SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS SUPPLEMENT DATED AUGUST 18, 2009

 

 

 

Watson Pharmaceuticals, Inc.

 

$     % Notes due 2014

$     % Notes due 2019

 

 

 

 

The     % notes due 2014, which we refer to as the 2014 notes, will mature on          , 2014, and the     % notes due 2019, which we refer to as the 2019 notes, will mature on          , 2019. We refer to the 2014 notes and the 2019 notes, collectively, as the notes. We will pay interest on the notes on           and           of each year, beginning          , 2010. We may redeem the notes of each series, as a whole at any time or in part from time to time, at the redemption prices described under the caption “Description of Notes — Optional Redemption.” If we experience a change of control triggering event and have not otherwise elected to redeem the notes, we will be required to offer to purchase the notes from holders as described under the caption “Description of Notes — Repurchase Upon a Change of Control.”

 

The notes will be our unsecured and unsubordinated obligations and will rank equally with our other unsecured and unsubordinated indebtedness from time to time outstanding. The notes will be effectively subordinated to our secured indebtedness to the extent of the value of the assets securing such indebtedness and to all liabilities of our subsidiaries. We do not intend to list the notes on any national securities exchange.

 

Investing in the notes involves risks that are described in the “Risk Factors” section beginning on page S-12 of this prospectus supplement.

 

 

 

 

 

 

 

None of the Securities and Exchange Commission, any state securities commission or other regulatory authority has approved or disapproved of these securities or determined if this prospectus supplement or the accompanying prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

The notes will be ready for delivery in book-entry form only through the facilities of The Depository Trust Company for the accounts of its participants, including Clearstream Banking, société anonyme, and Euroclear Bank S.A./N.V., as operator of the Euroclear System, on or about          , 2009.

 

 

 

 

Joint Book-Running Managers

 

 

The date of this prospectus supplement is          , 2009

 

You should rely only on the information contained or incorporated by reference in this prospectus supplement, the accompanying prospectus and any term sheet we authorize that supplements this prospectus supplement. We have not, and the underwriters have not, authorized any person to provide you with different information. If any person other than us provides you with different or inconsistent information, you should not rely on it. We and the underwriters are not making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus supplement and the accompanying prospectus and the documents incorporated by reference is accurate only as of their respective dates. Our business, properties, financial condition, results of operations and prospects may have changed since those dates.

 

 

 

 

TABLE OF CONTENTS

 

Prospectus Supplement

 

 

Prospectus

 

 

This document consists of two parts. The first part is this prospectus supplement, which describes the specific terms of the offering of the notes. The second part is the accompanying prospectus, which provides more general information, some of which may not be applicable to the offering of the notes. This prospectus supplement and the accompanying prospectus include important information about us, the notes and other information you should review before investing in the notes. This prospectus supplement also adds, updates and changes information contained in the accompanying prospectus. If there is any inconsistency between the information in this prospectus supplement and the accompanying prospectus, you should rely on the information in this prospectus supplement. Before investing in the notes, you should carefully read both this prospectus supplement and the accompanying prospectus, together with the additional information about us described under “Where You Can Find More Information” in the accompanying prospectus.

 

Unless otherwise stated or the context otherwise requires, references in this prospectus supplement and accompanying prospectus to “Watson,” “we,” “us” and “our” are to Watson Pharmaceuticals, Inc., a Nevada corporation, and its consolidated subsidiaries.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Any statements made in this prospectus supplement, the accompany prospectus and the information incorporated herein and therein by reference may contain “forward-looking” statements. We have based our forward-looking statements on management’s beliefs and assumptions based on information available to our management at the time these statements are made. Such forward-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, the completion of, and the expected benefits from, our acquisition of the Arrow Group (described herein), our beliefs about future revenue and expense levels and growth rates, prospects related to our strategic initiatives and business strategies, including the integration of, and synergies associated with, strategic acquisitions (including the proposed acquisition of the Arrow Group), express or implied assumptions about government regulatory action or inaction, anticipated product approvals and launches, business initiatives and product development activities, assessments related to clinical trial results, product performance and competitive environment, and anticipated financial performance. Without limiting the generality of the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,” “estimate,” “continue,” or “pursue,” or the negative or other variations thereof or comparable terminology, are intended to identify forward-looking statements. The statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. We caution the reader that these statements are based on certain assumptions, risks and uncertainties, many of which are beyond our control. In addition, certain important factors may affect our actual operating results and could cause such results to differ materially from those expressed or implied by forward-looking statements. We believe the risks and uncertainties discussed under the section entitled “Risks Related to Our Business,” and other risks and uncertainties detailed herein and from time to time in our filings with the Securities and Exchange Commission, may cause our actual results to vary materially than those anticipated in any forward-looking statement.

 

For a more detailed discussion of these and other risk factors, see Part I, Item 1A. “Risk Factors” and Part II, Item 7. “Management’s Discussion and Analysis of Results of Operations and Financial Condition” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 as well as in Part II, Item IA. “Risk Factors” and Part I, Item 2. “Management Discussion of Financial Condition and Results of Operation” in our Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2009. The forward-looking statements included in this prospectus supplement and the accompanying prospectus and the documents that we incorporate by reference herein and therein are made only as of their respective dates, and we undertake no obligation to update the forward-looking statements to reflect subsequent events or circumstances, except as required by law. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995.

 

PROSPECTUS SUPPLEMENT SUMMARY

	•	Expansion of Commercial Footprint.  We currently derive almost all of our revenue from sales in the United States. We believe that the Arrow Group’s commercial footprint in many developed and emerging countries will provide us with the opportunity to introduce certain of our generic and brand products into these markets and to expand our revenue base. In addition, the Arrow Group’s manufacturing network will provide us with the opportunity to expand our global supply chain. Moreover, the Arrow Group’s portfolio of product registrations in regions where the Arrow Group does not yet have a commercial presence will give us an opportunity to expand our sales and marketing operations into these markets.
	•	Extensive Product Portfolio and Pipeline.  The Arrow Group has launched a portfolio of more than 100 generic products, including more than 50 products it has developed internally. In addition, the Arrow Group

		has a significant product pipeline, consisting of approximately 40 new generic products that it expects to launch over the next three years across multiple markets, including the United States. Among these anticipated product launches is the launch of the authorized generic version of Lipitor® (atorvastatin) in November 2011, the benefits of which will be shared by us with selling shareholders of Robin Hood, as described in “— The Purchase Agreement” below.

	•	Provides Foundation for Generic Biologics.  The Arrow Group owns approximately 36% of Eden Biodesign, a biopharmaceutical company that provides development and manufacturing services to early stage biotechnology companies. We believe that Eden Biodesign could provide the operational expertise and manufacturing capability to support our long term investment in generic biologics.

	•	an increase in our ability to incur general unsecured indebtedness from $100.0 million to $500.0 million;
	•	the exclusion from the restrictions on “Indebtedness” for a principal amount of up to $151.4 million of certain acquired indebtedness expected to be assumed in connection with Acquisition and certain post-closing payment obligations expected to be incurred by us in connection with the Acquisition;
	•	certain modifications and clarifications with respect to the permissibility and terms of refinancing indebtedness with respect to the CODES; and
	•	the repayment by us of $100.0 million of outstanding borrowings under the term loan.

Issuer		Watson Pharmaceuticals, Inc.
Securities Offered		$      aggregate principal amount of     % notes due 2014
		$      aggregate principal amount of     % notes due 2019
		This offering is not conditioned on the completion of the Acquisition and is not subject to a mandatory redemption if the Acquisition is not consummated. If the Acquisition is not consummated, the notes offered hereby will remain outstanding.
Maturity Date		For the 2014 notes:          , 2014.
		For the 2019 notes:          , 2019.
Interest Payment Dates		and      of each year, commencing     , 2010.
Optional Redemption		We may redeem the 2014 notes and the 2019 notes, in each case, in whole at any time or in part from time to time, at our option, at a redemption price equal to the greater of (1) 100% of the principal amount of the notes to be redeemed and (2) the sum of the present values of the remaining scheduled payments of principal and interest in respect of the notes being redeemed (not including any portion of the payments of interest accrued but unpaid as of the date of redemption) discounted on a semi-annual basis (assuming a 360-day year of twelve 30-day months), at the Treasury Rate plus          basis points, in the case of the 2014 notes, and          basis points, in the case of the 2019 notes, plus, in each case, accrued and unpaid interest to the date of redemption, if any. See “Description of Notes — Optional Redemption.”
Repurchase Upon Change of Control		Upon the occurrence of a change of control of us and in a downgrade of the notes below an investment grade rating by each of Moody’s Investors Service Inc. and Standard & Poor’s Ratings Services, we will, in certain circumstances, be required to make an offer to purchase each of the 2014 notes and the 2019 notes at a price equal to 101% of the principal amount of the 2014 notes and 2019 notes to be repurchased, respectively, plus any accrued and unpaid interest to the date of repurchase, if any. See “Description of Notes — Repurchase Upon a Change of Control.”
Ranking		The notes will be:
		• general unsecured obligations of ours;
		• effectively subordinated in right of payment to any secured indebtedness of ours, to the extent of the assets securing such indebtedness, and to all existing and any future liabilities of our subsidiaries;
		• equal in right of payment with all existing and any future unsecured, unsubordinated indebtedness of ours; and

		• senior in right of payment to all existing and any future subordinated indebtedness of ours.
		After giving effect to the offering of the notes and the Acquisition and the application of the net proceeds of the offering as described in “Use of Proceeds,” we would have had, on a pro forma basis, approximately $1,703.0 million of consolidated indebtedness outstanding, approximately $158.0 million of which would have been secured indebtedness as of, in each case, June 30, 2009.
		Substantially all of our operations are conducted through our subsidiaries and, therefore, we depend on the cash flow of our subsidiaries to meet our obligations, including our obligations under the notes. Our right to receive assets of any of our subsidiaries upon a subsidiary’s liquidation or reorganization (and the consequent right of the holders of the notes to participate in those assets) will be effectively subordinated to the claims of the subsidiary’s creditors, except to the extent that we are recognized as a creditor of the subsidiary, in which case our claims would still be subordinate in right of payment to any security in the assets of the subsidiary and any indebtedness of the subsidiary senior to that held by us. Watson’s assets generally are held by, and its operations are conducted through, its subsidiaries.
Sinking Fund		None.
Form and Denomination of Notes		The notes of each series will initially be represented by one or more global notes which will be deposited with a custodian for, and registered in the name of a nominee of, The Depository Trust Company (“DTC”). The notes will be issued in denominations of $2,000 and integral multiples of $1,000 in excess of $2,000. Indirect holders trading their beneficial interests in the global notes through DTC must trade in DTC’s same-day funds settlement system and pay in immediately available funds. The notes may only be withdrawn from DTC in the limited situations described in “Description of Notes — Book-Entry System — Certificated Notes.”
Use of Proceeds		We estimate that the net proceeds from the sale of notes will be approximately      million after deducting the underwriting discount and estimated offering expenses payable by us. We intend to use the net proceeds from this offering, along with borrowings under our revolving credit facility and cash on hand, to consummate the Acquisition, redeem the CODES and repay $100.0 million of term loan borrowings under our senior credit agreement. See “Use of Proceeds.”
Further Issues		We may from time to time, without the consent of the holders of the notes, create and issue additional securities having the same terms and conditions (except for the issue date, the public offering price, and if applicable, the first interest payment date) as the 2014 notes or the 2019 notes, in each case, so that such issue shall be consolidated and form a single series with the outstanding 2014 notes or 2019 notes, as the case may be.
Trustee		Wells Fargo Bank, National Association
Risk Factors		See “Risk Factors” before considering an investment in the notes.

		Six Months Ended June 30,								Year Ended December 31,
		2009				2008				2008				2007				2006
		(unaudited)
		(in millions, except per share and ratio data)
Statement of Operations Data
Net revenues		$	1,345.2			$	1,249.6			$	2,535.5			$	2,496.7			$	1,979.2
Operating income (loss)		$	173.0			$	181.1			$	358.1			$	225.7			$	(422.1	)
Net income (loss)		$	102.1			$	110.9			$	238.4			$	141.0			$	(445.0	)
Basic earnings (loss) per share		$	0.99			$	1.08			$	2.32			$	1.38			$	(4.37	)
Diluted earnings (loss) per share		$	0.89			$	0.98			$	2.09			$	1.27			$	(4.37	)
Weighted average shares outstanding:
Basic			103.2				102.7				102.8				102.3				101.8
Diluted			118.5				117.5				117.7				117.0				101.8
Balance Sheet Data
Current assets		$	1,688.5			$	1,245.4			$	1,458.4			$	1,173.8			$	1,261.7
Working capital		$	497.9			$	820.5			$	976.4			$	728.8			$	571.7
Total debt		$	876.4			$	827.5			$	877.9			$	905.6			$	1,231.2
Total assets		$	3,850.4			$	3,489.8			$	3,677.9			$	3,472.0			$	3,760.6
Total stockholders’ equity		$	2,232.1			$	1,970.4			$	2,108.6			$	1,849.5			$	1,680.4
Other Data
Ratio of earnings to fixed charges(1)			14.4				11.2				11.1				5.3				—
EBITDA(2)		$	267.8			$	271.9			$	548.2			$	513.4			$	(198.9	)

(1)		“Earnings” consist of income from continuing operations before income taxes and fixed charges. “Fixed charges” consist of interest expense (which includes interest on indebtedness and amortization of debt expense) and the portion of rents that we believe to be representative of the interest factor. Due to the losses incurred by us for the year ended December 31, 2006 the coverage ratio was less than 1:1. We would have needed to generate additional earnings of $403.4 million to cover our fixed charges in the year ended December 31, 2006.
(2)		EBITDA is a supplemental measure of our performance that is not required by, or presented in accordance with generally accepted accounting principles (“GAAP”). EBITDA is not a measurement of our financial

		performance under GAAP and should not be considered in isolation or as an alternative to our income, cash flows or any other measure of performance or liquidity prepared in accordance with GAAP. Other companies may calculate EBITDA differently and, therefore, our EBITDA may not be comparable to similarly titled measures reported by other companies.
		We consider EBITDA to be an important financial measurement for investors because it provides information related to our ability to provide cash flows to meet future debt service, capital expenditures and working capital requirements and fund future growth. “EBITDA” represents net income before interest expense, provisions for income taxes and depreciation and amortization.

		Six Months Ended
		June 30,								Year Ended December 31,
		2009				2008				2008				2007				2006
		(unaudited)
		(in millions)
Net income (loss)		$	102.1			$	110.9			$	238.4			$	141.0			$	(445.0	)
Interest expense			9.3				13.7				28.2				44.5				22.1
Interest income			(3.3	)			(4.0	)			(9.0	)			(8.9	)			(28.4	)
Provision for income taxes			68.5				66.7				119.9				83.2				34.1
Depreciation			47.3				44.2				90.0				77.2				54.6
Amortization			43.9				40.4				80.7				176.4				163.7
EBITDA		$	267.8			$	271.9			$	548.2			$	513.4			$	(198.9	)

		Six Months Ended				Year Ended
		June 30,				December 31,
		2009				2008
		(unaudited)
		(in millions)
Statement of Operations Data (1)
Revenues		$	251.2			$	658.8
Result from operations		$	21.8			$	156.0
Profits for the period from continuing operations		$	16.1			$	136.2
Balance Sheet Data
Total current assets		$	442.8
Total current liabilities		$	161.2
Shareholder loan notes		$	132.7
Equity		$	255.1

(1)		In connection with the preparation of the unaudited pro forma condensed combined financial information contained in “Unaudited Pro Forma Condensed Combined Financial Information”, certain information presented in the above table has been reclassified to conform to the presentation used by Watson in its consolidated financial statements.

		Pro Forma
		Six Months
		Ended				Year Ended
		June 30, 2009				December 31, 2008
		(unaudited)
		(in millions, except per share and ratio data)
Statement of Operations Data
Net revenues		$	1,593.0			$	3,177.7
Operating income		$	174.6			$	444.6
Net income from continuing operations		$	85.5			$	269.4
Basic earnings per share		$	0.71			$	2.25
Diluted earnings per share		$	0.71			$	2.24
Weighted average shares outstanding:
Basic			120.1				119.7
Diluted			121.1				120.3
Balance Sheet Data
Current assets		$	1,616.3
Working capital		$	586.9
Total debt		$	1,387.2
Total assets		$	5,873.4
Total stockholders’ equity		$	2,812.9
Other Data
Ratio of earnings to fixed charges(1)			3.9				3.9
EBITDA(2)		$	310.3			$	712.3

(1)		See note (1) under “Summary Historical Financial Information — Watson” for information related to the calculation of this ratio.
(2)		Pro forma EBITDA is a non-GAAP financial measure. See Note 2 under “— Summary Historical Financial Information — Watson” for description of this financial measure and the reasons we think this measure is important for investors. Other companies may calculate pro forma EBITDA differently than we do and, therefore, our pro forma may not be comparable to similarly titled measures reported by other companies. The

		following is a reconciliation of pro forma net income, the most comparable GAAP financial measure, to pro forma EBITDA:

		Six Months
		Ended				Year Ended
		June 30, 2009				December 31, 2008
		(unaudited)
		(in millions)
Pro forma net income		$	85.5			$	269.4
Interest expense			42.5				111.6
Interest income			(0.1	)			—
Provision for income taxes			54.0				85.5
Depreciation			51.1				98.3
Amortization			77.3				147.5
Pro forma EBITDA		$	310.3			$	712.3

 

You should carefully consider the risks described below together with the risk factors described in and incorporated by reference into this prospectus supplement and the accompanying prospectus, as well as all of the other information in, and incorporated by reference into, this prospectus supplement and the accompanying prospectus before you decide to buy the notes. If any of the risks actually occur, our business, financial condition or results of operations could suffer. In that event, we may be unable to meet our obligations under the notes and you may lose all or part of your investment.

 

For a discussion of the risks related to our business, see “Item 1A. Risk Factors” in our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2009.

 

Risks Relating to the Acquisition

 

If we do not successfully integrate the Arrow Group into our business operations, our business could be adversely affected.

 

Upon the close of the Acquisition, we will need to successfully integrate the operations of the Arrow Group with our business operations. Integrating the operations of the Arrow Group with that of our own will be a complex and time-consuming process. Prior to the Acquisition, the Arrow Group operated independently, with its own business, corporate culture, locations, employees and systems. There may be substantial difficulties, costs and delays involved in any integration of the business of the Arrow Group with that of our own. These may include:

 

 

Many of these risks are accentuated because the Arrow Group’s operations, employees and customers are largely located outside of the United States. Any one or all of these factors may increase operating costs or lower anticipated financial performance. Many of these factors are also outside of our control. Achieving anticipated synergies and the potential benefits underlying our reasons for the Acquisition will depend on successful integration of the businesses. The failure to integrate the business operations of the Arrow Group successfully would have a material adverse effect on our business, financial condition and results of operations.

 

Upon the close of the Acquisition, we may have exposure to additional tax liabilities.

 

As a multinational corporation, we will be subject to income taxes as well as non-income based taxes, in both the United States and various foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes and other tax liabilities. Changes in tax laws or tax rulings may have a significantly adverse impact on our effective tax rate. Recent proposals by the current U.S. administration for fundamental U.S. international tax reform, including without limitation provisions that would limit the ability of U.S. multinationals to defer U.S. taxes on foreign income, if enacted, could have a significant adverse impact on our effective tax rate following the Acquisition.

 

Upon the consummation of the Acquisition, we will be subject to a variety of additional risks that may negatively impact our operations.

 

Upon the consummation of the Acquisition, we will be subject to new and additional risks associated with the business and operations of the Arrow Group. The additional risks we may be exposed to include but are not limited to the following:

 

 

 

We cannot assure you that we will be able to adequately address these additional risks. If we are unable to do so, our operations might suffer.

 

The Arrow Group’s operations may become less attractive if political and diplomatic relations between the United States and any country where the Arrow Group conducts business operations deteriorates.

 

The relationship between the United States and the countries where the Arrow Group conducts business operations may weaken over time. Changes in the state of the relations between any such country and the United States are difficult to predict and could adversely affect our future operations or cause potential target businesses to become less attractive. This could lead to a decline in our profitability. Any meaningful deterioration of the political and diplomatic relations between the United States and the relevant country could have a material adverse effect on our operations after a successful completion of a business combination.

 

The Arrow Group’s global operations will expose us to additional risks and challenges associated with conducting business internationally.

 

Although we currently have limited international operations, upon the consummation of the Acquisition, we will operate on a global basis with offices or activities in Europe, Africa, Asia, South America, Australia and North America. We will face several risks inherent in conducting business internationally, including compliance with international and regulations of the United States and various other countries that apply to our international operations. Compliance with these laws will increase our cost of doing business in foreign jurisdictions. These laws and regulations include laws relating to the pharmaceutical industry, data privacy requirements, labor relations laws, tax laws, anti-competition regulations, import and trade restrictions, export requirements, U.S. laws such as the Foreign Corrupt Practices Act, and local laws which also prohibit payments to governmental officials. Given the high level of complexity of these laws, however, there is a risk that some provisions may be inadvertently breached, for example through fraudulent or negligent behavior of individual employees, our failure to comply with certain formal documentation requirements or otherwise. Violations of these laws and regulations could result in fines, criminal sanctions against us, our officers or our employees, and prohibitions on the conduct of our business. Any such violations could include prohibitions on our ability to offer our products in one or more countries and could materially damage our reputation, our brand, our international expansion efforts, our ability to attract and retain employees, our business and our operating results. Our success depends, in part, on our ability to anticipate these risks and manage these difficulties upon the closing of the Acquisition. These factors or any combination of these factors may adversely affect our revenue or our overall financial performance.

Foreign currency fluctuations could adversely affect our business and financial results.

 

The Arrow Group does business and generates sales in several countries outside the United States. As such, upon the consummation of the Acquisition, foreign currency fluctuations may affect the costs that we incur in such international operations. It is also possible that some or all of our operating expenses may be incurred in non-U.S. dollar currencies. The appreciation of non-U.S. dollar currencies in those countries where we have operations against the U.S. dollar would increase our costs and could harm our results of operations and financial condition.

 

Prior to the Acquisition, the Arrow Group was a privately-held company and its new obligations of being a part of a public company may require significant resources and management attention.

 

Upon consummation of the Acquisition, Robin Hood and the Arrow Group companies will become subsidiaries of our consolidated company, and will need to comply with the Sarbanes-Oxley Act of 2002 and the rules and regulations subsequently implemented by the Securities and Exchange Commission and the Public Company Accounting Oversight Board. We will need to ensure that the Arrow Group establishes and maintains effective disclosure controls as well as internal controls and procedures for financial reporting, and such compliance efforts may be costly and may divert the attention of management.

 

The Acquisition may not close as anticipated.

 

We expect that the Acquisition will close during the second half of 2009, but it is possible that the closing of the Acquisition may not close when anticipated, if at all. If the Acquisition does not close, our outstanding notes will not be redeemed and will remain outstanding. The closing of the Acquisition is subject to our obtaining all relevant third-party and government consents, as well as our compliance with other requirements contained in the purchase agreement governing the Acquisition. A delay in the closing of the Acquisition or a failure to consummate the Acquisition may inhibit our ability to execute our business plan, and we cannot predict the resultant impact on our stock price if the Acquisition does not close.

 

We will incur significant transaction, integration and restructuring costs in connection with the Acquisition.

 

We will incur significant transaction costs related to the Acquisition. In addition, the combined company will incur integration and restructuring costs following the completion of the Acquisition as we integrate the Arrow Group businesses with our businesses. Although we expect that the realization of benefits and efficiencies related to the integration of the businesses may offset these transaction, integration and restructuring costs over time, no assurances can be made that this net benefit will be achieved in the near term, or at all, which could adversely affect our financial condition and results of operations.

 

The unaudited pro forma financial information included elsewhere in this prospectus supplement may not be representative of our results as a combined company after the consummation of the Acquisition, and accordingly, you have limited financial information on which to evaluate the combined company and your investment decision.

 

We and the Arrow Group currently operate as separate companies. We have had no prior history as a combined entity and our operations have not previously been managed on a combined basis. The pro forma financial information is presented for informational purposes only and is not necessarily indicative of the financial position or results of operations that would have actually occurred had the Acquisition been completed at or as of the dates indicated, nor is it indicative of the future operating results or financial position of the combined company. The pro forma financial information does not reflect future nonrecurring charges resulting from the Acquisition. The unaudited pro forma financial information does not reflect future events that may occur after the Acquisition, including the potential realization of operating cost savings (synergies) or restructuring activities or other costs related to the planned integration of the Arrow Group, and do not consider potential impacts of current market conditions on revenues or expenses. The pro forma financial information presented in this prospectus supplement is

based in part on certain assumptions regarding the Acquisition that we believe are reasonable under the circumstances. We cannot assure you that our assumptions will prove to be accurate over time.

 

The historical financial information of the Arrow Group included and incorporated by reference in this prospectus supplement may not be representative of the future financial results of the Arrow Group.

 

The Arrow Group is a relatively new company, and it has a limited history of operations. The historical growth of the Arrow Group’s revenues has been rapid, and it may not be representative of the Arrow Group’s future financial performance. Among other things, the Arrow Group’s historical financial statements have been significantly impacted by the timing of new product introductions. The Arrow Group’s future financial performance will be largely dependent on the number of competitors for its current and pipeline product portfolio and its ability to obtain FDA or other regulatory body approvals and subsequently commercialize its pipeline products. We cannot assure you that the Arrow Group’s business will continue to grow at historical rates, or at all. If the Arrow Group’s business does not significantly grow in future periods, the expected benefits of the Acquisition will be diminished.

 

A write-off of a significant portion of the goodwill and other intangibles recorded in connection with the Acquisition would negatively affect the combined company’s financial results.

 

Based on our preliminary valuations, we expect to record goodwill of approximately $650.2 million as a result of the Acquisition. On at least an annual basis, we assess whether there has been an impairment in the value of goodwill. If the carrying value of goodwill exceeds its estimated fair value, impairment is deemed to have occurred, and the carrying value of goodwill is written down to fair value. Under current accounting rules, this would result in a charge to the combined company’s operating earnings. Accordingly, any determination requiring the write-off of a significant portion of goodwill recorded in connection with the Acquisition would negatively affect our results of operations. Of the total estimated consideration, we also expect to allocate approximately $601.0 million to identified intangibles representing currently marketed products (“CMP”) and approximately $568.0 million to identified in-process research and development (“IPR&D”) intangible products. The CMP and IPR&D amounts will be subject to future impairment testing if market conditions for the underlying products experience a significant adverse change. If evidence of impairment exists, we would be required to take an impairment charge to our operating earnings, which could have a material adverse effect on our results of operations.

 

Risks Relating to the Notes

 

The notes are subject to prior claims of any of our existing and future secured creditors. Further, your right to receive payments on the notes is effectively subordinated to all of our subsidiaries’ existing and future liabilities.

 

The notes are our unsecured general obligations. Holders of our secured indebtedness will have claims that are prior to your claims as holders of the notes, to the extent of the assets securing such indebtedness. The indenture governing the notes permits us and our subsidiaries to incur additional secured indebtedness. In the event of a bankruptcy, liquidation, dissolution, reorganization or similar proceeding, our pledged assets would be available to satisfy obligations of our secured indebtedness before any payment could be made on the notes. To the extent that such assets cannot satisfy in full our secured indebtedness, the holders of such indebtedness would have a claim for any shortfall that would rank equally in right of payment with the notes. In any of the foregoing events, we cannot assure you that there will be sufficient assets to pay amounts due on the notes. As a result, holders of the notes may receive less, ratably, than holders of our secured indebtedness.

 

Assuming the Transaction had been completed as of June 30, 2009 and we issue notes with an aggregate principal amount of $850.0 million and the net proceeds of the offering had been applied as intended, we would have had, on a pro forma as adjusted basis, approximately $1,703.0 million of consolidated indebtedness outstanding, which includes the Preferred Stock issued in the Acquisition and the Robin Hood Loan assumed by us, approximately $158.0 million of which would have been secured indebtedness.

The limited covenants in the notes and the indenture may not provide protection against some events or developments that may affect our ability to repay the notes or the trading prices for the notes.

 

The indenture governing the notes does not:

 

 

For these reasons, you should not consider the covenants in the indenture as a significant factor in evaluating whether to invest in the notes. In addition, we are subject to periodic review by independent credit rating agencies. An increase in the level of our outstanding indebtedness, or other events that could have an adverse impact on our business, properties, financial condition, results of operations or prospects, may cause the rating agencies to downgrade our debt credit rating generally, and the ratings on the notes, which could adversely impact the trading prices for, or the liquidity of, the notes. Any such downgrade could also adversely affect our cost of borrowing, limit our access to the capital markets or result in more restrictive covenants in future debt agreements.

 

Our credit ratings may not reflect all risks of your investment in the notes.

 

The credit ratings assigned to the notes are limited in scope, and do not address all material risks relating to an investment in the notes, but rather reflect only the view of each rating agency at the time the rating is issued. There can be no assurance that such credit ratings will remain in effect for any given period of time or that a rating will not be lowered, suspended or withdrawn entirely by the applicable rating agencies, if, in such rating agency’s judgment, circumstances so warrant. Credit ratings are not a recommendation to buy, sell or hold any security. Each agency’s rating should be evaluated independently of any other agency’s rating. Actual or anticipated changes or downgrades in our credit ratings, including any announcement that our ratings are under further review for a downgrade, could affect the market value of the notes and increase our corporate borrowing costs.

 

We may not be able to repurchase the notes upon a change of control.

 

Upon a change of control of us and a downgrade of the notes below an investment grade rating by Moody’s Investors Service Inc. or Standard & Poor’s Ratings Services, we will be required to make an offer to each holder of notes to repurchase all or any part of such holder’s notes at a price equal to 101% of their principal amount, plus accrued and unpaid interest, if any, to the date of purchase. If we experience a change of control triggering event, there can be no assurance that we would have sufficient financial resources available to satisfy our obligations to repurchase the notes. Our failure to purchase the notes as required under the indenture governing the notes would result in a default under the indenture, which could have material adverse consequences for us and the holders of the notes. See “Description of Notes — Repurchase Upon a Change of Control.”

 

Active trading markets may not develop for the notes.

 

The notes are new issues of securities with no established trading markets. We do not intend to apply for listing of the notes on a national securities exchange. The underwriters have advised us that they presently intend to make a market in the notes of each series as permitted by applicable law. However, the underwriters are not obligated to

make markets in the notes and may cease their market-making activities at any time at their discretion without notice. In addition, the liquidity of the trading markets in the notes, and the market prices quoted for the notes, may be adversely affected by changes in the overall market for securities and by changes in the financial performance or our prospects and/or companies in our industry generally. As a result, no assurance can be given that active trading markets will develop or be maintained for the notes, as to the liquidity of any markets that do develop or as to your ability to sell any notes you may own or the prices at which you may be able to sell your notes.

 

We estimate that the net proceeds from the sale of notes will be approximately      million, after deducting the underwriting discount and estimated offering expenses payable by us.

 

The following table illustrates the current estimated sources and uses of cash in connection with the Transactions. For purposes of the following table we have assumed an aggregate principal amount of note issued in this offering of $850.0 million. Actual amounts will vary from estimated amounts depending on several factors, including the actual aggregate principal amount of notes we issue in the offering available cash at the time of the closing of the Acquisition, the timing of the Acquisition and other factors. For more information, see “Prospectus Supplement Summary — Acquisition of the Arrow Group,” “Prospectus Supplement Summary — Financing for the Acquisition and Debt Retirement” and “Unaudited Pro Forma Condensed Combined Consolidated Financial Information.”

 

 

 

 

In the event that the Acquisition is not consummated, we will use the net proceeds to redeem the CODES, repay $100.0 million of outstanding borrowings under the term loan of our senior credit agreement and for working capital and other general purposes.

 

As part of our business strategy, we seek to acquire and invest in complementary products, technologies or businesses. Although we have no present understanding, commitments or agreements to make any material acquisitions or investments, other than the Acquisition, we may from time to time identify, analyze and negotiate possible acquisition transactions, and we expect to continue to do so in the future. Pending these uses, we intend to invest any available net proceeds from this offering in investment grade, interest-bearing instruments.

 

The following table sets forth our consolidated cash and cash equivalents and our consolidated capitalization as of June 30, 2009:

 

 

in each case, as if such transactions had occurred on June 30, 2009.

 

This table should be read in conjunction with “Prospectus Supplement Summary— Acquisition of the Arrow Group,” “Use of Proceeds,” “Unaudited Pro Forma Condensed Combined Financial Information,” our consolidated financial statements and related notes, which are incorporated by reference in this prospectus supplement and the accompanying prospectus and the audited financial statements of the Arrow Group, included as Exhibit 99.1 to the Registration Statement on Form S-3 of which this prospectus supplement and the accompanying prospectus forms a part.

 

 

 

 

The following unaudited pro forma condensed combined financial information is presented to illustrate the estimated effects of the pending Acquisition by Watson of Robin Hood, the parent company of the Arrow Group companies (Robin Hood, together with Watson, are referred to as the “Combined Entity”), which was announced on June 17, 2009 and the proposed issuance by Watson of $850.0 million of notes and the related financing transactions on Watson’s historical financial position and Watson’s results of operations. For a description of the Transactions, see “Prospectus Supplement Summary — Acquisition of the Arrow Group,” “Prospectus Supplement Summary — Financing for the Acquisition and Debt Retirement” and “Use of Proceeds.” The following unaudited pro forma condensed combined balance sheet as of June 30, 2009 and unaudited pro forma condensed combined statement of operations for the six months ended June 30, 2009 are based on the historical unaudited financial statements of Watson (which are available in Watson’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2009 that was previously filed with the SEC on July 31, 2009 and historical financial information of Arrow Group which has been reconciled from International Financial Reporting Standards (“IFRS”) to U.S. generally accepted accounting principles (“U.S. GAAP”). The following unaudited pro forma condensed combined statement of operations for the year ended December 31, 2008 is based on the historical audited financial statements of Watson (which are available in Watson’s Annual Report on Form 10-K that was previously filed with the SEC on February 23, 2009) and the historical audited IFRS consolidated financial statements of Arrow Group for the year ended December 31, 2008 (refer to Exhibit 99.1 to the Registration Statement on Form S-3 of which this prospectus supplement and the accompanying prospectus forms a part for the IFRS financials of Arrow Group for the two years ended December 31, 2008) which Arrow Group’s management has, reconciled to U.S. GAAP. The IFRS reconciliation to U.S. GAAP is unaudited. The Acquisition has been accounted for as a business purchase combination using the acquisition method of accounting under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 141 (revised), “Business Combinations,” as amended, (“SFAS 141R”) and after applying the pro forma assumptions and adjustments described in the accompanying notes to unaudited pro forma condensed combined financial information.

 

The pro forma adjustments are preliminary and are based upon available information and certain assumptions, described in the accompanying notes to unaudited pro forma condensed combined financial information, that management believes are reasonable under the circumstances. Within 75 days following the closing date of the Acquisition, certain pro forma adjustments will be included within a Current Report on Form 8-K/A which may differ from the preliminary allocations within the accompanying unaudited pro forma condensed combined financial information. The establishment of the fair value of consideration for acquisitions requires the extensive use of accounting estimates and management judgment to establish the fair value of consideration, including contingent consideration. The allocation of the purchase price of identifiable tangible and intangible assets acquired and liabilities assumed also requires the extensive use of accounting estimates and management judgment to determine their respective fair values. The purchase price for the Arrow Group was allocated to identifiable tangible and intangible assets acquired and liabilities assumed based on a preliminary estimate of fair values as of June 30, 2009, with any excess being allocated to goodwill. Significant judgment is required in determining the estimated fair values of IPR&D, identifiable intangible assets, certain tangible assets and certain liabilities assumed. Such a valuation requires detailed estimates and assumptions including, but not limited to, determining the timing and estimated costs to complete each in-process project, projecting the timing of regulatory approvals, estimating future cash flows and direct costs in addition to developing the appropriate discount rates and current market profit margins. Management believes the fair values assigned to the assets to be acquired and liabilities to be assumed are based on reasonable estimates and assumptions. Preliminary fair value estimates and resulting purchase price allocations will change as additional information becomes available.

 

The unaudited pro forma condensed combined statement of operations for the year ended December 31, 2008 and the six months ended June 30, 2009 assumes the Acquisition occurred on January 1, 2008. The unaudited pro forma condensed combined balance sheet as of June 30, 2009 assumes the Acquisition occurred on June 30, 2009. The unaudited pro forma condensed combined financial information has been prepared by management for illustrative purposes only and is not necessarily indicative of the condensed consolidated financial position or results of operations that would have been realized had the Acquisition occurred as of the dates indicated, nor is it meant to be indicative of any anticipated condensed consolidated financial position or future results of operations

that the Combined Entity will experience after the Acquisition. In addition, the accompanying unaudited pro forma condensed combined statements of operations do not include any expected synergies which may be achievable subsequent to the Acquisition or the impact of any one-time transaction related costs. Certain financial information of Robin Hood as presented in its consolidated financial statements has been reclassified to conform to the historical presentation in Watson’s consolidated financial statements for purposes of preparation of the unaudited pro forma condensed combined financial information.

 

This unaudited pro forma condensed combined financial information should be read in conjunction with the accompanying notes and assumptions as well as the historical consolidated financial statements and related notes of Watson contained in its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Report on Form 8-K filed by Watson with the SEC and the historical consolidated financial statements and related notes of Arrow Group filed as an exhibit to this Registration Statement on Form S-3 of which this prospectus supplement and the accompanying prospectus forms a part.

 

Watson Pharmaceuticals, Inc.

 

Unaudited Pro Forma Condensed Combined Balance Sheet

June 30, 2009

 

 

See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Information.

 

Watson Pharmaceuticals, Inc.

 

Unaudited Pro Forma Condensed Combined Statement of Operations

Year Ended December 31, 2008

 

 

See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Information.

Watson Pharmaceuticals, Inc.

 

Unaudited Pro Forma Condensed Combined Statement of Operations

Six Months Ended June 30, 2009

 

 

See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial Information.

 

Watson Pharmaceuticals, Inc.

 

Notes to Unaudited Pro Forma Condensed Combined Financial Information

 

 

On June 16, 2009, Watson entered into the Purchase Agreement to acquire privately-held Robin Hood Holdings Limited. Watson expects the Acquisition to close in the second half of 2009. Under the terms of the Purchase Agreement, Watson will acquire all the outstanding shares of common stock of Robin Hood Holdings Limited for the following consideration:

 

 

Under the terms of the Purchase Agreement, the Common Consideration is fixed as to the number of shares to be issued, subject to certain equitable adjustments as defined by the Purchase Agreement. The fair value assigned to the Common Consideration will be determined in accordance with SFAS 141 (revised 2007) “Business Combinations” (“SFAS 141R”) based on the market price of Watson’s common stock at the closing of the Acquisition. In the accompanying preliminary purchase price allocation, the value of the Common Consideration is based on the closing market price of Watson’s common stock as of August 10, 2009 of $34.31. The final purchase price allocation will be based on the market price of Watson’s common stock at the closing of Acquisition, which is likely to differ from the market price used in the accompanying unaudited pro forma condensed combined financial statements. Accordingly, the fair value assigned to the Common Consideration in the final purchase price allocation and the resulting final purchase price allocations are likely to change and could yield materially different results than this preliminary purchase price allocation. For example, the market price of Watson’s common stock has increased approximately $4.00 since Watson entered into the Purchase Agreement. An additional $4.00 increase or decrease in the market price of Watson’s common stock would increase or decrease the Common Consideration, and the total consideration in the Acquisition, by approximately $67.8 million.

 

The Preferred Consideration, paid at the Closing, will be paid in the form of zero-coupon, non-convertible preferred stock which will be mandatorily redeemable in the amount of $200.0 million three years after the closing of the Acquisition. The fair value of the Preferred Consideration is estimated to be $150.0 million for the purposes of the accompanying unaudited pro forma condensed combined financial statements and is presented within other long-term liabilities.

 

Payment of contingent consideration will be based on post-tax gross profits, as defined in the Purchase Agreement, of sales within the United States (the “Territory”) from product launch date up to and including May 31, 2013 (the “Contingent Payment Period”) for the product atorvastatin. The determination of contingent payment amounts is dependent upon the existence of generic competition within the Territory and post-tax gross profits earned, as defined in the Purchase Agreement. At any time there is no competing generic product launched in the Territory during the Contingent Payment Period, payment of contingent consideration will be calculated as 50% of the post-tax gross profits, as defined in the Purchase Agreement. At any time that there is a competing product to atorvastatin launched in the Territory during the Contingent Payment Period, payment of contingent consideration will be calculated as either 85% of the post-tax gross profits or 15% of the post-tax gross profits, as defined in the Purchase Agreement, with total contingent payments being limited to $250.0 million during any period where there is a competing product during the Contingent Payment Period. In the accompanying preliminary purchase price allocation, the fair value of the contingent consideration was estimated based on the current information available. Fair value estimates of the contingent consideration at the closing date of the Acquisition could yield materially different results than this preliminary purchase price allocation. The fair value of the contingent consideration is

 

Watson Pharmaceuticals, Inc.

 

Notes to Unaudited Pro Forma Condensed Combined Financial Information — (Continued)

 

estimated to be $100.0 million for the purposes of the accompanying unaudited pro forma condensed combined financial statements.

 

 

The unaudited pro forma condensed combined financial information was prepared using the acquisition method of accounting and was based on the historical financial information of Watson and Arrow Group. The acquisition method of accounting is based on SFAS 141R, which Watson adopted on January 1, 2009 and uses the fair value concepts defined in SFAS No. 157, “Fair Value Measurements,” as amended (“SFAS 157”), which Watson has adopted in the required periods. The historical consolidated financial information has been adjusted in the accompanying unaudited pro forma condensed combined financial statements to give effect to pro forma events that are (1) directly attributable to the Acquisition, (2) factually supportable, and (3) with respect to the unaudited pro forma condensed combined statements of operations are expected to have a continuing impact on the combined results.

 

SFAS 141R requires, among other things, that most assets acquired and liabilities assumed in a business purchase combination be recognized at their fair values as of the Acquisition and that the fair value of acquired IPR&D be recorded on the balance sheet regardless of the likelihood of success of the related product or technology as of the Acquisition. In addition, SFAS 141R establishes that any common stock consideration transferred be measured at the Acquisition at the then current market price. This requirement will likely result in a per share equity component that is different at Acquisition than the amount assumed in these unaudited pro forma condensed combined financial statements.

 

SFAS 157 defines fair value, establishes the framework for measuring fair value for any asset acquired or liability assumed under U.S. GAAP, expands disclosures about fair-value measurements and specifies a hierarchy of valuation techniques based on the nature of the inputs used to develop the fair value measures. Fair value is defined in SFAS 157 as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” This is an exit price concept for the valuation of an asset or liability. Market participants are assumed to be buyers or sellers in the most advantageous market for the asset or liability. Fair value measurement for an asset assumes the highest and best use by these market participants. As a result of the requirements of SFAS 157, Watson may be required to record assets which are not intended to be used or sold and/or to value assets at fair value measurements that do not reflect Watson’s intended use for those assets. Fair value measurements can be highly subjective and it is possible the application of reasonable judgment could develop different assumptions resulting in a range of alternative estimates using the same facts and circumstances.

 

 

Following the Acquisition, Watson will conduct a review of Arrow Group’s accounting policies in an effort to determine if differences in accounting policies require restatement or reclassification of Arrow Group’s results of operations or reclassification of assets or liabilities to conform to Watson’s accounting policies and classifications. As a result of that review, Watson may identify differences between the accounting policies of the two companies that, when conformed, could have a material impact on these pro forma condensed combined financial statements. During the preparation of these pro forma condensed combined financial statements, Watson was not aware of any material differences between accounting policies of the two companies (after the Arrow Group financial information was reconciled from IFRS to U.S. GAAP, as discussed in Note 4 below) and accordingly, these pro forma condensed combined financial statements do not assume any material differences in accounting policies between the two companies.

 

Watson Pharmaceuticals, Inc.

 

Notes to Unaudited Pro Forma Condensed Combined Financial Information — (Continued)

 

 

The accompanying unaudited pro forma condensed combined financial statements were prepared based on the following historical financial information of Arrow Group:

 

 

At this time, Watson is not aware of any differences in the reconciliations of Arrow Group’s IFRS-based consolidated financial statements and financial information to U.S. GAAP that would have a material impact on the accompanying unaudited pro forma condensed combined financial statements.

 

 

The Acquisition will require a cash payment of $1.05 billion payable at the closing of the Acquisition. Watson intends to fund the cash portion of the consideration by using a combination of available cash, borrowings under its senior credit agreement and the issuance of the notes offered hereby. The accompanying unaudited pro forma condensed combined financial statements assume the repayment or redemption of certain short-term and long-term debt in connection with the anticipated financing transactions. The following is a summary of the anticipated financing transactions (new borrowings, repayments, redemptions and transaction costs representing net cash receipts of $509.0 million) related to the Transactions (in millions):

 

 

The debt structure and interest rates used for purposes of preparing the accompanying unaudited pro forma condensed combined financial statements may be considerably different than the actual debt structure and interest rates incurred by Watson based on market conditions at the time of the debt financing.

 

Watson Pharmaceuticals, Inc.

 

Notes to Unaudited Pro Forma Condensed Combined Financial Information — (Continued)

 

 

This footnote should be read in conjunction with “Note 1. Description of Transaction,” “Note 2. Basis of Presentation,” “Note 3. Accounting Policies,” “Note 4. Reconciliation of IFRS to U.S. GAAP” and “Note 5. Proposed Financing Transactions.” Adjustments included in the column “Pro Forma Adjustments” to the accompanying unaudited pro forma condensed combined balance sheet as at June 30, 2009 are represented by the following:

 

a. Under the acquisition method of accounting, the total estimated consideration, as indicated in the following table, is allocated to Arrow Group’s identifiable tangible and intangible assets and liabilities based on their estimated fair values as of the Acquisition. The estimated consideration is allocated as follows (in millions):

 

 

b. Reflects the elimination of historical equity of Arrow Group.

 

c. Reflects the settlement of shareholder loans at Robin Hood at the Acquisition.

 

d. Represents the estimated fair value adjustment to mark up inventory to fair value. This estimated step-up in inventory is preliminary and is subject to change based upon management’s final determination of the fair values of finished goods and work-in-process inventories. The Combined Entity will reflect the increased valuation of Arrow Group’s inventory as the acquired inventory is sold, which for purposes of these unaudited pro forma condensed combined financial statements is assumed will occur within the first year, post-acquisition. As there is no continuing impact of the inventory step-up on the Combined Entity results, the increased cost is not included in the unaudited pro forma condensed combined statement of operations.

 

e. Following the Acquisition, property, plant and equipment is required to be measured at fair value, unless those assets are classified as held-for-sale at the time of the Acquisition. At this time, Watson’s preliminary review of the nature, condition and age of Arrow Group’s property, plant and equipment indicates the assets were acquired fairly recently with Arrow Group being founded in the year 2000. Accordingly, for the

 

Watson Pharmaceuticals, Inc.

 

Notes to Unaudited Pro Forma Condensed Combined Financial Information — (Continued)

 

purposes of preparing these unaudited pro forma condensed combined financial statements, Watson believes that the current Arrow Group book values for property, plant and equipment represent the best estimate of fair value. The final fair value determination of property, plant and equipment may differ from this preliminary determination. For each $10.0 million fair value adjustment to property, plant and equipment, assuming a weighted average useful life of 10 years, annual depreciation expense would change by approximately $1.0 million.

 

f. Of the total estimated consideration, approximately $601 million has been allocated to identified intangibles representing currently marketed products (“CMP”) that are expected to be amortized over a weighted average useful life of nine years. Approximately $568 million has been allocated to identified IPR&D intangible products. The IPR&D amounts will be capitalized and accounted for as indefinite-lived intangible assets and will be subject to impairment testing until completion or abandonment of the projects. Upon successful completion of each project and launch of the product, Watson will make a separate determination of useful life of the IPR&D intangible and amortization will be recorded as an expense. As the IPR&D intangibles are not currently marketed, no amortization of these items is reflected in the unaudited pro forma combined condensed statements of operations for either the year ended December 31, 2008 or the six months ended June 30, 2009.

 

This fair value estimate for identifiable intangible assets is preliminary and is determined based on the assumptions that market participants would use in pricing an asset, based on the most advantageous market for the asset (i.e. their highest and best use). This preliminary fair value estimate could include assets that are not intended to be used, may be sold or are intended to be used in a manner other than their best use. For purposes of the accompanying unaudited pro forma condensed combined financial information, it is assumed that all assets will be used and assets will be used in a manner that represents their highest and best use. The final fair value determination for identified intangibles, including the IPR&D intangibles, may differ from this preliminary determination.

 

The fair value of identifiable intangible assets is determined primarily using the “income approach,” which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the more significant assumptions inherent in the development of the identifiable intangible assets valuations, from the perspective of a market participant, include the estimated net cash flows for each year for each project or product (including net revenues cost of sales, research and development costs, selling and marketing costs and working capital/asset contributory asset charges), the appropriate discount rate to select in order to measure the risk inherent in each future cash flow stream, the assessment of each asset’s life cycle, competitive trends impacting the asset and each cash flow stream as well as other factors. The major risks and uncertainties associated with the timely and successful completion of the IPR&D projects include legal risk and regulatory risk. No assurances can be given that the underlying assumptions used to prepare the discounted cash flow analysis will not change or the timely completion of each project to commercial success will occur. For these and other reasons, actual results may vary significantly from estimated results.

 

g. Reflects a deferred income tax liability representing the estimated impact of purchase accounting adjustments for the inventory fair value step-up and identifiable intangible assets acquired and liabilities assumed. This estimate of deferred tax liabilities was determined based on the excess book basis over the tax basis of the inventory fair value step-up and identifiable intangible assets acquired at an estimated statutory tax rate of approximately 30%. This estimate is preliminary and is subject to change based upon management’s final determination of the fair values of tangible and identifiable intangible assets acquired and liabilities assumed.

 

h. Watson records provisions for uncertain tax positions in accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109,” (“FIN 48”). Assessments of uncertain tax positions and the determination of corresponding tax provisions involve complex

 

Watson Pharmaceuticals, Inc.

 

Notes to Unaudited Pro Forma Condensed Combined Financial Information — (Continued)

 

judgments about future events and rely on estimates and assumptions by management. Income taxes are exceptions to both the recognition and fair value measurement principles of SFAS 141R. Under U.S. GAAP, income taxes continue to be accounted for under the guidance of SFAS No. 109, “Accounting for Income Taxes,” as amended, (“SFAS 109”), and related interpretative guidance. As such, the Combined Entity would continue to account for Arrow Group’s uncertain tax positions using SFAS 109. Arrow Group, as a private company based outside the United Stated, was not required to adopt FIN 48. Arrow Group’s current accounting approach for uncertain tax positions is based on Arrow Group’s management estimates and assumptions. As Watson’s management does not yet have full and complete access to relevant information about the Arrow Group uncertain tax positions and Watson’s management estimates and assumptions concerning Arrow Group’s accounting approach for uncertain tax positions could differ from Arrow Group’s management estimates and assumptions, final assessments of uncertain tax positions could differ materially from the amounts included in the accompanying unaudited pro forma condensed combined financial information. Accordingly, Watson has not adjusted the Arrow Group’s book values for uncertain tax positions in the accompanying unaudited pro forma condensed combined financial information as required under FIN 48 as full and complete relevant information concerning Arrow Group’s uncertain tax positions is not available.

 

i. Under SFAS 141R contingencies are required to be measured at fair value, if the acquisition-date fair value of the asset or liability arising from the contingency can be determined. If the acquisition-date fair value of the asset or liability cannot be determined, the asset or liability would be recognized at the acquisition date if both of the following criteria are met: (1) it is probable that an asset existed or that a liability had been incurred at the acquisition date, and (2) the amount of the asset or liability can be reasonably estimated. These criteria are to be applied using the guidance in SFAS No. 5, “Accounting for Contingencies,” (“SFAS 5”), and FASB Interpretation No. 14, “Reasonable Estimation of the Amount of a Loss,” (“FIN 14”). Arrow Group is involved in various legal proceedings, including product liability, patent disputes, commercial, environmental and antitrust matters, which are considered normal business activities. However, Watson does not have sufficient time to assess if the fair value of these potential contingencies can be determined and, if determinable, to value these contingencies under a fair value standard. Determining their fair value would require a detailed review and complete knowledge of complex legal matters and associated defense strategies for all outstanding Arrow Group legal proceedings. A detailed review cannot be completed prior to the preparation of the unaudited pro forma condensed combined financial information. If fair value cannot be determined for Arrow Group’s contingencies, the Combined Entity would continue to account for the Arrow Group contingencies using SFAS 5 and FIN 14. As Watson’s management does not yet have full and complete access to relevant information about the Arrow Group contingencies and Watson’s management estimates and assumptions concerning Arrow Group’s accounting for contingencies could differ, final assessments of the liability positions for contingencies could differ materially from the amounts included in the accompanying unaudited pro forma condensed combined financial information. Accordingly, for the purpose of the unaudited pro forma condensed combined financial information, Watson has not adjusted the Arrow Group’s book values for contingencies.

 

j. Goodwill is calculated as the difference between the fair value of the consideration expected to be transferred and the values assigned to the identifiable tangible and intangible assets acquired and liabilities assumed. The amount of goodwill presented in the above table reflects the estimated goodwill from the preliminary purchase price allocation of $650.2 million and the elimination of historical goodwill reflected in Arrow Group’s historical combined financial statements of $20.0 million.

 

k. Reflects the elimination of intercompany balances and an adjustment of certain balance sheet amounts for intercompany profit in inventory.

 

l. Prior to closing, Robin Hood, or an affiliate of Robin Hood, will obtain the Robin Hood Loan for $151.4 million. The Robin Hood Loan will mature within two years of issuance. The Robin Hood Loan will be mandatorily repayable from anticipated royalty and milestones net proceeds from Sepracor, Inc. The Robin

 

Watson Pharmaceuticals, Inc.

 

Notes to Unaudited Pro Forma Condensed Combined Financial Information — (Continued)

 

Hood Loan will be guaranteed by one or more of the Sellers (the “Guarantor”). In the event Sepracor Inc. fails to make anticipated royalty/milestone payments to Watson for any reason, the Guarantor or one or more of the Sellers must repay the outstanding portion of the Robin Hood Loan or reimburse Arrow Group for such defaulted amount.

 

 

This footnote should be read in conjunction with “Note 1. Description of Transaction,” “Note 2. Basis of Presentation,” “Note 3. Accounting Policies,” “Note 4. Reconciliation of IFRS to U.S. GAAP,” “Note 5. Proposed Financing Transactions” and “Note 6. Unaudited Pro Forma Condensed Combined Balance Sheet Adjustments.” Adjustments included in the column “Pro Forma Adjustments” to the accompanying unaudited pro forma condensed combined statement of operations for the year ended December 31, 2008 and six months ended June 30, 2009 are represented by the following:

 

a. Represents the elimination of net sales and cost of sales for product sales between Watson and Arrow Group for the respective periods.

 

b. Represents increased amortization for fair value adjustments of identified intangible assets with definite lives. The increase in amortization expense for CMP intangible assets is based on a weighted average useful life of nine years as follows:

 

 

A $100.0 million increase or decrease in value allocated to identified intangible assets with average useful lives of nine years would increase or decrease annual amortization by approximately $11.0 million.

 

c. To eliminate Arrow Group historical amortization expense as pro forma amortization expense is calculated above in note 7b.

 

d. Reflects lower interest income due to the use of cash balances of the Combined Entity to finance a portion of the Acquisition. For the year ended December 31, 2008, all interest income was eliminated as the expected net use of cash to fund the Acquisition exceeded the average available cash balances for that year. Additional interest expense was calculated on the shortfall for 2008 at the actual interest rate paid on borrowings under the senior credit agreement for 2008 and is included below in the table in note 7e.

 

e. Reflects higher interest expense and amortization of debt issue costs related to the issuance of $850 million aggregate principal amount of notes offered hereby to finance the Acquisition. Estimated interest expense on the notes assumes an interest rate of 6.25% on a $425.0 million principal amount on the 5 year tranche and 7.18% on a $425.0 million principal amount on the 10 year tranche. If the principal amounts of either tranche change the assumed interest expense would change accordingly. Also reflects the repayment of $100.0 million of term loan borrowing and an additional $345.0 million of revolving credit facility borrowings under the senior credit agreement at period average rates and the elimination of all interest charges related to

 

Watson Pharmaceuticals, Inc.

 

Notes to Unaudited Pro Forma Condensed Combined Financial Information — (Continued)

 

the CODES which are expected to be redeemed. A summary of the pro forma interest adjustments in the accompanying pro forma condensed combined statement of operations is as follows:

 

 

 

 

A 1/8% increase or decrease in the variable interest rate on borrowings under the senior credit agreement would increase or decrease the annual interest expense by approximately $0.6 million. A 1/8% increase or decrease in the interest rate on the notes offered hereby would increase or decrease the annual interest expense by approximately $1.1 million.

 

f. Represents the income tax effect for unaudited pro forma condensed combined statement of operations adjustments using a statutory tax rate of approximately 38% for Watson’s future period pro forma adjustments and an estimated weighted average statutory tax rate of approximately 30% for Arrow Group’s future period pro forma adjustments.

 

g. Reflects elimination of advisory, legal and regulatory costs incurred in the six months ended June 30, 2009, which are directly attributable to the pending Acquisition but which are not expected to have a continuing impact on the Combined Entity results.

 

 

a. Represents the issue of Common Consideration of approximately 16.9 million shares of common stock.

 

b. Represents the issue of Common Consideration of approximately 16.9 million shares of common stock and the elimination of approximately 14.4 million shares from the diluted share base as the CODES, which are convertible into common stock of Watson, are assumed to have been redeemed at January 1, 2008 in the preparation of the accompanying unaudited pro forma condensed combined financial information.

 

 

In order to obtain regulatory approval under the HSR Act, in connection with the Acquisition, Watson and/or the Arrow Group may be required to divest certain assets. Although we expect the impact of any such divestiture to be minimal, the impact of any such divestiture cannot be accurately determined until finalized, and accordingly, no adjustment for any potential divestitures are reflected in the accompanying unaudited pro forma condensed combined financial information.

 

We will issue $      aggregate principal amount of     % senior notes due 2014 (the “2014 notes”) and $     aggregate principal amount of     % senior notes due 2019 (the “2014 notes” and together with the 2019 notes, the “notes”). The 2014 notes and the 2019 notes will be issued as separate series of debt securities under a senior note indenture dated as of          , 2009 (the “indenture”) between us and Wells Fargo Bank, National Association, as trustee. The indenture provides that our debt securities may be issued in one or more series, with different terms, in each case as authorized from time to time by us. The specific terms of each other series that we may issue in the future may differ from those of the notes. The indenture does not limit the aggregate amount of debt securities that may be issued under the indenture, nor does it limit the number of other series or the aggregate amount of any particular series.

 

The following description is a summary, and does not describe every aspect of the notes and the indenture. The following description is subject to, and qualified in its entirety by, all the provisions of the indenture, including definitions of certain terms used in the indenture, a copy of which we have filed with the SEC as an exhibit to the registration statement of which this prospectus supplement and the accompanying prospectus form a part. We urge you to read the indenture and the notes because they, and not this description, define your rights as a holder of the notes.

 

The terms of the notes include those expressly set forth in the indenture and those made part of the indenture by reference to the Trust Indenture Act of 1939, as amended (the “Trust Indenture Act”).

 

For purposes of this description, references to “Watson,” “the Company,” “we,” “us” and “our” refer only to Watson Pharmaceuticals, Inc. and not to any of its current or future subsidiaries. References to “Arrow” refer to the Arrow Group.

 

General

 

The 2014 notes will be limited initially to $      aggregate principal amount and the 2019 notes will be limited initially to $      aggregate principal amount, but we may from time to time, without giving notice to or seeking the consent of the holders of the notes of either series, issue additional notes of either series having the same terms (except for the issue date, the public offering price and, if applicable, the first interest payment date) and ranking equally and ratably with the original notes of such series. Any such additional debt securities having such similar terms, together with the original notes of the applicable series, will constitute a single series of debt securities for all purposes under the indenture, including, without limitation, waivers, amendments and redemptions.

 

The notes will be: