Allergan Finance LLC 10-Q 2006
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
For the transition period from to
Commission file number 001-13305
WATSON PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
311 Bonnie Circle
Corona, CA 92880-2882
(Address of principal executive offices, including zip code)
(Registrants telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The number of shares outstanding of the Registrants only class of common stock as of November 3, 2006 was approximately 102,468,000.
WATSON PHARMACEUTICALS, INC.
TABLE OF CONTENTS
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
WATSON PHARMACEUTICALS, INC.
(Unaudited; in thousands)
See accompanying Notes to Condensed Consolidated Financial Statements.
WATSON PHARMACEUTICALS, INC.
(Unaudited; in thousands, except per share amounts)
See accompanying Notes to Condensed Consolidated Financial Statements.
WATSON PHARMACEUTICALS, INC.
(Unaudited; in thousands)
See accompanying Notes to Condensed Consolidated Financial Statements.
WATSON PHARMACEUTICALS, INC.
NOTE 1 GENERAL
Watson Pharmaceuticals, Inc. (Watson or the Company) is primarily engaged in the development, manufacture, marketing, sale and distribution of brand and off-patent (generic) pharmaceutical products. Watson was incorporated in 1985 and began operations as a manufacturer and marketer of off-patent pharmaceuticals. Through internal product development and synergistic acquisitions of products and businesses, the Company has grown into a diversified specialty pharmaceutical company. Watson operates manufacturing, distribution, research and development and administrative facilities primarily in the United States of America (U.S.).
The accompanying Condensed Consolidated Financial Statements should be read in conjunction with the Companys Annual Report on Form 10-K for the year ended December 31, 2005. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted from the accompanying Condensed Consolidated Financial Statements. The year end balance sheet was derived from the audited financial statements. The accompanying interim financial statements are unaudited, but reflect all adjustments which are, in the opinion of management, necessary to fairly state Watsons consolidated financial position, results of operations and cash flows for the periods presented. Unless otherwise noted, all such adjustments are of a normal, recurring nature. Certain reclassifications, none of which affected net income or retained earnings, have been made to prior period amounts to conform to current period presentation. The Companys results of operations and cash flows for the interim periods are not necessarily indicative of the results of operations and cash flows that it may achieve in future periods or for the full year.
In the year ended December 31, 2005 the Company acquired additional common shares in Scinopharm Taiwan, Ltd. (Scinopharm), previously accounted for under the cost method, to an ownership level in excess of 20%. Accordingly, as required by Accounting Principles Board (APB) Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock (APB 18), results of operations, earnings per share and cash flows from operating and investing activities have been restated for the three and nine months ended September 30, 2005 to conform to current period presentation.
Acquisition of Andrx Corporation
On November 3, 2006, the Company acquired all the outstanding shares of common stock of Andrx Corporation (Andrx) in an all-cash transaction for $25 per share, or total consideration of approximately $1.9 billion (the Andrx Acquisition). Andrx distributes pharmaceutical products primarily to independent and chain pharmacies and physicians offices and is considered a leader in formulating and commercializing difficult-to-replicate controlled-release pharmaceutical products and selective immediate-release products. For additional information on the Andrx Acquisition, refer to NOTE 12 SUBSEQUENT EVENTS.
Comprehensive income includes all changes in equity during a period except those that resulted from investments by or distributions to the Companys stockholders. Other comprehensive income (loss) refers to revenues, expenses, gains and losses that, under generally accepted accounting principles, are included in comprehensive income (loss), but excluded from net income as these amounts are recorded directly as an adjustment to stockholders equity. Watsons other comprehensive income (loss) is comprised of unrealized gains (losses) on its holdings of publicly traded debt and equity securities, net of realized gains (losses) included in net income and foreign currency translation adjustments. Other comprehensive income includes unrealized
gains on our holdings in shares of Andrx common stock. For additional information on the impact of the Andrx Acquisition on our accounting for unrealized gains related to Andrx, refer to NOTE 12 SUBSEQUENT EVENTS. The components of comprehensive income including attributable income taxes consisted of the following (in thousands):
Preferred and Common Stock
As of September 30, 2006 and December 31, 2005 there were 2,500,000 shares of no par value per share preferred stock authorized, with none issued. As of September 30, 2006 and December 31, 2005, there were 500,000,000 shares of $0.0033 par value per share common stock authorized, with 111,865,000 and 110,205,000 shares issued, and 102,465,000 and 100,805,000 outstanding, respectively. Approximately 9,399,800 shares were held as treasury shares as of September 30, 2006 and December 31, 2005, respectively.
During 2005, we repurchased approximately 9.4 million shares of our common stock at an aggregate cost of $300.0 million under the Companys $300.0 million stock repurchase program approved by the Companys Board of Directors (Board) on February 10, 2005 (the 2005 Repurchase Program). This completed our stock repurchase program under the 2005 Repurchase Program.
On February 15, 2006, the Board authorized the expenditure of an additional $300.0 million to repurchase shares of the Companys outstanding common stock (the 2006 Repurchase Program). Repurchases are authorized to be made in open market or privately negotiated transactions from time to time in compliance with the SEC Rule 10b-18, subject to market conditions, applicable legal requirements and other factors. Additionally, the Board has authorized that purchases may be made under Rule 10b5-1 promulgated under the Securities and Exchange Act of 1934, as amended. A Rule 10b5-1 plan allows Watson to repurchase its shares during periods when it would normally not be active in the market due to its internal trading blackout periods. All such purchases must be made in accordance with a pre-defined plan that is established when the plan administrator is not aware of any material non-public information. At this time, the Company has no current plans to repurchase common stock under the 2006 Repurchase Program.
Provisions for Sales Returns and Allowances
As customary in the pharmaceutical industry, the Companys gross product sales are subject to a variety of deductions in arriving at reported net product sales. When the Company recognizes revenue from the sale of its products, an estimate of sales returns and allowances (SRA) is recorded which reduces product sales and accounts receivable. These adjustments include estimates for chargebacks, rebates, cash discounts and returns and other allowances. These provisions are estimated based on historical payment experience, historical relationship to revenues, estimated customer inventory levels and current contract sales terms with direct and
indirect customers. The estimation process used to determine our SRA provision has been applied on a consistent basis and no material adjustments have been necessary to increase or decrease our reserves for SRA as a result of a significant change in underlying estimates. The Company uses a variety of methods to assess the adequacy of our SRA reserves to ensure that our financial statements are fairly stated. This includes periodic reviews of customer inventory data, customer contract programs and product pricing trends to analyze and validate the SRA reserves.
The provision for chargebacks is our most significant sales allowance. A chargeback represents an amount payable in the future to a wholesaler for the difference between the invoice price paid to the Company by our wholesale customer for a particular product and the negotiated contract price that the wholesalers customer pays for that product. The Companys chargeback provision and related reserve vary with changes in product mix, changes in customer pricing and changes to estimated wholesaler inventory. The provision for chargebacks also takes into account an estimate of the expected wholesaler sell-through levels to indirect customers at contract prices. The Company validates the chargeback accrual quarterly through a review of the inventory reports obtained from our largest wholesale customers. This customer inventory information is used to verify the estimated liability for future chargeback claims based on historical chargeback and contract rates. These large wholesalers represent 85% - 90% of the Companys chargeback payments. The Company continually monitors current pricing trends and wholesaler inventory levels to ensure the liability for future chargebacks is fairly stated. The following table summarizes the activity in the Companys major categories of SRA (in thousands):
Earnings Per Share
Basic earnings per share is computed by dividing net income by the weighted average common shares outstanding during a period. Diluted earnings per share is based on the treasury stock method and includes the effect from potential issuance of common stock, such as shares issuable upon conversion of the $575 million convertible contingent senior debentures (CODES), and the dilutive effect of stock options and restricted stock awards outstanding during the period. Common share equivalents have been excluded where their inclusion would be anti-dilutive. In accordance with Emerging Issues Task Force (EITF) Issue No. 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share, the Company is required to add approximately 14.4 million shares associated with the conversion of the CODES to the number of shares outstanding for the calculation of diluted earnings per share for all periods in which the securities were outstanding. A reconciliation of the numerators and denominators of basic and diluted earnings per share
consisted of the following (in thousands, except per share amounts):
Stock awards to purchase 10.8 million and 6.2 million common shares for the three month periods ended September 30, 2006 and 2005, respectively, were outstanding but were not included in the computation of diluted earnings per share because the options were antidilutive. Stock awards to purchase 10.1 million and 6.3 million common shares for the nine month periods ended September 30, 2006 and 2005, respectively, were outstanding but were not included in the computation of diluted earnings per share because the options were antidilutive.
Recent Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 151, Inventory Costs-an Amendment of ARB No. 43, Chapter 4 (SFAS 151). SFAS 151 clarifies that items such as abnormal freight, handling costs, and wasted materials (spoilage) be recognized as current period charges rather than as a portion of the inventory cost. Unallocated overheads are to be recognized as an expense in the period in which they are incurred. In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. This Statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The provision of this Statement shall be applied prospectively. The adoption of SFAS 151 on January 1, 2006, did not have a material effect on our Condensed Consolidated Financial Statements.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R), which replaces SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123) as well as SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure (SFAS 148), supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and amends SFAS No. 95, Statement of Cash Flows (SFAS 95). SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The intrinsic value method as permitted under APB 25 together with the
pro forma disclosures previously permitted under SFAS 123 no longer will be an alternative to financial statement recognition. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for attributing compensation cost to reporting periods and the transition method to be used at date of adoption. The transition methods include modified prospective and modified retrospective adoption options. Under the modified retrospective option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all unvested stock options at the beginning of the first quarter of adoption of SFAS 123R, while the modified retrospective method would record compensation expense for all unvested stock options beginning with the first period restated. SFAS 123R also requires any previously recorded unearned or deferred compensation accounts (i.e. contra-equity accounts) within stockholders equity be recorded as a reduction to additional paid-in capital balances rather than shown as contra equity accounts as was permitted prior to January 1, 2006. SFAS 95 is amended to require excess tax benefits be reported as a financing cash flow rather than as a reduction in taxes paid within the Consolidated Statement of Cash Flows. On January 1, 2006, the Company adopted SFAS 123R using the modified prospective method option.
In March 2005, the SEC issued SEC Staff Bulletin No. 107 (SAB 107) which describes the SEC staff position as well as supplemental implementation guidance on the application and adoption of SFAS 123R. The Company has applied the provisions of SAB 107 and its guidance in our adoption of SFAS 123R on January 1, 2006 (Refer to NOTE 2 SHARE-BASED COMPENSATION).
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS 154), which replaces APB Opinion No. 20, Accounting Changes (APB 20) and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements (SFAS 3). SFAS 154 applies to all voluntary changes in accounting principle and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS 154 also requires retrospective application to prior period financial statements involving changes in accounting principle unless it is impracticable to determine either the period-specific or cumulative effect of the change. This statement also requires that a change in the method of depreciation, amortization or depletion of long-lived assets be accounted for as a change in accounting estimate that is accounted for prospectively. SFAS 154 also retains many provisions of APB 20 including those related to reporting a change in accounting estimate, a change in the reporting entity and a correction of an error and also carries forward provisions of SFAS 3 governing the reporting of accounting changes in interim financial statements. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 on January 1, 2006, did not have a material effect on our Consolidated Financial Statements.
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes An Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for the uncertainty in recognizing income taxes in an organization in accordance with FASB Statement No. 109 by providing detailed guidance for financial statement recognition, measurement and disclosure involving uncertain tax positions. FIN 48 requires an uncertain tax position to meet a more-likely-than-not recognition threshold at the effective date to be recognized both upon the adoption of FIN 48 and in subsequent periods. FIN 48 is effective for fiscal years beginning after December 15, 2006. As the provisions of FIN 48 will be applied to all tax positions upon initial adoption, the cumulative effect of applying the provisions of FIN 48 will be reported as an adjustment to the opening balance of retained earnings for that fiscal year. The Company is currently evaluating FIN 48 and the effect, if any, on our Condensed Consolidated Financial Statements.
NOTE 2 SHARE-BASED COMPENSATION
As indicated above, effective January 1, 2006, the Company adopted the modified prospective method of SFAS 123R which requires the measurement and recognition of compensation expense for all share-based compensation awards made to employees and directors based on estimated fair values. SFAS 123R eliminates previously available alternatives to account for share-based compensation transactions, as the Company formerly did, using the recognition and measurement principles of APB 25 and related interpretations. Under the intrinsic value method of APB 25, no stock-based employee compensation expense had been recognized for employee options in the Companys Condensed Consolidated Statements of Income, as all employee options granted under the Companys stock option plans or employee stock purchase plan (ESPP) either had an exercise price equal to the market value of the underlying common stock on the date of grant or were deemed non-compensatory under APB 25 for common stock issued under our ESPP. In accordance with the modified prospective method, the consolidated financial statements for prior periods have not been restated to reflect, and do not include, the share-based compensation impact of FAS 123R.
Stock Option Plans
The Company has adopted several stock option plans, all of which have been approved by the Companys shareholders, that authorize the granting of options to purchase the Companys common shares subject to certain conditions. At September 30, 2006, the Company had reserved 14.6 million of its common shares for issuance of share-based compensation awards under the Companys stock option and restricted stock plans. Options are granted at the fair value of the shares underlying the options at the date of the grant and generally become exercisable over periods ranging from three to five years and expire in ten years. In conjunction with certain of the Companys acquisitions, Watson assumed stock option and warrant plans from the acquired companies. The options and warrants in these plans were adjusted by the individual exchange ratios specified in each transaction. No additional options or warrants have been granted under any of the assumed plans. In connection with the Andrx Acquisition, the Company assumed the Andrx Corporation 2000 Stock Option Plan, as amended and restated (the "Andrx Plan"), and converted the shares remaining available for future grants thereunder into shares available for future grants under the Amendment and Restatement of the 2001 Incentive Award Plan of Watson Pharmaceuticals, Inc. (the "Watson Plan"). The shares available for future awards under the Watson Plan will not be used for grants to individuals who, as of immediately prior to the effective time of the Andrx Acquisition, were providing services (whether as an employee, director or consultant) to the Company or any entity that was a subsidiary of the Company immediately prior to the effective time of the Andrx Acquisition. As of September 30, 2006, approximately 6.1 million shares of common stock remain available for future grants under the Andrx Plan, of which no more than approximately 0.3 million shares are available for award grants other than stock options.
The Company estimates the fair value of its stock option plans and the ESPP using the Black-Scholes option pricing model (the Option Model). The Option Model requires the use of subjective and complex assumptions, including the options expected term and the estimated future price volatility of the underlying stock, which determine the fair value of the share-based awards. The Companys estimate of expected term in 2006 was determined based on the weighted average period of time that options granted are expected to be outstanding considering current vesting schedules and the historical exercise patterns of existing option plans. Beginning in 2005, the expected volatility assumption used in the Option Model changed from being based on historical volatility to implied volatility based on traded options on the Companys stock in accordance with guidance provided in SFAS 123R and SAB 107. Prior to 2005, the Companys measurement of expected volatility was based on the historical volatility of its stock. The risk-free interest rate used in the Option Model is based on the yield of U.S. Treasuries with a maturity closest to the expected term of the Companys stock options.
The following weighted average assumptions were used for stock options granted during the three and nine months ended September 30, 2006 and 2005:
Effective January 1, 2006, in accordance with the provisions of SFAS 123R, share-based compensation expense recognized during a period is based on the value of the portion of share-based awards that are expected to vest with employees. Accordingly, the recognition of share-based compensation expense beginning January 1, 2006 has been reduced for estimated future forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant with adjustments recorded in subsequent period compensation expense if actual forfeitures differ from those estimates. Prior to 2006, we accounted for forfeitures as they occurred for the disclosure of pro forma information presented in our Notes to Condensed Consolidated Financial Statements for prior periods. Share-based compensation expense recognized under SFAS 123R includes share-based awards granted subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R as well as share-based awards granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123. In conjunction with the adoption of SFAS 123R, we changed the method of recognizing share-based compensation expense from the accelerated multiple-option approach to the ratable single-option approach.
As a result of adopting SFAS 123R on January 1, 2006, the Companys operating income and net income before income tax was reduced by $1.6 million and $6.1 million, and net income was reduced by $1.0 million ($0.01 per basic and diluted share) and $3.8 million ($0.04 per basic and $0.03 per diluted share) for the three and nine months ended September 30, 2006, related to the Companys employee stock option plans, respectively. There was no employee stock option compensation related expense recognized in the three and nine months ended September 30, 2005. Total stock option cost capitalized as part of inventory was $0.2 million and $0.9 million for three and nine months ended September 30, 2006, respectively. There was no stock option cost capitalized as part of inventory in the three and nine months ended September 30, 2005.
On December 15, 2005 the Compensation Committee of the Board approved the accelerated vesting of certain unvested, out-of-the-money stock options having an exercise price of $38.00 or greater. The acceleration of vesting was effective December 15, 2005, for stock options previously awarded to the Companys employees, including its executive officers under the Companys equity compensation plans. In connection with the acceleration of vesting terms of these options, the Company recognized an additional $6.9 million, pre-tax non-cash compensation expense on a pro forma basis in accordance with SFAS 123 in the three months ended December 31, 2005. The acceleration action was taken in order to reduce the impact on future compensation expense of recognizing share based payment transactions within future periods consolidated statements of income upon adoption of SFAS 123R on January 1, 2006.
A summary of the changes in the Companys stock option plans during the nine months ended September 30, 2006 is presented below (in thousands, except per share amounts):
As of September 30, 2006, the Company had $11.7 million of total unrecognized compensation expense, net of estimated forfeitures, related to stock option grants, which will be recognized over the remaining weighted average period of 1.8 years.
During 2005, the Compensation Committee of the Board authorized and issued restricted stock to the Companys employees, including its executive officers and certain non-employee directors (the Participants) under the Companys equity compensation plans. The restricted stock award program offers Participants the opportunity to earn shares of our common stock over time, rather than options that give Participants the right to purchase stock at a set price. Restricted stock awards are grants that entitle the holder to shares of common stock subject to certain terms. Restricted stock awards generally have restrictions eliminated over a one to four year period. Restrictions generally lapse for non-employee directors after one year. Restrictions generally lapse for employees over a two to four year period. The fair value of restricted stock grants is based on the fair market value of our common stock on the respective grant dates. Restricted stock compensation is being amortized and charged to operations over the same period as the restrictions are eliminated for the Participants.
The Companys operating income and net income before income tax provision was reduced by $1.4 and $2.6 million and net income was reduced by $0.9 million ($0.01 per basic and diluted share) and $1.6 million ($0.02 per basic and $0.01 per diluted share) for the three and nine months ended September 30, 2006, related to the Companys restricted stock plans, respectively. For the three and nine months ended September 30, 2005 the Companys operating income and net income before income tax provision was reduced by $0.4 million and net income was reduced by $0.2 million ($0.00 per basic and diluted share) related to the Companys restricted stock plans, respectively. Total restricted stock cost capitalized as part of inventory was $0.4 million and $0.8 for the three and nine months ended September 30, 2006, respectively. Restricted stock cost capitalized as part of inventory in the three and nine months ended September 30, 2005 was $0.2 million.
A summary of the changes in restricted stock grants during the nine months ended September 30, 2006 is presented below (in thousands, except per share amounts):
As of September 30, 2006, the Company had $8.5 million of total unrecognized compensation expense, net of estimated forfeitures, related to restricted stock grants, which will be recognized over the remaining weighted average period of 2.2 years.
An ESPP was established for eligible employees to purchase shares of the Companys common stock at 85% of the lower of the fair market value of Watson common stock on the effective date of subscription or the date of purchase. Under the ESPP, employees could authorize the Company to withhold up to 15% of their compensation during any offering period for common stock purchases, subject to certain limitations. The ESPP was implemented on January 1, 2002 and was qualified under Section 423 of the Internal Revenue Code. The Board authorized an aggregate of 700,000 shares of the Companys common stock for issuance under the ESPP. As of December 31, 2005, a total of 471,307 shares were issued under the ESPP. On June 29, 2005 the Compensation Committee of the Board terminated the ESPP effective January 1, 2006.
The following weighted average assumptions were used for the ESPP during the three and nine months ended September 30, 2005:
Pro Forma Information for Periods Prior to the Adoption of FAS 123R
Prior to 2006, the Company determined stock-based compensation expense using the intrinsic value method of APB 25 and we provided the disclosures required by SFAS 123, as amended by SFAS 148. The following table provides the pro forma effects on net income and earnings per share for the three and nine months ended September 30, 2005 as if the fair value recognition provisions of SFAS 123R had been applied to options and ESPP
grants under the Companys employee compensation plans (in thousands, except per share amounts):
NOTE 3 ACQUISITIONS
Acquisition of Andrx Corporation
On November 3, 2006, the Company completed the Andrx Acquisition. Accordingly, the Companys Condensed Consolidated Financial Statements for the nine months ended September 30, 2006 do not include the results of operations, cash flows or financial position of Andrx. For additional information on the Andrx Acquisition, refer to NOTE 12 SUBSEQUENT EVENTS.
Acquisition of Sekhsaria Chemicals Ltd.
On March 16, 2006, the Company acquired Sekhsaria Chemicals Ltd. (Sekhsaria), a private company located in Mumbai, India that provides active pharmaceutical ingredient and finished dosage formulation expertise to the global pharmaceutical industry. The Company acquired all the outstanding shares of Sekhsaria for approximately $29.5 million plus acquisition costs. The transaction was accounted for as a purchase in accordance with SFAS No. 141, Business Combinations SFAS 141 and accordingly, the tangible assets acquired were recorded at fair value on acquisition date based on reasonable assumptions.
The results of operations of Sekhsaria have been included in the Companys Condensed Consolidated Financial Statements subsequent to the date of acquisition. Pro forma results of operations have not been presented because the effect of the acquisition was not material.
Additional Investment in Scinopharm
The Company holds an equity interest in Scinopharm. In January 2006, we made an additional investment in Scinopharm of approximately $12.0 million which increased our ownership share to approximately 31%. Additionally, we have an option to acquire an additional 44% interest in Scinopharm at a cost of approximately $80 million which expires in October 2007.
Acquisition of Manufacturing Facility in Goa, India
In October 2005, the Company entered into an asset purchase agreement to purchase a manufacturing facility located in Goa, India from Dr. Reddys Laboratories, Ltd. for total cash consideration of approximately $16.4 million plus acquisition costs. The transaction included a manufacturing facility, machinery and equipment.
NOTE 4 INVESTMENTS
The Companys equity investments in publicly traded securities are classified as available-for-sale and are recorded at fair value based on quoted market prices using the specific identification method. These investments are classified as current marketable securities, or investment and other assets, as appropriate, on the Companys Condensed Consolidated Balance Sheets.
The Companys debt investments in U.S. Treasury and agency securities are classified as available-for-sale and are recorded at fair value based on quoted market prices using the specific identification method.
The following table provides a summary of the fair value and unrealized holding gain (loss) related to Watsons available-for-sale securities (in thousands):
Gross unrealized gains at September 30, 2006 and December 31, 2005 primarily relate to our holdings in shares of Andrx common stock. The gross unrealized holding loss at September 30, 2006 and December 31, 2005 is attributable to adjustments, included in other comprehensive income, for the decline in fair value in the Companys investment in U.S. Treasury and agency securities. For additional information on the impact of the Andrx Acquisition on our accounting for unrealized gains related to Andrx, refer to NOTE 12 SUBSEQUENT EVENTS.
The Companys net unrealized gain related to its available-for-sale securities increased $4.2 million for the nine month period ended September 30, 2006. During the nine month period ended September 30, 2005, the Companys net unrealized holding gain decreased $5.0 million. These changes in the Companys net unrealized holding gain are included in other comprehensive income.
The Companys investment in the common stock of Andrx is classified as a current investment on the Companys Condensed Consolidated Balance Sheets at September 30, 2006 and December 31, 2005. The Company did not sell any of its shares of Andrx during the nine month periods ended September 30, 2005 and 2006. (Refer to NOTE 1 GENERAL.)
The Companys investments in U.S. Treasury and agency securities are classified as a current investment on the Companys Condensed Consolidated Balance Sheet at September 30, 2006 and December 31, 2005.
The contractual maturities of the U.S. Treasury and agency securities at September 30, 2006 are as follows (in thousands):
For additional information on the impact of the Andrx Acquisition on our accounting for current marketable securities, refer to NOTE 12 SUBSEQUENT EVENTS.
The Companys investments in the common stock of NovaDel Pharma Inc. and Amarin Corporation plc (Amarin) are classified as non-current investments and are included in investments and other assets on the Companys Condensed Consolidated Balance Sheets at September 30, 2006 and December 31, 2005.
NOTE 5 SEGMENTS
Watson has two reportable operating segments: Brand and Generic. The Brand business segment includes the Companys lines of Specialty Products and Nephrology products. Watson has aggregated its Brand product lines in a single reportable segment because of similarities in regulatory environment, methods of distribution and types of customer. This segment includes patent-protected products and certain trademarked off-patent products that Watson sells and markets as Brand pharmaceutical products. The Generic business segment includes off-patent pharmaceutical products that are therapeutically equivalent to proprietary products. The Company sells its Brand and Generic products primarily to pharmaceutical wholesalers, drug distributors and chain drug stores.
The Company evaluates segment performance based on segment net revenues, gross profit and contribution. Segment contribution represents segment gross profit less direct research and development expenses and selling and marketing expenses. The Company does not report depreciation expense, total assets, and capital expenditures by segment as such information is not used by management, or has not been accounted for at the segment level.
The other revenue classification for the three month period ended September 30, 2006 and 2005 consists primarily of royalties and revenues from research, development and licensing fees and, beginning in 2006,
commission revenue earned as a sales agent of Cephalon, Inc. from the launch of Fentanyl Citrate. Net revenues and segment contribution information for the Companys Brand and Generic segments, consisted of the following:
For additional information on the impact of the Andrx Acquisition on our operating segments related to Andrx, refer to NOTE 12 SUBSEQUENT EVENTS.
NOTE 6 INVENTORIES
Inventories consist of finished goods held for sale and distribution, raw materials and work-in-process. Included in inventory at September 30, 2006 and December 31, 2005 is approximately $11.3 and $6.0 million, respectively, of inventory that is pending approval by the U.S. Food and Drug Administration (FDA) or has not been launched due to contractual restrictions. This inventory consists of generic pharmaceutical products that are capitalized only when the bioequivalence of the product is demonstrated or the product is already FDA approved and is awaiting a contractual triggering event to enter the marketplace.
Inventories are stated at the lower of cost (first-in, first-out method) or market (net realizable value) and consisted of the following (in thousands):
NOTE 7 ASSET IMPAIRMENT CHARGES
In Accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144), Watson reevaluates the carrying value of identifiable intangible and long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. SFAS 144 defines impairment as the condition that exists when the carrying amount of a long-lived asset exceeds its fair value. An impairment loss is recognized only if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value.
In the quarter ended June 30, 2006, revisions to the Companys long range product sales forecast were deemed necessary as a result of a detailed analysis of prescription trends and a review of sales and inventory data provided by our largest customers. As a result of these downward revisions to our long range product sales forecast, the Company conducted a product right impairment review. Results of our impairment review indicated future undiscounted cash flows for four product rights were less than their respective carrying values. An analysis was undertaken to determine the fair values for the four product rights and an impairment of approximately $67.0 million was recognized predominantly relating to Alora® (purchased in 1999) and Actigall® (purchased in 2002).
NOTE 8 GOODWILL AND OTHER INTANGIBLE ASSETS
Watson tests its goodwill and intangible assets with indefinite lives by comparing the fair value of each of the Companys reporting units to the respective carrying value of the reporting units. The Company performs this impairment testing annually during the second quarter and when events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Companys two reporting units are Brand and Generic pharmaceutical products. The carrying value of each reporting unit is determined by assigning the assets employed in, and liabilities relating to, to those reporting units, including the existing goodwill and intangible assets. Goodwill is considered impaired if the carrying amount exceeds the fair value of the reporting unit. During the second quarter of 2006, Watson performed its annual assessment for the impairment of goodwill and determined there was no indication of impairment.
During the nine months ended September 30, 2006, in conjunction with the acquisition of Sekhsaria, the total purchase price in excess of the fair value of net assets acquired amounted to $24.3 million (See Note 3
ACQUISITIONS). This entire amount was recorded as an addition to goodwill under the Generic pharmaceutical product segment. Goodwill for the Companys reporting units consisted of the following (in thousands):
Other intangible assets consist primarily of product rights. The original cost and accumulated amortization of these intangible assets are as follows (in thousands):