broker shares.


   The third proposal presented to the shareholders was to approve an amendment
   to the Company's Certificate of Incorporation to increase the authorized
   number of shares of Common Stock from 60,000,000 to 90,000,000. There were
   11,368,619 shares of Common Stock cast in favor of such proposal which
   represented a majority of the outstanding shares of the Company's Common
   Stock, and 5,424,154 shares of Common Stock voted against such proposal,
   including 4,792,700 abstentions and non-voted Broker Shares.


   The fourth proposal presented to the shareholders was to approve and adopt
   the Company's 1997 Directors Stock Option Plan.  There were 14,892,583 shares
   of Common Stock cast in favor of such proposal which represented a majority
   of the shares of the Company's Common Stock cast for such proposal, 1,441,854
   shares of Common Stock voted against such proposal, and 459,136 shares
   abstained.


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K.
------   -------------------------------- 


   (a)  Exhibits:


        27 -  Financial Data Schedule.


   (b)  Reports on Form 8-K:


   The Company, on July 14, 1998, filed a Current Report on Form 8-K, relating
   to the consummation of the transactions with Merck KGaA and its affiliates.

                                      -15-
<PAGE>
 
                                  SIGNATURE



   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.



PHARMACEUTICAL RESOURCES, INC.


                                  (Registrant)



August 7, 1998                   /s/ Kenneth I. Sawyer
                                 ---------------------------------------
                                 Kenneth I. Sawyer
                                 Chief Executive Officer and Chairman of
                                 the Board of Directors
                                 (Principal Executive Officer)



August 7, 1998                   /s/ Dennis J. O'Connor
                                 ---------------------------------------
                                 Dennis J. O'Connor
                                 Vice President - Chief Financial Officer and
                                 Secretary
                                 (Principal Accounting and Financial Officer)

                                      -16-
<PAGE>
 
                                 EXHIBIT INDEX
                                 -------------

 



   Exhibit Number               Description                     Page Number
   --------------               -----------                     -----------

       27               Financial Data Schedule                      18

                                      -17-