**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**FORM 10-Q**

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**x****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

**FOR THE QUARTERLY PERIOD ENDEDJUNE 30, 2007**

**or**

**o****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

**For the transition period from                  to               **

**Commissionfile number 001-13305**

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**WATSONPHARMACEUTICALS, INC.**

(Exact name of registrantas specified in its charter)

| **Nevada**                       |   | **95-3872914**                        |
|----------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of |   | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)  |   |                                  |

 

**311Bonnie Circle**

**Corona,CA  92880-2882**

(Address ofprincipal executive offices, including zip code)

**(951)493-5300**

(Registrant’stelephone number, including area code)

Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.   Yes x   No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):

| Large accelerated filer x |   | Accelerated  filer o |   | Non-accelerated  filer o |
|---------------------------|--------|----------------------|--------|--------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o  No x

The number of sharesoutstanding of the Registrant’s only class of common stock as of July 30, 2007was approximately 103,479,000.

 

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**WATSON PHARMACEUTICALS, INC.**

**TABLE OF CONTENTS**

**FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2007**

**Part I. FINANCIAL INFORMATION**
| Item 1. Condensed Consolidated Financial  Statements (Unaudited):                                   | ** ** | ** **                                                                                                 |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------|
|                                                                                                |       |                                                                                                       |   |   |
|                                                                                                |       | Condensed Consolidated Balance Sheets as of June 30,  2007 and December 31, 2006                           |   |   |
|                                                                                                |       |                                                                                                       |   |   |
|                                                                                                |       | Condensed Consolidated Statements of Operations for  the Three and Six Months Ended June 30, 2007 and 2006 |   |   |
|                                                                                                |       |                                                                                                       |   |   |
|                                                                                                |       | Condensed Consolidated Statements of Cash Flows for  the Six Months Ended June 30, 2007 and 2006           |   |   |
|                                                                                                |       |                                                                                                       |   |   |
|                                                                                                |       | Notes to Condensed Consolidated Financial Statements                                                       |   |   |
|                                                                                                |       |                                                                                                       |   |   |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations |       |                                                                                                       |
|                                                                                                |       |                                                                                                       |   |   |
| Item 3. Quantitative and Qualitative Disclosure about  Market Risk                                  |       |                                                                                                       |
|                                                                                                |       |                                                                                                       |   |   |
| Item 4. Controls and Procedures                                                                     |       |                                                                                                       |
|                                                                                                |       |                                                                                                       |   |   |
|                                                                                                |       |                                                                                                       |   |   |
| **Part II. OTHER INFORMATION AND SIGNATURES**                                                       |
|                                                                                                |       |                                                                                                       |   |   |
| Item  1. Legal Proceedings                                                                          |       |                                                                                                       |
|                                                                                                |       |                                                                                                       |   |   |
| Item  1A. Risk Factors                                                                              |       |                                                                                                       |
|                                                                                                |       |                                                                                                       |   |   |
| Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                |       |                                                                                                       |
|                                                                                                |       |                                                                                                       |   |   |
| Item 4. Submission of Matters to a Vote of Security  Holders                                        |       |                                                                                                       |
|                                                                                                |       |                                                                                                       |   |   |
| Item 6.  Exhibits                                                                                   |       |                                                                                                       |
|                                                                                                |       |                                                                                                       |   |   |
| Signatures                                                                                          |       |                                                                                                       |

 

2

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**WATSON PHARMACEUTICALS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited; in thousands)**
| ** **                                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| **ASSETS**                                       |       |              |       |                  |       |
| Current assets:                                  |       |              |       |                  |       |
| Cash and cash  equivalents                       |       | $                 | 74,852     |                  | $          | 154,171 |   |
| Marketable  securities                           |       | 10,513            |       | 6,649                 |       |
| Accounts  receivable, net                        |       | 301,602           |       | 384,692               |       |
| Inventories                                      |       | 553,869           |       | 517,236               |       |
| Prepaid expenses  and other current assets       |       | 53,740            |       | 86,115                |       |
| Deferred tax  assets                             |       | 99,994            |       | 112,813               |       |
| Total current  assets                            |       | 1,094,570         |       | 1,261,676             |       |
|                                             |       |              |       |                  |       |
| Property and equipment,  net                     |       | 694,440           |       | 697,415               |       |
| Investments and other  assets                    |       | 70,015            |       | 76,377                |       |
| Deferred tax assets                              |       | 63,351            |       | 55,348                |       |
| Product rights and  other intangibles, net       |       | 691,560           |       | 779,284               |       |
| Goodwill                                         |       | 875,443           |       | 890,477               |       |
| Total assets                                     |       | $                 | 3,489,379  |                  | $          | 3,760,577 |   |
|                                             |       |              |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**   |       |              |       |                  |       |
| Current liabilities:                             |       |              |       |                  |       |
| Accounts payable  and accrued expenses           |       | $                 | 436,776    |                  | $          | 516,875 |   |
| Income taxes  payable                            |       | —            |       | 46,773                |       |
| Current portion  of long-term debt               |       | 5,602             |       | 107,059               |       |
| Deferred revenue                                 |       | 17,468            |       | 19,222                |       |
| Total current  liabilities                       |       | 459,846           |       | 689,929               |       |
|                                             |       |              |       |                  |       |
| Long-term debt                                   |       | 974,276           |       | 1,124,145             |       |
| Deferred revenue                                 |       | 50,834            |       | 58,086                |       |
| Other long-term  liabilities                     |       | 8,048             |       | 4,169                 |       |
| Other taxes payable                              |       | 45,669            |       | —                |       |
| Deferred tax  liabilities                        |       | 185,810           |       | 203,860               |       |
| Total  liabilities                               |       | 1,724,483         |       | 2,080,189             |       |
|                                             |       |              |       |                  |       |
| Commitments and  contingencies                   |       |              |       |                  |       |
|                                             |       |              |       |                  |       |
| Stockholders’ equity:                       |       |              |       |                  |       |
| Preferred stock                                  |       | —            |       | —                |       |
| Common stock                                     |       | 372               |       | 369                   |       |
| Additional paid-in  capital                      |       | 956,154           |       | 937,308               |       |
| Retained earnings                                |       | 1,106,728         |       | 1,041,638             |       |
| Accumulated other  comprehensive income          |       | 1,642             |       | 1,073                 |       |
| Treasury stock, at cost                          |       | (300,000          | )          | (300,000              | )          |
| Total  stockholders’ equity                 |       | 1,764,896         |       | 1,680,388             |       |
| Total liabilities and  stockholders’ equity |       | $                 | 3,489,379  |                  | $          | 3,760,577 |   |

 

*See accompanying Notes to Condensed Consolidated FinancialStatements.*

3

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**WATSON PHARMACEUTICALS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited; in thousands, except per share amounts)**
| ** **                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                               | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                               | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                               | ** ** | ** **                       | ** ** | **Restated  (Note 1)**    | ** ** | ** ** | ** ** | **Restated  (Note 1)** | ** ** |
| ** **                                               | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net revenues                                             |       | $                                | 603,005    |                           | $          | 510,356 |   | $ | 1,274,610 |   | $ | 917,589 |   |
| Cost of sales  (excluding amortization, presented below) |       | 360,438                          |       | 330,860                        |       | 785,158 |   | 565,614 |   |
| Gross profit                                             |       | 242,567                          |       | 179,496                        |       | 489,452 |   | 351,975 |   |
|                                                     |       |                             |       |                           |       |   |   |   |   |
| Operating  expenses:                                     |       |                             |       |                           |       |   |   |   |   |
| Research and development                                 |       | 35,503                           |       | 31,125                         |       | 73,311 |   | 60,962 |   |
| Selling and marketing                                    |       | 51,897                           |       | 43,291                         |       | 107,060 |   | 85,204 |   |
| General and administrative                               |       | 45,261                           |       | 27,483                         |       | 93,316 |   | 52,320 |   |
| Amortization                                             |       | 44,159                           |       | 41,101                         |       | 88,092 |   | 82,201 |   |
| Loss on impairment                                       |       | —                           |       | 66,981                         |       | — |   | 66,981 |   |
| Total operating expenses                                 |       | 176,820                          |       | 209,981                        |       | 361,779 |   | 347,668 |   |
| Operating income  (loss)                                 |       | 65,747                           |       | (30,485                        | )          | 127,673 |   | 4,307 |   |
|                                                     |       |                             |       |                           |       |   |   |   |   |
| Other (expense)  income:                                 |       |                             |       |                           |       |   |   |   |   |
| Early extinguishment of debt                             |       | (1,681                           | )          | 195                            |       | (4,410 | ) | (525 | ) |
| Interest income                                          |       | 1,803                            |       | 6,913                          |       | 4,732 |   | 13,165 |   |
| Interest expense                                         |       | (11,475                          | )          | (3,322                         | )          | (25,351 | ) | (6,623 | ) |
| Other income                                             |       | 3,034                            |       | 1,561                          |       | 6,437 |   | 5,076 |   |
| Total other (expense) income, net                        |       | (8,319                           | )          | 5,347                          |       | (18,592 | ) | 11,093 |   |
|                                                     |       |                             |       |                           |       |   |   |   |   |
| Income (loss)  before income taxes                       |       | 57,428                           |       | (25,138                        | )          | 109,081 |   | 15,400 |   |
| Provision (benefit)  for income taxes                    |       | 21,019                           |       | (9,527                         | )          | 41,060 |   | 5,837 |   |
| Net income  (loss)                                       |       | $                                | 36,409     |                           | $          | (15,611 | ) | $ | 68,021 |   | $ | 9,563 |   |
|                                                     |       |                             |       |                           |       |   |   |   |   |
| Earnings (loss)  per share:                              |       |                             |       |                           |       |   |   |   |   |
| Basic                                                    |       | $                                | 0.36       |                           | $          | (0.15 | ) | $ | 0.67 |   | $ | 0.09 |   |
| Diluted                                                  |       | $                                | 0.33       |                           | $          | (0.15 | ) | $ | 0.62 |   | $ | 0.09 |   |
|                                                     |       |                             |       |                           |       |   |   |   |   |
| Weighted average  shares outstanding:                    |       |                             |       |                           |       |   |   |   |   |
| Basic                                                    |       | 102,093                          |       | 101,666                        |       | 102,178 |   | 101,742 |   |
| Diluted                                                  |       | 117,080                          |       | 101,666                        |       | 116,909 |   | 102,125 |   |

 

*See accompanying Notes to Condensed Consolidated FinancialStatements.*

4

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**WATSON PHARMACEUTICALS, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited; in thousands)**
| ** **                                                           | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                           | ** ** | **June 30,**              | ** ** |
| ** **                                                           | ** ** | **2007**                       | ** ** | **2006** | ** ** |
| ** **                                                           | ** ** | ** **                     | ** ** | **Restated  (Note 1)** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES:**                           |       |                           |       |   |   |
| Net income                                                           |       | $                              | 68,021     |   | $ | 9,563 |   |
| Reconciliation  to net cash provided by operating activities:        |       |                           |       |   |   |
| Depreciation                                                         |       | 37,522                         |       | 24,569 |   |
| Amortization                                                         |       | 88,091                         |       | 82,201 |   |
| Loss on asset impairment                                             |       | —                         |       | 66,981 |   |
| Deferred income tax benefit                                          |       | (20,188                        | )          | (61,887 | ) |
| Provision for inventory reserve                                      |       | 26,946                         |       | 10,701 |   |
| Restricted stock and stock option compensation                       |       | 6,910                          |       | 6,653 |   |
| Earnings on equity method investments                                |       | (3,723                         | )          | (1,373 | ) |
| Gain on sale of securities                                           |       | (2,472                         | )          | (3,695 | ) |
| Loss on early extinguishment of debt                                 |       | 4,410                          |       | 525 |   |
| Loss on sale of fixed assets                                         |       | 917                            |       | 166 |   |
| Tax benefits from employee stock plans                               |       | 767                            |       | 785 |   |
| Mark to market on derivative                                         |       | 119                            |       | (732 | ) |
| Other                                                                |       | 2,016                          |       | (1,899 | ) |
| Changes in assets and liabilities (net of  acquisition of business): |       |                           |       |   |   |
| Accounts receivable, net                                             |       | 86,090                         |       | (13,618 | ) |
| Inventories                                                          |       | (67,980                        | )          | (38,542 | ) |
| Prepaid expenses and other current assets                            |       | 33,873                         |       | (776 | ) |
| Accounts payable and accrued expenses                                |       | (76,366                        | )          | 84,425 |   |
| Deferred revenue                                                     |       | (6,176                         | )          | (1,485 | ) |
| Income taxes payable                                                 |       | 18,058                         |       | 35,106 |   |
| Other assets                                                         |       | 2,407                          |       | (1,443 | ) |
| Total adjustments                                                    |       | 131,221                        |       | 186,662 |   |
| Net cash provided by operating activities                            |       | 199,242                        |       | 196,225 |   |
|                                                                 |       |                           |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                           |       |                           |       |   |   |
| Additions to  property and equipment                                 |       | (35,465                        | )          | (18,179 | ) |
| Acquisition of  product rights                                       |       | (368                           | )          | (302 | ) |
| Acquisition of  business, net of cash acquired                       |       | —                         |       | (29,664 | ) |
| Proceeds from  sale of marketable equity securities                  |       | 2,548                          |       | 2,203 |   |
| Proceeds from  sale of investments                                   |       | —                         |       | 4,695 |   |
| Additions to  marketable securities                                  |       | (4,230                         | )          | (3,944 | ) |
| Additions to  long-term investments                                  |       | (1,144                         | )          | (12,500 | ) |
| Distribution  from joint venture                                     |       | 715                            |       | 5,942 |   |
| Other, net                                                           |       | 92                             |       | — |   |
| Net cash used in investing activities                                |       | (37,852                        | )          | (51,749 | ) |
|                                                                 |       |                           |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                           |       |                           |       |   |   |
| Payments on term  debt                                               |       | (251,881                       | )          | (18,799 | ) |
| Proceeds from  stock plans                                           |       | 11,172                         |       | 7,283 |   |
| Net cash used in financing activities                                |       | (240,709                       | )          | (11,516 | ) |
| Net (decrease) increase in cash and cash equivalents                 |       | (79,319                        | )          | 132,960 |   |
| Cash and cash  equivalents at beginning of period                    |       | 154,171                        |       | 467,451 |   |
| Cash and cash  equivalents at end of period                          |       | $                              | 74,852     |   | $ | 600,411 |   |

 

*See accompanying Notes to Condensed Consolidated FinancialStatements.*

5

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**WATSONPHARMACEUTICALS, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**NOTE 1 —GENERAL**

WatsonPharmaceuticals, Inc. (“Watson” or the “Company”) is primarily engaged in thedevelopment, manufacture, marketing, sale and distribution of brand and off-patent(generic) pharmaceutical products. Watson was incorporated in 1985 and began operations as a manufacturerand marketer of off-patent pharmaceuticals. Through internal product development and synergistic acquisitions ofproducts and businesses, the Company has grown into a diversified specialtypharmaceutical company.  Watson operatesmanufacturing, distribution, research and development and administrativefacilities primarily in the United States of America (“U.S.”).

The accompanyingCondensed Consolidated Financial Statements should be read in conjunction withthe Company’s Annual Report on Form 10-K for the year ended December 31,2006.  Certain information and footnotedisclosures normally included in annual financial statements prepared in accordancewith generally accepted accounting principles have been condensed or omittedfrom the accompanying Condensed Consolidated Financial Statements.  The year end balance sheet was derived fromthe audited financial statements.  Theaccompanying interim financial statements are unaudited, but reflect alladjustments which are, in the opinion of management, necessary to presentfairly Watson’s consolidated financial position, results of operations and cashflows for the periods presented.  Unlessotherwise noted, all such adjustments are of a normal, recurring nature.  Certain reclassifications, none of whichaffected net income or retained earnings, have been made to prior periodamounts to conform to current period presentation.  The Company’s results of operations and cashflows for the interim periods are not necessarily indicative of the results ofoperations and cash flows that it may achieve in future periods or for the fullyear.

*Acquisition of Andrx Corporation*

On November 3, 2006, the Company acquired all theoutstanding shares of common stock of Andrx Corporation (“Andrx”) for $1.9billion (the “Andrx Acquisition”).  Priorto the Andrx Acquisition the Company held common shares in Andrx, which werepreviously classified as available-for-sale securities and recorded at fairvalue based upon quoted market prices with temporary differences between costand fair value presented as accumulated other comprehensive income withinstockholders’ equity, net of any related tax effect.  As required by Accounting Research Bulletin (“ARB”)No. 51, “Consolidated Financial Statements” (“ARB 51”), earnings (loss) onequity method investments has been restated for the three and six monthsended June 30, 2006 to accountfor our investment in common shares of Andrx prior to the Andrx Acquisitionusing the equity method of accounting in accordance with Accounting PrinciplesBoard (“APB”) Opinion No. 18, “The Equity Method of Accounting for Investmentsin Common Stock” (“APB 18”).  Othercomprehensive income has also been restated for the three and six monthsended June 30, 2006 to reflect thesechanges.

*ComprehensiveIncome*

Comprehensiveincome includes all changes in equity during a period except those thatresulted from investments by or distributions to the Company’sstockholders.  Other comprehensive incomerefers to revenues, expenses, gains and losses that, under generally acceptedaccounting principles, are included in comprehensive income, but excluded fromnet income as these amounts are recorded directly as an adjustment tostockholders’ equity.  Watson’s othercomprehensive income is composed of unrealized (losses) gains on its holdingsof publicly traded debt and equity securities and foreign currency translationadjustments.  The components ofcomprehensive income, including attributable income taxes, consisted of thefollowing (in thousands):
| ** **                                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                      | ** ** | ** **                                          | ** ** | **Restated**                                      | ** ** | ** ** | ** ** | **Restated** | ** ** |
| Net income  (loss)                              |       | $                                                   | 36,409     |                                              | $          | (15,611 | ) | $ | 68,021 |   | $ | 9,563 |   |
|                                            |       |                                                |       |                                              |       |   |   |   |   |
| Other  comprehensive income (loss):             |       |                                                |       |                                              |       |   |   |   |   |
| Unrealized (loss) gain on securities            |       | (805                                                | )          | (14                                               | )          | (815 | ) | 1,110 |   |
| Less related income taxes                       |       | 295                                                 |       | 5                                                 |       | 299 |   | (421 | ) |
| Total unrealized (loss) gain on securities, net |       | (510                                                | )          | (9                                                | )          | (516 | ) | 689 |   |
|                                            |       |                                                |       |                                              |       |   |   |   |   |
| Translation gain (loss)                         |       | 867                                                 |       | (595                                              | )          | 1,085 |   | (430 | ) |
| Total other  comprehensive income (loss)        |       | 357                                                 |       | (604                                              | )          | 569 |   | 259 |   |
| Total  comprehensive income (loss)              |       | $                                                   | 36,766     |                                              | $          | (16,215 | ) | $ | 68,590 |   | $ | 9,822 |   |

 

6

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*Preferred and Common Stock*

As of June 30, 2007 and December 31, 2006, 2,500,000shares of no par value per share preferred stock were authorized, with noneissued.  As of June 30, 2007 and December31, 2006, 500,000,000 shares of $0.0033 par value per share common stock wereauthorized, with 112,856,000 and 111,867,000 shares issued and 103,456,000 and102,467,000 outstanding, respectively. Of the issued shares, 9,399,800 shares were held as treasury shares asof June 30, 2007 and December 31, 2006, respectively.

On February 15, 2006, theCompany’s Board of Directors authorized the expenditure of $300.0 million torepurchase shares of the Company’s outstanding common stock (the “2006Repurchase Program”).  No common stockwas repurchased under the 2006 Repurchase Program which expired on February 15,2007.

*Provisionsfor Sales Returns and Allowances*

As customary in the pharmaceutical industry, the Company’s grossproduct sales are subject to a variety of deductions in arriving at reportednet product sales.  When the Companyrecognizes revenue from the sale of its products, an estimate of sales returnsand allowances (“SRA”) is recorded which reduces product sales and accountsreceivable. These adjustments include estimates for chargebacks, rebates, cashdiscounts and returns and other allowances. These provisions are estimated basedon historical payment experience, historical relationship to revenues,estimated customer inventory levels and current contract sales terms with directand indirect customers.  The estimationprocess used to determine our SRA provision has been applied on a consistentbasis and no material adjustments have been necessary to increase or decreaseour reserves for SRA as a result of a significant change in underlyingestimates.  The Company uses a variety of methods to assessthe adequacy of our SRA reserves to ensure that our financial statements arefairly stated.  This includes periodicreviews of customer inventory data, customer contract programs and productpricing trends to analyze and validate the SRA reserves.

The provision for chargebacks is our most significant salesallowance.  A chargeback represents anamount payable in the future to a wholesaler for the difference between theinvoice price paid to the Company by our wholesale customer for a particularproduct and the negotiated contract price that the wholesaler’s customer paysfor that product.  The Company’schargeback provision and related reserve vary with changes in product mix,changes in customer pricing and changes to estimated wholesaler inventory.  The provision for chargebacks also takes intoaccount an estimate of the expected wholesaler sell-through levels to indirectcustomers at contract prices.  TheCompany validates the chargeback accrual quarterly through a review of theinventory reports obtained from its largest wholesale customers.  This customer inventory information is usedto verify the estimated liability for future chargeback claims based onhistorical chargeback and contract rates. These large wholesalers represent 85% - 90% of the Company’s chargebackpayments.  The Company continually monitorscurrent pricing trends and wholesaler inventory levels to ensure the liabilityfor future chargebacks is fairly stated.  The following table summarizes the activityin the Company’s major categories of SRA (in thousands):
| ** **                                                        | ** ** | **Chargebacks** | ** ** | **Rebates** | ** ** | **Returns and  Other  Allowances** | ** ** | **Cash  Discounts** | ** ** | **Total** | ** ** |
|-------------------------------------------------------------------|------------|-----------------|------------|-------------|------------|-----------------------------------------|------------|---------------------|------------|-----------|------------|
|                                                              |       |            |       |        |       |                                    |       |                |       |      |       |
| Balance at  December 31, 2005                                     |       | $               | 139,605    |        | $          | 128,293                                 |       | $                   | 45,293     |      | $          | 12,094 |   | $ | 325,285 |   |
| Provision related to sales in six months ended June  30, 2006     |       | 567,776         |       | 201,959     |       | 83,987                                  |       | 34,570              |       | 888,292   |       |
| Credits and payments                                              |       | (539,685        | )          | (191,298    | )          | (85,178                                 | )          | (33,167             | )          | (849,328  | )          |
| Balance at June  30, 2006                                         |       | 167,696         |       | 138,954     |       | 44,102                                  |       | 13,497              |       | 364,249   |       |
| Add: Andrx opening balances                                       |       | 15,911          |       | 27,667      |       | 8,992                                   |       | 1,601               |       | 54,171    |       |
| Provision related to sales in six months ended  December 31, 2006 |       | 622,678         |       | 219,441     |       | 89,222                                  |       | 36,115              |       | 967,456   |       |
| Credits and payments                                              |       | (641,805        | )          | (205,524    | )          | (99,827                                 | )          | (37,141             | )          | (984,297  | )          |
| Balance at  December 31, 2006                                     |       | 164,480         |       | 180,538     |       | 42,489                                  |       | 14,072              |       | 401,579   |       |
| Provision related to sales in six months ended June  30, 2007     |       | 600,978         |       | 215,883     |       | 98,362                                  |       | 35,104              |       | 950,327   |       |
| Credits and payments                                              |       | (616,994        | )          | (229,595    | )          | (66,985                                 | )          | (36,072             | )          | (949,646  | )          |
| Balance at June 30,  2007                                         |       | $               | 148,464    |        | $          | 166,826                                 |       | $                   | 73,866     |      | $          | 13,104 |   | $ | 402,260 |   |

 

7

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*Earnings Per Share*

Basic earnings pershare is computed by dividing net income by the weighted average common sharesoutstanding during a period.  Dilutedearnings per share is based on the treasury stock method and includes theeffect from potential issuance of common stock, such as shares issuable uponconversion of the $575 million convertible contingent senior debentures (“CODES”),and the dilutive effect of stock options and restricted stock awardsoutstanding during the period.  Potentialcommon shares have been excluded where their inclusion would beanti-dilutive.  In accordance withEmerging Issues Task Force (“EITF”) Issue No. 04-8, “The Effect of ContingentlyConvertible Debt on Diluted Earnings per Share,” the Company is required to addapproximately 14.4 million shares associated with the conversion of the CODESto the number of shares outstanding for the calculation of diluted earnings pershare for all periods in which the securities were outstanding.  A reconciliation of the numerators anddenominators of basic and diluted earnings per share consisted of the following(in thousands, except per share amounts):
|                                                    | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                         | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                         | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                         | ** ** | ** **                       | ** ** | **Restated**                   | ** ** | ** ** | ** ** | **Restated** | ** ** |
| **Earnings  (loss) per share - basic**             |       |                             |       |                           |       |   |   |   |   |
| Net income (loss)                                  |       | $                                | 36,409     |                           | $          | (15,611 | ) | $ | 68,021 |   | $ | 9,563 |   |
| Basic weighted average common shares outstanding   |       | 102,093                          |       | 101,666                        |       | 102,178 |   | 101,742 |   |
| Earnings (loss) per share - basic                  |       | $                                | 0.36       |                           | $          | (0.15 | ) | $ | 0.67 |   | $ | 0.09 |   |
|                                               |       |                             |       |                           |       |   |   |   |   |
| **Earnings  (loss) per share - diluted**           |       |                             |       |                           |       |   |   |   |   |
| Net income (loss)                                  |       | $                                | 36,409     |                           | $          | (15,611 | ) | $ | 68,021 |   | $ | 9,563 |   |
| Add: Interest expense on CODES, net of tax         |       | 2,058                            |       | —                         |       | 4,001 |   | — |   |
| Net income (loss), adjusted                        |       | $                                | 38,467     |                           | $          | (15,611 | ) | $ | 72,022 |   | $ | 9,563 |   |
|                                               |       |                             |       |                           |       |   |   |   |   |
| Basic weighted average common shares outstanding   |       | 102,093                          |       | 101,666                        |       | 102,178 |   | 101,742 |   |
| Effect of dilutive securities:                     |       |                             |       |                           |       |   |   |   |   |
| Conversion of CODES                                |       | 14,357                           |       | —                         |       | 14,357 |   | — |   |
| Dilutive stock options                             |       | 630                              |       | —                         |       | 374 |   | 383 |   |
| Diluted weighted average common shares outstanding |       | 117,080                          |       | 101,666                        |       | 116,909 |   | 102,125 |   |
|                                               |       |                             |       |                           |       |   |   |   |   |
| Earnings (loss)  per share - diluted               |       | $                                | 0.33       |                           | $          | (0.15 | ) | $ | 0.62 |   | $ | 0.09 |   |

 

Stock awards to purchase 7.1 million and 10.4 millioncommon shares for the three months ended June 30, 2007 and 2006, respectively,were outstanding but were not included in the computation of diluted earningsper share because the options were antidilutive.  Stock awards to purchase 8.6 million commonshares for the six months ended June 30, 2007 and 2006, respectively, wereoutstanding but were not included in the computation of diluted earnings pershare because the options were antidilutive. Potential common shares related to the CODES convertible into 14.4million common shares were not included in the computation of diluted earningsper share for the three and six months ended June 30, 2006 because they wereantidilutive.

8

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*Recent Accounting Pronouncements*

In July 2006, the Financial Accounting StandardsBoard (“FASB”) issued Interpretation No. 48, “Accounting for Uncertaintyin Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48 clarifies the accounting for theuncertainty in recognizing income taxes in an organization in accordance withFASB Statement No. 109 by providing detailed guidance for financial statementrecognition, measurement and disclosure involving uncertain tax positions.  FIN 48 requires an uncertain tax position tomeet a more-likely-than-not recognition threshold at the effective date to berecognized both upon the adoption of FIN 48 and in subsequent periods.  FIN 48 is effective for fiscal yearsbeginning after December 15, 2006.  Asthe provisions of FIN 48 will be applied to all tax positions upon initialadoption, the cumulative effect of applying the provisions of FIN 48 will bereported as an adjustment to the opening balance of retained earnings for thatfiscal year.  As a result of the adoptionof FIN 48, the Company recorded a $2.9 million increase in the liability forunrecognized tax benefits resulting in a decrease to the January 1, 2007retained earnings balance of $2.9 million (for additional information on theadoption of FIN 48, see NOTE 9 — INCOME TAXES).

In September 2006, the FASB issued Statement ofFinancial Accounting Standards (“SFAS”) No. 157, “Fair-Value Measurements” (“SFAS157”) which defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles and expands disclosures aboutfair-value measurements. SFAS 157 is effective for financial statements issuedfor fiscal years beginning after November 15, 2007. The Company is currentlyreviewing SFAS 157 and has not yet determined the impact on its consolidatedfinancial statements.

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities — Including an Amendment of FASB StatementNo. 115,” (“SFAS 159”) which is effective for fiscal years beginning afterNovember 15, 2007. SFAS 159 permits an entity to choose to measure manyfinancial instruments and certain other items at fair value at specifiedelection dates. Subsequent unrealized gains and losses on items for which thefair value option has been elected will be reported in earnings. The Company iscurrently reviewing SFAS 159 and has not yet determined the impact, if any, onits consolidated financial statements.

**NOTE 2 —SHARE-BASED COMPENSATION**

Effective January 1, 2006, the Company adopted themodified prospective method of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”)which requires the measurement and recognition of compensation expense for allshare-based compensation awards made to employees and directors based onestimated fair values.

*Stock Option Plans*

A summary of the changes in the Company’s stock option plans during thesix months ended June 30, 2007 is presented below (in thousands, except pershare amounts):
|                                               | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**          | ** ** | ** **    | ** ** |
|-----------------------------------------------|------------|------------|------------|--------------|------------|-----------------------|------------|---------------|------------|
| ** **                                    | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average**           | ** ** | ** **    | ** ** |
| ** **                                    | ** ** | ** ** | ** ** | **Average**  | ** ** | **Remaining**         | ** ** | **Aggregate** | ** ** |
| ** **                                    | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Contractual**       | ** ** | **Intrinsic** | ** ** |
| ** **                                    | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Term (Years)** | ** ** | **Value**     | ** ** |
|                                          |       |       |       |         |       |                  |       |          |       |
| Outstanding at  December 31, 2006             |       | 10,985     |       | $            | 36.39      |                  |       |          |       |   |
| Granted                                       |       | 69         |       | 30.10        |       |                  |       |          |       |
| Exercised                                     |       | (435       | )          | 25.71        |       |                  |       |          |       |
| Cancelled                                     |       | (779       | )          | 37.15        |       |                  |       |          |       |
| Outstanding at  June 30, 2007                 |       | 9,840      |       | $            | 36.75      |                  | 5.3        |          | $          | 21,207 |   |
|                                          |       |       |       |         |       |                  |       |          |       |
| Vested and  expected to vest at June 30, 2007 |       | 9,285      |       | $            | 37.24      |                  | 5.1        |          | $          | 18,837 |   |
|                                          |       |       |       |         |       |                  |       |          |       |
| Options  exercisable at June 30, 2007         |       | 7,595      |       | $            | 39.18      |                  | 4.5        |          | $          | 11,422 |   |

 

As of June 30, 2007, the Company had $6.8 million of total unrecognizedcompensation expense, net of estimated forfeitures, related to stock optiongrants, which will be recognized over the remaining weighted average period of1.4 years.  Total intrinsic value ofstock options exercised for the three months ended June 30, 2007 and 2006 was$2.1 million and $1.6 million, respectively. Total intrinsic value of stock options exercised for the six monthsended June 30, 2007 and 2006 was $2.3 million and $1.9 million, respectively.

9

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*RestrictedStock*

A summary of the changes in restricted stock grants during the sixmonths ended June 30, 2007 is presented below (in thousands, except per shareamounts):
|                                                     | ** ** | ** ** | ** ** | ** **          | ** ** | **Weighted**          | ** ** | ** **    | ** ** |
|-----------------------------------------------------|------------|------------|------------|---------------------|------------|-----------------------|------------|---------------|------------|
| ** **                                          | ** ** | ** ** | ** ** | **Weighted**        | ** ** | **Average**           | ** ** | ** **    | ** ** |
| ** **                                          | ** ** | ** ** | ** ** | **Average**         | ** ** | **Remaining**         | ** ** | **Aggregate** | ** ** |
| ** **                                          | ** ** | ** ** | ** ** | **Grant Date** | ** ** | **Contractual**       | ** ** | **Intrinsic** | ** ** |
| ** **                                          | ** ** | **Shares** | ** ** | **Fair Value** | ** ** | **Term (Years)** | ** ** | **Value**     | ** ** |
|                                                |       |       |       |                |       |                  |       |          |       |
| Restricted  shares outstanding at December 31, 2006 |       | 569        |       | $                   | 30.26      |                  | 1.9        |          | $          | 17,211 |   |
| Granted                                             |       | 590        |       | 32.38               |       |                  |       | 19,103        |       |
| Vested                                              |       | (27        | )          | 29.71               |       |                  |       | (792          | )          |
| Cancelled                                           |       | (36        | )          | 31.35               |       |                  |       | (1,122        | )          |
| Restricted  shares outstanding at June 30, 2007     |       | 1,096      |       | $                   | 31.38      |                  | 2.1        |          | $          | 34,400 |   |

 

As of June 30, 2007, the Company had $18.0 million of totalunrecognized compensation expense, net of estimated forfeitures, related torestricted stock grants, which will be recognized over the remaining weightedaverage period of 2.1 years.

*Share-BasedCompensation*

The impact of share-basedcompensation on the Company’s results of operations for the three and six monthsended June 30, 2007 and 2006, respectively, was as follows (in thousands):
| ** **                                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                         | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                               |       |                                                |       |                                              |       |   |   |   |   |
| Total  share-based compensation expense            |       | $                                                   | 3,429      |                                              | $          | 3,535 |   | $ | 6,553 |   | $ | 5,773 |   |
| Tax benefit                                        |       | (1,255                                              | )          | (1,340                                            | )          | (2,467 | ) | (2,188 | ) |
| Share-based  compensation expense, net of tax      |       | $                                                   | 2,174      |                                              | $          | 2,195 |   | $ | 4,086 |   | $ | 3,585 |   |
|                                               |       |                                                |       |                                              |       |   |   |   |   |
| Share-based  compensation capitalized to inventory |       | $                                                   | 860        |                                              | $          | 605 |   | $ | 1,783 |   | $ | 1,080 |   |

 

**NOTE 3 —ACQUISITIONS**

*Acquisitionof Andrx Corporation*

On November 3, 2006, the Company acquired all the outstanding shares ofcommon stock of Andrx in an all-cash transaction for $25 per share, or totalconsideration of approximately $1.9 billion. Andrx, whose capabilities both augment and complement those of Watson,distributes pharmaceutical products primarily to independent and chainpharmacies and physicians’ offices and is considered a leader in formulatingand commercializing difficult-to-replicate controlled-release pharmaceuticalproducts and selective immediate-release products.  As a result of the Andrx Acquisition, Watsonnow has three operating segments: Generic, Brand and Distribution.

10

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*Acquisitionof Sekhsaria Chemicals Ltd.*

On March 16, 2006, theCompany acquired Sekhsaria Chemicals Ltd. (“Sekhsaria”), a private companylocated in Mumbai, India that provides active pharmaceutical ingredient andfinished dosage formulation expertise to the global pharmaceuticalindustry.  The Company acquired all theoutstanding shares of Sekhsaria for approximately $29.5 million plusacquisition costs.  The transaction wasaccounted for as a purchase in accordance with SFAS 141, “BusinessCombinations” (“SFAS 141”) andaccordingly, the assets acquired and liabilities assumed were recorded at fairvalue on the acquisition date.

*Additional Investment inScinopharm*

The Company holds an equityinterest in Scinopharm Taiwan Ltd. (“Scinopharm”).  In January 2006, the Company made anadditional investment in Scinopharm of approximately $12.0 million whichincreased its ownership interest to approximately 31%.  Additionally, the Company has an option,which expires in October 2007, to acquire an additional 44% interest inScinopharm at a cost of approximately $80 million.

**NOTE 4 —OTHER INCOME**

Otherincome consisted of the following (inthousands):
| ** **                                        | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                              |       |                                                |       |                                              |       |   |   |   |   |
| Earnings on  equity method investments - restated |       | $                                                   | 2,284      |                                              | $          | 1,658 |   | $ | 3,723 |   | $ | 1,373 |   |
| Gain on sale of  securities                       |       | 683                                                 |       | —                                            |       | 2,472 |   | 3,695 |   |
| Other income (expense)                            |       | 67                                                  |       | (97                                               | )          | 242 |   | 8 |   |
|                                              |       | $                                                   | 3,034      |                                              | $          | 1,561 |   | $ | 6,437 |   | $ | 5,076 |   |

 

As discussed in NOTE 1 –GENERAL, earnings on equity method investments has been restated to account forour investment in common shares of Andrx prior to the Andrx Acquisition usingthe equity method of accounting in accordance with APB 18.

**NOTE 5 —OPERATING SEGMENTS**

Watson has three reportableoperating segments: Generic, Brand and Distribution.  The Generic segment includes off-patentpharmaceutical products that are therapeutically equivalent to proprietaryproducts.  The Brand segment includes theCompany’s lines of Specialty Products and Nephrology products. Watson hasaggregated its Brand product lines in a single segment because of similaritiesin regulatory environment, methods of distribution and types of customer.  This segment includes patent-protectedproducts and certain trademarked off-patent products that Watson sells andmarkets as Brand pharmaceutical products. The Company sells its Brand and Generic products primarily to pharmaceuticalwholesalers, drug distributors and chain drug stores in the U.S.  Following the Andrx Acquisition, a thirdoperating segment was added representing the Anda distribution business (“Anda”).  The Distribution segment distributes genericpharmaceutical products manufactured by third parties to independentpharmacies, pharmacy chains, pharmacy buying groups and physicians’ offices inthe U.S.  Sales are principally generatedthrough an in-house telemarketing staff and through internally developedordering systems.  The Distributionsegment operating results are included in Watson results since the date of theAndrx Acquisition and exclude sales by Anda of Watson Generic and Brandproducts, which are included in their respective segment results.

“Other” revenue consists primarily of royalties,commissions, co-promotional revenue and the recognition of deferred revenueassociated with manufacturing, development and licensing arrangements.

11

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Net revenues and segmentcontribution information for the Company’s Generic, Brand and Distributionsegments, consisted of the following:
| ** **                  | ** ** | **Three Months Ended June 30, 2007** | ** ** | **Three Months Ended June 30, 2006** | ** ** |
|-----------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                  | ** ** | **Generic**                                                   | ** ** | **Brand**                                                     | ** ** | **Distribution** | ** ** | **Total** | ** ** | **Generic** | ** ** | **Brand** | ** ** | **Total** | ** ** |
|                        |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Product sales               |       | $                                                             | 327,446    |                                                          | $          | 96,924 |   | $ | 146,631 |   | $ | 571,001 |   | $ | 419,441 |   | $ | 88,051 |   | $ | 507,492 |   |
| Other                       |       | 18,195                                                        |       | 13,809                                                        |       | — |   | 32,004 |   | 990 |   | 1,874 |   | 2,864 |   |
| Net revenues                |       | 345,641                                                       |       | 110,733                                                       |       | 146,631 |   | 603,005 |   | 420,431 |   | 89,925 |   | 510,356 |   |
| Cost of sales  (1)          |       | 210,342                                                       |       | 26,795                                                        |       | 123,301 |   | 360,438 |   | 306,564 |   | 24,296 |   | 330,860 |   |
| Gross profit                |       | 135,299                                                       |       | 83,938                                                        |       | 23,330 |   | 242,567 |   | 113,867 |   | 65,629 |   | 179,496 |   |
| Gross margin                |       | 39                                                            | %          | 76                                                            | %          | 16 | % | 40 | % | 27 | % | 73 | % | 35 | % |
|                        |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Research and  development   |       | 23,968                                                        |       | 11,535                                                        |       | — |   | 35,503 |   | 18,124 |   | 13,001 |   | 31,125 |   |
| Selling and  marketing      |       | 13,197                                                        |       | 26,373                                                        |       | 12,327 |   | 51,897 |   | 13,526 |   | 29,765 |   | 43,291 |   |
| Contribution                |       | $                                                             | 98,134     |                                                          | $          | 46,030 |   | $ | 11,003 |   | 155,167 |   | $ | 82,217 |   | $ | 22,863 |   | 105,080 |   |
| Contibution margin          |       | 28                                                            | %          | 42                                                            | %          | 8 | % | 26 | % | 20 | % | 25 | % | 21 | % |
|                        |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| General and  administrative |       |                                                          |       |                                                          |       |   |   | 45,261 |   |   |   |   |   | 27,483 |   |
| Amortization                |       |                                                          |       |                                                          |       |   |   | 44,159 |   |   |   |   |   | 41,101 |   |
| Loss on  impairment         |       |                                                          |       |                                                          |       |   |   | — |   |   |   |   |   | 66,981 |   |
| Operating income (loss)     |       |                                                          |       |                                                          |       |   |   | $ | 65,747 |   |   |   |   |   | $ | (30,485 | ) |
| Operating margin            |       |                                                          |       |                                                          |       |   |   | 11 | % |   |   |   |   | (6 | )% |

 
| ** **                  | ** ** | **Six Months Ended June 30, 2007** | ** ** | **Six Months Ended June 30, 2006** | ** ** |
|-----------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                  | ** ** | **Generic**                                                 | ** ** | **Brand**                                                   | ** ** | **Distribution** | ** ** | **Total** | ** ** | **Generic** | ** ** | **Brand** | ** ** | **Total** | ** ** |
|                        |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Product sales               |       | $                                                           | 738,921    |                                                        | $          | 187,562 |   | $ | 292,071 |   | $ | 1,218,554 |   | $ | 740,856 |   | $ | 171,288 |   | $ | 912,144 |   |
| Other                       |       | 31,345                                                      |       | 24,711                                                      |       | — |   | 56,056 |   | 1,665 |   | 3,780 |   | 5,445 |   |
|                        |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Net revenues                |       | 770,266                                                     |       | 212,273                                                     |       | 292,071 |   | 1,274,610 |   | 742,521 |   | 175,068 |   | 917,589 |   |
| Cost of sales  (1)          |       | 482,965                                                     |       | 52,010                                                      |       | 250,183 |   | 785,158 |   | 523,948 |   | 41,666 |   | 565,614 |   |
| Gross profit                |       | 287,301                                                     |       | 160,263                                                     |       | 41,888 |   | 489,452 |   | 218,573 |   | 133,402 |   | 351,975 |   |
| Gross margin                |       | 37                                                          | %          | 75                                                          | %          | 14 | % | 38 | % | 29 | % | 76 | % | 38 | % |
|                        |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Research and  development   |       | 50,481                                                      |       | 22,830                                                      |       | — |   | 73,311 |   | 38,619 |   | 22,343 |   | 60,962 |   |
| Selling and  marketing      |       | 27,746                                                      |       | 52,784                                                      |       | 26,530 |   | 107,060 |   | 26,464 |   | 58,740 |   | 85,204 |   |
| Contribution                |       | $                                                           | 209,074    |                                                        | $          | 84,649 |   | $ | 15,358 |   | 309,081 |   | $ | 153,490 |   | $ | 52,319 |   | 205,809 |   |
| Contibution margin          |       | 27                                                          | %          | 40                                                          | %          | 5 | % | 24 | % | 21 | % | 30 | % | 22 | % |
|                        |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| General and  administrative |       |                                                        |       |                                                        |       |   |   | 93,316 |   |   |   |   |   | 52,320 |   |
| Amortization                |       |                                                        |       |                                                        |       |   |   | 88,092 |   |   |   |   |   | 82,201 |   |
| Loss on  impairment         |       |                                                        |       |                                                        |       |   |   | — |   |   |   |   |   | 66,981 |   |
| Operating income            |       |                                                        |       |                                                        |       |   |   | $ | 127,673 |   |   |   |   |   | $ | 4,307 |   |
| Operating margin            |       |                                                        |       |                                                        |       |   |   | 10 | % |   |   |   |   | 0 | % |

 

----

(1)  Excludesamortization of acquired intangibles including product rights.

**NOTE 6 —INVENTORIES**

Inventoriesconsist of finished goods held for sale and distribution, raw materials andwork-in-process. Included in inventory at June 30, 2007 and December 31, 2006is approximately $26.6 million and $34.2 million, respectively, of inventorythat is pending approval by the U.S. Food and Drug Administration (“FDA”) or hasnot been launched due to contractual restrictions.  This inventory consists of genericpharmaceutical products that are capitalized only when the bioequivalence ofthe product is demonstrated or the product is already FDA approved and isawaiting a contractual triggering event to enter the marketplace.

12

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Inventoriesare stated at the lower of cost (first-in, first-out method) or market (netrealizable value) and consisted of the following (in thousands):
|                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------|------------|-------------------|------------|-----------------------|------------|
| ** **         | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Raw materials      |       | $                 | 114,677    |                  | $          | 113,603 |   |
| Work-in-process    |       | 76,151            |       | 69,621                |       |
| Finished goods     |       | 363,041           |       | 334,012               |       |
| Total  inventories |       | $                 | 553,869    |                  | $          | 517,236 |   |

 

**NOTE 7 — GOODWILL**

Goodwill for the Company’s reportingunits consisted of the following (in thousands):
|                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Brand  pharmaceutical products   |       | $                 | 356,998    |                  | $          | 368,105 |   |
| Generic  pharmaceutical products |       | 432,662           |       | 433,774               |       |
| Distributed  products            |       | 85,783            |       | 88,598                |       |
| Total goodwill                   |       | $                 | 875,443    |                  | $          | 890,477 |   |

 

The $15 milliondecrease in goodwill during 2007 primarily relates to an adjustment to acquired income taxcontingencies.

**NOTE 8 — LONG-TERM DEBT**

Long-term debt consisted of the following (in thousands):
|                                                                                                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                  | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Senior Credit  Facility, due 2011, bearing interest at LIBOR plus 0.75% (“2006 Credit  Facility”) |       | $                 | 400,000    |                  | $          | 650,000 |   |
| CODES, face  amount of $575 million, due 2023, net of unamortized discount                                  |       | 574,264           |       | 574,125               |       |
| Other notes  payable                                                                                        |       | 5,614             |       | 7,079                 |       |
|                                                                                                        |       | 979,878           |       | 1,231,204             |       |
| Less: Current  portion                                                                                      |       | 5,602             |       | 107,059               |       |
| Total long-term  debt                                                                                       |       | $                 | 974,276    |                  | $          | 1,124,145 |   |

 

*Senior Credit Facility*

During the six months endedJune 30, 2007, the Company made prepayments of the 2006 Credit Facilitytotalling $250 million.  As a result ofthese pre-payments, the Company’s results for the three and six months endedJune 30, 2007 reflect a $1.7 and $4.4 million non-cash charge for debtrepurchase charges, respectively.  As ofJune 30, 2007, $400 million is outstanding under the 2006 Credit Facility.

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**NOTE 9 —INCOME TAXES**

On January 1, 2007, the Company adopted the provisions of FIN 48.  Differences between the amount recognized inthe consolidated financial statements prior to the adoption of FIN 48 and theamounts reported as a result of adoption have been accounted for as acumulative effect adjustment recorded to the January 1, 2007 retained earningsbalance.  The adoption of FIN 48decreased the January 1, 2007, balance of retained earnings by $2.9 million. Inaddition, the Company reclassified tax reserves for which a cash tax payment isnot expected in the next twelve months from current to non-current liabilities.

As of the adoption date, the liability for income tax associated withuncertain tax positions was $69.2 million. This amount is reduced for timing differences and amounts primarilyarising from business combinations which, if recognized, would be recorded togoodwill.  The net amount of $32.5million, if recognized, would favorably affect the Company’s effective taxrate.

As of June 30, 2007, the liability for income tax associated withuncertain tax positions was $46.2 million. This amount is reduced for timing differences and amounts primarilyarising from business combinations which, if recognized, would be recorded togoodwill.  The net amount of $29.4million, if recognized, would favorably affect the Company’s effective taxrate.

The Company’s continuingpractice is to recognize interest and penalties related to uncertain taxpositions in tax expense.  At adoption,the Company had accrued $6.5 million of interest and penalties (net of taxbenefit) related to uncertain tax positions and, as of June 30, 2007, theCompany had accrued $5.9 million of interest and penalties (net of tax benefit)related to uncertain tax positions.

The Company conducts business globally and, as a result, it filesfederal, state and foreign tax returns. In the normal course of business theCompany is subject to examination by taxing authorities.  With few exceptions, the Company is no longersubject to U.S. federal, state and local, or non-U.S. income tax examinationsfor years before 2000. While it is often difficult to predict the final outcomeor the timing of resolution of any particular uncertain tax position, theCompany believes its reserves for income taxes represent the most probableoutcome.  The Company adjusts thesereserves, as well as the related interest, in light of changing facts andcircumstances.

The Company anticipates that the total amount of liability forunrecognized tax benefits may change due to the settlement of audits and theexpiration of statute of limitations in the next 12 months.  Through June 30, 2007, the Company paid $4.8million (net of tax benefit) in settlement of uncertain tax benefits andaccrued interest and penalties.

**NOTE 10— STOCKHOLDERS’ EQUITY**

A summary of the changes instockholders’ equity for the six months ended June 30, 2007 consisted of thefollowing (in thousands):
| Stockholders’ equity,  December 31, 2006                                              |   | $         | 1,680,388 |   |
|--------------------------------------------------------------------------------------------|--------|-----------|-----------|--------|
| Adoption of FIN  48                                                                        |   | (2,931    | )         |
|                                                                                       |   | 1,677,457 |      |
| Common stock  issued under employee plans                                                  |   | 11,172    |      |
| Increase in  additional paid-in capital for restricted stock and stock option compensation |   | 6,910     |      |
| Net income                                                                                 |   | 68,021    |      |
| Other comprehensive  income                                                                |   | 569       |      |
| Tax benefits  from employee stock plans                                                    |   | 767       |      |
| Stockholders’ equity,  June 30, 2007                                                  |   | $         | 1,764,896 |   |

 

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**NOTE 11 —CONTINGENCIES**

*Legal Matters*

Watson and its affiliates are involved in various other disputes,governmental and/or regulatory inspections, inquires, investigations andproceedings, and litigation matters that arise from time to time in theordinary course of business. The process of resolving matters throughlitigation or other means is inherently uncertain and it is possible that anunfavorable resolution of these matters will adversely affect the Company, itsresults of operations, financial condition and cash flows.

*Phen-fenlitigation.  * Beginning in late 1997, a number ofproduct liability suits were filed against Watson, The Rugby Group (“Rugby”)and certain other Watson affiliates, as well as numerous other manufacturingdefendants, for personal injuries allegedly arising out of the use ofphentermine hydrochloride. The plaintiffs allege various injuries, ranging fromminor injuries and anxiety to heart damage and death. There are approximately14 cases, with a total of approximately 65 plaintiffs, pending againstWatson and its affiliates in numerous state and federal courts. Most of thecases involve multiple plaintiffs, and several were filed or certified as classactions. The Company believes it will be fully indemnified by Rugby’s formerowner, Aventis Pharmaceuticals (“Aventis”, formerly known as Hoechst MarionRoussel, Inc., and now known as Sanofi Aventis) for the defense of allsuch cases and for any liability that may arise out of these cases. Aventis iscurrently controlling the defense of all these matters as the indemnifyingparty under its agreements with the Company. Additionally, Watson may haverecourse against the manufacturing defendants in these cases.

*Cipro®Litigation.  * Beginning in July 2000, a numberof suits were filed against Watson, Rugby and other company affiliates invarious state and federal courts alleging claims under various federal andstate competition and consumer protection laws. Several plaintiffs have filedamended complaints and motions seeking class certification. As of March 8,2006, approximately 42 cases had been filed against Watson, Rugby and otherWatson entities. Twenty-two of these actions have been consolidated in the U.S.District Court for the Eastern District of New York (*In re: Ciprofloxacin Hydrochloride Antitrust Litigation,MDL Docket No. 001383* ). On May 20, 2003, the court hearing the consolidated actiongranted Watson’s motion to dismiss and made rulings limiting the theories underwhich plaintiffs can seek recovery against Rugby and the other defendants. OnMarch 31, 2005, the court hearing the consolidated action granted summaryjudgment in favor of the defendants on all of plaintiffs’ claims, denied theplaintiffs’ motions for class certification, and directed the clerk of thecourt to close the case. On May 7, 2005, three groups of plaintiffs fromthe consolidated action (the direct purchaser plaintiffs, the indirectpurchaser plaintiff purchasers and plaintiffs Rite Aid and CVS) filed noticesof appeal in the United States Court of Appeals for the Second Circuit,appealing, among other things, the May 20, 2003 order dismissing Watsonand the March 31, 2005 order granting summary judgment in favor of thedefendants. The three appeals were consolidated by the appellate court. Thedefendants have moved to transfer the appeal to the United States Court ofAppeals for the Federal Circuit on the ground that patent issues are involvedin the appeal. The plaintiffs have opposed the motion to transfer. Theappellate court has not ruled on the motion or the pending appeal. Otheractions are pending in various state courts, including New York, California,Kansas, Tennessee, Florida and Wisconsin. The actions generally allege that thedefendants engaged in unlawful, anticompetitive conduct in connection withalleged agreements, entered into prior to Watson’s acquisition of Rugby fromAventis, related to the development, manufacture and sale of the drug substanceciprofloxacin hydrochloride, the generic version of Bayer’s brand drug, Cipro®.. The actions generally seek declaratory judgment, damages, injunctive relief,restitution and other relief on behalf of certain purported classes ofindividuals and other entities. The courts hearing the cases in New York havedismissed the actions. Plaintiffs have sought leave to appeal the dismissal ofthe New York action. In Wisconsin, the plaintiffs appealed and on May 9,2006, the appellate court reversed the order of dismissal. On June 8,2006, the defendants filed a petition for review in the Wisconsin SupremeCourt. On July 13, 2007, the Wisconsin Supreme Court affirmed the decisionof the appellate court, and remanded the case for further proceedings.  In the action pending in Kansas, the courthas stayed the matter pending the outcome of the appeal in the consolidatedcase. In the action pending in the California Superior Court for the County ofSan Diego (*In re: Cipro Cases I &II, JCCP Proceeding Nos. 4154 & 4220*), on July 21,2004, the California Court of Appeal granted in part and denied in part thedefendants’ petition for a writ of mandate seeking to reverse the trial court’sorder granting the plaintiffs’ motion for class certification. Pursuant to theappellate court’s ruling, the majority of the plaintiffs will be permitted topursue their claims as a class. On April 13, 2005, the Superior Courtgranted the parties’ joint application to stay the California case pending theoutcome of the appeal of the consolidated case. In addition to the pendingactions, Watson understands that various state and federal agencies areinvestigating the allegations made in these actions. Aventis has agreed todefend and indemnify Watson and its affiliates in connection with the claimsand investigations arising from the conduct and agreements allegedly undertakenby Rugby and its affiliates prior to Watson’s acquisition of Rugby, and iscurrently controlling the defense of these actions.

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*GovernmentalReimbursement Investigations and Drug Pricing Litigation*  In November 1999, Schein Pharmaceutical, Inc., now known as WatsonPharma, Inc. (“Watson Pharma”) was informed by the U.S. Department ofJustice that Watson Pharma, along with numerous other pharmaceutical companies,is a defendant in a qui tam action brought in 1995 under the U.S. False ClaimsAct currently pending in the U.S. District Court for the Southern District ofFlorida. Watson Pharma has not been served in the qui tam action. A qui tamaction is a civil lawsuit brought by an individual for an alleged violation ofa federal statute, in which the U.S. Department of Justice has the right tointervene and take over the prosecution of the lawsuit at its option. Pursuantto applicable federal law, the qui tam action is under seal and, at this time,no details are available concerning, among other things, the various theoriesof liability against Watson Pharma or the amount of damages sought from it. Aqui tam action filed in the same court in 1995 has been partially unsealed,after the U.S. Department of Justice intervened, against three otherpharmaceutical companies (*In re PharmaceuticalIndustry Average Wholesale Price Litigation, United States of America ex rel.Ven-a-Care of the Florida Keys, Inc., v. Abbott Laboratories, et al., U.S.District Court for the District of Massachusetts, Civil Action No.01-12257-PBS). *That actionmay be the same qui tam action as the one pending against Watson Pharma.  The judge to whom that case has been assignedrecently issued opinions denying certain defendants’ Motions to Dismiss.

The Companybelieves that the qui tam action against the Company, which is still underseal, relates to whether allegedly improper price reporting by pharmaceutical manufacturersled to increased payments by Medicare and/or Medicaid. The qui tam action mayseek to recover damages from Watson Pharma based on its price reportingpractices. Watson Pharma subsequently also received and responded to notices orsubpoenas from the Attorneys General of various states, including Florida,Nevada, New York, California and Texas, relating to pharmaceutical pricingissues and whether allegedly improper actions by pharmaceutical manufacturersled to excessive payments by Medicare and/or Medicaid.

On June 26,2003, the Company received a request for records and information from the U.S.House Committee on Energy and Commerce in connection with that committee’sinvestigation into pharmaceutical reimbursements and rebates under Medicaid.The Company produced documents in response to the request. Other state andfederal inquiries regarding pricing and reimbursement issues are anticipated.

Beginning inJuly 2002, the Company and certain of its subsidiaries, as well asnumerous other pharmaceutical companies, were named as defendants in variousstate and federal court actions alleging improper or fraudulent reportingpractices related to the reporting of average wholesale prices and wholesaleacquisition costs of certain products, and that the defendants committed otherimproper acts in order to increase prices and market shares. Some of theseactions have been consolidated in the U.S. District Court for the Districtof Massachusetts (*In re: PharmaceuticalIndustry Average Wholesale Price Litigation, MDL Docket No. 1456*).  The consolidated amended complaint in thatcase alleges that the defendants’ acts improperly inflated the reimbursementamounts paid by various public and private plans and programs. The amendedcomplaint alleges claims on behalf of a purported class of plaintiffs that paidany portion of the price of certain drugs, which price was calculated based onits average wholesale price, or contracted with a pharmacy benefit manager toprovide others with such drugs. The Company has filed Answers to the variousamended consolidated class action complaints, and has opposed, with otherdefendants, the plaintiffs’ Motion for Leave to File a Fifth Amended MasterConsolidated Class Action Complaint. Defendants in the consolidated litigationhave been divided into two groups. The Company and its named subsidiaries arecontained in a large group of defendants (the “Track Two” Defendants) that iscurrently awaiting a ruling on the plaintiffs’ request for certification ofclasses of plaintiffs to maintain a class action against the drug companydefendants. Certain other defendants, referred to as the “Track One”defendants, have proceeded on a more expedited basis. The presiding judge inthe matter granted class certification with respect to certain companies andindividuals in the group of Track One Defendants. A trial was held with respectto some of the claims against this group of defendants, and the judge ruled infavor of the Plaintiffs as to some defendants and awarded damages.  All of the Track One Defendants agreed tosettle claims filed on behalf of one of the classes certified in that case, andsome of the Track One Defendants have agreed to settle with all of the classescertified in that case.  The presidingjudge has ordered the Company and other Track Two Defendants to enter mediationproceedings to explore the possibility of settling some or all of the claimspending in that case.

The Company andcertain of its subsidiaries also are named as defendants in various lawsuitsfiled by the Attorneys General of numerous states, including Nevada, Montana,Massachusetts, Wisconsin, Kentucky, Alabama, Illinois, Mississippi, Florida,Arizona, Missouri, Alaska, Hawaii, Idaho, and South Carolina*(State of Nevada v. American Home Products, et al.,Civil Action No. 02-CV-12086-PBS, United States District Court forthe District of Massachusetts; State of Montana v. Abbott Laboratories, et al.,Civil Action No. 02-CV-12084-PBS, United States District Court for theDistrict of Massachusetts; Commonwealth of Massachusetts v. Mylan Laboratories,et al., Civil Action No. 03-CV-11865-PBS, United States DistrictCourt for the District of Massachusetts; State of Wisconsin v. AbbottLaboratories, et al., Case No. 04-cv-1709, Wisconsin Circuit Court for DaneCounty; Commonwealth of Kentucky v. Alpharma, Inc., et al., Case Number04-CI-1487, Kentucky Circuit Court for Franklin County; State of Alabama v.Abbott Laboratories, Inc. et al., Civil Action No. CV05-219, AlabamaCircuit Court for Montgomery County; State of Illinois v. AbbottLaboratories, Inc. et al., Civil Action No. 05-CH-02474, IllinoisCircuit Court for Cook County; State of Mississippi v. AbbottLaboratories, Inc. et al., Civil Action No. G2005-2021 S/2,Mississippi Chancery Court of Hinds County; State of Florida ex rel.Ven-A-Care, Civil Action No 98-3032G, Florida Circuit Court in LeonCounty; State of Arizona ex rel. Terry Goddard, No. CV 2005-18711, ArizonaSuperior Court for Maricopa County; State of Missouri ex rel. Jeremiah W. (Jay)Nixon v. Mylan Laboratories, et al, Case no. 054-2486, Missouri Circuit Courtof St. Louis. State of Alaska v. Alpharma Branded Products Division Inc., etal., In the Superior Court for the State of Alaska Third Judicial District atAnchorage, C.A. No. 3AN-06-12026 CI. State of Idaho v. Alpharma USPDInc. et al., In the District Court of the Fourth Judicial District of the Stateof Idaho, in and for the County of Ada, C.A. No. CV-0C-0701847; State ofSouth Carolina and Henry D. McMaster v. Watson Pharmaceuticals(New Jersey), Inc., In the Court of Common Pleas for the FifthJudicial Circuit, State of South Carolina, County of Richland, C.A.No. 2006-CP-40-7152; State of South Carolina and Henry D. McMaster v.Watson Pharmaceuticals (New Jersey), Inc., In the Court of Common Pleasfor the Fifth Judicial Circuit, State of South Carolina, County of Richland,C.A. No. 2006-CP-40-7155; State of Hawaii v. AbbottLaboratories, Inc. et al., In the Circuit Court of the First Circuit,State of Hawaii, C.A. No. 06-1-0720-04 EEH).*

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These casesgenerally allege that the defendants caused the states to overpay pharmaciesand other providers for prescription drugs under state Medicaid Programs byinflating the reported Average Wholesale Price or Wholesale Acquisition Cost,and by reporting false prices to the United States government under the BestPrices rebate program. Several of these cases also allege that state residentswere required to make inflated copayments for drug purchases under the federalMedicare program, and companies were required to make inflated payments onprescription drug purchases for their employees or insured beneficiaries. Thesecases, some of which have been removed to federal court, are in the earlystages of pleading or are proceeding through pretrial discovery. OnJanuary 20, 2006, the Company was dismissed without prejudice from theactions brought by the States of Montana and Nevada because the Company was nottimely served.

The City of NewYork filed an action in the United States District Court for the SouthernDistrict of New York on August 4, 2004, against the Company and numerousother pharmaceutical defendants alleging similar claims. The case wastransferred to the United States District Court for the District ofMassachusetts, and was consolidated with several similar cases filed byindividual New York counties. A corrected Consolidated Complaint was filedon June 22, 2005 (*City of New York v.Abbott Laboratories, Inc., et al., Civil Action No. 01-CV-12257-PBS,United States District Court for the District of Massachusetts*). TheConsolidated Complaint included as plaintiffs the City of New York and 30 NewYork counties.  Since the filing of the Consolidated Complaint, casesbrought by a total of 14 additional New York counties have been transferred tothe District of Massachusetts. The Company is now named as a defendant in casesbrought by the City of New York and 44 New York counties, consolidated in theDistrict of Massachusetts case. An additional action raising similarallegations was filed by Orange County, New York, on April 5, 2007, and theCompany was served with a copy of the Complaint in that case on April 25, 2007(*County of Orange v. Abbott Laboratories,Inc., et al.* , United States District Court for the SouthernDistrict of New York, Case No. 07-CV-2777).

Additional actionsby other states, cities and/or counties are anticipated. These actions, ifsuccessful, could adversely affect the Company and may have a material adverseeffect on the Company’s business, results of operations, financial conditionand cash flows.

*FDA Matters.  *In May 2002, Watson reached an agreement with the FDA on the terms of aconsent decree with respect to its Corona, California manufacturing facility.The court approved the consent decree on May 13, 2002 (*  United Statesof America v. Watson Laboratories, Inc., and Allen Y. Chao*  , United States District Court for theCentral District of California, EDCV-02-412-VAP). The consent decree with theFDA does not require any fine, a facility shutdown, product recalls or anyreduction in production or service at the Company’s Corona facility. Theconsent decree applies only to the Corona facility and not other manufacturingsites. The decree requires Watson to ensure that its Corona, Californiafacility complies with the FDA’s cGMP regulations. Pursuant to the agreement,Watson hired an independent expert to conduct inspections of the Coronafacility at least once each year. In February 2003, February 2004,January 2005, January 2006 and January 2007, respectively, thefirst, second, third, fourth and fifth annual inspections were completed andthe independent expert submitted its report of the inspection to the FDA. Ineach instance, the independent expert reported its opinion that, based on thefindings of the audit of the facility, the FDA’s applicable cGMP requirements,applicable FDA regulatory guidance, and the collective knowledge, education,qualifications and experience of the expert’s auditors and reviewers, thesystems at Watson’s Corona facility audited and evaluated by the expert are incompliance with the FDA’s cGMP regulations. However, the FDA is not required toaccept or agree with the independent expert’s opinion. The FDA conducted aninspection of that facility from March 31, 2004 until May 6, 2004. Atthe conclusion of the inspection, the FDA issued a Form 483 listing theobservations made during the inspection, including observations related tocertain laboratory test methods and other procedures in place at the facility.In June 2004 the Company submitted its response to the FDA Form 483inspectional observations and met with FDA officials to discuss its response,including the corrective actions the Company had taken, and intended to take,to address the inspectional observations. The FDA conducted another inspectionof the facility from April 5, 2005 through April 13, 2005. At theconclusion of the inspection no formal observations were made and no FDAForm 483 was issued. The FDA conducted another inspection of the facility fromJuly 9, 2006 through July 21, 2006. At the conclusion of theinspection no formal observations were made and no FDA Form 483 wasissued.  From February 20, 2007 through 

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March 9, 2007, the FDAconducted another inspection of the facility.  At the conclusion of the inspection,the FDA issued a Form 483 listing the observations made during theinspection.  In April 2007 the Company submitted its response to the FDAForm 483 inspectional observations, including the corrective actions theCompany has taken to address the inspectional observations.  If, in thefuture, the FDA determines that, with respect to its Corona facility, Watsonhas failed to comply with the consent decree or FDA regulations, includingcGMPs, or has failed to adequately address the observations in theForm 483, the consent decree allows the FDA to order Watson to take avariety of actions to remedy the deficiencies. These actions could includeceasing manufacturing and related operations at the Corona facility, andrecalling affected products. Such actions, if taken by the FDA, could adverselyaffect the Company, its results of operations, financial position and/or cashflows.

*SecuritiesLitigation.  * Beginning in November 2003,several securities class action lawsuits were commenced in the United StatesDistrict Court for the Central District of California against Watson andcertain of its present and former officers and directors. On February 9,2004, the federal court issued an order consolidating all of the federalactions (In re: Watson Pharmaceuticals, Inc. Securities Litigation, CaseNo. CV-03-8236 AHM). In addition to the federal consolidated actions, twoshareholder derivative actions were filed in California Superior Court for theCounty of Riverside (*  Philip Orlando v. Allen Chao, et al., CaseNo. 403717; and Charles Zimmerman v. Allen Chao, et al, CaseNo. 403715*  ). Thesefederal and state cases all relate to the drop in the price of the Company’scommon stock in November 2001, and allege generally that the Companyfailed to timely advise investors about matters such as falling inventoryvaluations, increased competition and manufacturing difficulties, andtherefore, the Company’s published financial statements and publicannouncements during 2000 and 2001 were false and misleading. The shareholderderivative actions were dismissed without prejudice on November 16, 2004.On August 2, 2004, the United States District Court for the CentralDistrict of California court granted the defendants’ motion to dismiss thefederal consolidated action, and allowed plaintiffs until August 30, 2004to file an amended complaint. On August 30, 2004, the lead plaintiff inthe federal consolidated action notified the court that it did not intend tofile an amended complaint in response to the court’s order granting thedefendants’ motion to dismiss. On September 2, 2004, the District Courtentered a judgment of dismissal in favor of the defendants. On October 1,2004, one of the non-lead plaintiffs in the consolidated action filed a Noticeof Appeal of the dismissal of the action with the United States Court ofAppeals for the Ninth Circuit *(Pension Fund v. WatsonPharmaceuticals, Inc., USCA Docket No. 04-56791)*. Thecourt heard oral argument on the appeal on November 17, 2006. OnDecember 1, 2006, the court ordered appellants to file a new and separateaction against defendants within 28 days or show cause why they had not doneso. Appellants did not file a new and separate action, responding that such afiling would be time-barred and requesting a ruling on their appeal. As ofAugust 1, 2007, the appellate court had not ruled on the matter. The Companybelieves that it has substantial meritorious defenses and intends to defend thematters vigorously. However, these actions, if successful, could adverselyaffect the Company and could have a material adverse effect on the Company’sbusiness, results of operations, financial condition and cash flows.

*SecuritiesLitigation Against Andrx Corporation.  * OnOctober 11, 2005, Jerry Lowry filed a class action complaint on behalf ofpurchasers of the Andrx’s common stock during the class period (March 9,2005 through September 5, 2005) in the U.S. District Court for theSouthern District of Florida against Andrx Corporation and its then ChiefExecutive Officer, Thomas Rice (*Jerry Lowryv. Andrx Corporation, et al.,* Case No. 05-61640). The complaint seeks damages under theSecurities Exchange Act of 1934, and alleges that during the class period,Andrx failed to disclose that its manufacturing facilities were not in compliancewith current Good Manufacturing Practices (“cGMP”). The complaint furtheralleges that Andrx’s failure to be cGMP compliant led to the FDA placing Andrxon Official Action Indicated status, which resulted in not being eligible forapprovals of Andrx’s Abbreviated New Drug Applications. On July 24, 2006,the defendants moved to dismiss the action. On December 8, 2006, the courtgranted in part and denied in part the defendants’ motion to dismiss. On April18, 2007, plaintiffs filed a motion seeking class certification.  Andrx has opposed the motion.  Discovery is ongoing. Though we are not in aposition to determine the ultimate outcome of this matter, an adversedetermination of this action could have a material adverse effect on theCompany’s business, results of operations, financial condition and cash flows.

*NaproxenSodium (Naprelan).  * In October 1998, ElanCorporation Plc sued Andrx in the United States District Court for the SouthernDistrict of Florida, alleging that Andrx’s pending ANDA for a generic versionof Elan’s Naprelan® infringed Elan’s patent No. 5,637,320 (*Elan Corporation PLC v. AndrxPharmaceuticals, Inc.,* Case No. 98-7164). In March 2002, the District Court issued anorder that Elan’s patent was invalid, and in September 2002, Andrx commencedselling the 500mg strength of naproxen sodium, its generic version ofNaprelan®. In March 2003, the District Court issued an order denying,among other things, (i) Elan’s motion for consideration of theMarch 2002 order invalidating its patent, and (ii) Andrx’s motionasking the District Court for a ruling on its non-infringement defenses. Bothparties appealed that March 2003 decision (*Elan Corporation PLC v. Andrx Pharmaceuticals, Inc.,*  Case No. 03-1354). On May 5, 2004,the Federal Circuit Court of Appeals reversed the District Court’sdetermination that the Elan patent was invalid, and remanded the case back tothe District Court for a determination as to whether Andrx’s product infringesthe Elan patent. On July 12, 2005, the Federal Circuit Court of Appealsissued a decision, in an unrelated case, on how a court should address issuesof claim construction, and the District Court instructed the parties to filebriefs on how the District Court should proceed in this matter in light of the FederalCircuit Court of Appeals decision. The parties filed their briefs and areawaiting the court’s decision.

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InJanuary 2005, Elan filed a complaint in the U.S. District Court for theSouthern District of Florida seeking willful damages as a result of Andrx’ssale of its generic version of Naprelan® (*ElanCorporation PLC v. Andrx Pharmaceuticals, Inc.,*  Case No. 058-60158). InFebruary 2005, Andrx filed its answer to Elan’s January 2005complaint and filed a counterclaim for declaratory relief for unenforceabilitydue to inequitable conduct and for non-infringement and invalidity of theapplicable patent. This matter has been stayed pending resolution of theinfringement action. Andrx has sold and is continuing to sell its genericversion of the 500mg strength of Naprelan®. Therefore, an adverse determinationcould have a material adverse effect on the Company’s business, results ofoperations, financial condition and cash flows.

*MallinckrodtClaim.  * On February 17, 2006, Andrx filed acomplaint against Mallinckrodt in the U.S. District Court for the SouthernDistrict of Florida (*Andrx Therapeutics, Incv. Mallinckrodt, Inc..,* Case No. 06-60210). The complaint resulted from a dispute overcertain agreements, including a supply and marketing agreement entered intobetween Andrx and Mallinckrodt. The complaint sought to establish the parties’rights under the agreements, a judgment declaring that the agreements are stillin force and that Andrx has not defaulted in its obligations. In thealternative, Andrx sought a judgment for either breach of contract foranticipatory repudiation or for breach of duty of good faith. On March 10,2006, Mallinckrodt filed suit against Andrx in state court in Missouri, arisingfrom the same dispute referenced above (*Mallinckrodt, Inc.v. Andrx Laboratories, Inc., et al.,*  Case No. 06-1000). In its suit,Mallinckrodt alleged breach of contract, breach of implied covenant of goodfaith and fair dealing and sought damages of $9.5 million, along with adeclaratory judgment and injunctive relief. On June 29, 2007, the partiessettled all disputes related to the actions pending in Florida and Missouri,and the matters were dismissed with prejudice.

*Departmentof Health and Human Services Subpoena.  * InDecember 2003, the Company’s subsidiary, Watson Pharma, received asubpoena from the Office of the Inspector General (“OIG”) of the Department ofHealth and Human Services. The subpoena requested documents relating tophysician meetings conducted during 2002 and 2003 related to Watson Pharma’sFerrlecit® intravenous iron product. Watson Pharma provided the requesteddocuments and has not been contacted again by the OIG for several years.However, the Company cannot predict what additional actions, if any, may betaken by the OIG, Department of Health and Human Services, or othergovernmental entities.

*HormoneReplacement Therapy Litigation.  * Beginning inearly 2004, a number of product liability suits were filed against the Companyand certain Company affiliates, for personal injuries allegedly arising out ofthe use of hormone replacement therapy products, including but not limited toestropipate and estradiol. These complaints also name numerous otherpharmaceutical companies as defendants, and allege various injuries, includingovarian cancer, breast cancer and blood clots. Approximately ninety cases are pendingagainst Watson and/or its affiliates in state and federal courts representingclaims by approximately 142 plaintiffs. Many of the cases involve multipleplaintiffs. The majority of the cases have been transferred to and consolidatedin the United States District Court for the Eastern District of Arkansas (*In re: Prempro Products Liability Litigation, MDLDocket No. 1507*  ).Discovery in these cases is ongoing. The Company maintains product liabilityinsurance against such claims. However, these actions, if successful, or ifinsurance does not provide sufficient coverage against the claims, could adverselyaffect the Company and could have a material adverse effect on the Company’sbusiness, results of operations, financial condition and cash flows.

Watson and itsaffiliates are involved in various other disputes, governmental and/orregulatory inspections, inquires, investigations and proceedings, andlitigation matters that arise from time to time in the ordinary course ofbusiness. The process of resolving matters through litigation or other means isinherently uncertain and it is possible that an unfavorable resolution of thesematters will adversely affect the Company, its results of operations, financialcondition and cash flows.

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

The following discussion of our financial conditionand the results of operations should be read in conjunction with the CondensedConsolidated Financial Statements and notes thereto included elsewhere in thisQuarterly Report on Form 10-Q (“Quarterly Report”).  This discussion contains forward-lookingstatements that are subject to known and unknown risks, uncertainties and otherfactors that may cause our actual results to differ materially from thoseexpressed or implied by such forward-looking statements.  These risks, uncertainties and other factorsinclude, among others, those identified under “Cautionary Note RegardingForward-Looking Statements” under “Risks Related to our Business” in our AnnualReport on Form 10-K for the year ended December 31, 2006 and elsewhere in ourAnnual Report and this Quarterly Report.

**Overview**

Watson Pharmaceuticals, Inc. (“Watson”, the “Company” “we”, “us” or “our”)was incorporated in 1985 and is engaged in the development, manufacture, marketing,sale and distribution of brand and off-patent (generic) pharmaceuticalproducts. Watson operates manufacturing, distribution, research anddevelopment, and administrative facilities primarily in the United States (“U.S.”).  

**Acquisition of Andrx Corporation**

On November 3, 2006, the Company acquired allthe outstanding shares of common stock of Andrx Corporation (“Andrx”) in anall-cash transaction for $25 per share, or total consideration of approximately$1.9 billion (the “Andrx Acquisition”). Andrx distributes pharmaceuticalproducts primarily to independent and chain pharmacies and physicians’ officesand is considered a leader in formulating and commercializingdifficult-to-replicate controlled-release pharmaceutical products and selectiveimmediate-release products.

In conjunction with the Andrx Acquisition, the Companyrecorded a $497.8 million charge to operations in the year ended December 31,2006, in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 141, “Business Combinations” (“SFAS 141”), for in-process research anddevelopment (“IPR&D”) assets acquired that the Company determined had noalternative future use in their current state. The Company’s valuation ofIPR&D projects included over thirty controlled or immediate releaseproducts at various stages of research and development. These IPR&Dprojects were valued through discounted cash flow analysis utilizing the “income”approach at rates commensurate with their perceived risks, which for theseIPR&D projects ranged between 19%-20%. A partial list of cash flowconsiderations utilized for each of the IPR&D projects included anevaluation of a project’s estimated cost to complete, future product prospectsand competition, product lifecycles, expected date of market introduction andexpected pricing and cost structure. The major risks and uncertaintiesassociated with the timely and successful completion of these IPR&Dprojects include delays caused by legal actions brought by the Company’scompetitors and the timing of the receipt of necessary regulatory approvals. Noassurances can be given that the underlying assumptions used to prepare thediscounted cash flow analysis will not change or the timely completion of eachproject to commercial success will occur. For these and other reasons, actualresults may vary significantly from estimated results.

The charge for IPR&D in the year ended December31, 2006 related primarily to the acquisition of the following six IPR&Dprojects:

*Actos® and Extended-ReleaseMetformin Combination Product*

In December 2003, Andrx entered into an agreement withTakeda Chemical Industries, Ltd. (“Takeda”) to develop and market a combinationproduct consisting of Andrx’s approved 505(b)(2) New Drug Application (“NDA”)extended-release metformin and Takeda’s Actos® (pioglitazone), each of which is administered once a day for thetreatment of type 2 diabetes. The Company is responsible for obtainingregulatory approval of its extended-release metformin in countries that Takedadetermines it will market the combination product.  In addition, theCompany is responsible for the formulation and manufacture of the combinationproduct and Takeda is responsible for obtaining regulatory approval of andmarketing the combination product, both in the U.S. and in certain othercountries.

In March 2006, Takeda filed an NDA for thiscombination product and the NDA is under review by the U.S. Food and DrugAdministration (“FDA”).  Final approval and launch of the product isdependent, among other things, upon favorable resolution of the Official ActionIndicated (“OAI”) status at the Company’s Davie, Florida manufacturingfacility.  If approved and launched, the Company is eligible to receivefuture milestone payments and royalties from Takeda’s sale of this product.

The Company’s valuation of this IPR&D project atthe Andrx Acquisition date was $133 million.

20

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*Enoxaparin Sodium (generic version of Lovenox®)*

On May 2, 2005, Andrx entered into an agreement toobtain certain exclusive marketing rights for Amphastar Pharmaceuticals, Inc.’s(“Amphastar’s”) generic version of Aventis Pharmaceuticals, Inc.’s (“Aventis’”)Lovenox® injectable product.  Amphastar submittedits Abbreviated New Drug Application (“ANDA”) for generic Lovenox® to the FDAin March 2003.  Amphastar’s ANDA is the subject of a patent infringementlawsuit filed by Aventis. Amphastar has not obtained FDA approval for itsproduct and the product continues to be delayed by a Citizen Petition,including two supplements, and possibly other factors. Amphastar has submittedcomments to Aventis’ Citizen Petition and supplements. Our marketing rights forthis product generally extend to the U.S. retail pharmacy market, and we willreceive up to 50% of the net profits, as defined, generated from such sales.

The launch of this product is dependent upon Amphastarobtaining FDA approval.

The Company’s valuation of this IPR&D project atthe Andrx Acquisition date was $33 million.

*Metoprolol Succinate (generic version of Toprol-XL®)*

In 2003 and 2004, Andrx filed ANDAs seeking FDA approvalto market metoprolol succinate extended-release tablets in the 25mg, 50mg,100mg and 200mg strengths.  Andrx was awarded 180-days of marketexclusivity for the 50mg strength.  During the second quarter of thisyear, the Company announced that pursuant to an agreement with Sandoz, asubsidiary of Novartis AG (“Sandoz”), the Company relinquished its rights to a180-day period of marketing exclusivity for its 50mg strength product.  Asa result of Watson’s agreement to relinquish its marketing exclusivity, Sandozobtained final approval of its ANDA for metoprolol succinate extended-release50 mg tablets. Watson will be entitled to a share of Sandoz’s profits on salesof the product, which began in the third quarter of this year.

Andrx continues to pursue approval of its own pendingANDAs for metoprolol succinate extended-release tablets. Watson believes thatunder current FDA policy, Andrx will be barred from obtaining final approvaluntil March 18, 2008, when AstraZeneca’s pediatric study market exclusivityexpires.  Final approval and launch of the product is also dependent uponsatisfactorily resolving certain questions from the FDA regarding the ANDAs aswell as favorable resolution of the OAI status at the Company’s Davie, Floridamanufacturing facility.

The Company’s valuation of this IPR&D project atthe Andrx Acquisition date was $85 million.

*Methylphenidate Hydrochloride (generic version of Concerta®)*

Andrx has pending ANDAs for the generic versions ofConcerta® (methylphenidate hydrochloride extended-release tablets) in the 18mg,27mg, 36mg and 54mg strengths.

In September 2005, ALZA Corporation and McNeil-PPC,Inc. sued Andrx for patent infringement related to the generic version ofConcerta®.  The ANDAs remain under review by the FDA and McNeil-PPC, Inc. hasfiled a Citizen Petition relating to approval criteria for Concerta®generics.  Final approval and launch of the product is also dependent uponfavorable resolution of the OAI status at the Company’s Davie, Floridamanufacturing facility.

The Company’s valuation of this IPR&D project atthe Andrx Acquisition date was $94 million.

*Omeprazole (generic version of Prilosec®)*

Andrx has pending ANDAs for omeprazole delayed-releasecapsules, 10mg, 20mg and 40 mg strengths, which is bioequivalent toPrilosec®.  In 2001, AstraZeneca filed suit against Andrx alleginginfringement of a patent  (patent no.6,013,281) (“the ‘281 patent”) directed to a process for making an omeprazoleformulation. Andrx filed counterclaims of non-infringement, invalidity andunenforceability.  In May 2004, the district court ruled that the ‘281patent was invalid due to obviousness.  In April 2007, the U.S. Court ofAppeals for the Federal Circuit affirmed the 2004 District Court decision thatthe ‘281 patent is invalid.

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Andrx is currently enjoined from selling its genericversion of Prilosec® until October 20, 2007, the date upon which Orange Bookpatents 4,786,505 and 4,853,230 expire, including pediatric exclusivity.

The ANDAs remain under review by the FDA. Finalapproval and launch of the product is dependent upon favorable resolution ofthe OAI status at the Company’s Davie, Florida manufacturing facility. Upon approval and launch, we believe that we are entitled to the 180-day periodof market exclusivity with respect to the generic version of the 40mg strengthof Prilosec®.

The Company’s valuation of this IPR&D project atthe acquisition date was $57 million.

*Diltiazem HCl ER (Cardizem® LA)*

Andrx Corporation has pending ANDAs with the FDA forgeneric versions of Cardizem® LA (diltiazem HCl extended-release tablets),120mg, 180mg, 240mg, 300mg, 360mg and 420mg strengths. Andrx initially filedits ANDA for the 420mg strength on April 25, 2005, with a ParagraphIV certification and notification to the patent holder. On August 10, 2005,Biovail Laboratories Int’l SRL. (“Biovail”), which is the holder of the NDA forCardizem® LA, initiated a patent infringement lawsuit against the Company forthe 420mg strength in the U.S. District Court for the District of Delaware.Andrx subsequently amended its initial ANDA submission to include the 120mg,180mg, 240mg, 300mg and 360mg strengths, along with a related Paragraph IVcertification and notice letter. On October 14, 2005, Biovail initiated apatent infringement lawsuit on the remaining strengths.

The ANDAs remain under review by the FDA.  Finalapproval and launch of the product is dependent upon favorable resolution ofthe OAI status at the Company’s Davie, Florida manufacturing facility, as wellas expiration of the statutory 30-month stay of approval.  The Companybelieves that Andrx is the first ANDA applicant with a Paragraph IVcertification for each of the six strengths, and accordingly may be entitled to180 days of market exclusivity under the Hatch-Waxman Act.

The Company’s valuation of this IPR&D project atthe Andrx Acquisition date was $12 million.

Prior to the Andrx Acquisition, the Company heldcommon shares in Andrx, which were previously classified as available-for-salesecurities and recorded at fair value based upon quoted market prices withtemporary differences between cost and fair value presented as accumulatedother comprehensive income within stockholders’ equity, net of any related taxeffect. As required by Accounting Research Bulletin (“ARB”) No. 51, “ConsolidatedFinancial Statements” (“ARB 51”), earnings (loss) on equity method investmentshas been restated for the three and six months ended June 30, 2006 to account for our investment in commonshares of Andrx using the equity method of accounting in accordance withAccounting Principles Board (“APB”) Opinion No. 18, “The Equity Method ofAccounting for Investments in Common Stock” (“APB 18”). Other comprehensiveincome has also been restated for the three and six months ended June 30,2006 to reflect these changes.

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**Results of Operations**

Prescription pharmaceutical products in the U.S. are generally marketedas either generic or brand pharmaceuticals. Generic pharmaceutical products are bioequivalents of their respectivebrand products and provide a cost-efficient alternative to brand products.Brand pharmaceutical products are marketed under brand names through programsthat are designed to generate physician and consumer loyalty.

Watson has three reportable operating segments: Generic, Brand andDistribution.  The Generic segmentincludes off-patent pharmaceutical products that are therapeutically equivalentto proprietary products.  The Brandsegment includes the Company’s lines of Specialty Products and Nephrologyproducts. Watson has aggregated its Brand product lines in a single segmentbecause of similarities in regulatory environment, methods of distribution andtypes of customer.  This segment includespatent-protected products and certain trademarked off-patent products thatWatson sells and markets as Brand pharmaceutical products.  The Company sells its Brand and Genericproducts primarily to pharmaceutical wholesalers, drug distributors and chaindrug stores.  The Distribution segmentwas acquired as part of the Andrx Acquisition representing the Andrx “Anda”division.  The Distribution segmentmainly distributes generic pharmaceutical products manufactured by thirdparties, as well as by Watson, primarily to independent pharmacies, pharmacychains, pharmacy buying groups and physicians’ offices.  Sales are principally generated through anin-house telemarketing staff and through internally developed orderingsystems.  The Distribution segment operatingresults exclude sales by Anda of products reported in Watson’s Generic andBrand segments.

***Three Months Ended June 30, 2007Compared to Three Months Ended June 30, 2006***
| ** **                 | ** ** | **Three Months Ended June 30, 2007** | ** ** | **Three Months Ended June 30, 2006** | ** ** |
|----------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                 | ** ** | **Generic**                                                   | ** ** | **Brand**                                                     | ** ** | **Distribution** | ** ** | **Total** | ** ** | **Generic** | ** ** | **Brand** | ** ** | **Total** | ** ** |
|                       |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Product sales              |       | $                                                             | 327,446    |                                                          | $          | 96,924 |   | $ | 146,631 |   | $ | 571,001 |   | $ | 419,441 |   | $ | 88,051 |   | $ | 507,492 |   |
| Other                      |       | 18,195                                                        |       | 13,809                                                        |       | — |   | 32,004 |   | 990 |   | 1,874 |   | 2,864 |   |
|                       |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Net revenues               |       | 345,641                                                       |       | 110,733                                                       |       | 146,631 |   | 603,005 |   | 420,431 |   | 89,925 |   | 510,356 |   |
| Cost of sales (1)          |       | 210,342                                                       |       | 26,795                                                        |       | 123,301 |   | 360,438 |   | 306,564 |   | 24,296 |   | 330,860 |   |
| Gross profit               |       | 135,299                                                       |       | 83,938                                                        |       | 23,330 |   | 242,567 |   | 113,867 |   | 65,629 |   | 179,496 |   |
| Gross margin               |       | 39.1                                                          | %          | 75.8                                                          | %          | 15.9 | % | 40.2 | % | 27.1 | % | 73.0 | % | 35.2 | % |
|                       |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Research and development   |       | 23,968                                                        |       | 11,535                                                        |       | — |   | 35,503 |   | 18,124 |   | 13,001 |   | 31,125 |   |
| Selling and marketing      |       | 13,197                                                        |       | 26,373                                                        |       | 12,327 |   | 51,897 |   | 13,526 |   | 29,765 |   | 43,291 |   |
| Contribution               |       | $                                                             | 98,134     |                                                          | $          | 46,030 |   | $ | 11,003 |   | 155,167 |   | $ | 82,217 |   | $ | 22,863 |   | 105,080 |   |
| Contibution margin         |       | 28.4                                                          | %          | 41.6                                                          | %          | 7.5 | % | 25.7 | % | 19.6 | % | 25.4 | % | 20.6 | % |
|                       |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| General and administrative |       |                                                          |       |                                                          |       |   |   | 45,261 |   |   |   |   |   | 27,483 |   |
| Amortization               |       |                                                          |       |                                                          |       |   |   | 44,159 |   |   |   |   |   | 41,101 |   |
| Loss on impairment         |       |                                                          |       |                                                          |       |   |   | — |   |   |   |   |   | 66,981 |   |
| Operating income           |       |                                                          |       |                                                          |       |   |   | $ | 65,747 |   |   |   |   |   | $ | (30,485 | ) |
| Operating margin           |       |                                                          |       |                                                          |       |   |   | 10.9 | % |   |   |   |   | (6.0 | )% |

 

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(1)  Excludes amortization of acquired intangiblesincluding product rights.

**Generic Segment**

*Net Revenues*

Our generic pharmaceutical business develops, manufactures, markets,sells and distributes generic products that are the therapeutic equivalent totheir brand name counterparts and are generally sold at prices significantlyless than the brand product. As such, generic products provide an effective andcost-efficient alternative to brand products. When patents or other regulatoryexclusivity no longer protect a brand product, opportunities exist to introduceoff-patent or generic counterparts to the brand product. Our portfolio ofgeneric products includes products we have internally developed, products wehave licensed from third parties, and products we distribute for third parties.

Other revenues consist primarily of royalties and commission revenue.

Our Generic segment develops, manufactures, markets, sells anddistributes products within two product lines: Generics and Generic OralContraceptives.  Our Generics productline includes oral dosage, transdermal, injectible and transmucosal productsused for a variety of indications including pain management, depression, hypertensionand smoking cessation.

Net revenues from our Generic segment for the three months ended June30, 2007 decreased $74.8 million to $345.6 million or 18% compared to netrevenues of $420.4 million from the prior year period.  This decrease in net revenues was due to a$109.5 million decline in sales of certain authorized generic productsincluding oxycodone HCl controlled-release tablets and pravastatin sodiumtablets.  Generic segment sales ofoxycodone HCl controlled-release tablets ended in the first quarter of 2007 asthe supply and distribution agreement to sell this product terminated duringthe quarter.  This decline was offset inpart by revenue generated from the addition of products from the AndrxAcquisition ($25.2 million) and an increase in other revenues ($17.2 million).

The increase in other revenues in the three months ended June30, 2007 for the Generic segment was primarily related to commission revenuesearned on sales of fentanyl citrate troche (which commenced during the third quarterof 2006) and royalties earned on GlaxoSmithKline’s (“GSK’s”) sales ofWellbutrin XL® 150mg(which commenced during the first quarter of 2007).  Combined, the commission revenue androyalties totaled $13.9 million.  Goingforward, we expect other revenues to increase as a result of sales by Sandoz ofmetoprolol succinate 50 mg extended release tablets.

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*Gross Profit (Gross Margin)*

Gross profitrepresents net revenues less cost of sales. Cost of sales includes production and packaging costs for products wemanufacture, third party acquisition costs for products manufactured by others,profit-sharing or royalty payments for products sold pursuant in licensingagreements, inventory reserve charges, and excess capacity utilization charges,when applicable.  Cost of sales does notinclude amortization costs for acquired product rights or other acquiredintangibles.

Gross profit forour Generic segment increased $21.4 million to $135.3 million in the threemonths ended June 30, 2007 from $113.9 million in the prior year period.  This year over year increase in gross profitwas due primarily to the $17.2 million increase in other revenues.

Gross margins forour Generic segment increased 12 percentage points to 39.1% for the threemonths ended June 30, 2007 from 27.1% in the prior year period.  In the prior year period, our Generic segmentgross margin was negatively impacted by 8 percentage points due to sales ofoxycodone HCl and pravastatin sodium at lower gross margins.   The year-over-year increase in gross marginswas also due to the increase in other revenues. This increase in other revenues resulted in a 3.2 percentage pointimprovement in segment gross margin.  Weexpect further improvement in gross margins provided Sandoz launches itsmetoprolol succinate extended release tablets.

*Researchand Development Expenses*

Research anddevelopment (“R&D”) expenses consist predominantly of personnel costs,contract research, development and facilities costs associated with thedevelopment of our products.

R&D expenseswithin our Generic segment increased $5.8 million to $24.0 million or 32%during the three months ended June 30, 2007, as compared to $18.1 million fromthe same period of the prior year.  Thisincrease was due to R&D expenditures associated with our Florida-baseddevelopment group acquired in connection with the Andrx Acquisition.

*Sellingand Marketing Expenses*

Selling andmarketing expenses consist mainly of personnel costs, facilities costs,insurance and professional services costs.

**BrandSegment**

*NetRevenues*

Our brandpharmaceutical business develops, manufactures, markets, sells and distributesproducts within two sales and marketing groups: Specialty Products andNephrology.

Our Specialty Products product line includes urology products such asAndroderm®, Oxytrol® and Trelstar® and a number of non-promoted products.

Our Nephrologyproduct line consists of products for the treatment of iron deficiency anemiaand is generally marketed to nephrologists and dialysis centers.  The key product of the Nephrology group isFerrlecit®, which is used to treat low iron levels in patients undergoinghemodialysis in conjunction with erythropoietin therapy.

Other revenues in the Brand segment consist of co-promotion revenue,royalties, and revenue (including the amortization of deferred revenue)relating to our obligation to manufacture and supply two brand products to athird party. This contract manufacturing agreement was assumed as part of theAndrx Acquisition.

Other revenues also include revenue recognized from research,development and licensing agreements (including milestone payments). Revenuefrom development agreements is deferred and recognized over the entire contractperformance period, starting with the contract’s commencement, but not prior tothe removal of any contingencies for each individual milestone. We recognizethis revenue based upon the pattern in which the revenue is earned or theobligation is fulfilled.

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Net revenues from our Brand segment for the three months ended June 30,2007 increased $20.8 million to $110.7 million or 23% compared to net revenues of $89.9 millionfrom the prior year period.  The increasein net revenues was attributable to product sales, royalties and deferredrevenue related to a contract manufacturing agreement assumed in connectionwith the Andrx Acquisition ($8.6 million) and our share of profits on theAndroGel® co-promotion agreement ($6.4 million), which commenced in the fourthquarter of 2006.  Brand segment productsales also increased for certain non-promoted products within our SpecialtyProducts product line from the prior year period as the prior year period was negatively impacted by a reduction in wholesalerinventory levels.

*Gross Profit (Gross Margin)*

Gross profit fromour Brand segment increased 28% or $18.3 million in the current year period to$83.9 million from $65.6 million in the year ago period.  The year-over-year increase in gross profitwas primarily the result of the addition of Androgel® co-promotional other revenue in thecurrent year period of $6.4 million, lower production costs of $6.2 million,and higher sales of certain Specialty Products as the prior year period wasimpacted by a reduction in wholesaler inventory levels.

*Researchand Development Expenses*

R&D expenseswithin our Brand segment decreased $1.5 million to $11.5 million or 11% duringthe three months ended June 30, 2007, as compared to $13.1 million from thesame period of the prior year primarily due to decreased costs related to PhaseIII studies on the gel formulation of oxybutynin for overactive bladder asthese studies near completion.

*Sellingand Marketing Expenses*

Brand segment selling and marketing expenses decreased $3.4million to $26.4 million or 11% during the three months ended June 30, 2007as compared to $29.8 million from the same period of the prior year primarilydue to lower field sales force costs ($2.1 million) and lower product spendingfor Oxytrol® ($0.6 million) in the current year quarter.

***Distribution Segment***

*NetRevenues*

Our Distribution segment consists primarily of sales of genericpharmaceutical products sourced from third parties.  Customers include independent pharmacies,pharmacy chains, pharmacy buying groups and physicians’ offices.  Our Distribution segment results do notinclude sales of Generic and Brand products manufactured or licensed by us andsold to third parties through our distribution operations.  These sales are reflected in our Generic or Brandsegment.  As we acquired our Distributionsegment as part of the Andrx Acquisition in November, 2006, there are nocomparatives for the prior year period.

***SegmentContribution***
|                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Change** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **($ in thousands):** | ** ** | **2007**                                            | ** ** | **2006**   | ** ** | **Dollars** | ** ** | **%** | ** ** |
|                            |       |                                                |       |       |       |   |   |   |   |
| Segment contribution            |       |                                                |       |       |       |   |   |   |   |
| Generic                         |       | $                                                   | 98,134     |       | $          | 82,217 |   | $ | 15,917 |   | 19.4 | % |
| Brand                           |       | 46,030                                              |       | 22,863     |       | 23,167 |   | 101.3 | % |
| Distribution                    |       | 11,003                                              |       | —     |       | 11,003 |   | 100.0 | % |
|                            |       | $                                                   | 155,167    |       | $          | 105,080 |   | $ | 50,087 |   | 47.7 | % |
| *as % of net revenues*          | * *   | *25.7*                                              | *%*        | *20.6*     | *%*        | * * | * * | * * | * * |

 

Generic segmentcontribution increased for the three months ended June 30, 2007, as compared tothe same period of the prior year, due to higher other revenues partially offset by higher R&Dcosts as a result of our Andrx Acquisition.

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Brand segmentcontribution increased for the three months ended June 30, 2007, as compared tothe same period of the prior year, primarily due to an increase in other revenues and a decrease inmanufacturing costs as compared to the prior year period.

For moreinformation on segment contribution, refer to above Management’s Discussion andAnalysis of Financial Condition and Results of Operations and NOTE 5 in theaccompanying Notes to Condensed Consolidated Financial Statements in thisQuarterly Report.

***CorporateGeneral and Administrative Expenses***
|                                                | ** ** | **Three Months Ended June 30,** | ** ** | **Change** | ** ** |
|------------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **($ in thousands):**                | ** ** | **2007**                                            | ** ** | **2006**   | ** ** | **Dollars** | ** ** | **%** | ** ** |
|                                           | ** ** | ** **                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Corporate  general and administrative expenses |       | $                                                   | 45,261     |       | $          | 27,483 |   | $ | 17,778 |   | 64.7 | % |
| *as a % of net revenues*                       | * *   | *7.5*                                               | *%*        | *5.4*      | *%*        | * * | * * | * * | * * |
|                                                |            |                                                     |            |            |            |  |  |  |  |  |  |  |

 

Corporate generaland administrative expenses consist mainly of personnel costs, facilitiescosts, insurance and professional services costs, which support our sales,R&D, marketing, human resources, finance and administration functions.

Corporate generaland administrative expenses increased$17.8 million or 65% during thethree months ended June 30, 2007 as compared to the same period of the prioryear due primarily to the inclusion of corporate general and administrativecosts related to the Andrx Acquisition ($12.9 million) and higher litigationcosts ($3.6 million) relating to various matters.

***Amortization***
|                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Change** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **($ in thousands):** | ** ** | **2007**                                            | ** ** | **2006**   | ** ** | **Dollars** | ** ** | **%** | ** ** |
|                            |       |                                                |       |       |       |   |   |   |   |
| Amortization                    |       | $                                                   | 44,159     |       | $          | 41,101 |   | $ | 3,058 |   | 7.4 | % |
| *as a % of net revenues*        | * *   | *7.3*                                               | *%*        | *8.1*      | *%*        | * * | * * | * * | * * |
|                                 |            |                                                     |            |            |            |  |  |  |  |  |  |  |

 

The Company’samortizable assets consist primarily of acquired product rights.  For the three months ended June 30, 2007amortization expense includes charges related to intangible assets from the Andrx Acquisition.

***EarlyExtinguishment of Debt***
|                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Change** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **($ in thousands):** | ** ** | **2007**                                            | ** ** | **2006**   | ** ** | **Dollars** | ** ** | **%** | ** ** |
|                            |       |                                                |       |       |       |   |   |   |   |
| Early extinguishment of debt    |       | $                                                   | (1,681     | )          | $          | 195 |   | $ | (1,876 | ) | (962.1 | )% |
| *as a % of net revenues*        | * *   | *(0.3*                                              | *)%*       | *0.0*      | *%*        | * * | * * | * * | * * |
|                                 |            |                                                     |            |            |            |  |  |  |  |  |  |  |

 

During the quarterended June 30, 2007, the Company pre-paid $100 million of the Term Facilityunder the terms of the Senior Credit Facility (together the “2006 CreditFacility”).  The Company entered into the2006 Credit Facility in November 2006 to provide financing for the AndrxAcquisition.  As a result of thispre-payment, our results for the second quarter of 2007 reflect a $1.7 milliondebt repurchase charge.

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***InterestIncome***
|                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Change** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **($ in thousands):** | ** ** | **2007**                                            | ** ** | **2006**   | ** ** | **Dollars** | ** ** | **%** | ** ** |
|                            |       |                                                |       |       |       |   |   |   |   |
| Interest income                 |       | $                                                   | 1,803      |       | $          | 6,913 |   | $ | (5,110 | ) | (73.9 | )% |
| *as a %  of net revenues*       | * *   | *0.3*                                               | *%*        | *1.4*      | *%*        | * * | * * | * * | * * |
|                                 |            |                                                     |            |            |            |  |  |  |  |  |  |  |

 

Interest incomedecreased during the three months ended June 30, 2007, as compared to the prioryear period due to the use of available cash, cash equivalents and marketablesecurities to finance the Andrx Acquisition.

***InterestExpense***
|                                                                                           | ** ** | **Three Months Ended June 30,** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **($ in thousands):**                                                           | ** ** | **2007**                                            | ** ** | **2006**   | ** ** | **Change** | ** ** |
| Interest expense - 2006  Credit Facility                                                  |       | $                                                   | 8,076      |       | $          | — |   | $ | 8,076 |   |
| Interest expense -  convertible contingent senior debentures due 2023 (“CODES”) |       | 3,151                                               |       | 3,151      |       | — |   |
| Interest expense - 1998  Senior Notes                                                     |       | —                                              |       | 150        |       | (150 | ) |
| Interest and fees on  credit facility                                                     |       | —                                              |       | 248        |       | (248 | ) |
| Change in derivative  value                                                               |       | 95                                                  |       | (278       | )          | 373 |   |
| Interest expense -  other                                                                 |       | 153                                                 |       | 51         |       | 102 |   |
|                                                                                      |       | $                                                   | 11,475     |       | $          | 3,322 |   | $ | 8,153 |   |
| *as a % of net revenues*                                                                  | * *   | *1.9*                                               | *%*        | *0.7*      | *%*        | * * | * * |

 

Interest expenseincreased for the three months ended June 30, 2007 due to interest expenseincurred on debt issued to finance the Andrx Acquisition.

***OtherIncome***
|                                                   | ** ** | **Three Months Ended June 30,** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **($ in thousands):**                   | ** ** | **2007**                                            | ** ** | **2006**   | ** ** | **Change** | ** ** |
|                                              |       |                                                |       |       |       |   |   |
| Earnings on equity method  investments - restated |       | $                                                   | 2,284      |       | $          | 1,658 |   | $ | 626 |   |
| Gain on sale of  securities                       |       | 683                                                 |       | —     |       | 683 |   |
| Other income (expense)                            |       | 67                                                  |       | (97        | )          | 164 |   |
|                                              |       | $                                                   | 3,034      |       | $          | 1,561 |   | $ | 1,473 |   |
| *as a %  of net revenues*                         | * *   | *0.5*                                               | *%*        | *0.3*      | *%*        |   |   |

 

*Earningson Equity Method Investments*

The Company’sequity investments are accounted for under the equity-method when the Company’sownership does not exceed 50% and when the Company can exert significantinfluence over the management of the investee.  Asrequired by ARB 51, earnings (losses) on equity method investments have beenrestated for the three months ended June 30, 2006 to account for our investment in commonshares of Andrx prior to the Andrx Acquisition using the equity method ofaccounting in accordance with APB 18.

27

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The earningsrecorded during the three months ended June 30, 2007 primarily represent ourshare of earnings in Somerset Pharmaceuticals, Inc. (“Somerset”), our jointventure with Mylan Laboratories, Inc. For the remainder of 2007, we expect that our earnings from Somersetwill be below the current quarter amount.

***Provisionfor Income Taxes***
| ** **                      | ** ** | **Three Months Ended June 30,** | ** ** | ** ** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **($ in thousands):** | ** ** | **2007**                                            | ** ** | **2006**   | ** ** | **% Change** | ** ** |
|                            |       |                                                |       |       |       |   |   |
| Provision for income  taxes     |       | $                                                   | 21,019     |       | $          | (9,527 | ) |   |   |
| *as a %  of net revenues*       | * *   | *3.5*                                               | *%*        | *-1.9*     | *%*        | * * | * * |
| *Effective tax rate*            | * *   | *36.6*                                              | *%*        | *37.9*     | *%*        | (1.3 | )% |
|                                 |            |                                                     |            |            |            |  |  |  |  |

 

The provision forincome taxes differs from the amount computed by applying the statutory U.S.federal income tax rate primarily due to state taxes and other factors which,combined, increases the effective tax rate.

The effective taxrate for the three months ended June 30, 2007 declined 1.3% to 36.6% ascompared to 37.9% in the year ago period. The effective tax rate in the current year period is lower primarily dueto the extension of R&D tax incentives (1.0 percentage point).

**Results of Operations**

***Six Months Ended June 30, 2007Compared to Six Months Ended June 30, 2006***
| ** **                  | ** ** | **Six Months Ended June 30, 2007** | ** ** | **Six Months Ended June 30, 2006** | ** ** |
|-----------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                  | ** ** | **Generic**                                                 | ** ** | **Brand**                                                   | ** ** | **Distribution** | ** ** | **Total** | ** ** | **Generic** | ** ** | **Brand** | ** ** | **Total** | ** ** |
|                        |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Product sales               |       | $                                                           | 738,921    |                                                        | $          | 187,562 |   | $ | 292,071 |   | $ | 1,218,554 |   | $ | 740,856 |   | $ | 171,288 |   | $ | 912,144 |   |
| Other                       |       | 31,345                                                      |       | 24,711                                                      |       | — |   | 56,056 |   | 1,665 |   | 3,780 |   | 5,445 |   |
|                        |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Net revenues                |       | 770,266                                                     |       | 212,273                                                     |       | 292,071 |   | 1,274,610 |   | 742,521 |   | 175,068 |   | 917,589 |   |
| Cost of sales (1)           |       | 482,965                                                     |       | 52,010                                                      |       | 250,183 |   | 785,158 |   | 523,948 |   | 41,666 |   | 565,614 |   |
| Gross profit                |       | 287,301                                                     |       | 160,263                                                     |       | 41,888 |   | 489,452 |   | 218,573 |   | 133,402 |   | 351,975 |   |
| Gross margin                |       | 37.3                                                        | %          | 75.5                                                        | %          | 14.3 | % | 38.4 | % | 29.4 | % | 76.2 | % | 38.4 | % |
|                        |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Research and  development   |       | 50,481                                                      |       | 22,830                                                      |       | — |   | 73,311 |   | 38,619 |   | 22,343 |   | 60,962 |   |
| Selling and marketing       |       | 27,746                                                      |       | 52,784                                                      |       | 26,530 |   | 107,060 |   | 26,464 |   | 58,740 |   | 85,204 |   |
| Contribution                |       | $                                                           | 209,074    |                                                        | $          | 84,649 |   | $ | 15,358 |   | 309,081 |   | $ | 153,490 |   | $ | 52,319 |   | 205,809 |   |
| Contibution  margin         |       | 27.1                                                        | %          | 39.9                                                        | %          | 5.3 | % | 24.2 | % | 20.7 | % | 29.9 | % | 22.4 | % |
|                        |       |                                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| General and  administrative |       |                                                        |       |                                                        |       |   |   | 93,316 |   |   |   |   |   | 52,320 |   |
| Amortization                |       |                                                        |       |                                                        |       |   |   | 88,092 |   |   |   |   |   | 82,201 |   |
| Loss on impairment          |       |                                                        |       |                                                        |       |   |   | — |   |   |   |   |   | 66,981 |   |
| Operating income            |       |                                                        |       |                                                        |       |   |   | $ | 127,673 |   |   |   |   |   | $ | 4,307 |   |
| Operating margin            |       |                                                        |       |                                                        |       |   |   | 10.0 | % |   |   |   |   | 0.5 | % |

 

----

(1)  Excludes amortization of acquired intangiblesincluding product rights.

28

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**Generic Segment**

*Net Revenues*

Net revenues from our Generic segment for the six months ended June 30,2007 increased $27.7million to $770.3 million or 4%over net revenues of $742.5 million from the prior year period.  This increase in net revenues wasattributable to an increase in other revenue of $29.7 million, revenuegenerated from the addition of products from the Andrx Acquisition ($58.3million) offset in part by a decline in sales of certain authorized genericproducts including oxycodone HCl controlled-release tablets and pravastatinsodium tablets ($49.2 million).  Thedecline in sales of oxycodone HCl controlled-release tablets was due to thetermination of the distribution agreement in the first quarter of 2007.

The increase in other revenues for the six months ended June 30, 2007was primarily related to commission revenues earned on sales of fentanylcitrate troche and royalties earned on GSK’s sales of Wellbutrin XL® 150mg, together totaling $25.6 million.

*Gross Profit (Gross Margin)*

Gross profit forour Generic segment increased $68.7 million to $287.3 million in the six monthsended June 30, 2007 from $218.6 million in the prior year period.  This year-over-year increase in gross profitwas due to the following factors:

·                  Grossprofit from authorized generic products oxycodone HCl controlled-releasetablets and pravastatin sodium tablets increased $11.2 million primarily as aresult of price increases realized in the current year period and morefavorable commercial terms on sales of oxycodone HCl controlled-releasetablets.  As discussed above, ouragreement to sell oxycodone HCl controlled-release tablets ended during thefirst quarter of 2007.  Going forward, weexpect to realize minimal gross profit from the sale of pravastatin sodiumtablets.

·                  Otherrevenue increased $29.7 million as a result of commission revenue earned fromthe sale of fentanyl citrate troche and royalties earned in connection with thelicensing of a patent to GSK (which commenced during the first quarter of 2007).

·                  Grossprofit from products acquired in connection with the Andrx Acquisitioncontributed $8.9 million to the increase in Generic segment gross profit.

·                  Productioncost improvements and new products also contributed to the year-over-year grossprofit increase.

Gross margins forour Generic segment increased 7.9 percentage points to 37.3% for the six monthsended June 30, 2007 from 29.4% in the prior year period.  The increase in gross margins is primarilydue to an increase in other revenue (2.5 percentage points) and lower sales ofoxycodone HCl and pravastatin sodium in the current year period.  In the prior year period, gross margins werenegatively impacted by 5.9 percentage points due to the inclusion of theseauthorized generic products.

*Researchand Development Expenses*

R&D expenseswithin our Generic segment increased $11.9 million to $50.5 million or 31%during the six months ended June 30, 2007, as compared to $38.6 million fromthe same period of the prior year, due to the inclusion of R&D expendituresfrom the Andrx Acquisition.

*Sellingand Marketing Expenses*

Generic segment selling and marketing expenses increased slightlyduring the six months ended June 30, 2007 as compared to the same period of theprior year.

**BrandSegment**

*Net Revenues*

Net revenues from our Brand segment for the six months ended June 30,2007 increased $37.2million to $212.3 million or 21%over net revenues of $175.1 million from the prior year period.  The increase in net revenues was attributableto a $20.9 million increase inother revenues related to royalties and deferred revenues recognized from acontract manufacturing agreement assumed from the Andrx Acquisition ($9.2million) and our share of profits on the AndroGel® co-promotion agreement($11.7 million).  Brand segment productsales also increased for certain non-promoted products within our SpecialtyProducts product line from the prior year period as the prior year period wasimpacted by a reduction in wholesaler inventory levels.

29

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*Gross Profit (Gross Margin)*

Gross profit fromour Brand segment increased 20% or $26.9 million in the six months ended June30, 2007 to $160.3 million from $133.4 million in the year ago period.  The year-over-year increase in gross profitwas primarily the result of an increase in other revenues of $20.9 million,including the addition of Androgel® co-promotional revenue in the current year period of $11.7million and the addition of royalties and deferred revenue of $9.1 million relatedto a contract manufacturing agreement assumed in connection with the AndrxAcquisition.  Higher sales of certainSpecialty Products also contributed to higher gross profit in the current yearperiod as the prior year period was negatively impacted by a reduction inwholesaler inventory levels.

*Researchand Development Expenses*

R&D expenseswithin our Brand segment increased $0.5 million to $22.8 million or 2.2% duringthe six months ended June 30, 2007 as compared to $22.3 million from the prioryear period.

*Sellingand Marketing Expenses*

Brand segment selling and marketing expenses decreased $6.0 million to $52.8 million or 10% during the six months ended June 30, 2007as compared to $58.7 million from the same period of the prior year primarilydue to lower field sales force costs ($3.2 million) and lower product spendingfor Oxytrol®, Trelstar® and Ferrlecit® during the current period ($2.2million).

***Distribution Segment***

Net revenues of our Distribution segment consists primarily of sales ofgeneric pharmaceutical products sourced from third parties.  Customers include independent pharmacies,pharmacy chains, pharmacy buying groups and physicians’ offices.  Our Distribution segment results do notinclude sales of generic and brand products manufactured or licensed by Watsonand sold to third parties through our distribution operations.  These sales are reflected in our generic orbrand segment.  As we acquired ourDistribution segment as part of the Andrx Acquisition in November, 2006, thereare no comparatives for the prior year period.

***SegmentContribution***
|                                 | ** ** | **Six Months Ended June 30,** | ** ** | **Change** | ** ** |
|---------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **($ in thousands):** | ** ** | **2007**                                          | ** ** | **2006**   | ** ** | **Dollars** | ** ** | **%** | ** ** |
|                            |       |                                              |       |       |       |   |   |   |   |
| Segment  contribution           |       |                                              |       |       |       |   |   |   |   |
| Generic                         |       | $                                                 | 209,074    |       | $          | 153,490 |   | $ | 55,584 |   | 36.2 | % |
| Brand                           |       | 84,649                                            |       | 52,319     |       | 32,330 |   | 61.8 | % |
| Distribution                    |       | 15,358                                            |       | —     |       | 15,358 |   | 100.0 | % |
|                            |       | $                                                 | 309,081    |       | $          | 205,809 |   | $ | 103,272 |   | 50.2 | % |
| *as % of  net revenues*         | * *   | *24.2*                                            | *%*        | *22.4*     | *%*        | * * | * * | * * | * * |

 

Generic segmentcontribution increased for the six months ended June 30, 2007, as compared tothe same period of the prior year, due to higher levels of other revenues andgross profit partially offsetby higher R&D costs as a result of the Andrx Acquisition.

Brand segmentcontribution increased for the six months ended June 30, 2007, as compared tothe same period of the prior year, primarily due to an increase in other revenues and an increase innet product revenues related to certain non-promoted products within ourSpecialty Products product line as well as lower selling and marketingexpenses.

For moreinformation on segment contribution, refer to above Management’s Discussion andAnalysis of Financial Condition and Results of Operations and NOTE 5 in theaccompanying Notes to Condensed Consolidated Financial Statements in thisQuarterly Report.

30

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***CorporateGeneral and Administrative Expenses***

|                                                | ** ** | **Six Months Ended June 30,** | ** ** | **Change** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **($ in thousands):**                | ** ** | **2007**                                          | ** ** | **2006**   | ** ** | **Dollars** | ** ** | **%** | ** ** |
|                                           |       |                                              |       |       |       |   |   |   |   |
| Corporate  general and administrative expenses |       | $                                                 | 93,316     |       | $          | 52,320 |   | $ | 40,996 |   | 78.4 | % |
| *as a %  of net revenues*                      | * *   | *7.3*                                             | *%*        | *5.7*      | *%*        | * * | * * | * * | * * |
|                                                |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

Corporate generaland administrative expenses increased$41 million or 78% during the six months ended June 30, 2007 as compared to thesame period of the prior year primarily due to the inclusion of corporategeneral and administrative costs related to the Andrx Acquisition ($28.3 million)and higher litigation costs ($7.0 million) relating to various matters.

***Amortization***
|                                 | ** ** | **Six Months Ended June 30,** | ** ** | **Change** | ** ** |
|---------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **($ in thousands):** | ** ** | **2007**                                          | ** ** | **2006**   | ** ** | **Dollars** | ** ** | **%** | ** ** |
|                            |       |                                              |       |       |       |   |   |   |   |
| Amortization                    |       | $                                                 | 88,092     |       | $          | 82,201 |   | $ | 5,891 |   | 7.2 | % |
| *as a % of net revenues*        | * *   | *6.9*                                             | *%*        | *9.0*      | *%*        | * * | * * | * * | * * |
|                                 |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

The Company’samortizable assets consist primarily of acquired product rights.  For the six months ended June 30, 2007amortization expense includes charges related to intangible assets from the Andrx Acquisition.

***EarlyExtinguishment of Debt***
|                                 | ** ** | **Six Months Ended June 30,** | ** ** | **Change** | ** ** |
|---------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **($ in thousands):** | ** ** | **2007**                                          | ** ** | **2006**   | ** ** | **Dollars** | ** ** | **%** | ** ** |
|                            |       |                                              |       |       |       |   |   |   |   |
| Early extinguishment of  debt   |       | $                                                 | (4,410     | )          | $          | (525 | ) | $ | (3,885 | ) | 740.0 | % |
| *as a % of net revenues*        | * *   | *(0.3*                                            | *)%*       | *(0.1*     | *)%*       | * * | * * | * * | * * |
|                                 |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

During the six months ended June 30, 2007, the Company pre-paid $250million of the Term Facility under the terms of the 2006 Credit Facility.  As a result of this pre-payment, our resultsfor the six months ended June 30, 2007 reflect a $4.4 million debt repurchasecharge.

On March 31, 2006,the Company initiated a redemption notice to the holders of all of itsoutstanding senior unsecured 7 1/8% notes (“1998 Senior Notes”).  The 1998 Senior Notes were redeemed on May23, 2006.  As a result, the Companyincurred costs representing redemption fees, expenses, and a premium on theredemption.

***InterestIncome***
|                                 | ** ** | **Six Months Ended June 30,** | ** ** | **Change** | ** ** |
|---------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **($ in thousands):** | ** ** | **2007**                                          | ** ** | **2006**   | ** ** | **Dollars** | ** ** | **%** | ** ** |
|                            |       |                                              |       |       |       |   |   |   |   |
| Interest income                 |       | $                                                 | 4,732      |       | $          | 13,165 |   | $ | (8,433 | ) | (64.1 | )% |
| *as a % of net revenues*        | * *   | *0.4*                                             | *%*        | *1.4*      | *%*        | * * | * * | * * | * * |
|                                 |            |                                                   |            |            |            |  |  |  |  |  |  |  |

 

31

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Interest incomedecreased during the six month period ended June 30, 2007, as compared to theprior year period due to the use of available cash, cash equivalents andmarketable securities to finance the Andrx Acquisition.

***InterestExpense***
|                                          | ** ** | **Six Months Ended June 30,** | ** ** | ** ** | ** ** |
|------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **($ in thousands):**          | ** ** | **2007**                                          | ** ** | **2006**   | ** ** | **Change** | ** ** |
|                                     |       |                                              |       |       |       |   |   |
| Interest expense - 2006  Credit Facility |       | $                                                 | 18,450     |       | $          | — |   | $ | 18,450 |   |
| Interest expense -  CODES                |       | 6,302                                             |       | 6,302      |       | — |   |
| Interest expense - 1998  Senior Notes    |       | —                                            |       | 406        |       | (406 | ) |
| Interest and fees on  credit facility    |       | —                                            |       | 495        |       | (495 | ) |
| Change in derivative  value              |       | 119                                               |       | (731       | )          | 850 |   |
| Interest expense -  other                |       | 480                                               |       | 151        |       | 329 |   |
|                                     |       | $                                                 | 25,351     |       | $          | 6,623 |   | $ | 18,728 |   |
| *as a  % of net revenues*                |       | *2.0*                                             | *%*        | *0.7*      | *%*        |   |   |

 

Interest expenseincreased for the six months ended June 30, 2007 due to interest expenseincurred on debt issued to finance the Andrx Acquisition.

***OtherIncome***
|                                                   | ** ** | **Six Months Ended June 30,** | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|---------------------------------------------------|------------|------------|------------|
| **($ in thousands):**                   | ** ** | **2007**                                          | ** ** | **2006**   | ** ** | **Change** | ** ** |
|                                              |       |                                              |       |       |       |   |   |
| Earnings on equity method  investments - restated |       | $                                                 | 3,723      |       | $          | 1,373 |   | $ | 2,350 |   |
| Gain on sale of  securities                       |       | 2,472                                             |       | 3,695      |       | (1,223 | ) |
| Other income                                      |       | 242                                               |       | 8          |       | 234 |   |
|                                              |       | $                                                 | 6,437      |       | $          | 5,076 |   | $ | 1,361 |   |
| *as a % of net revenues*                          | * *   | *0.5*                                             | *%*        | *0.6*      | *%*        |   |   |

 

*Earningson Equity Method Investments*

The earningsrecorded during the six months ended June 30, 2007 primarily represent ourshare of earnings in Somerset.

*Gain onSale of Securities*

The 2006 and 2007gain on sale of securities resulted from the sale of our investment in Adheris,Inc. to inVentiv Health, Inc.  During thesix months ended June 30, 2006, we received cash proceeds of $4.7 million andcertain contingent consideration from our sale of our investment in Adheris,Inc.  During the six months ended June30, 2007, all contingencies were removed relating to the contingentconsideration received on the sale of our investment in Adheris, Inc.  Accordingly, the Company received cash and commonshares of inVentivHealth, Inc. during the period as additional proceeds on our sale of our investment inAdheris, Inc., resulting in a gain on sale of securities.

32

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***Provisionfor Income Taxes***

|                                 | ** ** | **Six Months Ended June 30, ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|---------------------------------------------------------|------------|------------|------------|
| **($ in thousands):** | ** ** | **2007**                                                | ** ** | **2006**   | ** ** | **% Change** | ** ** |
|                            |       |                                                    |       |       |       |   |   |
| Provision for income  taxes     |       | $                                                       | 41,060     |       | $          | 5,837 |   |   |   |
| *as a %  of net revenues*       | * *   | *3.2*                                                   | *%*        | *0.6*      | *%*        | * * | * * |
| *Effective tax rate*            | * *   | *37.6*                                                  | *%*        | *37.9*     | *%*        | (0.3 | )% |
|                                 |            |                                                         |            |            |            |  |  |  |  |

 

The provision forincome taxes increased in the six months ended June 30, 2007 due to higherlevels of income before income taxes. The effective tax rate for the six months ended June 30, 2007 declined0.3% to 37.6% as compared to 37.9% in the year ago period.  The effective tax rate in the current yearperiod is lower due to the extension of R&D tax incentives (1.0 percentagepoint) offset by an increase in permanent items (0.8 percentage points).

33

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**Liquidityand Capital Resources**

***WorkingCapital Position***

Working capital atJune 30, 2007 and December 31, 2006 is summarized as follows:
|                                         | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** |
|-----------------------------------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|
| **($ in thousands):**         | ** ** | **2007**          | ** ** | **2006**              | ** ** | **(Decrease)** | ** ** |
| ** **                              | ** ** | ** **        | ** ** | ** **            | ** ** | ** **     | ** ** |
| Current Assets:                         |       |              |       |                  |       |           |       |
| Cash and cash  equivalents              |       | $                 | 74,852     |                  | $          | 154,171        |       | $ | (79,319) |   |
| Marketable  securities                  |       | 10,513            |       | 6,649                 |       | 3,864          |       |
| Accounts  receivable, net of allowances |       | 301,602           |       | 384,692               |       | (83,090)       |       |
| Inventories                             |       | 553,869           |       | 517,236               |       | 36,633         |       |
| Other                                   |       | 153,734           |       | 198,928               |       | (45,194)       |       |
| Total current  assets                   |       | 1,094,570         |       | 1,261,676             |       | (167,106)      |       |
| Current liabilities:                    |       |              |       |                  |       |           |       |
| Accounts payable  and accrued expenses  |       | 436,776           |       | 516,875               |       | (80,099)       |       |
| Current portion  of long-term debt      |       | 5,602             |       | 107,059               |       | (101,457)      |       |
| Other                                   |       | 17,468            |       | 65,995                |       | (48,527)       |       |
| Total current  liabilities              |       | 459,846           |       | 689,929               |       | (230,083)      |       |
| Working Capital                         |       | $                 | 634,724    |                  | $          | 571,747        |       | $ | 62,977 |   |
| Current Ratio                           |       | 2.38              |       | 1.83                  |       |           |       |

 

Watson’sprimary source of liquidity is cash from operations.  Net working capital at June 30, 2007 was$634.7 million compared to $571.7 million at December 31, 2006 and $1.19billion at June 30, 2006.

Duringthe six months ended June 30, 2007, our working capital increased by $63million primarily due to net cash provided by operating activities.  The decrease in other current assets at June30, 2007 was due primarily to the collection of a $35 million legal settlementduring the period.  Cash and cashequivalents as well as current portion of long-term debt decreased at June 30,2007 as we pre-paid $250 million of debt incurred to finance the AndrxAcquisition.  Accounts payable andaccrued liabilities decreased during the period due primarily to payments ofaccrued royalties ($44.2 million), accrued severance and retention ($13.2million), legal and audit accruals ($12.5 million) and bonus accruals ($10.8million).  Other current liabilitiesdecreased $48.5 million primarily due to a reclassification of $46.7 million ofincome tax payable from current to long term as a result of the implementationof Financial AccountingStandards Board (“FASB”) Interpretation No. 48, “Accounting forUncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN48”).

We expect that2007 cash flows from operating activities will continue to exceed netincome.  In addition, management expectsthat cash flows from operating activities and available cash balances will besufficient to fund our operating liquidity needs in 2007.

***Cash Flows from Operations***

Summarized cash flow fromoperations is as follows:
|                                           | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------|------------|
| **($ in thousands):**           | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| ** **                                | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net cash provided by operating activities |       | $                                                 | 199,242    |   | $ | 196,225 |   |
|                                           |            |                                                   |            |  |  |  |  |

 

Net cash flows from operations represents net incomeadjusted for certain operating-related non-cash items and changes in assets andliabilities.  For the six monthsended June 30, 2007, cashprovided by operating activities was $199.2 million, compared to $196.2 million in the six months endedJune 30, 2006.

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***Investing Cash Flows***

Net cash flows used ininvesting activities are summarized as follows:
|                                       | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------|------------|---------------------------------------------------|------------|
| **($ in thousands):**       | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| ** **                            | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net cash used in investing activities |       | $                                                 | 37,852     |   | $ | 51,749 |   |
|                                       |            |                                                   |            |  |  |  |  |

 

Investing cash flows consist of expendituresrelated to acquisitions, capital expenditures, investment and marketablesecurity additions as well as proceeds from investment and marketable securitysales.  We used $37.9 million in net cash for investing activitiesduring the six months ended June 30, 2007 compared to $51.7 million used in investing activities during thesix months ended June 30, 2006.  The higher net cash used in investingactivities during the six months ended June 30, 2006 reflected our $29.7 million acquisition of Sekhsaria ChemicalsLtd. during 2006.  During the six monthsended June 30, 2007, we incurred higher capital expenditures on property andequipment ($35.5 million) than the comparable period in 2006 ($18.2 million).

***Financing Cash Flows***

Net cash flows used infinancing activities are summarized as follows:
|                                        | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------|------------|
| **($ in thousands):**        | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
|                                   | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net cash used in  financing activities |       | $                                                 | 240,709    |   | $ | 11,516 |   |
|                                        |            |                                                   |            |  |  |  |  |

 

Financing cash flows consistprimarily of borrowings and repayments of debt and proceeds from the exerciseof stock options.  For the sixmonths ended June 30, 2007, netcash used in financing activities was $240.7 million compared to $11.5 million during the six months endedJune 30, 2006.  As indicated above we pre-paid $250million of debt originally incurred to finance the Andrx Acquisition during thesix months ended June 30, 2007.

***Debtand Borrowing Capacity***

Ourdebt at June 30, 2007 and December 31, 2006 is summarized as follows:
|                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Increase**   | ** ** |
|------------------------------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|
| **($ in thousands):**    | ** ** | **2007**          | ** ** | **2006**              | ** ** | **(Decrease)** | ** ** |
| ** **                         | ** ** | ** **        | ** ** | ** **            | ** ** | ** **     | ** ** |
| Current portion of  long-term debt |       | $                 | 5,602      |                  | $          | 107,059        |       | $ | (101,457 | ) |
| Long-term debt                     |       | 974,276           |       | 1,124,145             |       | (149,869       | )          |
| Total debt                         |       | $                 | 979,878    |                  | $          | 1,231,204      |       | $ | (251,326 | ) |
| Debt to capital ratio              |       | 35.7              | %          | 42.3                  | %          |           |       |

 

InMarch 2003, we issued $575 million of our CODES.  As of June 30, 2007, the entire amount of theCODES remained outstanding at an effective annual interest rate ofapproximately 2.1%.

In May 1998, we issued $150 million of our 1998Senior Notes.  On March 31, 2006 theCompany initiated a redemption notice to the holders of all of its outstanding1998 Senior Notes.  As a result, theremaining 1998 Senior Notes were redeemed on May 23, 2006.

In November 2006, we entered into the 2006 Credit Facility with asyndicate of banks.  The 2006 CreditFacility provides an aggregate of $1.15 billion of senior financing to Watson,consisting of a $500 million revolving credit facility (“Revolving Facility”)and a $650 million senior term loan facility (“Term Facility”).  The 2006 Credit Facility was entered into inconnection with the Andrx Acquisition.

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The 2006 Credit Facility has a five-year term and will bear interestequal to LIBOR plus 0.75% (subject to certain adjustments).  The indebtedness under the 2006 CreditFacility is guaranteed by Watson’s material domestic subsidiaries.  The Revolving Facility is available forworking capital and other general corporate requirements subject to thesatisfaction of certain conditions. Indebtedness under the 2006 Credit Facility may be pre-payable, andcommitments reduced at the election of Watson without premium (subject tocertain conditions).  As of June 30,2007, the Company had not drawn any funds from the Revolving Facility.

During the six months ended June 30, 2007, the Company prepaid $250million of the amount outstanding under the Term Facility.  As of June 30, 2007, $400 million is outstanding under the TermFacility.  As a result of thispre-payment, our results for the six months ended June 30, 2007 reflect a $4.4million non-cash charge for debtrepurchase charges.

Under the terms of the 2006 Credit Facility, each ofour subsidiaries, other than minor subsidiaries, entered into a full andunconditional guarantee on a joint and several basis.  We are subject to, and, as of June 30, 2007,were in compliance with financial and operation covenants under the terms ofthe Credit Facility.  The agreementcurrently contains the following financial covenants:

·                  maintenance of a minimum net worth of atleast $1.35 billion;

·                  maintenance of a maximum leverage ratio notgreater than 3.25 to 1.0; and

·                  maintenance of a minimum interest coverageratio of at least 5.0 to 1.0.

At June 30, 2007, our net worth was $1.76 billion, and our leverage ratio was 1.94 to 1.0.  Our interest coverage ratio for the trailing twelve months ended June30, 2007 was 9.2 to 1.0.

Under the 2006 Credit Facility, interestcoverage ratio, with respect to any financial covenant period, is defined asthe ratio of EBITDA for such period to interest expense for such period.  The leverage ratio, for any financialcovenant period, is defined as the ratio of the outstanding principal amount offunded debt for the borrower and its subsidiaries at the end of such period, toEBITDA for such period.  EBITDA under theCredit Facility, for any covenant period, is defined as net income plus (1)depreciation and amortization, (2) interest expense, (3) provision for incometaxes, (4) extraordinary or unusual losses, (5) non-cash portion ofnonrecurring losses and charges, (6) other non-operating, non-cash losses, (7)minority interest expense in respect of equity holdings in affiliates, (8)non-cash expenses relating to stock-based compensation expense and (9) anyone-time charges related to the Andrx Acquisition; minus (1) extraordinary gains,(2) interest income and (3) other non-operating, non-cash income.

***Long-termObligations***

The following table lists our enforceable and legally bindingobligations as of June 30, 2007.  Some ofthe amounts included herein are based on management’s estimates and assumptionsabout these obligations, including their duration, the possibility of renewal,anticipated actions by third parties, and other factors.  Because these estimates and assumptions arenecessarily subjective, the enforceable and legally binding obligation we willactually pay in future periods may vary from those reflected in the table:
| ** **                                                        | ** ** | **Payments Due by Period (Including Interest)** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| **(in thousands):**                                          | ** ** | **Total**                                                                | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **4-5 years** | ** ** | **After 5 years  and Other** | ** ** |
| Long-term and other  debt                                         |       | $                                                                        | 1,236,822  |   | $ | 40,104 |   | $ | 198,164 |   | $ | 326,273 |   | $ | 672,281 |   |
| Liabilities incurred  for acquisitions of products and businesses |       | 1,583                                                                    |       | 1,196 |   | — |   | — |   | 387 |   |
| Income tax liability  for uncertain tax positions                 |       | 45,669                                                                   |       | — |   | — |   | — |   | 45,669 |   |
| Operating lease obligations                                       |       | 141,527                                                                  |       | 18,434 |   | 40,231 |   | 8,210 |   | 74,652 |   |
| Total contractual cash  obligations                               |       | $                                                                        | 1,425,601  |   | $ | 59,734 |   | $ | 238,395 |   | $ | 334,483 |   | $ | 792,989 |   |

 

The Company is involved in certain minor joint venture arrangementsthat are intended to complement the Company’s core business and markets.  The Company has the discretion to providefunding on occasion for working capital or capital expenditures.  The Company makes an evaluation of additionalfunding based on an assessment of the venture’s business opportunities.  The Company believes that any possiblecommitments arising from the current arrangements will not be significant tothe Company’s financial condition or results of operations.

We do not have any material off-balance sheet arrangements that have,or are reasonably likely to have, a current or future effect on our financialcondition, changes in financial conditions, revenues or expenses, results ofoperations, liquidity, capital expenditures or capital resources.

*Recent accounting pronouncements*

In July 2006, FASB issued FIN 48.  FIN 48 clarifies the accounting for theuncertainty in recognizing income taxes in an organization in accordance withFASB Statement No. 109 by providing detailed guidance for financial statementrecognition, measurement and disclosure involving uncertain tax positions.  FIN 48 requires an uncertain tax position tomeet a more-likely-than-not recognition threshold at the effective date to berecognized both upon the adoption of FIN 48 and in subsequent periods.  FIN 48 is effective for fiscal yearsbeginning after December 15, 2006.  Asthe provisions of FIN 48 will be applied to all tax positions upon initialadoption, the cumulative effect of applying the provisions of FIN 48 will bereported as an adjustment to the opening balance of retained earnings for thatfiscal year.  As a result of the adoptionof FIN 48, the Company recorded a $2.9 million increase in the liability forunrecognized tax benefits resulting in a decrease to the January 1, 2007retained earnings balance of $2.9 million (for additional information on theadoption of FIN 48, see NOTE 9 — INCOME TAXES in the accompanying Notesto Condensed Consolidated Financial Statements in this quarterly report on Form10-Q).

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InSeptember 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”)No. 157, “Fair-Value Measurements” (“SFAS 157”) which defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles and expands disclosures about fair-value measurements.SFAS 157 is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007. The Company is currently reviewing SFAS 157and has not yet determined the impact on its consolidated financial statements.

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities — Including an Amendment of FASBStatement No. 115,” (“SFAS 159”) which is effective for fiscal years beginningafter November 15, 2007. SFAS 159 permits an entity to choose to measure manyfinancial instruments and certain other items beginning at fair value atspecified election dates. Subsequent unrealized gains and losses on items forwhich the fair value option has been elected will be reported in earnings. TheCompany is currently reviewing SFAS 159 and has not yet determined the impact,if any, on its consolidated financial statements.

**ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURE ABOUT MARKET RISK**

We are exposed tomarket risk for changes in the market values of our investments (“InvestmentRisk”) and the impact of interest rate changes (“Interest Rate Risk”).  We have not used derivative financialinstruments in our investment portfolio. The quantitative and qualitative disclosures about market risk are setforth below.

**InvestmentRisk**

As of June 30, 2007, our total holdings in equitysecurities of other companies, including equity-method investments andavailable-for-sale securities, were $51.3 million.  Of this amount, we had equity-methodinvestments of $48.2 million and publicly traded equity securities(available-for-sale securities) at fair value totaling $2.9 million ($2.2million that was included in “Marketable securities” and $0.7 million that wasincluded in “Investments and other assets”). The fair values of these investments are subject to significantfluctuations due to volatility of the stock market and changes in generaleconomic conditions.  Based on the fairvalue of the publicly traded equity securities we held at June 30, 2007,an assumed 25%, 40% and 50% adverse change in the market prices of thesesecurities would result in a corresponding decline in total fair value ofapproximately $0.7 million, $1.1 million and $1.4 million, respectively.

We regularlyreview the carrying value of our investments and identify and recognize losses,for income statement purposes, when events and circumstances indicate that anydeclines in the fair values of such investments, below our accounting basis,are other than temporary.

**Interest Rate Risk**

Our exposure tointerest rate risk relates primarily to our non-equity investmentportfolio.  Our cash is invested inA-rated money market mutual funds, short-term securities and auction ratesecurities. Consequently, our interest rate and principal risk are minimal.

During 2004, webegan investing excess cash in U.S. Treasury securities classified asavailable-for-sale securities, with no security having a maturity in excess oftwo years.  These securities are exposedto interest rate fluctuations.  Becauseof the short-term nature of these investments, we are subject to minimalinterest rate risk and do not believe that an increase in market rates wouldhave a significant negative impact on the realized value of our portfolio.

Based on quotedmarket rates of interest and maturity schedules for similar debt issues, weestimate that the fair values of our CODES, our 2006 Credit Facility and ourother notes payable approximated their carrying values on June 30, 2007.  While changes in market interest rates mayaffect the fair value of our fixed-rate debt, we believe the effect, if any, ofreasonably possible near-term changes in the fair value of such debt on ourfinancial condition, results of operations or cash flows will not be material.

At this time, weare not party to any interest rate or derivative hedging contracts and have nomaterial foreign exchange or commodity price risks.

We do not believethat inflation has had a significant impact on our revenues or operations.

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**ITEM4.  CONTROLS AND PROCEDURES**

TheCompany maintains disclosure controls and procedures that are designed toensure that information required to be disclosed in the Company’s Exchange Actreports is recorded, processed, summarized and reported within the time periodsspecified in the U.S. Securities and Exchange Commission’s (“SEC’s”) rules andforms, and that such information is accumulated and communicated to the Company’smanagement, including its Principal Executive Officer and Principal Financial Officer,as appropriate, to allow timely decisions regarding required disclosure.  In designing and evaluating the disclosurecontrols and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.  Also, the Company has investments in certainunconsolidated entities.  As the Companydoes not control or manage these entities, its disclosure controls andprocedures with respect to such entities are necessarily substantially morelimited than those it maintains with respect to its consolidated subsidiaries.

Asrequired by SEC Rule 13a-15(b), the Company carried out an evaluation, underthe supervision and with the participation of the Company’s management,including the Company’s Principal Executive Officer and Principal FinancialOfficer, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures as of the end of the quarter covered by thisReport. Based on the foregoing, the Company’s Principal Executive Officer andPrincipal Financial Officer concluded that the Company’s disclosure controlsand procedures were effective.

Therehave been no changes in the Company’s internal control over financialreporting, during the three months ended June 30, 2007, that has materiallyaffected, or is reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

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**PART II. OTHER INFORMATION AND SIGNATURES**

**ITEM1.  LEGAL PROCEEDINGS**

For information regarding legal proceedings, refer to “PARTI, ITEM 3. LEGAL PROCEEDINGS,” of our Annual Report on Form 10-K for the yearended December 31, 2006 and *Legal Matters*in NOTE 11 — CONTINGENCIES in the accompanying Notes to Condensed ConsolidatedFinancial Statements in this quarterly report on Form 10-Q.

**ITEM1A.  RISK FACTORS**

In addition to the other information set forth in thisreport, you should carefully consider the risk factors previously disclosed inItem 1A. to Part 1 of our Annual Report on Form 10-K for the year endedDecember 31, 2006. There were no material changes from these risk factorsduring the six months ended June 30, 2007.

**ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS**

**(a) Recent Sales of UnregisteredSecurities**

There were nounregistered sales of equity securities.

**(b) Use of Proceeds**

N/A.

**(c) Issuer Purchases ofEquity Securities**

On February 15, 2006, theCompany’s Board of Directors authorized the expenditure of $300.0 million torepurchase shares of the Company’s outstanding common stock (the “2006Repurchase Program”).

No common stock was repurchased under the 2006 Repurchase Program whichexpired on February 15, 2007.

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**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

At our AnnualMeeting of Stockholders held on May 4, 2007, the following proposals were setbefore the stockholders for their vote:
| Proposal 1. |   | To elect three persons as Class III Directors  to a three-year term and until their successors are duly elected and  qualified. |
|-------------|--------|--------------------------------------------------------------------------------------------------------------------------------------|

 
|                                           | ** ** | **Allen**           | ** ** | **Michel J.** | ** ** | **Fred G.** | ** ** |
|-------------------------------------------|------------|---------------------|------------|--------------------|------------|------------------|------------|
| ** **                                | ** ** | **Chao, Ph.D** | ** ** | **Feldman**        | ** ** | **Weiss**        | ** ** |
| *Votes “For”*                   |       | 83,716,117          |       | 82,841,913         |       | 84,256,241       |       |
| *Votes to “Withhold Authority”* |       | 4,896,520           |       | 5,770,724          |       | 4,356,396        |       |

 

The terms of thefollowing directors continued after the annual meeting:
|                    | ** ** | **Expiration**   | ** ** |
|--------------------|------------|------------------|------------|
| **Class I**   | ** ** | **of Term** | ** ** |
| Michael J. Fedida  |       | 2008             |       |
| Albert F. Hummel   |       | 2008             |       |
| Catherine M. Klema |       | 2008             |       |

 
| Class II         | ** ** | ** ** | ** ** |
|------------------|------------|------------|------------|
| Jack Michelson   |       | 2009       |       |
| Ronald R. Taylor |       | 2009       |       |
| Andrew L. Turner |       | 2009       |       |

 
| Proposal 2. |   | To approve the Second Amendment and Restatement of  the 2001 Incentive Award Plan of Watson Pharmaceuticals, Inc.,:                                                                                      |
|-------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                     |
|        |   | Votes *“For”*—  81,783,251 shares  Votes *“Against”*— 5,922,120  shares  Votes *“Abstained”*— 907,266  shares Broker  “Non-Vote*”*— 0 shares |

 
| Proposal 3. |   | To ratify of the appointment of  PricewaterhouseCoopers LLP as the Company’s independent auditor for the year  ending December 31, 2007:                                                         |
|-------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                  |
|        |   | Votes *“For”*—  87,205,011 shares  Votes *“Against”*— 798,070 shares  Votes *“Abstained”*— 609,557  shares Broker  “Non-Vote*”*— 0 shares |

 

**ITEM 6.  EXHIBITS**

(a)Exhibits:

Reference is hereby made to the Exhibit Index on page 42.

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**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.
|                            | ** ** | **WATSON  PHARMACEUTICALS, INC.**                               |
|----------------------------|------------|-----------------------------------------------------------------|
| ** **                 | ** ** | **(Registrant)**                                                |
| ** **                 | ** ** | ** **                                                      |
|                       | By:        |                                                            | **/s/ R.  Todd Joyce** |
|                       |       | R. Todd Joyce                                                   |
|                       |       | Vice President —  Corporate Controller and Treasurer       |
|                       |       |                                                            |
|                       |       | (Principal  Financial Officer and Principal Accounting Officer) |
|                       |       |                                                            |
|                       |       |                                                            |
| Date:  August 6, 2007 |       |                                                            |
|                            |            |                                                                 |  |

 

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**WATSON PHARMACEUTICALS, INC.**

**EXHIBIT INDEX TO FORM 10-QFor the Quarterly Period Ended June 30, 2007**
| Exhibit  No. | ** ** | **Description**                                                                                                                            |
|--------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------|
| ** **   | ** ** | ** **                                                                                                                                 |
| 31.1         |       | Certification of Chairman and Chief Executive  Officer pursuant to Rule 13a-14a of the Securities Exchange Act of 1934.                    |
|         |       |                                                                                                                                       |
| 31.2         |       | Certification of Executive Vice President and Chief  Financial Officer pursuant to Rule 13a-14a of the Securities Exchange Act of  1934.   |
|         |       |                                                                                                                                       |
| 32.1         |       | Certification of Chairman and Chief Executive  Officer pursuant to Rule 13a-14(d) of the Securities Exchange Act of 1934.                  |
|         |       |                                                                                                                                       |
| 32.2         |       | Certification of Executive Vice President and Chief  Financial Officer pursuant to Rule 13a-14(d) of the Securities Exchange Act  of 1934. |

 

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