**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM 10-Q**

 

----

 

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

 

**FORTHE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003**

 

**or**

 

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

 

**For the transitionperiod from                to                **

 

**Commissionfile number 0-20045**

 

----

 

**WATSON PHARMACEUTICALS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Nevada**                                                      |   | **95-3872914**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification No.) |
|                                                            |
| **311 Bonnie Circle  Corona, CA  92880-2882**              |
| (Address of principal executive offices,  including zip code)   |
|                                                            |
| **(909) 493-5300**                                              |
| (Registrant’s telephone number, including  area code)      |

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.   Yes ý   No o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).  Yes ý  No o

 

The number of shares outstanding of the Registrant’s only class ofcommon stock as of October 31, 2003 was approximately 107,953,740.

 

 

----

 

**WATSON PHARMACEUTICALS, INC.**

**TABLE OF CONTENTS**

**FORM 10-Q FOR THE QUARTERLY PERIOD ENDEDSEPTEMBER 30, 2003**

 
| **Part I. FINANCIAL INFORMATION**                                                                          |
|------------------------------------------------------------------------------------------------------------|
|                                                                                                       |
| Item  1.  Condensed Consolidated Financial  Statements:                                               |
|                                                                                                       |
|                                                                                                       | Condensed Consolidated Balance Sheets as  of September 30, 2003 and December 31, 2002 |
|                                                                                                       |   |
|                                                                                                       | Condensed Consolidated Statements  of Income for the Three and Nine Months Ended September 30, 2003 and  2002 |
|                                                                                                       |   |
|                                                                                                       | Condensed Consolidated  Statements of Cash Flows for the Nine Months Ended September 30, 2003  and 2002 |
|                                                                                                       |   |
|                                                                                                       | 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 6.  Exhibits and Reports on Form 8-K                                                             |
|                                                                                                       |
| Signatures                                                                                                 |

 

----

 

**WATSONPHARMACEUTICALS, INC.**

**CONDENSED CONSOLIDATED BALANCESHEETS**

**(Unaudited;in thousands, except share amounts)**

 
|                                                                                                                      |   | **September 30,  2003** |      | **December 31,  2002** |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|-----------|-----------------------------|--------|
| **ASSETS**                                                                                                                |   |                         |      |                        |   |
| Current assets:                                                                                                           |   |                         |      |                        |   |
| Cash and cash equivalents                                                                                                 |   | $                            | 610,018   |                        | $      | 230,155 |   |
| Marketable securities                                                                                                     |   | 40,653                       |      | 42,649                      |   |
| Accounts receivable, net                                                                                                  |   | 122,255                      |      | 178,563                     |   |
| Inventories                                                                                                               |   | 399,588                      |      | 348,773                     |   |
| Prepaid expenses and other current assets                                                                                 |   | 29,967                       |      | 35,895                      |   |
| Deferred tax assets                                                                                                       |   | 89,259                       |      | 77,416                      |   |
| Total current assets                                                                                                      |   | 1,291,740                    |      | 913,451                     |   |
|                                                                                                                      |   |                         |      |                        |   |
| Property and equipment, net                                                                                               |   | 384,620                      |      | 304,667                     |   |
| Investments and other assets                                                                                              |   | 72,623                       |      | 75,435                      |   |
| Deferred tax assets                                                                                                       |   | 31,478                       |      | 34,596                      |   |
| Product rights and other intangibles, net                                                                                 |   | 1,014,059                    |      | 889,027                     |   |
| Goodwill                                                                                                                  |   | 446,288                      |      | 446,288                     |   |
| Total assets                                                                                                              |   | $                            | 3,240,808 |                        | $      | 2,663,464 |   |
|                                                                                                                      |   |                         |      |                        |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                             |   |                         |      |                        |   |
| Current liabilities:                                                                                                      |   |                         |      |                        |   |
| Accounts payable and accrued expenses                                                                                     |   | $                            | 209,703   |                        | $      | 172,363 |   |
| Income taxes payable                                                                                                      |   | 131,257                      |      | 111,565                     |   |
| Current portion of long-term debt                                                                                         |   | —                       |      | 83,360                      |   |
| Deferred revenue                                                                                                          |   | 10,965                       |      | 8,177                       |   |
| Total current liabilities                                                                                                 |   | 351,925                      |      | 375,465                     |   |
|                                                                                                                      |   |                         |      |                        |   |
| Long-term debt                                                                                                            |   | 722,427                      |      | 331,877                     |   |
| Deferred revenue                                                                                                          |   | 15,217                       |      | —                      |   |
| Other long-term liabilities                                                                                               |   | 9,938                        |      | 5,948                       |   |
| Deferred tax liabilities                                                                                                  |   | 145,494                      |      | 151,890                     |   |
| Total liabilities                                                                                                         |   | 1,245,001                    |      | 865,180                     |   |
|                                                                                                                      |   |                         |      |                        |   |
| Commitments and contingencies                                                                                             |   |                         |      |                        |   |
|                                                                                                                      |   |                         |      |                        |   |
| Stockholders’ equity:                                                                                                |   |                         |      |                        |   |
| Preferred stock; no par value per share; 2,500,000  shares authorized; none issued                                        |   | —                       |      | —                      |   |
| Common stock; $0.0033 par value per share;  500,000,000 shares authorized; 107,933,504 and 106,878,900 shares outstanding |   | 356                          |      | 353                         |   |
| Additional paid-in capital                                                                                                |   | 828,018                      |      | 797,097                     |   |
| Retained earnings                                                                                                         |   | 1,148,853                    |      | 998,850                     |   |
| Accumulated other comprehensive income                                                                                    |   | 18,580                       |      | 1,984                       |   |
| Total stockholders’ equity                                                                                           |   | 1,995,807                    |      | 1,798,284                   |   |
| Total liabilities and stockholders’ equity                                                                           |   | $                            | 3,240,808 |                        | $      | 2,663,464 |   |

 

*Seeaccompanying Notes to Condensed Consolidated Financial Statements.*

 

1

----

 

**WATSON PHARMACEUTICALS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

**(Unaudited; in thousands, except per shareamounts)**

 
|                                          |   | **Three Months Ended  September 30,** |    | **Nine Months Ended  September 30,** |       |
|-----------------------------------------------|--------|--------------------------------------------|---------|-------------------------------------------|------------|
|                                          |   | **2003**                                   |    | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                          |   |                                       |    |                                      |       |   |   |   |   |
| Net revenues                                  |   | $                                          | 358,756 |                                      | $          | 307,860 |   | $ | 1,051,558 |   | $ | 893,624 |   |
| Cost of sales                                 |   | 142,331                                    |    | 143,925                                   |       | 446,308 |   | 417,698 |   |
| Gross profit                                  |   | 216,425                                    |    | 163,935                                   |       | 605,250 |   | 475,926 |   |
|                                          |   |                                       |    |                                      |       |   |   |   |   |
| Operating expenses:                           |   |                                       |    |                                      |       |   |   |   |   |
| Research and development                      |   | 26,428                                     |    | 22,387                                    |       | 74,613 |   | 60,675 |   |
| Selling, general and administrative           |   | 87,547                                     |    | 56,149                                    |       | 227,420 |   | 178,046 |   |
| Amortization of intangibles                   |   | 17,820                                     |    | 16,176                                    |       | 54,040 |   | 44,012 |   |
| Total operating expenses                      |   | 131,795                                    |    | 94,712                                    |       | 356,073 |   | 282,733 |   |
| Operating income                              |   | 84,630                                     |    | 69,223                                    |       | 249,177 |   | 193,193 |   |
|                                          |   |                                       |    |                                      |       |   |   |   |   |
| Other income (expense):                       |   |                                       |    |                                      |       |   |   |   |   |
| Equity in earnings (losses) of joint ventures |   | (68                                        | )       | (1,945                                    | )          | 137 |   | (3,759 | ) |
| Impairment of securities                      |   | (1,605                                     | )       | —                                    |       | (15,865 | ) | — |   |
| Gain on sale of securities                    |   | 2,496                                      |    | —                                    |       | 5,510 |   | — |   |
| Gain on sale of subsidiary                    |   | —                                     |    | —                                    |       | 15,676 |   | — |   |
| Gain from legal settlement                    |   | —                                     |    | —                                    |       | — |   | 32,000 |   |
| Loss on early extinguishment of debt          |   | —                                     |    | —                                    |       | (2,807 | ) | — |   |
| Interest income                               |   | 1,603                                      |    | 1,869                                     |       | 4,287 |   | 5,146 |   |
| Interest expense                              |   | (5,980                                     | )       | (5,747                                    | )          | (18,901 | ) | (16,690 | ) |
| Other income (expense)                        |   | (293                                       | )       | 776                                       |       | (1,731 | ) | 791 |   |
| Total other income (expense), net             |   | (3,847                                     | )       | (5,047                                    | )          | (13,694 | ) | 17,488 |   |
|                                          |   |                                       |    |                                      |       |   |   |   |   |
| Income before income taxes                    |   | 80,783                                     |    | 64,176                                    |       | 235,483 |   | 210,681 |   |
| Provision for income taxes                    |   | 29,324                                     |    | 23,519                                    |       | 85,480 |   | 77,983 |   |
| Net income                                    |   | $                                          | 51,459  |                                      | $          | 40,657 |   | $ | 150,003 |   | $ | 132,698 |   |
|                                          |   |                                       |    |                                      |       |   |   |   |   |
| Earnings per share:                           |   |                                       |    |                                      |       |   |   |   |   |
| Basic                                         |   | $                                          | 0.48    |                                      | $          | 0.38 |   | $ | 1.40 |   | $ | 1.24 |   |
| Diluted                                       |   | $                                          | 0.47    |                                      | $          | 0.38 |   | $ | 1.38 |   | $ | 1.24 |   |
|                                          |   |                                       |    |                                      |       |   |   |   |   |
| Weighted average shares outstanding:          |   |                                       |    |                                      |       |   |   |   |   |
| Basic                                         |   | 107,762                                    |    | 106,784                                   |       | 107,282 |   | 106,590 |   |
| Diluted                                       |   | 109,658                                    |    | 107,199                                   |       | 108,459 |   | 107,284 |   |

 

*See accompanying Notes to Condensed ConsolidatedFinancial Statements.*

 

2

----

 

**WATSON PHARMACEUTICALS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited; in thousands)

 
|                                                              |   | **Nine Months Ended  September 30,** |    |
|-------------------------------------------------------------------|--------|-------------------------------------------|---------|
|                                                              |   | **2003**                                  |    | **2002** |   |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                        |   |                                      |    |   |   |
| Net income                                                        |   | $                                         | 150,003 |   | $ | 132,698 |   |
| Reconciliation to net cash provided by operating  activites:      |   |                                      |    |   |   |
| Depreciation                                                      |   | 20,683                                    |    | 18,900 |   |
| Amortization                                                      |   | 54,040                                    |    | 44,012 |   |
| Deferred income tax benefit                                       |   | (15,460                                   | )       | (4,691 | ) |
| Equity in (earnings) losses of joint ventures                     |   | (137                                      | )       | 3,467 |   |
| Gain on sale of securities                                        |   | (5,510                                    | )       | — |   |
| Gain on sale of subsidiary                                        |   | (15,676                                   | )       | — |   |
| Loss on early extinguishment of debt                              |   | 2,807                                     |    | — |   |
| Charge for impairment of securities                               |   | 15,865                                    |    | — |   |
| Tax benefits related to exercises of stock options                |   | 4,750                                     |    | 1,240 |   |
| Other                                                             |   | (826                                      | )       | 977 |   |
| Changes in assets and liabilities:                                |   |                                      |    |   |   |
| Accounts receivable                                               |   | 54,112                                    |    | (8,095 | ) |
| Inventories                                                       |   | (51,789                                   | )       | (31,826 | ) |
| Prepaid expenses and other current assets                         |   | 5,891                                     |    | 5,945 |   |
| Accounts payable and accrued expenses                             |   | 40,332                                    |    | 12,759 |   |
| Deferred revenue                                                  |   | 18,005                                    |    | (227 | ) |
| Income taxes payable                                              |   | 19,713                                    |    | 97,181 |   |
| Other assets                                                      |   | (933                                      | )       | 9,892 |   |
| Other liabilities                                                 |   | 2,057                                     |    | — |   |
| Total adjustments                                                 |   | 147,924                                   |    | 149,534 |   |
| Net cash provided by operating activities                         |   | 297,927                                   |    | 282,232 |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                        |   |                                      |    |   |   |
| Additions to property and equipment                               |   | (104,542                                  | )       | (56,220 | ) |
| Acquisitions of product rights                                    |   | (179,303                                  | )       | (121,152 | ) |
| Proceeds from sales of securities                                 |   | 12,122                                    |    | — |   |
| Proceeds from sale of subsidiary                                  |   | 16,368                                    |    | — |   |
| Distributions from equity investments                             |   | 13,500                                    |    | — |   |
| Other investing activities, net                                   |   | 3,944                                     |    | 1,292 |   |
| Net cash used in investing activities                             |   | (237,911                                  | )       | (176,080 | ) |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                        |   |                                      |    |   |   |
| Proceeds from issuance of debt, net of issuance  costs of $14,375 |   | 560,625                                   |    | — |   |
| Proceeds from borrowings under revolving credit  facility         |   | 60,000                                    |    | — |   |
| Principal payments on credit facility                             |   | (325,940                                  | )       | (48,581 | ) |
| Principal payments on acquisition liabilities                     |   | (1,012                                    | )       | (7,070 | ) |
| Proceeds from stock plans                                         |   | 26,174                                    |    | 4,803 |   |
| Net cash provided by (used in) financing  activities              |   | 319,847                                   |    | (50,848 | ) |
| Net increase in cash and cash equivalents                         |   | 379,863                                   |    | 55,304 |   |
| Cash and cash equivalents at beginning of period                  |   | 230,155                                   |    | 193,731 |   |
| Cash and cash equivalents at end of period                        |   | $                                         | 610,018 |   | $ | 249,035 |   |

 

*See accompanying Notes to Condensed Consolidated FinancialStatements.*

 

3

----

 

**WATSONPHARMACEUTICALS, INC.**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE A – GENERAL**

 

Watson Pharmaceuticals, Inc. (Watson or the Company) is primarilyengaged in the development, manufacture, marketing, sale and distribution ofbranded and off-patent (generic) pharmaceutical products. The Company alsodevelops advanced drug delivery systems designed to enhance the therapeuticbenefits of existing drug forms.  Watsonoperates manufacturing, distribution, research and development andadministrative facilities primarily in the United States of America.

 

The accompanying condensed consolidated financial statements should beread in conjunction with the Company’s Annual Report on Form 10-K for theyear ended December 31, 2002. Certain information and footnote disclosures normally included in annualfinancial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted from the accompanying consolidatedfinancial statements.  The year endbalance sheet was derived from the audited financial statements.  The accompanying interim financialstatements are unaudited, but reflect all adjustments which are, in the opinionof management, necessary to present fairly Watson’s consolidated financialposition, results of operations and cash flows for the periods presented.  Unless otherwise noted, all such adjustmentsare of a normal, recurring nature. Certain reclassifications, none of which affected net income or retainedearnings, have been made to prior period amounts to conform to current periodpresentation.  The Company’s results ofoperations and cash flows for the interim periods are not necessarilyindicative of the results of operations and cash flows that it may achieve infuture periods or for the full year.

 

*Comprehensive income*

 

Comprehensive income includes all changes in equity during a periodexcept those that resulted from investments by or distributions to theCompany’s stockholders.  Othercomprehensive income refers to revenues, expenses, gains and losses that, undergenerally accepted accounting principles, are included in comprehensive income,but excluded from net income as these amounts are recorded directly as anadjustment to stockholders’ equity. Watson’s other comprehensive income (loss) is comprised of unrealized gains(losses) on its holdings of publicly traded equity securities, net of realizedgains included in net income.  Thecomponents of comprehensive income and related income taxes consisted of thefollowing (in thousands):

 
|                                                        |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |       |
|-------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|------------|
|                                                        |   | **2003**                                   |   | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                        |   |                                       |   |                                      |       |   |   |   |   |
| Net income                                                  |   | $                                          | 51,459 |                                      | $          | 40,657 |   | $ | 150,003 |   | $ | 132,698 |   |
|                                                        |   |                                       |   |                                      |       |   |   |   |   |
| Other comprehensive income (loss):                          |   |                                       |   |                                      |       |   |   |   |   |
| Unrealized holding gain (loss) on securities                |   | 1,598                                      |   | (16,368                                   | )          | 16,670 |   | (84,049 | ) |
| Less related income taxes                                   |   | (641                                       | )      | 6,547                                     |       | (6,670 | ) | 33,620 |   |
| Total unrealized gain (loss) on securities, net             |   | 957                                        |   | (9,821                                    | )          | 10,000 |   | (50,429 | ) |
|                                                        |   |                                       |   |                                      |       |   |   |   |   |
| Reclassification for (gains) losses included in  net income |   | (891                                       | )      | —                                    |       | 10,355 |   | — |   |
| Less related income taxes                                   |   | 323                                        |   | —                                    |       | (3,759 | ) | — |   |
| Total reclassification, net                                 |   | (568                                       | )      | —                                    |       | 6,596 |   | — |   |
| Total other comprehensive income (loss)                     |   | 389                                        |   | (9,821                                    | )          | 16,596 |   | (50,429 | ) |
| Total comprehensive income                                  |   | $                                          | 51,848 |                                      | $          | 30,836 |   | $ | 166,599 |   | $ | 82,269 |   |

 

4

----

 

*Earnings per share*

 

Basic earnings per share is computed by dividing net income by theweighted average common shares outstanding. Diluted earnings per share is based on the treasury stock method and iscomputed by dividing net income by the weighted average number of common sharesand dilutive potential common shares outstanding, assuming the exercise of allin-the-money stock options. A reconciliation of the numerators and denominatorsof basic and diluted earnings per share consisted of the following (inthousands, except per share amounts):

 
|                                               |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|----------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                               |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
|                                               |   |                                       |   |                                      |   |   |   |   |   |
| **Numerator:**                                     |   |                                       |   |                                      |   |   |   |   |   |
| Net income                                         |   | $                                          | 51,459 |                                      | $      | 40,657 |   | $ | 150,003 |   | $ | 132,698 |   |
| **Denominator:**                                   |   |                                       |   |                                      |   |   |   |   |   |
| Basic weighted average common shares outstanding   |   | 107,762                                    |   | 106,784                                   |   | 107,282 |   | 106,590 |   |
| Effect of dilutive stock options                   |   | 1,896                                      |   | 415                                       |   | 1,177 |   | 694 |   |
| Diluted weighted average common shares outstanding |   | 109,658                                    |   | 107,199                                   |   | 108,459 |   | 107,284 |   |
|                                               |   |                                       |   |                                      |   |   |   |   |   |
| **Basic earnings per share**                       |   | $                                          | 0.48   |                                      | $      | 0.38 |   | $ | 1.40 |   | $ | 1.24 |   |
|                                               |   |                                       |   |                                      |   |   |   |   |   |
| **Diluted earnings per share**                     |   | $                                          | 0.47   |                                      | $      | 0.38 |   | $ | 1.38 |   | $ | 1.24 |   |

 

Excluded from the computation of diluted earnings per share are outstandingcommon stock options with an exercise price greater than the average marketprice of the common shares for the period reported.  For the three month periods ended September 30, 2003 and2002, excluded from the computation of diluted earnings per share were stockoptions to purchase 4.4 million and 10.8 million common shares, respectively.For the nine month periods ended September 30, 2003 and 2002, excludedfrom the computation of diluted earnings per share were stock options topurchase 6.3 million and 10.4 million common shares, respectively.

 

The effect of approximately 14.4 million shares related to the assumedconversion of the $575 million convertible contingent debentures (as describedin Note I) has been excluded from the computation of diluted earnings per sharefor the three and nine month periods ended September 30, 2003 as theconditions that would permit conversion have not been satisfied.

 

*Stock-basedcompensation*

 

The Company accounts for its stock-based employee compensation plans usingthe recognition and measurement principles of Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees” and relatedinterpretations.  No stock-basedemployee compensation expense has been recognized for the options in theaccompanying condensed consolidated statements of income, as all optionsgranted under the plans had an exercise price equal to the market value of theunderlying common stock on the date of grant.

 

5

----

 

Had the Company determined compensation expense for all prior periodsusing the fair value method prescribed by Statement of Financial AccountingStandards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” theCompany’s net income and earnings per share would have been as follows (inthousands, except per share amounts):

 
|                                                                                                     |   | **Three Months Ended  September 30,** |   | **Nine Months Ended  September 30,** |   |
|----------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                     |   | **2003**                                   |   | **2002**                                  |   | **2003** |   | **2002** |   |
|                                                                                                     |   |                                       |   |                                      |   |   |   |   |   |
| Net income                                                                                               |   | $                                          | 51,459 |                                      | $      | 40,657 |   | $ | 150,003 |   | $ | 132,698 |   |
| Total stock-based employee compensation expense  determined under fair value based method for all awards |   | 8,525                                      |   | 11,230                                    |   | 22,942 |   | 36,323 |   |
| Tax effect of compensation expense                                                                       |   | (3,095                                     | )      | (4,116                                    | )      | (8,328 | ) | (13,445 | ) |
| Pro forma net income                                                                                     |   | $                                          | 46,029 |                                      | $      | 33,543 |   | $ | 135,389 |   | $ | 109,820 |   |
|                                                                                                     |   |                                       |   |                                      |   |   |   |   |   |
| Earnings per share:                                                                                      |   |                                       |   |                                      |   |   |   |   |   |
| Basic - as reported                                                                                      |   | $                                          | 0.48   |                                      | $      | 0.38 |   | $ | 1.40 |   | $ | 1.24 |   |
| Basic - pro forma                                                                                        |   | $                                          | 0.43   |                                      | $      | 0.31 |   | $ | 1.26 |   | $ | 1.03 |   |
|                                                                                                     |   |                                       |   |                                      |   |   |   |   |   |
| Diluted - as reported                                                                                    |   | $                                          | 0.47   |                                      | $      | 0.38 |   | $ | 1.38 |   | $ | 1.24 |   |
| Diluted - pro forma                                                                                      |   | $                                          | 0.42   |                                      | $      | 0.31 |   | $ | 1.25 |   | $ | 1.02 |   |
|                                                                                                     |   |                                       |   |                                      |   |   |   |   |   |
| Weighted average shares outstanding:                                                                     |   |                                       |   |                                      |   |   |   |   |   |
| Basic                                                                                                    |   | 107,762                                    |   | 106,784                                   |   | 107,282 |   | 106,590 |   |
| Diluted                                                                                                  |   | 109,658                                    |   | 107,199                                   |   | 108,459 |   | 107,284 |   |

 

The weighted average fair value of the options has been estimated onthe date of grant using the Black-Scholes option-pricing model.  Weighted averages are used because ofvarying assumed exercise dates.  Thefollowing weighted average assumptions were used for options granted during thethree and nine months ended September 30, 2003 and 2002:

 

|                    |   | **2003**  |   | **2002**  |   |
|-------------------------|--------|-----------|--------|-----------|--------|
|                    |   |      |   |      |   |
| Dividend yield          |   | None      |   | None      |   |
| Expected volatility     |   | 38        | %      | 38        | %      |
| Risk-free interest rate |   | 3.38      | %      | 4.21      | %      |
| Expected term           |   | 5.3 years |   | 5.1 years |   |

 

*Recent accountingpronouncements*

 

In July 2002, the Financial Accounting Standards Board (FASB)issued SFAS No. 146, “Accounting for Costs Associated with Exit or DisposalActivities.”  SFAS No. 146 requiresrecognition of a liability for a cost associated with an exit or disposalactivity when the liability is incurred, as opposed to when the entity commitsto an exit plan as provided under previous guidance. This statement iseffective for exit or disposal activities initiated after December 31,2002. The Company adopted SFAS No. 146 on January 1, 2003, which had nomaterial impact on the Company’s condensed consolidated financial statements.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting forStock-Based Compensation – Transition and Disclosure.”  SFAS No. 148 amends SFAS No. 123,“Accounting for Stock-Based

 

6

----

 

Compensation,” to provide alternative methods of transition for avoluntary change to the fair value based method of accounting for stock-basedemployee compensation.  In addition,SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to requireprominent disclosures in both annual and interim financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results. The Company adopted SFAS No. 148 on January 1, 2003, which had nomaterial impact on the Company’s condensed consolidated financial statements.

 

InJanuary 2003, the FASB issued Interpretation No. (FIN) 46, “Consolidationof Variable Interest Entities” an interpretation of Accounting ResearchBulletin No. 51, “Consolidated Financial Statements.”  FIN 46 addresses consolidation by business enterprises ofvariable interest entities (VIE).  Undercurrent practice, consolidation occurs when one enterprise controls the otherthrough voting interests.  FIN 46explains how to identify VIE and how an enterprise assesses its interest in VIEto decide whether to consolidate the VIE. FIN 46 requires existing unconsolidated VIE to be consolidated by theirprimary beneficiaries if the entities do not effectively disperse risks amongthe parties involved.  VIE thateffectively disperse risks will not be consolidated unless a single party holdsan interest or combination of interests that effectively recombines risks thatwere previously dispersed.  FIN 46applies immediately to VIE created after January 31, 2003 and to VIE inwhich an enterprise obtains an interest after that date.  It applies in the first interim periodbeginning after December 15, 2003 to VIE in which an enterprise holds avariable interest that it acquired before February 1, 2003.  The Company is in the process of identifyingour interest in VIE to determine which, if any such entities, requireconsolidation under FIN 46.  If we determinewe should consolidate these entities, we would recognize certain assets anddebt on our condensed consolidated balance sheets and a cumulative adjustmentfor the accounting change in our condensed consolidated statements of income.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment ofStatement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149amends and clarifies accounting for derivative instruments, including certainderivative instruments embedded in other contracts, and for hedging activitiesunder SFAS No. 133. SFAS No. 149 is generally effective for contracts enteredinto or modified after June 30, 2003 (with a few exceptions) and forhedging relationships designated after June 30, 2003. The guidance is to beapplied prospectively.  The Companyadopted SFAS No. 149 on June 30, 2003, which had no material impact on itscondensed consolidated financial statements.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of Both Liabilities and Equity.”SFAS No. 150 improves the accounting for certain financial instruments that,under previous guidance, issuers could account for as equity.  SFAS No. 150 requires that those instrumentsbe classified as liabilities in statements of financial position.  SFAS No. 150 is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning afterJune 15, 2003.  The Company adoptedSFAS No. 150 during the third quarter of 2003, which had no material impact onits condensed consolidated financial statements.

 

**NOTE B – ACQUISITIONSOF PRODUCT RIGHTS**

 

In February 2003, Watson acquired the U.S. rights to the Fioricetâand Fiorinalâ product lines from Novartis PharmaceuticalsCorporation (Novartis).  These productsare indicated for the treatment of tension headaches.  The Company paid approximately $178 million in cash for therights to these products.

 

7

----

** **

**NOTE C – EQUITYINVESTMENTS**

 

Watson’s equity investments in publicly traded companies are classifiedas available-for-sale and are recorded at fair value based on quoted marketprices using the specific identification method.  These investments are classified as either current ornon-current, as appropriate, on the Company’s Condensed Consolidated BalanceSheets.

 

*Current investments*

 

The Company’s current investments are comprised of the common stock ofAndrx Corporation – Andrx Group (Andrx), publicly traded on the Nasdaq StockMarket under the symbol ADRX, and Dr. Reddy’s Laboratories, Limited (Dr.Reddy), traded on the Bombay Stock Exchange. These investments are included in “Marketable securities” on theCompany’s Condensed Consolidated Balance Sheets at September 30, 2003 andDecember 31, 2002.

 

During the three and nine month periods ended September 30, 2003,Watson sold a portion of its shares of its Andrx and Dr. Reddy common stockinvestments.  The Company did not sellany of its shares of Andrx and Dr. Reddy during the nine month period endedSeptember 30, 2002.  The followingtable provides a summary of the Company’s sales of its Andrx and Dr. Reddyholdings during the periods reported. Realized gains are computed using the specific identification method todetermine the cost basis for each investment (in thousands except shareamounts):

 

|                |   | **Three Months  Ended  September 30, 2003** |       | **Nine Months  Ended  September 30, 2003** |       |
|---------------------|--------|--------------------------------------------------|------------|-------------------------------------------------|------------|
|                |   |                                             | ** ** |                                            | ** ** |
| *Andrx:*            |   |                                             |       |                                            |       |
| Shares sold         |   | 47,000                                           |       | 117,000                                         |       |
| Proceeds from sale  |   | $                                                | 1,004      |                                            | $          | 2,376 |   |
| Gross realized gain |   | $                                                | 875        |                                            | $          | 2,054 |   |
|                |   |                                             |       |                                            |       |
| *Dr. Reddy:*        |   |                                             |       |                                            |       |
| Shares sold         |   | 146,228                                          |       | 436,228                                         |       |
| Proceeds from sale  |   | $                                                | 3,729      |                                            | $          | 9,746 |   |
| Gross realized gain |   | $                                                | 1,621      |                                            | $          | 3,456 |   |

 

*Non-currentinvestments*

 

The Company’s non-currentinvestments include its investment in the common stock of GenelabsTechnologies, Inc. (Genelabs), NovaDel Pharma Inc., and Amarin Corporation plc(Amarin), and warrants to purchase shares of common stock of Halsey Drug Co.,Inc. (Halsey).  These investments areincluded in “Investments and other assets” on the Company’s CondensedConsolidated Balance Sheets at September 30, 2003 and December 31,2002.

 

8

----

 

The following table provides a summary of the fair value and unrealizedholding gain (loss) related to Watson’s available-for-sale securities (inthousands):

 

|                          |   | **September 30,  2003** |   | **December 31,  2002** | ** ** |
|-------------------------------|--------|------------------------------|--------|-----------------------------|------------|
|                          |   |                         |   |                        |       |
| Equity securities:            |   |                         |   |                        |       |
| Cost basis                    |   | $                            | 32,535 |                        | $          | 49,669 |   |
| Gross unrealized holding gain |   | 29,553                       |   | 24,530                      |       |
| Gross unrealized holding loss |   | (252                         | )      | (13,625                     | )          |
| Fair value of securities      |   | $                            | 61,836 |                        | $          | 60,574 |   |

 

Gross unrealized gains primarily relate to our holdings in shares ofAndrx and Dr. Reddy common stock.  Thegross unrealized holding loss at September 30, 2003 is attributable toadjustments, included in other comprehensive income, for the decline in fairvalue in the Company’s investment in Amarin. Additionally, the Company recorded $1.6 million asset impairment chargeduring the quarter on the Halsey warrants (as described in Note K).  As of September 30, 2003, the fairvalue of the Halsey warrants was $9.2 million. The gross unrealized holdingloss at December 31, 2002 is primarily attributable to the Company’sinvestment in Genelabs.

 

The Company’s net unrealized holding gain related to itsavailable-for-sale securities, increased $0.4 million and $16.6 million for thethree and nine month periods ended September 30, 2003, respectively.  During the three and nine month periodsended September 30, 2002, the Company’s net unrealized holding gaindecreased $9.8 million and $50.4 million, respectively.  These changes in the Company’s netunrealized holding gain are included in other comprehensive income.

 

**NOTE D – OPERATINGSEGMENTS**

 

Watson has two reportable operating segments: branded and genericpharmaceutical products.  The brandedproducts segment includes the Company’s lines of Women’s Health,Urology/General Products and Nephrology products. Watson has aggregated itsbranded product lines in a single segment because of similarities in regulatoryenvironment, manufacturing processes, methods of distribution and types ofcustomer.  This segment includespatent-protected products and trademarked generic products that Watson sellsand promotes directly to healthcare professionals as branded pharmaceuticalproducts.  The generic products segmentincludes off-patent pharmaceutical products that are therapeutically equivalentto proprietary products.  The Companysells its branded and generic products primarily to pharmaceutical wholesalers,drug distributors and chain drug stores.

 

The accounting policies of the segments are described in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2002.  Watson primarily evaluates the performanceof its segments based on net revenues and gross profit.  The “other” classification consistsprimarily of contingent payments received from the settlement of a legaldispute, profit sharing revenues, and revenues from research, development andlicensing fees.  The Company does notreport depreciation expense, total assets, and capital expenditures by segmentas such information is not used by management, or accounted for at the segmentlevel.  Net revenues and gross profitinformation for the Company’s segments consisted of the following (inthousands):

 

9

----

 
|                            |   | **Three Months Ended  September 30,** |    | **Nine Months Ended  September 30,** |       |
|---------------------------------|--------|--------------------------------------------|---------|-------------------------------------------|------------|
|                            |   | **2003**                                   |    | **2002**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
|                            |   |                                       |    |                                      |       |   |   |   |   |
| **Net revenues:**               |   |                                       |    |                                      |       |   |   |   |   |
| Branded pharmaceutical products |   | $                                          | 184,640 |                                      | $          | 162,359 |   | $ | 554,302 |   | $ | 479,913 |   |
| Generic pharmaceutical products |   | 154,208                                    |    | 136,291                                   |       | 458,674 |   | 387,383 |   |
| Other                           |   | 19,908                                     |    | 9,210                                     |       | 38,582 |   | 26,328 |   |
| Total net revenues              |   | $                                          | 358,756 |                                      | $          | 307,860 |   | $ | 1,051,558 |   | $ | 893,624 |   |
| **Gross profit:**               |   |                                       |    |                                      |       |   |   |   |   |
| Branded pharmaceutical products |   | $                                          | 143,907 |                                      | $          | 124,145 |   | $ | 428,644 |   | $ | 365,373 |   |
| Generic pharmaceutical products |   | 52,610                                     |    | 30,580                                    |       | 138,024 |   | 84,226 |   |
| Other                           |   | 19,908                                     |    | 9,210                                     |       | 38,582 |   | 26,328 |   |
| Total gross profit              |   | $                                          | 216,425 |                                      | $          | 163,935 |   | $ | 605,250 |   | $ | 475,927 |   |

 

**NOTE E – INVENTORIES**

 

Inventories consist of finished goods held for distribution, rawmaterials and work-in-process. At September 30, 2003, inventories includedapproximately $45.4 million of inventory, net of reserve, relating to productsthat are pending approval by the Food and Drug Administration (FDA) or have notbeen launched due to contractual restrictions.

 

Inventories are stated at the lower of cost (first-in, first-outmethod) or market (net realizable value) and consisted of the following (in thousands):

 

|              |   | **September 30,  2003** |    | **December 31,  2002** |   |
|-------------------|--------|------------------------------|---------|-----------------------------|--------|
|              |   |                         |    |                        |   |
| Raw materials     |   | $                            | 127,444 |                        | $      | 116,806 |   |
| Work-in-process   |   | 76,439                       |    | 80,062                      |   |
| Finished goods    |   | 195,705                      |    | 151,905                     |   |
| Total inventories |   | $                            | 399,588 |                        | $      | 348,773 |   |

 

**NOTE F – NOTERECEIVABLE**

 

As part of a strategic alliance, in March 2000, the Companyentered into a loan agreement with Halsey. The loan consisted of principal of $17.5 million and bore interest atprime plus 2% with a maturity date of March 31, 2003.  During December 2002, Watson and Halseyamended the terms of this loan agreement. As amended, the loan now consists of principal of $21.4 million andbears interest at prime plus 4.5% maturing on March 31, 2006.  In consideration for the amendment, Halseyissued to Watson warrants to purchase common stock.  The warrants were valued at fair value of $10.8 million and therelated carrying value of the note was reduced by the fair value of the warrants(See Note K).  As of September 30,2003, the book value of the note, net of reserve, was $10.0 million.  The note is collateralized by a first lienon all of Halsey’s assets and is senior to all other indebtedness incurred byHalsey.

 

Halsey’s ability to repay the note is dependent upon its ability toobtain funding for its ongoing operations. If Halsey is unable to obtain adequate funding to support itsoperations, it may cease to operate as a going concern.  If Halsey were to cease operations, recoveryof the net book value of the note would be dependent upon there beingsufficient net proceeds generated from the sale of the operating assets ofHalsey as Watson holds a first lien on all of Halsey’s assets.  The Company will continue to monitor Halsey’sactivities to ascertain the recoverability of the note balance.

 

10

----

** **

**NOTE G – ASSETS HELDFOR DISPOSITION**

 

In connection withthe acquisition of Schein Pharmaceutical, Inc. (Schein), Watson acquired twoinjectable pharmaceutical manufacturing facilities, Steris Laboratories, Inc.(Steris), located in Phoenix, Arizona and Marsam Pharmaceuticals, Inc.(Marsam), located in Cherry Hill, New Jersey. Upon acquisition, Watson intended to dispose of these facilities and,accordingly, these assets were reported as assets held for disposition in theCompany’s Condensed Consolidated Balance Sheets.  Watson recorded these assets held for disposition at estimatedfair value.  The operating expensesassociated with the facilities were recorded separately in the Company’sCondensed Consolidated Statements of Income as loss on assets held fordisposition.

 

AtDecember 31, 2002, the Company had approximately $6 million of propertyrelated to Marsam and approximately $22 million of inventories andapproximately $1 million of fixed assets related to Steris.

 

On January 1,2003 Watson reclassified its assets held for disposition as held and used.  This reclassification was made as a resultof the absence of a completed sale transaction or binding offer for either of thefacilities, in accordance with SFAS No. 144. The related assets were reclassified as inventories and property andequipment, as appropriate, in the Company’s Condensed Consolidated BalanceSheets.  For the three and nine monthsended September 30, 2002, $8.1 million and $21.8 million of operatingexpenses related to the Steris facility were reclassified to cost of sales,research and development expenses and selling, general and administrativeexpenses, as appropriate.

 

Although the assets were reclassified as held and used, the Companycontinues its efforts to dispose of the Marsam property and continues toevaluate divestiture or other alternatives related to the Steris facility.

 

**NOTE H – GOODWILL ANDOTHER INTANGIBLE ASSETS**

 

Watson tests itsgoodwill and intangible assets with indefinite lives by comparing the fairvalue of each of the Company’s reporting units to the respective carrying valueof the reporting units.  The Companyperforms this impairment testing annually during the second quarter or whenevents occur or circumstances change that would more likely than not reduce thefair value of a reporting unit below its carrying amount.  The Company’s reporting units have beenidentified by Watson as branded and generic pharmaceutical products.  The carrying value of each reporting unit isdetermined by assigning the assets and liabilities, including the existinggoodwill and intangible assets, to those reporting units.  Goodwill is considered impaired if the carryingamount exceeds the fair value of the asset.

 

During the secondquarter of 2003, Watson performed its annual test for the impairment ofgoodwill and determined there was no indication of impairment.  There were no additions to goodwill recordedduring the nine months ended September 30, 2003.  At September 30, 2003, goodwill for the Company’s reportingunits consisted of the following (in thousands):

 

| Branded pharmaceutical products |   | $      | 358,798 |   |
|---------------------------------|--------|--------|---------|--------|
| Generic pharmaceutical products |   | 87,490 |    |
| Total goodwill                  |   | $      | 446,288 |   |

 

11

----

 

Other intangible assets consist primarily ofproduct rights.  The original cost andaccumulated amortization of these intangible assets are as follows (inthousands):

 
|                                              |   | **September 30,  2003** |      | **December 31,  2002** |   |
|---------------------------------------------------|--------|------------------------------|-----------|-----------------------------|--------|
|                                              |   |                         |      |                        |   |
| Product rights and related intangibles            |   | $                            | 1,286,273 |                        | $      | 1,107,200 |   |
| Less accumulated amortization                     |   | (272,214                     | )         | (218,173                    | )      |
| Total product rights and related intangibles, net |   | $                            | 1,014,059 |                        | $      | 889,027 |   |

 

Assuming no additions, disposals oradjustments are made to the carrying values and/or useful lives of the assets,annual amortization expense on product rights and related intangibles isestimated to be approximately $71.7 million in 2003, $71.5 million in 2004 and$71.8 million in each of 2005, 2006 and 2007. The Company’s current product rights and related intangibles have aweighted average useful life of approximately 19 years.

 

**NOTEI – LONG-TERM DEBT**

Long-term debt consisted of the following (in thousands):

 
|                                                                                                         |   | **September 30,  2003** |    | **December 31,  2002** | ** ** |
|--------------------------------------------------------------------------------------------------------------|--------|------------------------------|---------|-----------------------------|------------|
|                                                                                                         |   |                         |    |                        |       |
| Senior unsecured notes, 7.125%, face amount of  $150 million, due 2008                                       |   | $                            | 149,142 |                        | $          | 149,023 |   |
| Term loan facility, due 2005                                                                                 |   | —                       |    | 265,928                     |       |
| Convertible contingent debentures, face amount of  $575 million due 2023, net of $1,772 unamortized discount |   | 573,228                      |    | —                      |       |
| Other notes payable                                                                                          |   | 57                           |    | 286                         |       |
| Total debt                                                                                                   |   | $                            | 722,427 |                        | $          | 415,237 |   |
| Less current portion                                                                                         |   | —                       |    | (83,360                     | )          |
| Total long-term debt                                                                                         |   | $                            | 722,427 |                        | $          | 331,877 |   |

 

In May 1998, Watson issued $150 million of its senior unsecurednotes (1998 Senior Notes).  These notesare due in May 2008 but may be redeemed earlier under certaincircumstances.  The Company is requiredto make interest only payments due semi-annually in May andNovember at an effective annual rate of 7.2%.

 

The 1998 Senior Notes were issued pursuant to a shelf registrationstatement authorizing up to $300 million in debt securities, preferred stock orcommon stock.  On April 2, 2003,the Company determined that it did not intend to offer any additional debtsecurities, preferred stock or common stock under the registration statement,and filed an amendment with the Securities and Exchange Commissionderegistering the remaining unsold $150 million aggregate amount of debtsecurities, preferred stock and common stock covered by the registrationstatement.

 

In March 2003, the Company issued $575 million of convertiblecontingent senior debentures (CODES). The CODES, which are convertible into shares of Watson’s common stockupon the occurrence of certain events, are due in March 2023, with interestpayments due semi-annually in March and September at an effectiveannual interest rate of 2.1%.

 

The CODES are convertible into Watson’s common stock at a conversionprice of approximately $40.05 per share (subject to certain adjustments).  The CODES may be converted, at the option ofthe holders, prior to maturity under any of the following circumstances:

 

12

----

 

•                  during anyquarterly conversion period (period from and including the thirtieth tradingday in a fiscal quarter to, but not including, the thirtieth trading day in theimmediately following fiscal quarter) if the closing sale price per share ofWatson’s common stock for a period of at least 20 trading days during the 30consecutive trading-day period ending on the first day of such conversionperiod is more than 125% of the conversion price in effect on that thirtiethday;

 

•                  on or beforeMarch 15, 2018, during the five business-day period following any 10consecutive trading-day period in which the daily average trading price for theCODES for such ten-day period was less than 105% of the average conversionvalue for the debentures during that period. This conversion feature represents an embedded derivative.  However, based on the de minimis valueassociated with this feature, no value has been assigned at issuance and atSeptember 30, 2003;

 

•                  during anyperiod, following the earlier of (a) the date the CODES are rated by bothStandard & Poor’s Rating Services and Moody’s Investor Services, Inc., and(b) April 21, 2003, when the long-term credit rating assigned to the CODESby either Standard & Poor’s or Moody’s (or any successors to theseentities) is lower than “BB” or “Ba3”, respectively, or when either of theserating agencies does not have a rating then assigned to the CODES for anyreason, including any withdrawal or suspension of a rating assigned to theCODES.  This conversion featurerepresents an embedded derivative. However, based on the de minimis value associated with this feature, novalue has been assigned at issuance and at September 30, 2003;

 

•                  if the CODEShave been called for redemption; or

 

•                  upon theoccurrence of specified corporate transactions.

 

The Company may redeem some or all of the CODES for cash, on or afterMarch 20, 2008, for a price equal to 100% of the principal amount of theCODES plus accrued and unpaid interest (including contingent interest) to, butexcluding, the redemption date.

 

The CODES contain put options which may require the Company torepurchase for cash all or a portion of the CODES on March 15 of 2010,2015 and 2018 at a repurchase price equal to 100% of the principal amount ofthe CODES plus any accrued and unpaid interest (including contingent interest)to, but excluding, the date of repurchase.

 

In addition, the holders of the CODES have the right to receivecontingent interest payments during any six-month period from March 15 toSeptember 14 and from September 15 to March 14, commencing onSeptember 15, 2003, if the average trading price of the CODES for the fivetrading days ending on the second trading day immediately preceding therelevant six-month period equals 120% or more of the principal amount of theCODES.  The interest rate used tocalculate the contingent interest is the greater of 5% of the Company’sthen-current estimated per annum borrowing rate for senior non-convertiblefixed-rate debt with a maturity date and other terms comparable to that of theCODES or 0.33% per annum.  Thiscontingent interest payment feature is an embedded derivative and has beenbifurcated and recorded separately in the Condensed Consolidated Balance Sheetsin other long-term liabilities.  Theinitial fair value assigned to the embedded derivative was $1.9 million, whichis recorded as a discount to the CODES (See Note J).

 

The Company used a portion of the proceeds from the issuance of theCODES to retire the outstanding balance of the Company’s term loan andrevolving credit facility it entered into in July 2000 (2000Facility).  The total outstanding balanceof the 2000 Facility consisted of a $246 million term loan balance and a $60million revolving credit balance. The Company terminated the 2000 Facility inMarch 2003 upon repayment of the outstanding balance.  As a result of the early retirement of the 2000Facility, the Company incurred a charge

 

13

----

 

in the amount of $2.8 million for the unamortized bank fees associatedwith this debt.  This charge is reportedseparately in the Condensed Consolidated Statements of Income.

 

In May 2003, the Company entered into an agreement****witha syndicate of lenders for a five-year, $300 million senior, unsecuredrevolving credit facility for working capital and other general corporatepurposes. Watson’s assets generally are held by, and its operations generallyare conducted through, its subsidiaries. Within the meaning of Regulation S-X, Rule 3-10, the Company has noassets or operations independent of its subsidiaries.  The terms of the new credit facility require each subsidiary,other than minor subsidiaries, to provide full and unconditional guarantees ona joint and several basis. In order to provide subsidiary guarantees inconnection with this credit facility, the Company was also required, by theterms of the Indenture for the 1998 Senior Notes, to grant similar subsidiaryguarantees in favor of the 1998 Senior Note holders. The subsidiary guaranteesrelated to both the new credit facility and the 1998 Senior Notes are full andunconditional, on a joint and several basis, and are given by all subsidiariesother than minor subsidiaries.  As ofSeptember 30, 2003, the Company had not drawn any funds from the revolvingcredit facility.

 

**NOTE J – FINANCIALINSTRUMENTS**

 

*Fair value offinancial instruments*

 

The Company’s financial instruments consist primarily of cash and cashequivalents, marketable securities, accounts and other receivables,investments, trade accounts payable, senior subordinated notes, CODES andembedded derivatives related to the issuance of the CODES.  The carrying amounts of cash and cashequivalents, marketable securities, accounts and other receivables and tradeaccounts payable are representative of their respective fair values due totheir relatively short maturities.  Thefair values of investments in companies that are publicly traded are based onquoted market prices.  The fair value ofinvestments in privately held companies, or cost-method investments, are basedon historical cost, adjusted for any write-down related to impairment.  The Company estimates the fair value of itsfixed rate long-term obligations based on quoted market rates of interest andmaturity schedules for similar issues. The carrying value of these obligations approximates their fairvalue.  The fair value of the embedded derivativesrelated to the CODES is based on a present value technique using discountedexpected future cash flows.

 

*Derivative financialinstruments*

 

The Company’s derivative financial instruments consist of embeddedderivatives related to its CODES.  Theseembedded derivatives include certain conversion features and a contingentinterest feature.   See Note I for amore detailed description of these features of the CODES.  Although the conversion features representembedded derivative financial instruments, based on the de minimis value ofthese features at the time of issuance and at September 30, 2003, no valuehas been assigned to these instruments. The contingent interest feature provides unique tax treatment under theInternal Revenue Service’s Contingent Debt Regulations.  In essence, interest accrues, for taxpurposes, on the basis of the instrument’s comparable yield (the yield at whichthe issuer would issue a fixed rate instrument with similar terms). Thisembedded derivative is reported on the Company’s Condensed Consolidated BalanceSheets at fair value and the changes in the fair value of the embeddedderivative are reported as gains or losses in the Company’s CondensedConsolidated Statements of Income.

 

At September 30, 2003, the carrying amount of $4.0 millionapproximates the estimated fair value of the Company’s derivative financialinstruments.  Such financial instrumentswere not in place at September 30, 2002.

 

During the three and nine month periods ended September 30, 2003,the fair value of the Company’s derivative financial instruments increased$56,000 and $2 million, respectively. These changes in fair value were recorded as a charge to interestexpense during the respective periods.

 

14

----

 

**NOTE K – IMPAIRMENTOF SECURITIES**

 

At September 30, 2003, investments andother assets included an investment in three million shares of the common stockof Genelabs Technologies, Inc. (Genelabs), a publicly traded company, with anadjusted cost basis of $3.9 million. This investment has been classified as available-for-sale, pursuant toSFAS No. 115, “Accounting for Certain Investments in Debt and EquitySecurities.”  Available-for-salesecurities are carried at fair value, based on quoted market prices, withunrealized gains and losses reported as a separate component of stockholders’equity.  During the first quarter of2003, management determined that an other than temporary decline in the fairvalue of Genelabs’ common stock existed and, as a result, wrote-down theinitial cost basis of the investment to its fair value at March 31, 2003of $3.9 million.  In connection withthis write-down, an asset impairment charge of $13.0 million was recorded andrecognized in earnings.  This impairmentshould have been recognized in the first quarter of 2002, as the investment hadbeen in an unrealized loss position for an extended period.  Recognition of the impairment in the firstquarter of 2003 was an error.  However,this charge would not have been material to the Company’s 2002 financialstatements, and is not expected to be material to the Company’s 2003 earningsor trend of earnings.

 

At September 30, 2003, investments and other assetsincluded an investment in 400,000 American Depository Receipts of Amarin,classified as an available-for-sale security, with a cost basis of $1.3million.  During the second quarter of2003, management determined that an other-than-temporary decline in fair valueof its Amarin investment existed.  As aresult, the Company wrote down the initial cost basis of the investment to itsfair value at June 30, 2003.  Inconnection with this write-down, an asset impairment charge of $1.2 million wasrecorded and recognized in earnings.

 

At September 30, 2003, investment and other assetsincluded an investment in 10,700,665 warrants to purchase shares of commonstock of Halsey with a fair value at acquisition of $10.8 million.  During the third quarter of 2003, managementdetermined that an other-than-temporary decline in fair value of its Halseyinvestment existed.  As a result, theCompany wrote down the initial cost basis of the investment to its fair valueof $9.2 million at September 30, 2003. In connection with this write-down, an asset impairment charge of $1.6million was recorded and recognized in earnings.

 

**NOTE L – SALE OFSUBSIDIARY**

 

During the first quarter of 2003, the Company completed the sale of itssubsidiary located in the United Kingdom (UK). The Company received proceeds from this sale of approximately $16.4million and recorded a pre-tax gain of approximately $15.7 million.  During 2002, the subsidiary had netrevenues, gross profit and net income of $10.8 million, $6.3 million and $3.2million, respectively.

 

In connection with the sale, the Company has provided certainwarranties and indemnifications to the buyer including an indemnificationrelating to website content. The buyer must give written notice to the Companywithin 18 months of the completion of the sale transaction of any claim arisingout of these indemnifications.  TheCompany does not expect any liability arising out of a claim, if any, to have amaterial adverse impact on its results of operations, financial position orcash flows.  No liability has beenrecorded in relation to these indemnifications at September 30, 2003.

 

15

----

 

**ITEM 2****.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following discussion of our financial condition and the results ofour operations should be read in conjunction with the condensed consolidatedfinancial statements and notes thereto included elsewhere in this QuarterlyReport.  This discussion containsforward-looking statements that are subject to known and unknown risks, uncertaintiesand other factors that may cause our actual results to differ materially fromthose expressed or implied by such forward-looking statements.  These risks, uncertainties and other factorsinclude, among others, those identified under “Cautionary Note RegardingForward-Looking Statements” and elsewhere in this Quarterly Report and under“Risk Factors” in our Annual Report on Form 10-K for the year endedDecember 31, 2002.

 

**Results of Operations**

 

***Net Revenues***

 
|                              |   | **Three  Months Ended  September 30,** |       | **Nine Months  Ended  September 30,** |   |
|-----------------------------------|--------|---------------------------------------------|------------|--------------------------------------------|--------|
| **($ in thousands):**             |   | **2003**                                    | ** ** | **2002**                                   |   | **%  Change** | ** ** | **2003** |   | **2002** | ** ** | **%****Change** | ** ** |
|                              |   |                                        |       |                                       |   |   |   |   |   |   |   |   |   |
| Net Revenues by Segment:          |   |                                        |       |                                       |   |   |   |   |   |   |   |   |   |
| Branded pharmaceutical products   |   | $                                           | 184,640    |                                       | $      | 162,359 |   | 13.7 | % | $ | 554,302 |   | $ | 479,913 |   | 15.5 | % |
| *% of total product net revenues* |   | *54.5*                                      | *%*        | *54.4*                                     | *%*    |   |   | *54.7* | *%* | *55.3* | % |   |   |
| Generic pharmaceutical products   |   | 154,208                                     |       | 136,291                                    |   | 13.1 | % | 458,674 |   | 387,383 |   | 18.4 | % |
| *% of total product net revenues* |   | *45.5*                                      | *%*        | *45.6*                                     | *%*    |   |   | *45.3* | *%* | *44.7* | % |   |   |
| Other                             |   | 19,908                                      |       | 9,210                                      |   | 116.2 | % | 38,582 |   | 26,328 |   | 46.5 | % |
| Total net revenues                |   | $                                           | 358,756    |                                       | $      | 307,860 |   | 16.5 | % | $ | 1,051,558 |   | $ | 893,624 |   | 17.7 | % |

 

Total net revenues for the three and nine months endedSeptember 30, 2003 increased compared to the corresponding 2002 periodsdue to increases in net revenues in both our branded and generic segments aswell as other revenues.

 

*BrandedPharmaceutical Products*

 

The increase in net revenues from our branded pharmaceutical productssegment for the three and nine month periods was primarily attributable toincreases in product sales within our Urology/General Products division.  The acquisition of the Fioricet® andFiorinal® product lines during the first quarter of 2003, and the launch of ourOxytrolTM product during the second quarter of 2003 were the primaryfactors contributing to the increase. In addition to the new products within our Urology/General Productsdivision, higher unit sales of our Androderm® testosterone patch, resultingfrom focused product promotions and prescription growth, also contributed tothe overall increase within the division. Women’s Health also contributed approximately $20 million to theincrease in net revenues for the nine month period as a result of new productlaunches such as our Necon® 7/7/7 and MononessaTM products.  The increase in net revenues was partiallyoffset by the decrease in Nephrology net revenues for the nine month period.

 

We expect net revenues from our branded segment to increase during thefourth quarter of 2003 at a slightly higher rate than the increase experiencedin the third quarter of 2003, as a result of higher sales of Oxytrol® and thelaunch of an oral contraceptive product prior to year-end.

 

16

----

 

*GenericPharmaceutical Products*

 

The increases in net revenues from our generic segment were related tonew products launched and products reintroduced during, or subsequent to, thecorresponding 2002 periods, as well as price increases on certain products.

 

We expect net revenues from our generic segment in the fourth quarterof 2003 to increase at a higher rate than the increase experienced in the thirdquarter of 2003, primarily as a result of anticipated product launches.

 

*Other Revenues*

 

Other revenues consist primarily of payments resulting from a legalsettlement, royalty revenues, and revenues recognized as a result of partialcompletion of research and development activities for third parties.

 

The increase in other revenues from the prior year periods wasprimarily attributable to revenue received from Aventis Pharmaceuticals(Aventis) under a 1998 agreement entered into in connection with ouracquisition of the Rugby Group, Inc. Pursuant to the agreement, we are entitled to a portion of the proceedsreceived by Aventis in connection with Barr Laboratories, Inc.’s sales ofciprofloxacin tablets.

 

Additionally, revenues from research and development agreementsincreased slightly over prior year periods. These revenues (typically milestone payments) are recorded under the“contingency-adjusted performance model,” which requires deferral of revenueuntil such time as contract milestone requirements, as specified in theindividual agreement, have been met and cash has been received.  Thereafter, once contingencies have beenremoved, revenue is recognized based on the percentage of completion method.

 

Other revenues for the nine months endedSeptember 30, 2003 include $21.0 million in payments from a 2001 legalsettlement.  The payment received in thethird quarter of 2003 represents the final payment from this settlement.  We expect other revenues to be approximately$45 million to $50 million for the full year 2003.

 

*NetRevenue Mix*

 

Net revenue mix is an important considerationin evaluating the profitability of our business.  Our branded products generally realize higher gross profitmargins than our generic products.  Anysignificant change in our net revenue mix could substantially impact our grossprofit, gross margin and the overall profitability of our business.

 

For the three and nine month periods endedSeptember 30, 2003, our net revenue mix remained consistent with thecorresponding 2002 periods. We expect the net revenue mix for the fourthquarter of 2003 to be consistent with that of the third quarter of 2003.

 

***Gross Profit Marginon Product Net Revenues (Gross Margin)***

*** ***
|                                 |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|--------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
|                                 |   | **2003**                                    |   | **2002**                                   |   | **Change** |   | **2003** |   | **2002** |   | **Change** |   |
|                                 |   |                                        |   |                                       |   |   |   |   |   |   |   |   |   |
| Gross Margin by Segment:             |   |                                        |   |                                       |   |   |   |   |   |   |   |   |   |
| Branded pharmaceutical products      |   | 77.9                                        | %      | 76.5                                       | %      | 1.4 | % | 77.3 | % | 76.1 | % | 1.2 | % |
| Generic pharmaceutical products      |   | 34.1                                        | %      | 22.4                                       | %      | 11.7 | % | 30.1 | % | 21.7 | % | 8.4 | % |
| Gross margin on product net revenues |   | 58.0                                        | %      | 51.8                                       | %      | 6.2 | % | 55.9 | % | 51.8 | % | 4.1 | % |

 

17

----

 

Overall gross margin on product net revenues for the three and ninemonths ended September 30, 2003 increased compared to the same periods ayear ago.

 

The increase in gross margin from our branded segment for the three andnine months ended September 30, 2003, was attributable to increasedmargins in our Urology/General Products division as a result of higher grossmargins realized on the products that we introduced during 2003. The increasewas partially offset by the decreased margin in Women’s Health due to lowermargins realized on Necon® 7/7/7 and MononessaTM products as a result of aprofit sharing arrangement with the manufacturer.

 

The increase in the gross margin from our generic segment for the threeand nine months ended September 30, 2003, was primarily attributable toprice increases on certain products.

 

We expect our gross margins for the fourth quarter to remain consistentwith the third quarter of 2003.

 

***Research andDevelopment (R&D) Expenses***

*** ***
|                   |   | **Three  Months Ended  September 30,** |       | **Nine  Months Ended  September 30,** |       |
|------------------------|--------|---------------------------------------------|------------|--------------------------------------------|------------|
| **($ in thousands):**  |   | **2003**                                    | ** ** | **2002**                                   | ** ** | **%  Change** | ** ** | **2003** | ** ** | **2002** | ** ** | **%  Change** | ** ** |
|                   |   |                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| R&D expenses       |   | $                                           | 26,428     |                                       | $          | 22,387 |   | 18.1 | % | $ | 74,613 |   | $ | 60,675 |   | 23.0 | % |
| *as % of net revenues* |   | *7.4*                                       | *%*        | *7.3*                                      | *%*        |   |   | *7.1* | *%* | *6.8* | *%* |   |   |
|                        |        |                                             |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Research and development expenses increased from the correspondingprior year periods due to increased spending on clinical studies and expandedgeneric development programs.  Theclinical studies relate to our anti-fungal nail patch, continued studies withOxytrol® and additional indications for Ferrlecit®.  Expenses also increased due to biostudies and other expensesrelated to various generic products under different stages of development.

 

We expect research and development expenses for the remainder of 2003to continue to increase slightly due to our efforts in both branded and genericproduct development.

 

***Selling, General andAdministrative (SG&A) Expenses***

 
|                   |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
| **($ in thousands):**  |   | **2003**                                    |   | **2002**                                   |   | **%****Change** |   | **2003** |   | **2002** |   | **%****Change** |   |
|                   |   |                                        |   |                                       |   |   |   |   |   |   |   |   |   |
| SG&A expenses      |   | $                                           | 87,547 |                                       | $      | 56,149 |   | 55.9 | % | $ | 227,420 |   | $ | 178,046 |   | 27.7 | % |
| *as % of net revenues* |   | *24.4*                                      | *%*    | *18.2*                                     | *%*    |   |   | *21.6* | *%* | *19.9* | *%* |   | * * |
|                        |        |                                             |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

SG&A expenses increased from the corresponding prior year periodsdue to higher spending associated with the Oxytroläproduct launch.  The third quarter of2003 includes marketing expenses associated with our Oxytrol® product launchand additional costs related to expansion of our sales force through ourrelationship with Ventiv Health Inc., our contract sales organization.

 

18

----

 

***Amortization Expense***

*** ***
|                  |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|-----------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
| **($ in thousands):** |   | **2003**                                    |   | **2002**                                   |   | **%****Change** |   | **2003** |   | **2002** |   | **%****Change** |   |
|                  |   |                                        |   |                                       |   |   |   |   |   |   |   |   |   |
| Amortization expense  |   | $                                           | 17,820 |                                       | $      | 16,176 |   | 10.2 | % | $ | 54,040 |   | $ | 44,012 |   | 22.8 | % |
|                       |        |                                             |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in amortization expense was primarily due to amortizationassociated with the Fiorinalâand Fioricetâ product lines acquired inFebruary 2003.  See Note B in theaccompanying Notes to Condensed Consolidated Financial Statements in thisQuarterly Report. Assuming no additions, disposals or adjustments are made tothe carrying values and/or useful lives of our product rights and otherintangible assets, we expect amortization expense for the fourth quarter of2003 to remain consistent with that of the third quarter of 2003.

 

***Equity in Earnings(Losses) of Joint Ventures***

*** ***
|                                          |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|-----------------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
| **($ in thousands):**                         |   | **2003**                                    |   | **2002**                                   |   | **%****Change** |   | **2003** |   | **2002** |   | **%****Change** |   |
|                                          |   |                                        |   |                                       |   |   |   |   |   |   |   |   |   |
| Equity in earnings (losses) of joint ventures |   | $                                           | (68    | )                                          | $      | (1,945 | ) | -96.5 | % | $ | 137 |   | $ | (3,759 | ) | -103.6 | % |
|                                               |        |                                             |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

The change from the prior year losses is attributable to income fromour interest in ANCIRC Pharmaceuticals (ANCIRC), a joint venture with AndrxCorporation.  The income from ANCIRCsubstantially offset the losses from our interest in Somerset Pharmaceuticals,Inc. (Somerset), a joint venture with Mylan Laboratories, Inc.  During the fourth quarter, we expect ourANCIRC earnings to continue to offset Somerset losses, consistent with that ofthe third quarter of 2003.

 

***Impairment ofSecurities***

*** ***
|                     |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|--------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
| **($ in thousands):**    |   | **2003**                                    |   | **2002**                                   |   | **%****Change** |   | **2003** |   | **2002** |   | **%****Change** |   |
|                     |   |                                        |   |                                       |   |   |   |   |   |   |   |   |   |
| Impairment of securities |   | $                                           | 1,605  |                                       | $      | — |   | n/a |   | $ | 15,865 |   | $ | — |   | n/a |   |
|                          |        |                                             |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

During the third quarter of 2003, we recorded a $1.6 million impairmentcharge related to our investment in Halsey warrants. During the second quarterof 2003, we recorded a $1.2 million impairment charge related to our investmentin Amarin. Additionally, we recorded a $13.0 million impairment charge duringthe first quarter of 2003, related to our investment in Genelabs.  See Note K in the accompanying Notes toCondensed Consolidated Financial Statements in this Quarterly Report.

 

At September 30, 2003, we had a total gross unrealized holdingloss of $252,000 related to our investment in Amarin, which had a fair valueless than its recorded cost for approximately three months.  Investments are considered to be impairedwhen a decline in fair value is judged to be other-than-temporary.  If a decline in fair value is determined tobe other-than-temporary, an impairment charge is recorded and a new cost basisin the investment is established.  Weemploy a systematic methodology that considers all available evidence inevaluating potential impairment of our investments.  In the event that the cost of an investment exceeds its fair

19

----

 

value, we evaluate, among other factors, general market conditions, theduration and extent to which the fair value is less than cost, as well as ourintent and ability to hold the investment. We also consider specific adverse conditions related to the financialhealth of and business outlook for the investee, including industry and sectorperformance, changes in technology, operational and financing cash flowfactors, and rating agency actions. However, when the carrying value of an investment is greater than therealizable value for an extended period, unless sufficient positive, objectiveevidence exists to support such an extended period, the decline will beconsidered other-than-temporary.  Anydecline in the market prices of our equity investments that are deemed to beother-than-temporary may require us to incur additional impairment charges.

 

***Gain on Sale ofSecurities***

*** ***
|                       |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|----------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
| **($ in thousands):**      |   | **2003**                                    |   | **2002**                                   |   | **%****Change** |   | **2003** |   | **2002** |   | **%****Change** |   |
|                       |   |                                        |   |                                       |   |   |   |   |   |   |   |   |   |
| Gain on sale of securities |   | $                                           | 2,496  |                                       | $      | — |   | n/a |   | $ | 5,510 |   | $ | — |   | n/a |   |
|                            |        |                                             |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

Our gain on sale of securities resulted from the sale of shares of Dr.Reddy and Andrx common stock.  See NoteC in the accompanying Notes to Condensed Consolidated Financial Statements inthis Quarterly Report.

 

***Gain on Sale ofSubsidiary***

*** ***
|                       |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|----------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
| **($ in thousands):**      |   | **2003**                                    |   | **2002**                                   |   | **%****Change** |   | **2003** |   | **2002** |   | **%****Change** |   |
|                       |   |                                        |   |                                       |   |   |   |   |   |   |   |   |   |
| Gain on sale of subsidiary |   | $                                           | — |                                       | $      | — |   | n/a |   | $ | 15,676 |   | $ | — |   | n/a |   |
|                            |        |                                             |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

During the first quarter of 2003, we sold our subsidiary located in theUnited Kingdom.  As a result of thesale, we recorded a pre-tax gain of $15.7 million.   During 2002, the subsidiary had net revenues, gross profit andnet income of $10.8 million, $6.3 million and $3.2 million, respectively.  See Note L in the accompanying Notes toCondensed Consolidated Financial Statements in this Quarterly Report.

 

***Gain from Legal Settlement***

*** ***
|                       |   | **Three  Months Ended  September 30,** |       | **Nine  Months Ended  September 30,** |   |
|----------------------------|--------|---------------------------------------------|------------|--------------------------------------------|--------|
| **($ in thousands):**      |   | **2003**                                    | ** ** | **2002**                                   |   | **%  Change** | ** ** | **2003** |   | **2002** | ** ** | **%****Change** | ** ** |
|                       |   |                                        |       |                                       |   |   |   |   |   |   |   |   |   |
| Gain from legal settlement |   | $                                           | —     |                                       | $      | — |   | n/a |   | $ | — |   | $ | 32,000 |   | -100 | % |
|                            |        |                                             |            |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

During the second quarter of 2002, we recorded a $32 million gain as aresult of the settlement reached with Bristol-Myers Squibb (BMS) resolving alloutstanding disputes between the companies related to buspirone.

 

20

----

*** ***

***Loss on EarlyExtinguishment of Debt***

*** ***
|                                 |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|--------------------------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
| **($ in thousands):**                |   | **2003**                                    |   | **2002**                                   |   | **%****Change** |   | **2003** |   | **2002** |   | **%****Change** |   |
|                                 |   |                                        |   |                                       |   |   |   |   |   |   |   |   |   |
| Loss on early extinguishment of debt |   | $                                           | — |                                       | $      | — |   | n/a |   | $ | 2,807 |   | $ | — |   | n/a |   |
|                                      |        |                                             |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

During the first quarter of 2003, as a result of the retirement of ourprevious credit facility, we incurred a $2.8 million charge for the unamortizedbank fees associated with the credit facility. See Note I in the accompanying Notes to Condensed Consolidated FinancialStatements in this Quarterly Report.

 

***Interest Expense***

*** ***
|                  |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |   |
|-----------------------|--------|---------------------------------------------|--------|--------------------------------------------|--------|
| **($ in thousands):** |   | **2003**                                    |   | **2002**                                   |   | **%****Change** |   | **2003** |   | **2002** |   | **%****Change** |   |
|                  |   |                                        |   |                                       |   |   |   |   |   |   |   |   |   |
| Interest expense      |   | $                                           | 5,980  |                                       | $      | 5,747 |   | 4.1 | % | $ | 18,901 |   | $ | 16,690 |   | 13.2 | % |
|                       |        |                                             |        |                                            |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest expense remained fairly consistent for the three month periodsended September 30, 2003 and 2002 as lower borrowing rates offset higherdebt balances in the current year.  Theincrease in interest expense for the nine month period ended September 30,2003 was primarily the result of the adjustments made to the fair value of ourderivative financial instruments during the second and third quarters of 2003.  The changes in the fair value of $2 millionand $56,000 for the three months ended June 30, 2003 andSeptember 30, 2003, respectively, were recorded as interest expense.  See Note J in the accompanying Notes toCondensed Consolidated Financial Statements in this Quarterly Report.

 

**Liquidity and CapitalResources**

 

We assess liquidity by our ability to generate cash tofund our operations.  Significantfactors that affect the management of our liquidity include: current balancesof cash, cash equivalents and value of marketable securities; expected cashflows provided by operations; current levels of our accounts receivable,inventory and accounts payable balances; our expected investment in capital;access to financing sources, including credit and equity arrangements; and thefinancial flexibility to attract long-term capital on satisfactory terms.

 

We generated cash in excess of our working capital requirements for thenine months ended September 30, 2003. Our cash flows provided by operations were $298 million, an increase ofapproximately $16 million from the previous year’s period.  This increase was primarily related to theincrease in net income and changes from the prior year balances of accountsreceivable and accounts payable and accrued expenses.  Additionally, during the third quarter of 2003, we received $17.5million in upfront and milestone payments from our amended agreement for thedevelopment of certain hormonal therapies. These increases were substantially offset by the changes, year overyear, in balances of inventories and income taxes payable.

 

The increase in inventories is the result ofsupply chain initiatives to further improve customer service levels and tosupport recently launched products and products that have yet to be launcheddue to contractual restrictions.  Of theapproximately $400 million of inventories at September 30, 2003, $45.4million were in support of expected new product launches and marketinginitiatives, including bupropion hydrochloride sustained-release tablets. Undera previously announced settlement with GlaxoSmithKline (GSK), we receivedrights in the U.S. market to distribute 100mg. and 150mg. bupropionhydrochloride sustained-release tablets, which are the generic versions ofGSK’s

 

21

----

 

Wellbutrin® SR and Zyban® products and aremanufactured by a GSK subsidiary, once a third party launches a fullysubstitutable generic equivalent of those products in the U.S. market.  As of September 30, 2003, we had a $5.0million inventory reserve with respect to the potential expiration of a portionof our bupropion hydrochloride inventory. In the event we do not launch this product during the fourth quarter of2003, we expect to establish an additional inventory reserve of approximately$10 million due to the expiration dating of a portion of the product inventory.

 

In addition to the increase in inventories, other significant uses ofcash for the nine months ended September 30, 2003, included theacquisition of product rights ($179.3 million), additions to property andequipment ($104.5 million) and principal payments on our previous creditfacility ($325.9 million, of which $306.1 million was paid from the proceeds ofthe issuance of our convertible contingent debentures as discussed below).  We currently expect to spend between $130million to $140 million for property and equipment additions in 2003, ofwhich we expect approximately $35 million to be related to the installation andimplementation of our new Enterprise Resource Planning system.

 

InMay 1998, we issued $150 million of senior unsecured notes dueMay 2008 (1998 Senior Notes), with interest payable semi-annually inMay and November at an effective rate of 7.2%, pursuant to a shelfregistration statement authorizing up to $300 million in debt securities,preferred stock or common stock.  OnApril 2, 2003, we determined that we did not intend to offer anyadditional debt securities, preferred stock or common stock under theregistration statement, and filed an amendment with the Securities and ExchangeCommission deregistering the remaining unsold $150 million aggregate amount ofdebt securities, preferred stock and common stock covered by the registrationstatement.  In March 2003, weissued $575 million of convertible contingent senior debentures (CODES) due in2023.  As of September 30, 2003,the entire amount of the CODES remained outstanding at an effective annualinterest rate of approximately 2.1%.

 

We useda portion of the proceeds from the issuance of the CODES to repay the $306.1million balance on our term loan and revolving credit facility we entered intoin July 2000 (2000 Facility).  Weterminated the 2000 Facility in March 2003 upon our repayment of thisbalance.

 

InMay 2003, we entered into an agreement****with a syndicate of lenders for afive-year, $300 million senior, unsecured revolving credit facility for workingcapital and other general corporate purposes. As of September 30, 2003, the total $300 million under therevolving credit facility was available to us. Under the terms of the revolvingcredit facility, each of our subsidiaries, other than minor subsidiaries,entered into a full and unconditional guarantee on a joint and severalbasis.  In order to provide subsidiaryguarantees in connection with the new credit facility, we were required toissue similar guarantees to the 1998 Senior Note holders.

 

Our cash and current marketable securities totaled $650.7 million atSeptember 30, 2003.  The fair valueof our current marketable securities may fluctuate significantly due to volatilityof the stock market and changes in general economic conditions.  See Item 3 in this Quarterly Report on Form10-Q.  We believe that our cash andmarketable securities balance and our expected cash flows from operations willbe sufficient to meet our normal operating requirements during the next twelvemonths.  However, we continue to reviewopportunities to acquire or invest in companies, technologies, product rightsand other investments that are compatible with our existing business.  We could use cash and financing sourcesdiscussed herein, or financing sources that subsequently become available, tofund additional acquisitions or investments. In addition, we may consider issuing additional debt or equitysecurities in the future to fund potential acquisitions or investment, torefinance existing debt, or for general corporate purposes.  If a material acquisition or investment iscompleted, our operating results and financial condition could change materiallyin future periods.  However, no assurancecan be given that additional funds will be available on satisfactory terms, orat all, to fund such activities.

 

**CAUTIONARYNOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

Any statements made in this report that are not statements ofhistorical fact or that refer to estimated or anticipated future events areforward-looking statements.  We havebased our forward-looking statements on our

 

22

----

 

management’s beliefs and assumptions based on information available toour management at the time these statements are made.  Such forward-looking statements reflect our current perspectiveof our business, future performance, existing trends and information as of thedate of this filing.  These include, butare not limited to, our beliefs about future revenue and expense levels andgrowth rates, prospects related to our strategic initiatives and businessstrategies, express or implied assumptions about government regulatory actionor inaction, anticipated product approvals and launches, business initiativesand product development activities, assessments related to clinical trialresults, product performance and competitive environment, and anticipatedfinancial performance. Without limiting the generality of the foregoing, wordssuch as *“may,”“will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,”“estimate,” “continue,” or “pursue,”* or the negative othervariations thereof or comparable terminology, are intended to identifyforward-looking statements.  Thestatements are not guarantees of future performance and involve certain risks,uncertainties and assumptions that are difficult to predict.

 

**Wecaution the reader that certain important factors may affect our actualoperating results and could cause such results to differ materially from thoseexpressed or implied by forward-looking statements.  We believe the following important risks, uncertainties and otherfactors, among others, may affect our actual results:**

 

• the success of our product development activitiesand uncertainties related to the timing or outcome of such activities;

 

• the timing and unpredictability of regulatoryauthorizations and product launches, which is particularly sensitive in ourgeneric business;

 

• the outcome of our litigation (including,without limitation, patent, trademark and copyright litigation), and the costs,expenses and possible diversion of management’s time and attention arising fromsuch litigation;

 

• our ability to retain key personnel;

 

• our ability to adequately protect our technologyand enforce our intellectual property rights;

 

• our ability to obtain and maintain a sufficientsupply of products to meet market demand in a timely manner;

 

• our dependence on sole source suppliers and therisks associated with a production interruption or supply delays at such thirdparty 

suppliers or at our own manufacturingfacilities;

 

• the scope, outcome and timeliness of anygovernmental, court or other regulatory action that may involve us (including,without limitation, the scope, outcome or timeliness of any inspection or otheraction of the FDA);

 

• our success in divesting assets or facilities weintend to dispose of;

 

• the increasing costs of insurance, andlimitations on obtaining insurance coverage;

 

• the scope, outcome and effect of investigations,actions or legislation related to our product pricing;

 

• the availability to us, on commerciallyreasonable terms, of raw materials and other third party sourced products;

 

• ourexposure to product liability and other lawsuits and contingencies;

 

• our mix of product sales between brandedproducts, which typically have higher margins, and generic products;

 

23

----

 

• our dependence on revenues from significantproducts, in particular, Ferrlecit®, for which 2003 net revenues are expectedto be 

approximately 10% of our total net revenues;

 

• our dependence on revenues from significantcustomers;

 

• the ability of third parties to assert patentsor other intellectual property rights against us which, among other things,could cause a delay or disruption in the manufacture, marketing or sale of ourproducts;

 

• ourability to license patents or other intellectual property rights from thirdparties on commercially reasonable terms;

 

• the expiration of patent and regulatoryexclusivity on certain of our products that will result in competitive andpricing pressures;

 

• difficulties and delays inherent in productdevelopment, manufacturing and sale, such as:

 

• products that may appear promising in thedevelopment stage may fail to reach market for numerous reasons, includingefficacy or safety concerns;

 

• the inability to obtain necessary regulatoryapprovals and the difficulty or excessive cost to manufacture;

 

• seizure or recall of products;

 

• the failure to obtain, the imposition oflimitations on the use of, or loss of patent and other intellectual propertyrights; and

 

• manufacturing or distribution problems;

 

• our successful compliance with extensive,costly, complex and evolving governmental regulations and restrictions;

 

• market acceptance of and continued demand forour products and the impact of competitive products and pricing;

 

• our ability to successfully compete in both thebranded and generic pharmaceutical product sectors;

 

• ourtimely and successful implementation of strategic initiatives, includingintegrating companies and products we acquire and new enterprise resourceplanning systems; and

 

• other risks and uncertainties detailed hereinand from time to time in our Securities and Exchange Commission filings.

 

We disclaim any obligation to publicly update any forward-lookingstatements, whether as a result of new information, future events orotherwise.  We also may make additionaldisclosures in our Annual Report on Form 10-K, Quarterly Reports on Form 10-Qand Current Reports on Form 8-K that we may file from time to time with theSecurities and Exchange Commission (SEC). Please also note that we provided a cautionary discussion of risks anduncertainties under the section entitled “Risk Factors” in our AnnualReport on Form 10-K for the year ended December 31, 2002.  The factors identified above and those setforth in our SEC filings are the factors that we think could cause our actualresults to differ materially from expected results.  Other factors besides those listed here could also adverselyaffect us.  This discussion is providedas permitted by the Private Securities Litigation Reform Act of 1995.

 

24

----

** **

**ITEM 3****.  QUANTITATIVE AND QUALITATIVE DISCLOSUREABOUT MARKET RISK**

 

We are exposed to market risk for changes in the market values of ourinvestments (Investment Risk) and the impact of interest rate changes (InterestRate Risk).  We have not used derivativefinancial instruments in our investment portfolio.  The quantitative and qualitative disclosures about market riskare set forth below.

 

**Investment Risk**

 

As of September 30, 2003, our total investment in equitysecurities of other companies was $80.5 million.  Of this amount, we had equity-method investments of $24.0 millionand publicly traded equity securities (available-for-sale securities) at fairvalue totaling $56.5 million ($40.7 million that was included in “Marketablesecurities” and $15.8 million that was included in “Investments and otherassets”).  The fair values of theseinvestments are subject to significant fluctuations due to volatility of thestock market and changes in general economic conditions.  Based on the fair value of the publiclytraded equity securities we held at September 30, 2003, an assumed 25%,40% and 50% adverse change in the market prices of these securities wouldresult in a corresponding decline in total fair value of approximately $14million, $23 million and $28 million, respectively.

 

At September 30, 2003, our investment in Andrx consisted ofapproximately 1.4 million shares of Andrx common stock with a fair market valueof $26.5 million.  Because Andrx is apublicly traded equity security, our holdings of Andrx have exposure toinvestment risk.   The market price ofAndrx common shares has been, and may continue to be, volatile as reflected inthe table below.  On November 4, 2003,before the filing of this Form 10-Q, the closing price of Andrx common stockwas $20.36.

 

The following table sets forth the Andrx high and low market price pershare information, based on published financial sources, for 2003 and 2002:

 

|                 |   | **High** |   | **Low** |   |
|----------------------|--------|----------|--------|---------|--------|
| **2003, by quarter** |   |     |   |    |   |
| First                |   | $        | 16.83  |    | $      | 7.68 |   |
| Second               |   | $        | 24.20  |    | $      | 11.10 |   |
| Third                |   | $        | 25.90  |    | $      | 16.32 |   |
|                 |   |     |   |    |   |
| **2002, by quarter** |   |     |   |    |   |
| First                |   | $        | 71.27  |    | $      | 31.13 |   |
| Second               |   | $        | 48.20  |    | $      | 25.80 |   |
| Third                |   | $        | 27.89  |    | $      | 16.61 |   |
| Fourth               |   | $        | 23.19  |    | $      | 10.75 |   |

 

In addition, our marketable securities include shares of common stockof Dr. Reddy’s Laboratories, Limited (Dr. Reddy).  As of September 30, 2003, Watson owned 603,772 common sharesof Dr. Reddy with a market value of approximately $14.2 million.  Dr. Reddy’s shares trade on the Bombay StockExchange (BSE) and on the New York Stock Exchange in the form of Americandepositary shares.  However, the sharesof Dr. Reddy common stock that we hold are currently tradable only on the BSE,since our shares are not presently in the form of American depositaryshares.  The liquidity of our Dr. Reddyinvestment may be limited due to the current Dr. Reddy daily trading volume onthe BSE, among other factors.  Thefollowing table sets forth the Dr. Reddy high and low market price per shareinformation, based on published financial sources, for 2003 and 2002:

 

25

----

 

|                 |   | **High** |   | **Low** |   |
|----------------------|--------|----------|--------|---------|--------|
| **2003, by quarter** |   |     |   |    |   |
| First                |   | $        | 21.00  |    | $      | 18.03 |   |
| Second               |   | $        | 23.53  |    | $      | 17.58 |   |
| Third                |   | $        | 27.90  |    | $      | 21.85 |   |
|                 |   |     |   |    |   |
| **2002, by quarter** |   |     |   |    |   |
| First                |   | $        | 23.76  |    | $      | 18.91 |   |
| Second               |   | $        | 24.00  |    | $      | 18.40 |   |
| Third                |   | $        | 21.64  |    | $      | 16.00 |   |
| Fourth               |   | $        | 19.47  |    | $      | 14.26 |   |

 

**We regularly review the carrying value of our investmentsand identify and recognize losses, for income statement purposes, when eventsand circumstances indicate that any declines in the fair values of suchinvestments, below our accounting basis, are other than temporary.  During 2003, we made such a determinationwith respect to our investments in Genelabs, Amarin and Halsey resulting inimpairment charges of $13.0 million, $1.2 million, and $1.6 million,respectively (see Note K in the accompanying Notes to Condensed ConsolidatedFinancial Statements in this Quarterly Report).**

 

AtSeptember 30, 2003, our investment in warrants to purchase approximately10.7 million shares of Halsey common stock (See Note C) had a fair market valueof $9.2 million.  The market price of Halsey common shares hasbeen, and may continue to be, volatile. During the third quarter of 2003, the market price fluctuated between alow of $0.77 and a high of $1.65.  OnNovember 4, 2003, the closing price of Halsey common stock was $0.68.  Due to the volatility of this investment,subsequent impairment charges may be required if they are determined to beother than temporary.

 

**Interest Rate Risk**

 

Our exposure to interest rate risk relates primarily to our non-equityinvestment portfolio.  Our cash isinvested in A-rated money market mutual funds and short-term securities.Consequently, our interest rate and principal risk are minimal.

 

Based on quoted market rates of interest andmaturity schedules for similar debt issues, we estimate that the fair values ofour CODES and our fixed-rate senior unsecured notes approximated their carryingvalues September 30, 2003.  Whilechanges in market interest rates may affect the fair value of our fixed-ratedebt, we believe the effect, if any, of reasonably possible near-term changesin the fair value of such debt on our financial condition, results ofoperations or cash flows will not be material.

 

At this time, we are not party to any interest rate or derivativehedging contracts and have no material foreign exchange or commodity pricerisks.

 

26

----

** **

**ITEM 4****.  CONTROLS AND PROCEDURES**

 

The Company maintains disclosure controls and procedures that aredesigned to ensure that information required to be disclosed in the Company’sExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms, and that such informationis accumulated and communicated to the Company’s management, including itsPrincipal Executive Officer and Principal Financial Officer, as appropriate, toallow timely decisions regarding required disclosure.  In designing and evaluating the disclosure controls andprocedures, management recognized that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures.  Also,the Company has investments in certain unconsolidated entities.  As the Company does not control or managethese entities, its disclosure controls and procedures with respect to suchentities are necessarily substantially more limited than those it maintainswith respect to its consolidated subsidiaries.

 

As required by SEC Rule 13a-15(b), the Company carried out anevaluation, under the supervision and with the participation of the Company’smanagement, including the Company’s Principal Executive Officer and PrincipalFinancial Officer, of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures as of the end of the quartercovered by this Report. Based on the foregoing, the Company’s PrincipalExecutive Officer and Principal Financial Officer concluded that the Company’sdisclosure controls and procedures were effective at the reasonable assurancelevel.

 

There have been no changes in the Company’s internal control overfinancial reporting, during the three months ended September 30, 2003,that has materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting

 

27

----

** **

**PART II****.  OTHER INFORMATION AND SIGNATURES**

 

**ITEM 1****.  LEGAL PROCEEDINGS**

 

The Company is party to certain lawsuits and legal proceedings, whichare described in “Part I, Item 3. Legal Proceedings,” of our Annual Report onForm 10-K for the year ended December 31, 2002.  The following is a description of material developments duringthe period covered by this Quarterly Report and should be read in conjunctionwith the Annual Report referenced above.

 

*Phen-fen Litigation.*  With respect to the phenterminehydrochloride product liability lawsuits pending against the Company, certainof its subsidiaries, and others, additional actions raising similar issues havebeen filed, and some actions have been settled or otherwise dismissed.  As of October 15, 2003, approximately389 actions were pending against the Company and other Company entities in anumber of state and federal courts.  TheCompany believes that it will be fully indemnified by The Rugby Group’s formerowner, Aventis Pharmaceuticals (Aventis, formerly known as Hoechst MarionRoussel, Inc.) for the defense of all such cases and for any liability that mayarise out of these cases.  Aventis iscurrently controlling the defense of all these cases as the indemnifying partyunder its agreements with the Company.

 

*Cipro Litigation.*  On September 4, 2003, the court hearingthe action pending in California Superior Court (*Cipro Cases I & II, JCCP ProceedingNos. 4154 and*4220) granted plaintiffs’ motion for classcertification.  On September 19,2003, the court hearing the action pending in Wisconsin Circuit Court (*Barbara A. Meyers,**et. al, v.Bayer AG, et. al., Case No**. 00-CV-9347*)granted the defendants’ motion to dismiss. Plaintiffs have appealed.  OnOctober 27, 2003, the court hearing the action pending in New York SupremeCourt (A*nneCunningham, et. al. v. Bayer AG, et. al., Case No. 603820-00*)granted the defendants’ motion to dismiss. Other courts in which motions to dismiss are pending still have not ruled.  On October 3, 2003, the Rugby Group,Inc. responded to the complaint in the consolidated action pending in theUnited States District Court for the Eastern District of New York (*In re:Ciprofloxacin Hydrochloride Antitrust Litigation, MDL Docket No.*001383).  Discovery is ongoing.  Aventis is currently controlling the defenseof these matters as the indemnifying party under its agreements with theCompany.

 

*Government Reimbursement Investigations andProceedings.* With regard to the consolidated actions alleging improper or fraudulentreporting practices related to the reporting of average wholesale prices ofcertain products pending in the United States District Court for the Districtof Massachusetts (*In re: Pharmaceutical Industry Average Wholesale Price Litigation, MDLDocket No. 1456*), the court has scheduled a hearing forNovember 21, 2003 to consider the motions to dismiss the Amended MasterConsolidated Complaint filed by the Company and other defendants.  On October 1, 2003, an action was filedin the United States District Court for the District of Massachusetts by theCommonwealth of Massachusetts.  (*TheCommonwealth of Massachusetts v. Mylan Laboratories, Inc., et al., Civil ActionNo**. 03-cv-11865 (PBS)*).  This action names as defendants numerouspharmaceutical companies that are alleged to have sold generic pharmaceuticalproducts, including the Company and its subsidiary, Schein Pharmaceutical, Inc.(now known as Watson Pharma, Inc.)  Thecomplaint alleges, among other things, that the defendants inflated thereported prices for specified drug products, resulting in false and inflatedclaims being paid by Massachusetts under its Medicaid program.  The Company has not yet responded to thiscomplaint.  With respect to otherreimbursement inquiries, the Company has produced records in response to therequest for records and information from the House of Representatives Committeeon Energy and Commerce in connection with that Committee’s investigation intopharmaceutical reimbursements and rebates under Medicaid, and is reviewingadditional documents to complete its response to the request.  In August 2003, the Company received asubpoena from the Attorney General for the State of California for productionof additional records in connection with that State’s pending investigationinto pharmaceutical pricing matters. The Company has not yet responded to the subpoena.

 

*FDA Matters.*  On September 12, 2003,Steris Laboratories, Inc., which the Company acquired in connection with ouracquisition of Schein Pharmaceutical, Inc. in August, 2000, completed its finalindependent expert

 

28

----

 

inspection required pursuantto the terms of the October 1998 Consent Decree.  The inspection found the Steris facility to be in a satisfactorystate of Good Manufacturing Practices control. The Company is continuing to evaluate divestiture or otheralternatives related to the Steris facility.

 

The Company and its affiliates are involved in various other disputes,governmental and/or regulatory inspections, investigations and proceedings, andlitigation matters that arise from time to time in the ordinary course ofbusiness.  The process of resolvingmatters through litigation or other means is inherently uncertain and it ispossible that the resolution of these matters will adversely affect theCompany, its results of operations, financial position and/or cash flows.

 

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

 

(a) Exhibits:

 

Reference is hereby made to theExhibit Index on page 31.

 

(b) Reports on Form 8-K filed during the quarter endedSeptember 30, 2003:

 

On August 5, 2003, the Company filed a Current Report on Form 8-Kwith the Securities and Exchange Commission reporting, under Item 12, that ithad issued a news release announcing its financial results for the quarterended June 30, 2003.

 

29

----

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|                               |   | **WATSON PHARMACEUTICALS, INC**.  (Registrant)            |
|------------------------------------|--------|-----------------------------------------------------------|
|                               |   |                                                      |
|                               | By:    | **/s/ Charles P. Slacik**                                 |
|                               |   | Charles P. Slacik                                         |
|                               |   | Executive Vice President – Chief Financial  Officer  |
|                               |   | (Principal Financial Officer)                             |
|                               |   |                                                      |
|                               |   |                                                      |
|                               | By:    | **/s/ R. Todd Joyce**                                     |
|                               |   | R. Todd Joyce                                             |
|                               |   | Vice President – Corporate Controller and  Treasurer |
|                               |   | (Principal Accounting Officer)                            |
|                               |   |                                                      |
| Dated:  November 5, 2003 |   |                                                      |

 

30

----

 

**WATSON PHARMACEUTICALS, INC.**

 

**EXHIBITINDEX TO FORM 10-Q**

**Forthe Quarterly Period Ended September 30, 2003**

 

 
| **Exhibit  No.** |   | **Description** |
|------------------|--------|-----------------|
|             |   |            |
| *10.1            |   |            | Third Amendment to the Watson Pharmaceuticals, Inc. 2001 Incentive  Award Plan effective as of August 4, 2003. |
|             |   |            |   |
| 31.1             |   |            | Certification of Chairman and Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|             |   |            |   |
| 31.2             |   |            | Certification of Executive Vice President and Chief Financial Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|             |   |            |   |
| 32.1             |   |            | Certification of Chairman and Chief Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002. |
|             |   |            |   |
| 32.2             |   |            | Certification of Executive Vice President and Chief Financial Officer  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |

 

----

*Compensation Plan or Agreement

 

31

----