**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

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**FORM 10-Q**

 

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**ý****QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(d)**

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLYPERIOD ENDED MARCH 31, 2004**

 

**or**

 

**o****TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d)**

**OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from           to           **

 

**Commission filenumber 0-20045**

 

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**WATSON PHARMACEUTICALS, INC.**

(Exact name of registrant as specified in its charter)

 

| **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 May 4, 2004 was approximately 108,868,970.

 

 

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**WATSON PHARMACEUTICALS, INC.**

** **

**TABLE OF CONTENTS**

** **

**FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004**

 
| **Part I.  FINANCIAL INFORMATION**                                                                         |                                                                                                 |
|------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------|
|                                                                                                       |                                                                                                 |
| Item 1.  Condensed  Consolidated Financial Statements:                                                |                                                                                                 |
|                                                                                                       |                                                                                                 |
|                                                                                                       | Condensed  Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003                    |   |
|                                                                                                       |                                                                                                 |   |
|                                                                                                       | Condensed  Consolidated Statements of Income for the Three Months Ended March 31, 2004  and 2003     |   |
|                                                                                                       |                                                                                                 |   |
|                                                                                                       | Condensed  Consolidated Statements of Cash Flows for the Three Months Ended March 31,  2004 and 2003 |   |
|                                                                                                       |                                                                                                 |   |
|                                                                                                       | 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                                                                                                 |                                                                                                 |

 

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**WATSON PHARMACEUTICALS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

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

 
|                                                                                                                      |   | **March 31,  2004** |      | **December  31,  2003** |   |
|---------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-----------|-------------------------|--------|
| **ASSETS**                                                                                                                |   |                |      |                    |   |
| Current assets:                                                                                                           |   |                |      |                    |   |
| Cash and cash equivalents                                                                                                 |   | $                   | 449,937   |                    | $      | 553,353 |   |
| Marketable securities                                                                                                     |   | 18,966              |      | 20,368                  |   |
| Accounts receivable, net                                                                                                  |   | 214,176             |      | 211,174                 |   |
| Inventories                                                                                                               |   | 395,788             |      | 393,393                 |   |
| Prepaid expenses and other current assets                                                                                 |   | 36,758              |      | 38,561                  |   |
| Deferred tax assets                                                                                                       |   | 105,171             |      | 106,640                 |   |
| Total current assets                                                                                                      |   | 1,220,796           |      | 1,323,489               |   |
|                                                                                                                      |   |                |      |                    |   |
| Property and equipment, net                                                                                               |   | 435,943             |      | 424,995                 |   |
| Investments and other assets                                                                                              |   | 44,028              |      | 50,096                  |   |
| Deferred tax assets                                                                                                       |   | 26,768              |      | 27,130                  |   |
| Product rights and other intangibles, net                                                                                 |   | 983,521             |      | 1,001,295               |   |
| Goodwill                                                                                                                  |   | 455,595             |      | 455,595                 |   |
| Total assets                                                                                                              |   | $                   | 3,166,651 |                    | $      | 3,282,600 |   |
|                                                                                                                      |   |                |      |                    |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                             |   |                |      |                    |   |
| Current liabilities:                                                                                                      |   |                |      |                    |   |
| Accounts payable and accrued expenses                                                                                     |   | $                   | 209,576   |                    | $      | 215,388 |   |
| Income taxes payable                                                                                                      |   | 40,394              |      | 111,982                 |   |
| Deferred revenue                                                                                                          |   | 7,592               |      | 11,315                  |   |
| Total current liabilities                                                                                                 |   | 257,562             |      | 338,685                 |   |
|                                                                                                                      |   |                |      |                    |   |
| Long-term debt                                                                                                            |   | 621,027             |      | 722,535                 |   |
| Deferred revenue                                                                                                          |   | 9,846               |      | 10,767                  |   |
| Other long-term liabilities                                                                                               |   | 9,416               |      | 9,641                   |   |
| Deferred tax liabilities                                                                                                  |   | 149,039             |      | 143,626                 |   |
| Total liabilities                                                                                                         |   | 1,046,890           |      | 1,225,254               |   |
|                                                                                                                      |   |                |      |                    |   |
| 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; 108,821,900 and 108,330,300 shares outstanding |   | 359                 |      | 357                     |   |
| Additional paid-in capital                                                                                                |   | 857,522             |      | 841,007                 |   |
| Retained earnings                                                                                                         |   | 1,248,373           |      | 1,201,714               |   |
| Accumulated other comprehensive income                                                                                    |   | 13,507              |      | 14,268                  |   |
| Total stockholders’ equity                                                                                           |   | 2,119,761           |      | 2,057,346               |   |
| Total liabilities and stockholders’ equity                                                                           |   | $                   | 3,166,651 |                    | $      | 3,282,600 |   |

 

*See accompanying Notes to CondensedConsolidated Financial Statements.*

 

1

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**WATSON PHARMACEUTICALS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME**

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

 
|                                           |   | **Three  Months Ended  March 31,** |    |
|------------------------------------------------|--------|------------------------------------|---------|
|                                           |   | **2004**                           |    | **2003** |   |
|                                           |   |                               |    |   |   |
| Net revenues                                   |   | $                                  | 409,658 |   | $ | 336,922 |   |
| Cost of sales                                  |   | 196,481                            |    | 149,601 |   |
| Gross profit                                   |   | 213,177                            |    | 187,321 |   |
|                                           |   |                               |    |   |   |
| Operating expenses:                            |   |                               |    |   |   |
| Research and development                       |   | 29,681                             |    | 22,484 |   |
| Selling, general and administrative            |   | 77,411                             |    | 67,659 |   |
| Amortization                                   |   | 17,932                             |    | 18,435 |   |
| Total operating expenses                       |   | 125,024                            |    | 108,578 |   |
| Operating income                               |   | 88,153                             |    | 78,743 |   |
|                                           |   |                               |    |   |   |
| Other income (expense):                        |   |                               |    |   |   |
| Equity in earnings (losses) of joint  ventures |   | (1,579                             | )       | 117 |   |
| Loss on impairment of assets                   |   | (891                               | )       | (13,042 | ) |
| Gain on sales of securities                    |   | 3,938                              |    | 1,089 |   |
| Gain on sale of subsidiary                     |   | —                             |    | 15,676 |   |
| Loss on early extinguishment of debt           |   | (14,006                            | )       | (2,807 | ) |
| Interest income                                |   | 1,207                              |    | 1,242 |   |
| Interest expense                               |   | (3,743                             | )       | (5,341 | ) |
| Other income (expense)                         |   | (164                               | )       | (594 | ) |
| Total other income (expense), net              |   | (15,238                            | )       | (3,660 | ) |
|                                           |   |                               |    |   |   |
| Income before income taxes                     |   | 72,915                             |    | 75,083 |   |
| Provision for income taxes                     |   | 26,256                             |    | 27,254 |   |
| Net income                                     |   | $                                  | 46,659  |   | $ | 47,829 |   |
|                                           |   |                               |    |   |   |
|                                           |   |                               |    |   |   |
| Earnings per share:                            |   |                               |    |   |   |
| Basic                                          |   | $                                  | 0.43    |   | $ | 0.45 |   |
| Diluted                                        |   | $                                  | 0.42    |   | $ | 0.44 |   |
|                                           |   |                               |    |   |   |
| Weighted average shares outstanding:           |   |                               |    |   |   |
| Basic                                          |   | 108,580                            |    | 106,942 |   |
| Diluted                                        |   | 110,780                            |    | 107,622 |   |

 

*See accompanying Notes to Condensed Consolidated FinancialStatements.*

 

2

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**WATSON PHARMACEUTICALS, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited; in thousands)

 
|                                                             |   | **Three  Months Ended  March 31,** |    |
|------------------------------------------------------------------|--------|------------------------------------|---------|
|                                                             |   |                               |
|                                                             |   | **2004**                           |    | **2003** |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                        |   |                               |    |   |   |
| Net income                                                       |   | $                                  | 46,659  |   | $ | 47,829 |   |
| Reconciliation to net cash provided by operating activities:     |   |                               |    |   |   |
| Depreciation                                                     |   | 7,026                              |    | 6,926 |   |
| Amortization                                                     |   | 17,932                             |    | 18,435 |   |
| Deferred income tax benefit (provision)                          |   | 7,842                              |    | (9,019 | ) |
| Equity in (earnings) losses of joint ventures                    |   | 1,579                              |    | (117 | ) |
| Gain on sales of securities                                      |   | (3,938                             | )       | (1,089 | ) |
| Gain on sale of subsidiary                                       |   | —                             |    | (15,676 | ) |
| Loss on early extinguishment of debt                             |   | 14,006                             |    | 2,807 |   |
| Loss on impairment of assets                                     |   | 891                                |    | 13,042 |   |
| Tax benefits from employee stock plans                           |   | 3,410                              |    | 50 |   |
| Mark to market on derivative                                     |   | (225                               | )       | — |   |
| Other                                                            |   | 218                                |    | (1,005 | ) |
| Changes in assets and liabilities:                               |   |                               |    |   |   |
| Accounts receivable, net                                         |   | (3,002                             | )       | 19,292 |   |
| Inventories                                                      |   | (2,395                             | )       | (16,941 | ) |
| Prepaid expenses and other current assets                        |   | 1,803                              |    | 8,071 |   |
| Accounts payable and accrued expenses                            |   | (5,813                             | )       | 25,996 |   |
| Deferred revenue                                                 |   | (4,644                             | )       | (1,367 | ) |
| Income taxes payable                                             |   | (71,588                            | )       | (28,172 | ) |
| Other assets                                                     |   | 796                                |    | (778 | ) |
| Total adjustments                                                |   | (36,102                            | )       | 20,455 |   |
| Net cash provided by operating activities                        |   | 10,557                             |    | 68,284 |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                        |   |                               |    |   |   |
| Additions to property and equipment                              |   | (23,169                            | )       | (21,580 | ) |
| Acquisitions of product rights                                   |   | (158                               | )       | (178,238 | ) |
| Proceeds from sales of marketable equity securities              |   | 4,706                              |    | 3,829 |   |
| Proceeds from sale of Halsey note receivable                     |   | 5,381                              |    | — |   |
| Proceeds from sale of subsidiary                                 |   | —                             |    | 16,368 |   |
| Other investing activities, net                                  |   | 1,783                              |    | 1,212 |   |
| Net cash used in investing activities                            |   | (11,457                            | )       | (178,409 | ) |
| **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 | ) |
| Payments to repurchase 1998 Senior Notes                         |   | (101,615                           | )       | — |   |
| Premium paid on 1998 Senior Notes repurchase                     |   | (14,006                            | )       | — |   |
| Principal payments on acquisition liabilities                    |   | (2                                 | )       | (1,009 | ) |
| Proceeds from stock plans                                        |   | 13,107                             |    | 1,970 |   |
| Net cash (used in) provided by financing activities              |   | (102,516                           | )       | 295,646 |   |
| Net increase in cash and cash equivalents                        |   | (103,416                           | )       | 185,521 |   |
| Cash and cash equivalents at beginning of period                 |   | 553,353                            |    | 230,155 |   |
| Cash and cash equivalents at end of period                       |   | $                                  | 449,937 |   | $ | 415,676 |   |

 

*See accompanying Notes to Condensed Consolidated FinancialStatements.*

 

3

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**WATSON PHARMACEUTICALS,INC.**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE A – GENERAL**

 

WatsonPharmaceuticals, Inc. (Watson or the Company) is primarily engaged in thedevelopment, manufacture, marketing, sale and distribution of branded andoff-patent (generic) pharmaceutical products. The Company also developsadvanced drug delivery systems designed to enhance the therapeutic benefits ofexisting drug forms.  Watson operatesmanufacturing, distribution, research and development and administrative facilitiesprimarily in the United States of America (U.S.).

 

Theaccompanying condensed consolidated financial statements should be read inconjunction with the Company’s Annual Report on Form 10-K for the yearended December 31, 2003.  Certaininformation and footnote disclosures normally included in annual financialstatements prepared in accordance with generally accepted accounting principleshave been condensed or omitted from the accompanying consolidated financialstatements.  The year end balance sheetwas derived from the audited financial statements.  The accompanying interim financial statements are unaudited, butreflect all adjustments which are, in the opinion of management, necessary topresent fairly Watson’s consolidated financial position, results of operationsand cash flows for the periods presented. Unless otherwise noted, all such adjustments are of a normal, recurringnature.  Certain reclassifications, noneof which affected net income or retained earnings, have been made to priorperiod amounts to conform to current period presentation.  The Company’s results of operations and cashflows for the interim periods are not necessarily indicative of the results ofoperations and cash flows that it may achieve in future periods or for the fullyear.

 

*Comprehensive income*

 

Comprehensiveincome includes all changes in equity during a period except those thatresulted from investments by or distributions to the Company’sstockholders.  Other comprehensiveincome refers to revenues, expenses, gains and losses that, under generallyaccepted accounting principles, are included in comprehensive income, butexcluded from net income as these amounts are recorded directly as anadjustment to stockholders’ equity.  Watson’sother comprehensive income (loss) is comprised of unrealized gains (losses) onits holdings of publicly traded equity securities, net of realized gains(losses) included in net income.  Thecomponents of comprehensive income and related income taxes consisted of thefollowing (in thousands):

 

|                                                        |   | **Three  Months Ended  March 31,** |   |
|-------------------------------------------------------------|--------|------------------------------------|--------|
|                                                        |   |                               |
|                                                        |   | **2004**                           |   | **2003** |   |
|                                                        |   |                               |   |   |   |
| Net income                                                  |   | $                                  | 46,659 |   | $ | 47,829 |   |
|                                                        |   |                               |   |   |   |
| Other comprehensive income (loss):                          |   |                               |   |   |   |
| Unrealized holding loss on securities                       |   | (97                                | )      | (2,632 | ) |
| Less related income taxes                                   |   | 35                                 |   | 1,053 |   |
| Total unrealized loss on securities, net                    |   | (62                                | )      | (1,579 | ) |
|                                                        |   |                               |   |   |   |
| Reclassification for gains (losses)  included in net income |   | (1,091                             | )      | 11,953 |   |
| Less related income taxes                                   |   | 392                                |   | (4,338 | ) |
| Total reclassification, net                                 |   | (699                               | )      | 7,615 |   |
| Total other comprehensive income (loss)                     |   | (761                               | )      | 6,036 |   |
| Total comprehensive income                                  |   | $                                  | 45,898 |   | $ | 53,865 |   |

 

4

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*Earnings per share*

 

Basic earningsper share is computed by dividing net income by the weighted average commonshares outstanding.  Diluted earningsper share is computed by dividing net income by the weighted average number ofcommon shares and dilutive potential common shares outstanding based on thetreasury stock method, assuming the exercise of all in-the-money stock options.A reconciliation of the numerators and denominators of basic and dilutedearnings per share consisted of the following (in thousands, except per shareamounts):

 

|                                                |   | **Three  Months Ended  March 31,** |   |
|-----------------------------------------------------|--------|------------------------------------|--------|
|                                                |   |                               |
|                                                |   | **2004**                           |   | **2003** |   |
|                                                |   |                               |   |   |   |
| **Numerator:**                                      |   |                               |   |   |   |
| Net income                                          |   | $                                  | 46,659 |   | $ | 47,829 |   |
| **Denominator:**                                    |   |                               |   |   |   |
| Basic weighted average common shares  outstanding   |   | 108,580                            |   | 106,942 |   |
| Effect of dilutive stock options                    |   | 2,200                              |   | 680 |   |
| Diluted weighted average common shares  outstanding |   | 110,780                            |   | 107,622 |   |
|                                                |   |                               |   |   |   |
| **Basic earnings per share**                        |   | $                                  | 0.43   |   | $ | 0.45 |   |
|                                                |   |                               |   |   |   |
| **Diluted earnings per share**                      |   | $                                  | 0.42   |   | $ | 0.44 |   |

 

Excluded fromthe computation of diluted earnings per share are outstanding common stockoptions with an exercise price greater than the average market price of thecommon shares for the periods reported. For the three month periods ended March 31, 2004 and 2003, excluded fromthe computation of diluted earnings per share were stock options to purchase5.5 million and 9.9 million common shares, respectively.

 

The effect ofapproximately 14.4 million shares which would have been issuable uponconversion of the $575 million convertible contingent debentures (as describedin Note F) has been excluded from the computation of diluted earnings per sharefor the three month period ended March 31, 2004 because the conditions thatwould permit conversion have not been satisfied.

 

*Stock-based compensation*

 

The Companyaccounts for its stock-based employee compensation plans using the recognitionand measurement principles of Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” and related interpretations.  No stock-based employee compensation expensehas been recognized for the options in the accompanying condensed consolidatedstatements of income, as all options granted under the plans had an exerciseprice equal to the market value of the underlying common stock on the date ofgrant.

 

5

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Had theCompany determined compensation expense for all prior periods using the fairvalue method prescribed by Statement of Financial Accounting Standards (SFAS)No. 123, “Accounting for Stock-Based Compensation,” the Company’s net incomeand earnings per share would have been as follows (in thousands, except pershare amounts):

 

|                                                                                                                                                |   | **Three  Months Ended  March 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                                                                                |   |                               |
|                                                                                                                                                |   | **2004**                           |   | **2003** |   |
|                                                                                                                                                |   |                               |   |   |   |
| Net income                                                                                                                                          |   | $                                  | 46,659 |   | $ | 47,829 |   |
| Deduct:   Total stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |   | 4,461                              |   | 5,428 |   |
| Pro forma net income                                                                                                                                |   | $                                  | 42,198 |   | $ | 42,401 |   |
|                                                                                                                                                |   |                               |   |   |   |
| Earnings per share:                                                                                                                                 |   |                               |   |   |   |
| Basic - as reported                                                                                                                                 |   | $                                  | 0.43   |   | $ | 0.45 |   |
| Basic - pro forma                                                                                                                                   |   | $                                  | 0.39   |   | $ | 0.40 |   |
|                                                                                                                                                |   |                               |   |   |   |
| Diluted - as reported                                                                                                                               |   | $                                  | 0.42   |   | $ | 0.44 |   |
| Diluted - pro forma                                                                                                                                 |   | $                                  | 0.38   |   | $ | 0.39 |   |
|                                                                                                                                                |   |                               |   |   |   |
| Weighted average shares outstanding:                                                                                                                |   |                               |   |   |   |
| Basic                                                                                                                                               |   | 108,580                            |   | 106,942 |   |
| Diluted                                                                                                                                             |   | 110,780                            |   | 107,622 |   |

 

The weightedaverage fair value of the stock options and Employee Stock Purchase Plan(“ESPP”) has been estimated on the date of grant using the Black-Scholes optionpricing model. Weighted averages are used because of varying assumed exercisedates.  The weighted average fair valueof ESPP granted for the three months ended March 31, 2004 and 2003 was $9.73per share and $7.63 per share, respectively. The following weighted average assumptions were used for stock optionsgranted during the three months ended March 31, 2004 and 2003:

 

|                    |   | **Three  Months Ended  March 31,** |   |
|-------------------------|--------|------------------------------------|--------|
|                    |   |                               |
|                    |   | **2004**                           |   | **2003** |   |
|                    |   |                               |   |   |   |
| Dividend yield          |   | None                               |   | None |   |
| Expected volatility     |   | 21                                 | %      | 44 | % |
| Risk-free interest rate |   | 3.51                               | %      | 3.48 | % |
| Expected term           |   | 5.3 years                          |   | 5.2 years |   |

 

 

The following weighted average assumptionswere used for ESPP during the three months ended March 31, 2004 and 2003:

 

|                    |   | **Three  Months Ended  March 31,** |   |
|-------------------------|--------|------------------------------------|--------|
|                    |   |                               |
|                    |   | **2004**                           |   | **2003** |   |
|                    |   |                               |   |   |   |
| Dividend yield          |   | None                               |   | None |   |
| Expected volatility     |   | 21                                 | %      | 40 | % |
| Risk-free interest rate |   | 3.51                               | %      | 3.26 | % |
| Expected term           |   | 6 months                           |   | 6 months |   |

 

6

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*Recent accounting pronouncements*

 

In January2003, the FASB issued Interpretation No. (FIN) 46, “Consolidation of VariableInterest Entities” an interpretation of Accounting Research Bulletin No. 51,“Consolidated Financial Statements.” The primary objectives of FIN 46 are to provide guidance on theidentification of entities which the Company may control through means otherthan through voting rights (“variable interest entities”) and to determine whenand which business enterprise (“primary beneficiary”) should consolidate the variableinterest entity.  FIN 46 requiresexisting unconsolidated variable interest entities to be consolidated by theirprimary beneficiaries if the entities do not effectively disperse risks amongthe parties involved.  Variable interestentities that effectively disperse risks will not be consolidated unless asingle party holds an interest or combination of interests that effectivelyrecombines risks that were previously dispersed.  In addition, FIN 46 requires that the primary beneficiary, aswell as all other enterprises with a significant variable interest in avariable interest entity, make additional disclosures.  Certain disclosure requirements of FIN 46were effective for financial statements issued after January 31, 2003.  In December 2003, the FASB revised FIN 46(FIN 46R) to address certain FIN 46 implementation issues.  The revised provisions are applicable nolater than the first reporting period ending after March 15, 2004.    The Company adopted FIN 46 and FIN 46Rand, based upon the evaluation performed of all interests, have determined theCompany does not have any variable interest entities that requireconsolidation.

 

In April 2004,the FASB issued FASB Staff Position No. 129-1 (FSP 129-1), “DisclosureRequirements under FASB Statement No. 129, Disclosure of Information aboutCapital Structure, Relating to Contingently Convertible Securities.”  This FSP requires the disclosure provisionsof Statement 129 to apply to all existing and newly created contingentlyconvertible securities and to their potentially dilutive effects on earningsper share.  The Company has adopted thedisclosure requirements of FSP 129-1 in its Condensed Consolidated FinancialStatements.

 

**NOTEB – EQUITY INVESTMENTS**

 

Watson’sequity investments in publicly traded companies are classified asavailable-for-sale and are recorded at fair value based on quoted market pricesusing the specific identification method. These investments are classified as either current or non-current, asappropriate, on the Company’s Condensed Consolidated Balance Sheets.

 

*Current investments*

 

The Company’sinvestment in the common stock of Andrx Corporation – Andrx Group (Andrx),publicly traded on the Nasdaq Stock Market under the symbol ADRX, is classifiedas a current investment and is included in “Marketable securities” on theCompany’s Condensed Consolidated Balance Sheets at March 31, 2004 and December31, 2003.

 

During the three month period ended March 31, 2004, Watson sold aportion of its shares of its Andrx common stock investment.  During the three month period ended March31, 2004, Watson sold 150,000 shares of its investment in the common stock ofAndrx for proceeds of $4.3 million and recorded a pre-tax gain of $3.9million.  Realized gains are computedusing the specific identification method to determine the cost basis for eachinvestment.  The Company did not sellany of its shares of Andrx during the three month period ended March 31, 2003.

 

During thethree month period ended March 31, 2003, Watson sold 190,000 shares of its investmentin the common stock of Dr. Reddy’s Laboratories, Limited (Dr. Reddy) andrecorded a pre-tax gain of $1.1 million. At December 31, 2003 and March 31, 2004, the Company held no shares ofDr. Reddy common stock.

 

7

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*Non-current investments*

 

The Company’sinvestments in the common stock of Genelabs Technologies, Inc. (Genelabs),NovaDel Pharma Inc., Amarin Corporation plc (Amarin), and warrants to purchaseshares of common stock of Halsey Drug Co., Inc. (Halsey) are classified asnon-current investments and are included in “Investments and other assets” onthe Company’s Condensed Consolidated Balance Sheets at March 31, 2004 andDecember 31, 2003.  During the periodended March 31, 2004, the Company wrote off its remaining investment in theHalsey warrants, net of proceeds from the sale of its note receivable.

 

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

 

|                          |   | **March 31,  2004** |   | **December  31,  2003** |   |
|-------------------------------|--------|---------------------|--------|-------------------------|--------|
|                          |   |                |   |                    |   |
| Equity securities:            |   |                |   |                    |   |
| Cost basis                    |   | $                   | 7,297  |                    | $      | 10,556 |   |
| Gross unrealized holding gain |   | 21,969              |   | 23,336                  |   |
| Gross unrealized holding loss |   | (752                | )      | (716                    | )      |
| Fair value of securities      |   | $                   | 28,514 |                    | $      | 33,176 |   |

 

Gross unrealized gains primarily relate to our holdings in shares ofAndrx common stock.  The grossunrealized holding loss at March 31, 2004 and December 31, 2003 is attributableto adjustments, included in other comprehensive income, for the decline in fairvalue in the Company’s investment in Amarin.

 

The Company’s net unrealized holding gain related to itsavailable-for-sale securities, decreased $760,000 for the three month periodended March 31, 2004.  During the threemonth period ended March 31, 2003, the Company’s net unrealized holding gainincreased $6.0 million.  These changesin the Company’s net unrealized holding gain are included in othercomprehensive income.

 

**NOTEC – OPERATING SEGMENTS**

 

Watson has two reportable operating segments:branded and generic pharmaceutical products. The branded products segment includes the Company’s lines of Women’sHealth, Urology/General Products and Nephrology products. Watson has aggregatedits branded product lines in a single segment because of similarities inregulatory environment, manufacturing processes, methods of distribution andtypes of customer.  This segmentincludes patent-protected products and trademarked generic products that Watsonsells and promotes directly to healthcare professionals as brandedpharmaceutical products.  The genericproducts segment includes off-patent pharmaceutical products that aretherapeutically equivalent to proprietary products.  The Company sells its branded and generic products primarily topharmaceutical wholesalers, drug distributors and chain drug stores.

 

Thesignificant accounting policies of the segments are described in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2003.  Watson primarily evaluates the performanceof its segments based on net revenues and gross profit.  The “other” classification for the threemonth period ended March 31, 2004 consisted primarily of royalties and revenuesfrom research, development and licensing fees. The “other” classification for the three month period ended March 31,2003 consisted primarily of contingent payments received from the settlement ofa legal dispute and revenues from research, development and licensingfees.  The Company does not reportdepreciation expense, total assets, and capital expenditures by segment as suchinformation 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):

 

8

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|                            |   | **Three  Months Ended  March 31,** |    |
|---------------------------------|--------|------------------------------------|---------|
|                            |   |                               |
|                            |   | **2004**                           |    | **2003** |   |
|                            |   |                               |    |   |   |
| **Net revenues:**               |   |                               |    |   |   |
| Branded pharmaceutical products |   | $                                  | 169,381 |   | $ | 183,761 |   |
| Generic pharmaceutical products |   | 225,017                            |    | 143,199 |   |
| Other                           |   | 15,260                             |    | 9,962 |   |
| Total net revenues              |   | $                                  | 409,658 |   | $ | 336,922 |   |
| **Gross profit:**               |   |                               |    |   |   |
| Branded pharmaceutical products |   | $                                  | 123,734 |   | $ | 140,697 |   |
| Generic pharmaceutical products |   | 74,183                             |    | 36,662 |   |
| Other                           |   | 15,260                             |    | 9,962 |   |
| Total gross profit              |   | $                                  | 213,177 |   | $ | 187,321 |   |

 

**NOTE D – INVENTORIES**

 

Inventoriesconsist of finished goods held for distribution, raw materials andwork-in-process. At March 31, 2004, finished goods inventories includedapproximately $11.2 million of products that are pending approval by the Foodand Drug Administration (FDA) or have not been launched due to contractualrestrictions.  This inventory representsgeneric pharmaceutical products that are capitalized only when thebioequivalence of the product is demonstrated or the product is alreadyapproved and awaiting a contractual triggering event to enter the marketplace.

 

Inventoriesare stated at the lower of cost (first-in, first-out method) or market (netrealizable value) and consisted of the following (in thousands):

 

|              |   | **March 31,  2004** |    | **December  31,  2003** |   |
|-------------------|--------|---------------------|---------|-------------------------|--------|
|              |   |                |    |                    |   |
| Raw materials     |   | $                   | 120,729 |                    | $      | 123,239 |   |
| Work-in-process   |   | 78,805              |    | 70,436                  |   |
| Finished goods    |   | 196,254             |    | 199,718                 |   |
| Total inventories |   | $                   | 395,788 |                    | $      | 393,393 |   |

 

**NOTE E – GOODWILL AND OTHER INTANGIBLE ASSETS**

 

Watsontests its goodwill and intangible assets with indefinite lives by comparing thefair value of each of the Company’s reporting units to the respective carryingvalue of the reporting units.  TheCompany performs this impairment testing annually during the second quarter andwhen events occur or circumstances change that would more likely than notreduce the fair value of a reporting unit below its carrying amount.  The Company’s two reporting units arebranded and generic pharmaceutical products. The carrying value of each reporting unit is determined by assigning theassets and liabilities, including the existing goodwill and intangible assets,to those reporting units.  Goodwill isconsidered impaired if the carrying amount exceeds the fair value of the asset.

 

Duringthe second quarter of 2003, Watson performed its annual test for the impairmentof goodwill and determined there was no indication of impairment.  There were no additions to goodwill recordedduring the three months ended March 31, 2004. At March 31, 2004 and December 31, 2003, goodwill for the Company’sreporting units consisted of the following (in thousands):

 

9

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| Branded pharmaceutical products |   | $      | 368,105 |   |
|---------------------------------|--------|--------|---------|--------|
| Generic pharmaceutical products |   | 87,490 |    |
| Total goodwill                  |   | $      | 455,595 |   |

 

Other intangible assets consistprimarily of product rights.  Theoriginal cost and accumulated amortization of these intangible assets are asfollows (in thousands):

 

|                                               |   | **March 31,  2004** |      | **December  31,  2003** |   |
|----------------------------------------------------|--------|---------------------|-----------|-------------------------|--------|
|                                               |   |                |      |                    |   |
| Product rights and related intangibles             |   | $                   | 1,282,916 |                    | $      | 1,291,311 |   |
| Less accumulated amortization                      |   | (299,395            | )         | (290,016                | )      |
| Total product rights and related  intangibles, net |   | $                   | 983,521   |                    | $      | 1,001,295 |   |

 

Assuming noadditions, disposals or adjustments are made to the carrying values and/oruseful lives of the assets, annual amortization expense on product rights andrelated intangibles is estimated to be approximately $71.5 million in each ofthe next five years.  The Company’scurrent product rights and related intangibles have a weighted average usefullife of approximately nineteen years.

 

**NOTE F – LONG-TERM DEBT**

 

Long-term debt consisted of thefollowing (in thousands):

 

|                                                                                                         |   | **March 31,  2004** |    | **December  31,  2003** |   |
|--------------------------------------------------------------------------------------------------------------|--------|---------------------|---------|-------------------------|--------|
| Senior unsecured notes, 7.125%, face amount  of $150 million, due 2008, net of $776 unamortized discount     |   | $                   | 47,609  |                    | $      | 149,183 |   |
| Convertible contingent debentures, face  amount of $575 million due 2023, net of $1,634 unamortized discount |   | 573,366             |    | 573,297                 |   |
| Other notes payable                                                                                          |   | 52                  |    | 55                      |   |
| Total debt                                                                                                   |   | $                   | 621,027 |                    | $      | 722,535 |   |
| Less current portion                                                                                         |   | —              |    | —                  |   |
| Total long-term debt                                                                                         |   | $                   | 621,027 |                    | $      | 722,535 |   |

 

*1998 Senior Notes*

 

In May 1998, Watson issued $150 million ofits senior unsecured notes (1998 Senior Notes).  These notes are due in May 2008 but may be redeemed earlierunder certain circumstances.  TheCompany is required to make interest only payments due semi-annually in May andNovember at an effective annual rate of 7.7%.

 

In February 2004, the Company initiated atender offer to purchase all of its outstanding 1998 Senior Notes due 2008 anda related consent solicitation.  TheCompany received tenders of 1998 Senior Notes and deliveries of relatedconsents from holders of approximately 67.74 percent of the $150 millionaggregate principal amount of 1998 Senior Notes outstanding or $101.6 million.  We recorded a $14.0 million charge in thefirst quarter of 2004 related to fees, expenses and premium paid.  As a result, the Company received therequired consents to eliminate substantially all of the restrictive covenantsof the indenture governing the 1998 Senior Notes and to make certainamendments.  The Company executed anddelivered a supplemental indenture setting forth the amendments.

 

10

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*Convertible Contingent Senior Debentures*

 

In March 2003,the Company issued $575 million of convertible contingent senior debentures(CODES).  The CODES, which areconvertible into shares of Watson’s common stock upon the occurrence of certainevents, are due in March 2023, with interest payments due semi-annually inMarch and September at an effective annual interest rate of 2.3%, excludingchanges in fair value of the contingent interest derivative.

 

The CODES are convertible into Watson’scommon stock at a conversion price of approximately $40.05 per share (subjectto certain adjustments).  The CODES maybe converted, at the option of the holders, prior to maturity under any of thefollowing circumstances:

 

•                  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% ($50.06) of the conversion price in effect on thatthirtieth day;

 

•                  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 atMarch 31, 2004;

 

•                  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 CODES byeither Standard & Poor’s or Moody’s (or any successors to these entities)is lower than “BB” or “Ba3”, respectively, or when either of these ratingagencies does not have a rating then assigned to the CODES for any reason,including any withdrawal or suspension of a rating assigned to the CODES.  This conversion feature represents anembedded derivative.  However, based onthe de minimis value associated with this feature, no value has been assignedat issuance and at March 31, 2004;

 

•                  if the CODEShave been called for redemption; or

 

•                  upon theoccurrence of specified corporate transactions.

 

The Companymay redeem some or all of the CODES for cash, on or after March 20, 2008, for aprice equal to 100% of the principal amount of the CODES plus accrued andunpaid interest (including contingent interest) to, but excluding, theredemption date.

 

The CODEScontain put options which may require the Company to repurchase for cash all ora portion of the CODES on March 15 of 2010, 2015 and 2018 at a repurchase priceequal to 100% of the principal amount of the CODES plus any accrued and unpaidinterest (including contingent interest) to, but excluding, the date ofrepurchase.

 

In addition,the holders of the CODES have the right to receive contingent interest paymentsduring any six-month period from March 15 to September 14 and from September 15to March 14, commencing on September 15, 2003, if the average trading price ofthe CODES for the five trading days ending on the second trading dayimmediately preceding the relevant six-month period equals 120% or more of theprincipal amount of the CODES.  Theinterest rate used to calculate the contingent interest is the greater of 5% ofthe Company’s then-current estimated per annum borrowing rate for seniornon-convertible fixed-rate debt with a maturity date and 

 

11

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other terms comparable to thatof the CODES 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.

 

*Credit Facility*

 

In May 2003,the Company 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. Watson’s assets generally areheld by, and its operations generally are conducted through, itssubsidiaries.  Within the meaning ofRegulation S-X, Rule 3-10, the Company has no assets or operations independentof its subsidiaries.  The terms of thenew credit facility require each subsidiary, other than minor subsidiaries, toprovide full and unconditional guarantees on a joint and several basis. Inorder to provide subsidiary guarantees in connection with this credit facility,the Company was also required, by the terms of the Indenture for the 1998Senior Notes, to grant similar subsidiary guarantees in favor of the 1998Senior Note holders. The subsidiary guarantees related to both the new creditfacility and the 1998 Senior Notes are full and unconditional, on a joint andseveral basis, and are given by all subsidiaries other than minorsubsidiaries.  Watson is subject tocertain financial and operational covenants, all of which, as of March 31,2004, the Company was in compliance.  Asof March 31, 2004, the Company had not drawn any funds from the revolvingcredit facility.

 

**NOTE G – FINANCIALINSTRUMENTS**

 

*Fair value of financial instruments*

 

The Company’sfinancial instruments consist primarily of cash and cash equivalents, marketablesecurities, accounts and other receivables, investments, trade accountspayable, senior subordinated notes, CODES and embedded derivatives related tothe issuance of the CODES.  The carryingamounts of cash and cash equivalents, marketable securities, accounts and otherreceivables and trade accounts payable are representative of their respectivefair values due to their relatively short maturities.  The fair values of investments in companies that are publiclytraded are based on quoted market prices. The fair value of investments in privately held companies, orcost-method investments, are based on historical cost, adjusted for anywrite-down related to impairment.  TheCompany estimates the fair value of its fixed rate long-term obligations based onquoted market rates of interest and maturity schedules for similar issues.  The carrying value of these obligationsapproximates their fair value.  The fairvalue of the embedded derivatives related to the CODES is based on a presentvalue technique using discounted expected future cash flows.

 

*Derivative financial instruments*

 

The Company’sderivative financial instruments consist of embedded derivatives related to itsCODES.  These embedded derivativesinclude certain conversion features and a contingent interest feature.   See Note F for a more detailed descriptionof these features of the CODES. Although the conversion features represent embedded derivative financialinstruments, based on the de minimis value of these features at the time ofissuance and at March 31, 2004, no value has been assigned to theseinstruments.  The contingent interestfeature provides unique tax treatment under the Internal Revenue Service’sContingent Debt Regulations.  Inessence, interest accrues, for tax purposes, on the basis of the instrument’scomparable yield (the yield at which the issuer would issue a fixed rateinstrument with similar terms). This embedded derivative is reported on theCompany’s Condensed Consolidated Balance Sheets at fair value and the changes inthe fair value of the embedded derivative are reported as gains or losses inthe Company’s Condensed Consolidated Statements of Income.

 

At March 31,2004 and 2003, the carrying amount of $4.9 million and $2.0 millionrespectively, approximated the estimated fair value of the Company’s derivativefinancial instruments.

 

12

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During thethree month period ended March 31, 2004, the fair value of the Company’sderivative financial instruments decreased $0.2 million.  The change in fair value was recorded as areduction of interest expense during the respective period.

 

**NOTE H – COMMITMENTSAND CONTINGENCIES**

 

*Facility and equipment leases*

 

The Company has entered intooperating leases for certain facilities and equipment.  The terms of the operating leases for theCompany’s facilities require the Company to pay property taxes, normalmaintenance expenses and maintain minimum insurance coverage.  Total rental expense for operating leasesfor the three months ended March 31, 2004 and 2003 were $2.8 million and $2.9million, respectively.

 

Future minimum leasepayments under all non-cancelable operating leases consist of approximately$8.7 million in 2004, $6.7 million in 2005, $5.5 million in 2006, $4.9 millionin 2007 and $21.6 million thereafter.

 

*Employee retirement plans*

 

The Company maintainscertain defined contribution retirement plans covering substantially allemployees.  The Company contributes tothe plans based upon the employee contributions.  Watson’s contributions to these retirement plans for the threemonths ended March 31, 2004 and 2003 were $1.4 million and $1.5 million,respectively.  The Company does notsponsor any defined benefit retirement plans or postretirement benefit plans.

 

*Legal matters*

 

See Part II. Item 1. in thisQuarterly Report for detail associated with current legal proceedings.

 

13

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**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following discussion of our financialcondition and the results of our operations should be read in conjunction withthe condensed consolidated financial statements and notes thereto includedelsewhere in this Quarterly Report. This discussion contains forward-looking statements that are subject toknown and unknown risks, uncertainties and other factors that may cause ouractual results to differ materially from those expressed or implied by suchforward-looking statements.  Theserisks, uncertainties and other factors include, among others, those identifiedunder “Cautionary Note Regarding Forward-Looking Statements” and elsewhere inthis Quarterly Report and under “Risk Factors” in our Annual Report on Form10-K for the year ended December 31, 2003.

 

**Resultsof Operations**

 

During the first quarter of2004, we experienced strong growth in generic revenues due to new productlaunches in the fourth quarter of 2003 and the first quarter of 2004.  This growth was offset by lower branded revenuesin the Women’s Health and General Products groups, partially as a result of atemporary backorder on one oral contraceptive product, which has since beenresolved, and lower Androderm® product sales due to customerstocking in the fourth quarter of 2003 in advance of a December 2003 priceincrease.

 

***Net Revenues***

 

|                              |   | **Three  Months Ended  March 31,** |    |
|-----------------------------------|--------|------------------------------------|---------|
|                              |   |                               |
| **($in thousands):**              |   | **2004**                           |    | **2003** |   | **%  Change** |   |
|                              |   |                               |    |   |   |   |   |
| Net Revenues by Segment:          |   |                               |    |   |   |   |   |
| Branded pharmaceutical products   |   | $                                  | 169,381 |   | $ | 183,761 |   | (7.8 | )% |
| *% of total product net revenues* |   | *42.9*                             | *%*     | *56.2* | % |   |   |
| Generic pharmaceutical products   |   | 225,017                            |    | 143,199 |   | 57.1 | % |
| *% of total product net revenues* |   | *57.1*                             | *%*     | *43.8* | % |   |   |
| Other                             |   | 15,260                             |    | 9,962 |   | 53.2 | % |
| Total net revenues                |   | $                                  | 409,658 |   | $ | 336,922 |   | 21.6 | % |

 

*Branded Pharmaceutical Products*

 

The decrease in net revenues from our brandedpharmaceutical products segment for the three month period was primarilyattributable to a decrease in net revenues within our Women’s Health andGeneral Products groups.  During thefirst quarter of 2004, we experienced an overall decline in our oralcontraceptive product line due to a backorder on one product, Microgestin®, and lower sales of our mature products, partially offset by sales ofour new TriNessaTM product. The backorder was related to a packaging issue, which has beenresolved.  We have resumed shipments ofthis product.  We also experienced unitsales declines for our Androderm® testosteronepatch compared to the first quarter of 2003 due to customer stocking in thefourth quarter of 2003 in advance of a December 2003 price increase.  These decreases were partially offset by thelaunches of new products, subsequent to the first quarter of 2003, whichrepresented 14% of total brand sales for the first quarter of 2004.

 

Although branded pharmaceutical products netrevenues declined by 8% in the first quarter of 2004 as compared to the firstquarter of 2003, we expect to experience growth for the full year of 2004.  We expect our branded net revenues to be slightlyhigher in the second quarter of 2004 as compared to the second quarter of 2003and the first quarter of 2004; we have resumed shipments of our Microgestin® product and we expect customer purchasing of our Androderm® productto normalize in the second quarter of 2004. In the second half of 2004, we expect branded net revenues to grow as aresult of new products and improved sales, based on current prescriptiontrends, of our TriNessaTM, Oxytrol® and Androderm® products.

 

14

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*Generic Pharmaceutical Products*

 

The increase in net revenues from our genericsegment was the result of 6 new product launches, including bupropionhydrochloride sustained-release during the first quarter of 2004 and glipizideextended-release and oxycodone acetaminophen during the fourth quarter of 2003,which collectively represented 33% of our total generic net revenues in thefirst quarter of 2004.  Our nicotine gumproduct also contributed to the year over year increase.

 

We expect our recent product launches to continueto contribute to improvements year over year in net revenues from our genericsegment.  For the full year of 2004, 27%of our forecasted generic net revenues are expected to come from those productslaunched in the fourth quarter of 2003 and the first quarter of 2004.

 

*Other revenues*

 

The increase in other revenues in the firstquarter of 2004 primarily related to timing of revenue recognition fromresearch and development agreements. These revenues (including milestone payments) are deferred and recognizedover the entire contract performance period, starting with the contract’scommencement, but not prior to the removal of any contingencies for eachindividual milestone.  Therefore, uponreceipt of the milestone payment, a portion of the payment is recognized asrevenue based on the cumulative costs incurred for the project as a percentageof the total expected costs of the project. This method ensures proper matching of revenues and costs.

 

During the first quarter of 2004, we receivedrevenue from Aventis Pharmaceuticals (Aventis) in connection with BarrLaboratories, Inc.’s sales of ciprofloxacin tablets.  During the first quarter of 2003, other net revenues includedcontingent payments received from Aventis relating to a litigationsettlement.  The final payment relatingto this settlement was received from Aventis in the third quarter of 2003.

 

*Net Revenue Mix*

 

Net revenue mix is an important consideration in evaluating theprofitability of our business.  Ourbranded products generally realize higher gross profit margins than our genericproducts.  Any significant change in ournet revenue mix could substantially impact our gross profit, gross margin andthe overall profitability of our business.

 

For the three month period ended March 31, 2004, our net revenue mixwas 43% brand and 57% generic, compared to 56% brand and 44% generic for thesame period ended March 31, 2003.  Thisresulted in an overall decline in gross margin, as noted below.

 

15

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***GrossProfit Margin on Product Net Revenues (Gross Margin)***

 

|                                 |   | **Three  Months Ended  March 31,** |   |
|--------------------------------------|--------|------------------------------------|--------|
|                                 |   |                               |
|                                 |   | **2004**                           |   | **2003** |   | **Change** |   |
|                                 |   |                               |   |   |   |   |   |
| Gross Margin by Segment:             |   |                               |   |   |   |   |   |
| Branded pharmaceutical products      |   | 73.1                               | %      | 76.6 | % | -3.5 | % |
| Generic pharmaceutical products      |   | 33.0                               | %      | 25.6 | % | 7.4 | % |
| Gross margin on product net revenues |   | 50.2                               | %      | 54.2 | % | -4.0 | % |

 

The decrease in gross margin from our brandedsegment for the three months ended March 31, 2004 was attributable to a higherportion of total branded sales from in-licensed products, including Necon 7/7/7®, Mononessa® and TriNessaTM, which havelower gross margins.

 

The increase in the gross margin from ourgeneric pharmaceutical products is due to the launch of higher margin products,including oxycodone acetaminophen and glipizide extended release, and increasedsales on existing products with higher margins, such as nicotine gum, as wellas price increases on certain products subsequent to the first quarter of2003.  The increase was partially offsetby a cost of sales charge of $6.6 million relating to the expiration dating ofa portion of inventory on hand of 150 mg. bupropion hydrochloridesustained-release tablets prior to the launch of the product at the end ofMarch 2004.

 

For the full year of 2004, we expect grossmargin from product net revenues to be slightly higher than gross marginsexperienced in the first quarter of 2004 due to the cost of sales charge forbupropion hydrochloride sustained-release during the first quarter and a netrevenue mix that reflects a higher percentage from branded products during thesecond half of 2004 as compared to the first half of 2004.  Overall gross margins are expected to beapproximately 54% for the full year of 2004.

 

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

 

|                  |   | **Three  Months Ended  March 31,** |   |
|-----------------------|--------|------------------------------------|--------|
|                  |   |                               |
| **($in thousands):**  |   | **2004**                           |   | **2003** |   | **%  Change** |   |
|                  |   |                               |   |   |   |   |   |
| R&D expenses      |   | $                                  | 29,681 |   | $ | 22,484 |   | 32.0 | % |
| *as% of net revenues* |   | *7.2*                              | *%*    | *6.7* | *%* |   | * * |
|                       |        |                                    |        |  |  |  |  |  |  |

 

Research and development expenses increasedfrom the corresponding prior year period due to expanded generic developmentprograms and spending on clinical studies. We have an increased number of generic products under different stagesof development, which account for a significant portion of the increase overthe prior year period.  The clinicalstudies relate to our continued studies with Oxytrol®, a transdermal contraceptivepatch, new pain products and additional indications for Ferrlecit®.

 

We expect research and development expense toincrease slightly from first quarter 2004, in line with our estimates of 30%growth for the full year of 2004, as a result of our commitment to increasedinvestment in both our generic and branded product pipelines.

 

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

 

|                  |   | **Three  Months Ended  March 31,** |   |
|-----------------------|--------|------------------------------------|--------|
|                  |   |                               |
| **($in thousands):**  |   | **2004**                           |   | **2003** |   | **%  Change** |   |
|                  |   |                               |   |   |   |   |   |
| SG&A expenses     |   | $                                  | 77,411 |   | $ | 67,659 |   | 14.4 | % |
| *as% of net revenues* |   | *18.9*                             | *%*    | *20.1* | *%* |   | * * |
|                       |        |                                    |        |  |  |  |  |  |  |

 

Selling, general and administrative expensesincreased from the corresponding prior year period due to higher spendingassociated with our Oxytrol® product and marketing expenses related to the expansionof our sales force through our relationship with Ventiv Health Inc., ourcontract sales organization.

 

We expect selling, general and administrativeexpenses to continue to be between 19% and 21% of net revenues for the secondquarter of 2004 as well as the full year, depending on the timing of initiationof marketing and other promotional programs.

 

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

 

|                                           |   | **Three  Months Ended  March 31,** |   |
|------------------------------------------------|--------|------------------------------------|--------|
|                                           |   |                               |
| **($in thousands):**                           |   | **2004**                           |   | **2003** |   |
|                                           |   |                               |   |   |   |
| Equity in earnings (losses) of joint  ventures |   | $                                  | (1,579 | ) | $ | 117 |   |
|                                                |        |                                    |        |  |  |  |  |

 

The changefrom the prior year earnings is the result of increased losses from ourinterest in Somerset Pharmaceuticals, Inc. (Somerset), our joint venture withMylan Laboratories, Inc.  Somersetobtained an approvable letter in February 2004 for its NDA for EmSamTM, aselegeline patch for the treatment of depression.  Somerset continues to incur expenses associated with on goingtrials, operational costs and the remaining FDA requirements.  In 2004, these expenses are expected to behigher than the prior year.

 

***Gain on Sale ofSecurities***

 

|                       |   | **Three  Months Ended  March 31,** |   |
|----------------------------|--------|------------------------------------|--------|
|                       |   |                               |
| **($in thousands):**       |   | **2004**                           |   | **2003** |   |
|                       |   |                               |   |   |   |
| Gain on sale of securities |   | $                                  | 3,938  |   | $ | 1,089 |   |
|                            |        |                                    |        |  |  |  |  |

 

Our gain onsale of securities resulted from the sale of 150,000 shares of Andrx commonstock in the first quarter of 2004 and the sale of 190,000 shares of Dr. Reddycommon stock in the first quarter of 2003. We no longer hold any shares of common stock of Dr. Reddy.  At March 31, 2004, we held approximately697,000 shares of Andrx common stock at a fair value of $19.0 million with agross unrealized holding gain of $17.1 million.  See Note B in the accompanying Notes to Condensed ConsolidatedFinancial Statements in this Quarterly Report.

 

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***Loss on EarlyExtinguishment of Debt***

 

|                                 |   | **Three  Months Ended  March 31,** |   |
|--------------------------------------|--------|------------------------------------|--------|
|                                 |   |                               |
| **($in thousands):**                 |   | **2003**                           |   | **2002** |   |
|                                 |   |                               |   |   |   |
| Loss on early extinguishment of debt |   | $                                  | 14,006 |   | $ | 2,807 |   |
|                                      |        |                                    |        |  |  |  |  |

 

 

In February2004, we repurchased $101.6 million of our 1998 Senior Notes for totalconsideration of $115.1 million, or a 13% premium over each note’s facevalue.  As a result of the repurchase,we incurred a $14.0 million charge related to fees, expenses, and the premiumpaid (as described in Note F).

 

During thefirst quarter of 2003, as a result of the retirement of our previous creditfacility, we incurred a $2.8 million charge for the unamortized bank feesassociated with this credit facility.

 

***Interest Expense***

 

|                 |   | **Three  Months Ended  March 31,** |   |
|----------------------|--------|------------------------------------|--------|
|                 |   |                               |
| **($in thousands):** |   | **2004**                           |   | **2003** |   | **%  Change** |   |
|                 |   |                               |   |   |   |   |   |
| Interest expense     |   | $                                  | 3,743  |   | $ | 5,341 |   | -29.9 | % |
|                      |        |                                    |        |  |  |  |  |  |  |

 

Interestexpense decreased for the three month period ended March 31, 2004 as a resultof the repurchase of a portion of our 1998 Senior Notes in February 2004 andincrease capitalized interest related to higher balances of capital projects inprocess.

 

**Liquidityand Capital Resources**

 

 We assess liquidity by our ability togenerate cash to fund our operations. Significant factors that affect the management of our liquidity include:current balances of cash, cash equivalents and value of marketable securities;expected cash flows provided by operations; current levels of our accountsreceivable, inventory and accounts payable balances; our expected investment incapital; access to financing sources, including credit and equity arrangements;and the financial flexibility to attract long-term capital on satisfactoryterms.

 

We generatedcash in excess of our working capital requirements for the three months endedMarch 31, 2004.  Our cash flows providedby operations were $10.6 million.  Cashflow from operations was positively impacted primarily by net income.  Cash flow from operations was negativelyimpacted primarily by the change in balances from December 31, 2003 of incometax payable due to a tax payment of $80 million made in the first quarter of2004.

 

Othersignificant uses of cash for the three months ended March 31, 2004, includedthe additions to property and equipment ($23.2 million) and the repurchase of$101.6 million of our 1998 Senior Notes (as discussed above and in NoteF).  We currently expect to spendbetween $130 million to $140 million for property and equipment additionsfor the full year of 2004, of which we expect approximately $21 million to berelated to the installation and implementation of our new Enterprise ResourcePlanning system.

 

In March 2003, we issued $575 millionof convertible contingent senior debentures (CODES) due in 2023.  As of March 31, 2004, the entire amount ofthe CODES remained outstanding at an effective annual interest rate ofapproximately 2.3%.

 

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In February 2004, werepurchased $101.6 million of our 1998 Senior Notes for total consideration of$115.1 million, or a 13% premium over each note’s face value.  We recorded a charge in the first quarter of2004 related to fees, expenses and the premium paid of $14.0 million.  Interest expense in 2004 will decline as aresult of the repurchase.

 

In May 2003, we entered into anagreementwith a syndicate of lenders for a five-year, $300 million senior,unsecured revolving credit facility for working capital and other generalcorporate purposes.  As of March 31,2004, the total $300 million under the revolving credit facility was availableto us. Under the terms of the revolving credit facility, each of our subsidiaries,other than minor subsidiaries, entered into a full and unconditional guaranteeon a joint and several basis.  In orderto provide subsidiary guarantees in connection with the new credit facility, wewere required to issue similar guarantees to the 1998 Senior Note holders.  We are subject to and, as of March 31, 2004,were in compliance with certain financial and operation covenants under theterms of the credit facility.

 

Our cash andcurrent marketable securities totaled $468.9 million at March 31, 2004.  The fair value of our current marketablesecurities may fluctuate significantly due to volatility of the stock marketand changes in general economic conditions. See Item 3 in this Quarterly Report on Form 10-Q.  We believe that our cash and marketablesecurities balance and our expected cash flows from operations will besufficient 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 changematerially in future periods.  However,no assurance can be given that additional funds will be available onsatisfactory terms, or at all, to fund such activities.

 

*Recent accounting pronouncements*

 

In January2003, the FASB issued Interpretation No. (FIN) 46, “Consolidation of VariableInterest Entities” an interpretation of Accounting Research Bulletin No. 51,“Consolidated Financial Statements.” The primary objectives of FIN 46 are to provide guidance on theidentification of entities which the Company may control through means otherthan through voting rights (“variable interest entities”) and to determine whenand which business enterprise (“primary beneficiary”) should consolidate thevariable interest entity.  FIN 46requires existing unconsolidated variable interest entities to be consolidatedby their primary beneficiaries if the entities do not effectively disperserisks among the parties involved. Variable interest entities that effectively disperse risks will not beconsolidated unless a single party holds an interest or combination ofinterests that effectively recombines risks that were previouslydispersed.  In addition, FIN 46 requiresthat the primary beneficiary, as well as all other enterprises with asignificant variable interest in a variable interest entity, make additionaldisclosures.  Certain disclosurerequirements of FIN 46 were effective for financial statements issued afterJanuary 31, 2003.  In December 2003, theFASB revised FIN 46 (FIN 46R) to address certain FIN 46 implementationissues.  The revised provisions areapplicable no later than the first reporting period ending after March 15,2004.    The Company adopted FIN 46 andFIN 46R and, based upon the evaluation performed of all interests, havedetermined the Company does not have any variable interest entities thatrequire consolidation.

 

In April 2004,the FASB issued FASB Staff Position No. 129-1 (FSP 129-1), “DisclosureRequirements under FASB Statement No. 129, Disclosure of Information aboutCapital Structure, Relating to Contingently Convertible Securities.”  This FSP requires the disclosure provisionsof Statement 129 to apply to all existing and newly created contingentlyconvertible securities and to their potentially dilutive effects on earningsper share.  The Company has adopted thedisclosure requirements of FSP 129-1 in its Condensed Consolidated FinancialStatements.

 

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**CAUTIONARYNOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

Any statements made in this report that arenot statements of historical fact or that refer to estimated or anticipatedfuture events are forward-looking statements. We have based our forward-looking statements on management’s beliefs andassumptions based on information available to our management at the time thesestatements are made.  Suchforward-looking statements reflect our current perspective of our business,future performance, existing trends and information as of the date of this filing.  These include, but are not limited to:

 

•                  our beliefsabout future revenue and expense levels and growth rates,

•                  prospectsrelated to our strategic initiatives and business strategies,

•                  express orimplied assumptions about government regulatory action or inaction,

•                  anticipatedproduct approvals and launches,

•                  businessinitiatives and product development activities,

•                  assessmentsrelated to clinical trial results,

•                  productperformance and competitive environment, and

•                  anticipatedfinancial performance.

 

Without limiting the generality of theforegoing, words such as *“may,” “will,” “expect,” “believe,” “anticipate,”“intend,” “could,” “would,” “estimate,” “continue,” or “pursue,”* orthe negative other variations thereof or comparable terminology, are intendedto identify forward-looking statements. The statements are not guarantees of future performance and involvecertain risks, uncertainties and assumptions that are difficult to predict.

 

We caution thereader that certain important factors may affect our actual operating resultsand could cause such results to differ materially from those expressed orimplied 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 activities and uncertaintiesrelated to the timing or outcome of these activities;

 

• the timing and unpredictability of regulatory authorizations and productlaunches, which is particularly sensitive in our generic business;

 

• mix of generic and branded product sales and the impact on margins andprofitability;

 

• the outcome of our litigation, and the costs, expenses and possiblediversion of management’s time and attention arising from such litigation;

 

• our ability to retain key personnel;

 

• our ability to adequately protect our technology and enforce ourintellectual property rights;

 

• our ability to obtain and maintain a sufficient supply of products tomeet market demand in a timely manner;

 

• our dependence on sole source suppliers and the risks associated withproduction interruptions or supply delays at such third party suppliers or atour own manufacturing facilities;

 

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

 

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

 

• the increasing costs of insurance, and limitations on obtaining insurancecoverage;

 

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

 

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• the availability to us, on commercially reasonable terms, of rawmaterials and other third party sourced products;

 

• our exposure toproduct liability and other lawsuits and contingencies;

 

•our mix of product sales between branded products, which typically have highermargins, and generic products;

 

• our dependence on revenues from significant products, in particular,Ferrlecit®, for which 2004 net revenues are expected to be approximately 10% ofour total net revenues;

 

• our dependence on revenues from significant customers;

 

• the ability of third parties to assert patents or other intellectualproperty rights against us which, among other things, could cause a delay ordisruption in the manufacture, marketing or sale of our products;

 

• our ability tolicense patents or other intellectual property rights from third parties oncommercially reasonable terms;

 

• the expiration of patent and regulatory exclusivity on certain of ourproducts that will result in competitive and pricing pressures;

 

• difficulties and delays inherent in product development, manufacturingand 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 evolvinggovernmental regulations and restrictions;

 

• market acceptance of and continued demand for our products and theimpact of competitive products and pricing;

 

• our ability to successfully compete in both the branded and genericpharmaceutical product sectors;

 

• our timely andsuccessful implementation of strategic initiatives, including integratingcompanies and products we acquire and new enterprise resource planning systems;and

 

• other risks and uncertainties detailed herein and from time to time inour Securities and Exchange Commission filings.

 

We disclaimany obligation to publicly update any forward-looking statements, whether as aresult of new information, future events or otherwise.  We also may make additional disclosures inour Annual Report on 

 

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Form 10-K, Quarterly Reports onForm 10-Q and Current Reports on Form 8-K that we may file from time to timewith the Securities and Exchange Commission (SEC).  Please also note that we provided a cautionary discussion ofrisks and uncertainties under the section entitled “Risk Factors” in our AnnualReport on Form 10-K for the year ended December 31, 2003.  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.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK**

 

We are exposed to market risk for changes inthe market values of our investments (Investment Risk) and the impact ofinterest rate changes (Interest Rate Risk). We have not used derivative financial instruments in our investmentportfolio.  The quantitative andqualitative disclosures about market risk are set forth below.

 

**InvestmentRisk**

 

As of March 31, 2004, our total holdings inequity securities of other companies, including equity-method investments andavailable-for-sale securities, were $45.0 million.  Of this amount, we had equity-methodinvestments of $16.5 million and publicly traded equity securities(available-for-sale securities) at fair value totaling $28.5 million ($19.0million that was included in “Marketable securities” and $9.5 million that wasincluded in “Investments and other assets”). The fair values of these investments are subject to significantfluctuations due to volatility of the stock market and changes in generaleconomic conditions.  Based on the fairvalue of the publicly traded equity securities we held at March 31, 2004,an assumed 25%, 40% and 50% adverse change in the market prices of thesesecurities would result in a corresponding decline in total fair value ofapproximately $7.1 million, $11.4 million and $12.3 million,respectively.

 

At March 31, 2004, our investment in Andrxconsisted of approximately 697,000 shares of Andrx common stock with a fairmarket value of $19 million.  BecauseAndrx is a publicly traded equity security, our holdings of Andrx have exposureto investment risk.   The market priceof Andrx common shares has been, and may continue to be volatile.  For example, on March 31, 2004, the finaltrading day of the quarter, the closing price of Andrx was $27.20.  On May 4, 2004, before the filing of thisForm 10-Q, the closing price of Andrx common stock was $23.76.

 

The following table sets forth the Andrx highand low market price per share information, based on published financialsources, for 2004 and 2003 and further reflects the volatility of the stockprice:

 

|                 |   | **High** |   | **Low** |   |
|----------------------|--------|----------|--------|---------|--------|
| **2004, by quarter** |   |     |   |    |   |
| First                |   | $        | 30.87  |    | $      | 23.55 |   |
|                 |   |     |   |    |   |
| **2003, by quarter** |   |     |   |    |   |
| First                |   | $        | 16.83  |    | $      | 7.68 |   |
| Second               |   | $        | 24.20  |    | $      | 11.10 |   |
| Third                |   | $        | 25.90  |    | $      | 16.32 |   |
| Fourth               |   | $        | 24.05  |    | $      | 17.00 |   |

 

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

 

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**Interest Rate Risk**

 

Our exposureto interest rate risk relates primarily to our non-equity investment portfolio.  Our cash is invested in A-rated money marketmutual funds and short-term securities. Consequently, our interest rate andprincipal 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 on March 31, 2004.  While changesin market interest rates may affect the fair value of our fixed-rate debt, webelieve the effect, if any, of reasonably possible near-term changes in thefair value of such debt on our financial condition, results of operations orcash flows will not be material.

 

At this time, we are not party to anyinterest rate or derivative hedging contracts and have no material foreignexchange or commodity price risks.

 

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**ITEM 4. CONTROLS AND PROCEDURES**

 

The Companymaintains disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in the Company’s Exchange Act reports isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and that such information is accumulated andcommunicated to the Company’s management, including its Principal ExecutiveOfficer and Principal Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures,management recognized that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and management necessarily was required to applyits judgment in evaluating the cost-benefit relationship of possible controls andprocedures.  Also, the Company hasinvestments in certain unconsolidated entities.  As the Company does not control or manage these entities, itsdisclosure controls and procedures with respect to such entities arenecessarily substantially more limited than those it maintains with respect toits consolidated subsidiaries.

 

As required bySEC Rule 13a-15(b), the Company carried out an evaluation, under thesupervision and with the participation of the Company’s management, includingthe Company’s Principal Executive Officer and Principal Financial Officer, ofthe effectiveness of the design and operation of the Company’s disclosurecontrols and procedures as of the end of the quarter covered by this Report.Based on the foregoing, the Company’s Principal Executive Officer and PrincipalFinancial Officer concluded that the Company’s disclosure controls andprocedures were effective at the reasonable assurance level.

 

There havebeen no changes in the Company’s internal control over financial reporting,during the three months ended March 31, 2004, that has materially affected, oris reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

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**PART II.  OTHER INFORMATION AND SIGNATURES**

 

**ITEM1.  LEGAL PROCEEDINGS**

 

The Company is party to certainlawsuits and legal proceedings, which are described in “Part I, Item 3. LegalProceedings,” of our Annual Report on Form 10-K for the year ended December 31,2003.  The following is a description ofmaterial developments during the period covered by this Quarterly Report andshould be read in conjunction with 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 April 15, 2004, approximately 610actions were pending against the Company and other Company entities in a numberof 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.

 

*FDAMatters.*  On April 8, 2004, the United States DistrictCourt for the District of Arizona entered an order vacating the Consent Decreeof Condemnation and Permanent Injunction previously entered against SterisLaboratories, Inc. and other defendants on October 21, 1998.  The court entered the order upon Steris’request, which the FDA agreed not to oppose. The Company is continuing to evaluate divestiture or otheralternatives related to the Steris facility.

 

With respect to the May 2002 consent decreeentered against Watson Laboratories, Inc. in connection with the Company’sCorona, California facility, the FDA conducted an inspection of that facilityfrom March 31, 2004 until May 6, 2004. At the conclusion of the inspection, the FDA issued a Form 483 listingthe observations made during the inspection, including observations related tocertain laboratory test methods and other procedures in place at thefacility.  The Company intends to submita response to the FDA that will address the FDA’s observations.  However, the FDA is not required to accept or agree with the Company'sresponses.  If, in the future, the FDAdetermines that, with respect to its Corona facility, Watson has failed tocomply with the consent decree or FDA regulations, including cGMPs, or hasfailed to adequately address the observations in the Form 483, the consentdecree allows the FDA to order Watson to take a variety of actions to remedythe deficiencies. These actions could include ceasing manufacturing and relatedoperations at the Corona facility, and recalling affected products.  Such actions, if taken by the FDA, couldadversely affect the Company, its results of operations, financial positionand/or cash flows.

 

*SecuritiesLitigation**. *On April 8,2004, the plaintiffs in the shareholders derivative action pending in theCalifornia Superior Court for the County of Riverside  *(Charles Zimmerman v. AllenChao, etal., Lead Case No. 403715)*, filed a consolidated complaint,which generally alleges claims that are similar to the previously filedcomplaints in that action.  The Companyis required to respond to this consolidated complaint on or before May 24,2004.  In the case pending in the UnitedStates District Court for the Central District of California (In re WatsonPharmaceuticals, Inc. Securities Litigation, Case No. CV-03-8236 AHM), on March19, 2004, the court entered an order requiring the plaintiffs to file aconsolidated complaint by April 23, 2004. The consolidated complaint generally alleges claims that are similar tothe allegations in the previously filed complaints in that action.  The court’s order also set a briefingschedule for the defendants’ motion to dismiss the consolidated complaint.  Pursuant to the court’s order, thedefendants are required to file their motion to dismiss the consolidatedcomplaint on or before May 24, 2004, and the hearing on the motion is scheduledfor July 26, 2004.

 

The Company and its affiliates are involvedin various other disputes, governmental and/or regulatory inspections,investigations and proceedings, and litigation matters that arise from time totime in the ordinary course of business. The process of resolving matters through litigation or other means isinherently uncertain and it is possible that the resolution of these matterswill adversely affect the Company, its results of operations, financialposition and/or cash flows.

 

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**ITEM6.  EXHIBITS AND REPORTS ON FORM 8-K**

 

(a) Exhibits:

 

Reference ishereby made to the Exhibit Index on page 28.

 

(b) Reports onForm 8-K filed during the quarter ended March 31, 2004:

 

On February 5,2004, the Company filed a Current Report on Form 8-K with the Securities andExchange Commission reporting, under Item 12, stating that it had issued a newsrelease announcing its financial results for the fourth quarter and full yearended December 31, 2003.

 

On February10, 2004, the Company filed a Current Report on Form 8-K with the Securitiesand Exchange Commission reporting, under Item 5, stating that it had commenceda cash tender offer and consent solicitation for all of its $150,000,000principal amount of 7 1/8 % Senior Notes due 2008.

 

On March 30,2004, the Company filed a Current Report on Form 8-K with the Securities andExchange Commission reporting under Item 5, that the Company’s Board ofDirectors voted to increase the size of the current Board from 8 to 9 membersand appointed Catherine M. Klema to fill the newly created vacancy.

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned,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)                           |

 

 

Date:  May 10, 2004

 

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**WATSON PHARMACEUTICALS, INC.**

 

**EXHIBIT INDEX TO FORM10-Q**

**For the QuarterlyPeriod Ended March 31, 2004**

 
| **Exhibit No.** |   | **Description**                                                                                                                    |
|-----------------|--------|------------------------------------------------------------------------------------------------------------------------------------|
| 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. |

 

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