UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended March 31, 2004

OR

For the transition period from                   to                   

Commission file number 0-18443

MEDICIS PHARMACEUTICAL CORPORATION

8125 North Hayden Road
Scottsdale, Arizona 85258-2463

(602) 808-8800

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 [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) YES [X] NO [  ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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MEDICIS PHARMACEUTICAL CORPORATION

Table of Contents

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Part I. Financial Information

Item 1. Financial Statements

MEDICIS PHARMACEUTICAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

See accompanying notes to condensed consolidated financial statements.

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MEDICIS PHARMACEUTICAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

See accompanying notes to condensed consolidated financial statements.

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MEDICIS PHARMACEUTICAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)

See accompanying notes to condensed consolidated financial statements.

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MEDICIS PHARMACEUTICAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

See accompanying notes to condensed consolidated financial statements.

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MEDICIS PHARMACEUTICAL CORPORATION

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(unaudited)

1. ORGANIZATION AND BASIS OF PRESENTATION

     Medicis Pharmaceutical Corporation and its wholly owned subsidiaries (“Medicis” or the “Company”) are a leading specialty pharmaceutical company focusing primarily on developing and marketing products in the United States for the treatment of dermatological, aesthetic, pediatric and podiatric conditions in the United States and Canada. The Company offers a broad range of drugs addressing various conditions including acne, fungal infections, asthma, rosacea, hyperpigmentation, photoaging, psoriasis, eczema, skin and skin-structure infections, seborrheic dermatitis and cosmesis (improvement in the texture and appearance of skin). In March 2003, Medicis expanded into the dermal aesthetic market through its acquisition of the exclusive U.S. and Canadian rights to market, distribute and commercialize the dermal restorative products known as RESTYLANE^®, PERLANE^® and RESTYLANE FINE LINES™ from Q-Med AB, a Swedish biotechnology/medical device company and its affiliates, collectively Q-Med. The RESTYLANE^®, PERLANE^® and RESTYLANE FINE LINES™ products, which are used for treating fine lines and wrinkles, shaping facial contours, correcting deep facial folds and enhancing the appearance and fullness of lips, are currently sold in numerous countries outside the United States by Q-Med and are offered in Canada by Medicis. RESTYLANE^® was approved for use in the U.S. by the Food and Drug Administration (the “FDA”) on December 12, 2003, followed by the product launch and first U.S. commercial sales of RESTYLANE^® on January 6, 2004. PERLANE^® and RESTYLANE FINE LINES™ are not yet approved for use in the U.S. In addition to the Company’s expansion into the dermal aesthetic market, Medicis had previously expanded into the pediatric market in November 2001 through its merger with Ascent Pediatrics, Inc. (“Ascent”). Ascent markets products to U.S.-based pediatricians, including an oral treatment for children with asthma and other inflammatory respiratory conditions. On April 20, 2004 Medicis announced that BioMarin Pharmaceutical Inc., (“BioMarin”) and Medicis had entered into an asset purchase agreement, and have agreed to enter into a license agreement and securities purchase agreement at the date of closing, whereby BioMarin will purchase assets related to ORAPRED^®, including assets concerning the Ascent field sales force, and will be granted the exclusive worldwide rights to ORAPRED^®. The transaction will close two business days following the satisfaction of certain closing conditions. See Note 14 for further discussion.

     The accompanying interim condensed consolidated financial statements of Medicis have been prepared in conformity with accounting principles generally accepted in the United States, consistent in all material respects with those applied in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2003 (“fiscal 2003”). The financial information is unaudited but reflects all adjustments, consisting only of normal recurring accruals, which are, in the opinion of the Company’s management, necessary to a fair statement of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2003. Certain prior period amounts have been reclassified to conform with current period presentation.

     On January 2, 2004, the Company announced a 2 for 1 stock split in the form of a stock dividend payable on January 23, 2004, to stockholders of record at the close of business on January 12, 2004. All share and per share data have been restated to reflect the stock split effected in the form of a stock dividend.

2. STOCK-BASED COMPENSATION

     As of March 31, 2004, the Company has five stock-based employee compensation plans. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Other than restricted stock, no stock-based employee compensation cost is reflected in net income, as all options granted

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under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

     The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), to stock-based employee compensation (amounts in thousands, except per share amounts):

     As required, the pro forma disclosures above include options granted since April 1, 1996. Consequently, the effects of applying SFAS No. 123 for providing pro forma disclosures may not be representative of the effects on reported net income for future years until all options outstanding are included in the pro forma disclosures. For purposes of pro forma disclosures, the estimated fair value of stock-based compensation plans and other options is amortized to expense primarily over the vesting period.

3. RESEARCH AND DEVELOPMENT COSTS AND ACCOUNTING FOR STRATEGIC COLLABORATIONS

     All research and development costs, including payments related to products under development, and research consulting agreements, are expensed as incurred. The Company makes up-front, non-refundable payments to third parties for new technologies and for research and development work that has been completed. These up-front payments may be expensed at the time of payment depending on the nature of the payment made.

     The Company’s policy on accounting for costs of strategic collaborations determines the timing of the recognition of certain development costs. In addition, this policy determines whether the cost is classified as development expense or capitalized as an asset. Management is required to form judgments with respect to the commercial status of such products in determining whether development costs meet the criteria for immediate expense or capitalization.

     On December 22, 2003, the Company announced that Corixa Corporation (“Corixa”) and Medicis agreed to terminate further development of Corixa’s immunotherapeutic product, PVAC™ treatment. Medicis and Corixa concluded that data from the recently completed clinical trial of PVAC™ treatment in mild to moderate psoriasis patients did not support further development of the product. Medicis has no further financial obligation to Corixa.

     On September 26, 2002, Medicis entered into an exclusive license and development agreement with Dow Pharmaceutical Sciences, Inc. (“Dow”) for the development and commercialization of a patented dermatologic product. Under terms of the agreement, Medicis made an initial payment of $5.4 million to Dow and, in accordance with the agreement between the parties, is required to make potential additional payments upon the certification that certain development milestones have occurred. The initial $5.4 million

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was recorded as a charge to research and development expense during the quarter ended September 30, 2002. During the quarter ended December 31, 2003, a development milestone was achieved, and $2.4 million was paid to Dow and was recorded as a charge to research and development expense.

     On September 4, 2002, the Company purchased the Abbreviated New Drug Application (“ANDA”) for a pediatric prescription product from a third-party pharmaceutical company for $9.0 million. Under terms of the agreement, the Company may be required to make future contingent payments based on the achievement of certain milestones. The contingent payments, if the milestones are achieved, would be payable at the six (6)-, twelve (12)-, and eighteen (18)-month anniversaries of the closing of the agreement. During the quarters ended September 30, 2003 and March 31, 2004, the second and third milestones were achieved and $3.5 and $4.5 million, respectively, became payable to the third-party pharmaceutical company. The Company accounted for the initial payment and the subsequent contingent payments as an acquisition of an intangible asset and commenced amortizing the asset over 15 years beginning in the second quarter of fiscal 2003. This ANDA will be included as part of the BioMarin transaction discussed in Note 14.

4. ACQUISITION OF RESTYLANE^® FAMILY OF PRODUCTS FROM THE Q-MED GROUP

     On March 10, 2003, Medicis acquired all outstanding shares of HA North American Sales AB from Q-Med, a Swedish biotechnology/medical device company. HA North American Sales AB holds a license for the exclusive U.S. and Canadian rights to market, distribute and commercialize the dermal restorative product lines known as RESTYLANE^®, PERLANE^® and RESTYLANE FINE LINES™. The RESTYLANE^®, PERLANE^® and RESTYLANE FINE LINES™ products are currently being sold in 77 countries by Q-Med, and Medicis is currently selling these products in Canada. RESTYLANE^® was approved for use in the U.S. by the FDA on December 12, 2003, followed by the product launch and first U.S. commercial sales of RESTYLANE^® on January 6, 2004. PERLANE^® and RESTYLANE FINE LINES™ are not yet approved for use in the U.S. Under terms of the agreements, a wholly owned subsidiary of Medicis acquired all outstanding shares of HA North American Sales AB for total consideration of approximately $160.0 million, payable upon the successful completion of certain milestones or events. Medicis paid $58.2 million upon closing of the transaction, $53.3 million in December 2003 upon FDA approval of RESTYLANE^®, and will pay approximately $19.4 million upon certain cumulative commercial milestones being achieved and approximately $29.1 million upon FDA approval of PERLANE^®.

5. MERGER OF ASCENT PEDIATRICS, INC.

     As part of its merger with Ascent completed in November 2001, the Company may be required to make contingent purchase price payments (“Contingent Payments”) for each of the first five years following closing based upon reaching certain sales threshold milestones on the Ascent products for each twelve month period ending November 15, 2006. From time to time the Company assesses the probability and likelihood of payment in the coming respective November period based on current sales trends. There can be no assurance that such payment ultimately will be made, nor is the accrual of a liability an indication of current sales levels. A total of approximately $18.0 million is included in short-term contract obligation in the Company’s condensed consolidated balance sheets as of March 31, 2004, representing the first two years’ Contingent Payments. Pursuant to the merger agreement, payment of the contingent portion of the purchase price will be withheld pending the final outcome of the litigation discussed in Note 15. As part of the transaction with BioMarin announced on April 20, 2004, Medicis will remain responsible for the Contingent Payments under the Ascent merger agreement. See Note 14.

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6. SEGMENT AND PRODUCT INFORMATION

     The Company operates in one significant business segment: Pharmaceuticals. The Company’s current pharmaceutical franchises are divided between the Dermatological and Non-Dermatological fields. The Dermatological field represents products for the treatment of Acne and Acne-related dermatological conditions and Non-acne dermatological conditions. The Non-Dermatological field represents products for the treatment of Asthma and Urea Cycle Disorder. The Acne and Acne-related dermatological product lines include core brands DYNACIN^®, PLEXION^® and TRIAZ^®. The Non-acne dermatological product lines include core brands LOPROX^®, OMNICEF^®, and RESTYLANE^®. The Non-Dermatological product lines include BUPHENYL^® and core brand ORAPRED^®.

     The Company’s pharmaceutical products, with the exception of BUPHENYL^®, are promoted to dermatologists, podiatrists, pediatricians, or plastic surgeons. Such products are often prescribed by physicians outside these four specialties; including family practitioners, general practitioners, primary-care physicians and OB/GYNs, as well as hospitals, governmental agencies and others. All products, with the exception of BUPHENYL^®, are sold primarily to wholesalers and retail chain drug stores. BUPHENYL^® is primarily sold directly to hospitals and pharmacies.

     The percentage of net revenues for each of the product categories is as follows:

7. RESTRICTED CASH AND SHORT-TERM INVESTMENTS

     In connection with the acquisition of the products from Q-Med (see Note 4), the Company was required to establish an escrow account related to the $53.3 million the Company would pay to Q-Med upon FDA approval of the RESTYLANE^® product. The Company initially funded the restricted cash account through transfers of existing short-term investments into the escrow account. In December 2003, the restriction on the account was released as the FDA approved the RESTYLANE^® product for use in the United States. The account was liquidated and $53.3 million was paid to Q-Med. The Company did not have any restricted cash or short-term investments as of March 31, 2004.

8. INVENTORIES

     The Company utilizes third parties to manufacture and package inventories held for sale, takes title to certain raw materials and components once received at the manufacturers’ facilities, and warehouses finished goods at third-party warehouse facilities until packaged for final distribution and sale. Inventories consist of salable products held at the Company’s third-party warehouses, as well as raw materials and components at the manufacturers’ facilities, and are valued at the lower of cost or market using the first-in, first-out method. The Company provides valuation reserves for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions.

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     Inventories at March 31, 2004 and June 30, 2003, are as follows (amounts in thousands):

9. CONTINGENT CONVERTIBLE SENIOR NOTES

     On June 4, 2002 and June 10, 2002, the Company sold $400.0 million aggregate principal amount of its 2.5% Contingent Convertible Senior Notes Due 2032 (the “Old Notes”) in private transactions. As discussed below, approximately $230.8 million in principal amount of the Old Notes was exchanged for New Notes on August 14, 2003. The Old Notes bear interest at a rate of 2.5% per annum, which is payable on June 4 and December 4 of each year, beginning on December 4, 2002. The Company also will pay contingent interest at a rate equal to 0.5% per annum during any six-month period, with the initial six-month period commencing June 4, 2007, if the average trading price of the Old Notes reaches certain thresholds. The Old Notes will mature on June 4, 2032.

     The Company may redeem some or all of the Old Notes at any time on or after June 11, 2007, at a redemption price, payable in cash, of 100% of the principal amount of the Old Notes, plus accrued and unpaid interest, including contingent interest, if any. Holders of the Old Notes may require the Company to repurchase all or a portion of their Old Notes on June 4, 2007, 2012 and 2017; and upon a change in control, as defined in the indenture governing the Old Notes, at 100% of the principal amount of the Old Notes, plus accrued and unpaid interest to the date of the repurchase, payable in cash.

     The Old Notes are convertible, at the holders’ option, prior to the maturity date into shares of the Company’s Class A common stock in the following circumstances:

	•		during any quarter commencing after June 30, 2002, if the closing price of the Company’s Class A common stock over a specified number of trading days during the previous quarter, including the last trading day of such quarter, is more than 110% of the conversion price of the Old Notes, or $31.96. The Old Notes are initially convertible at a conversion price of $29.05 per share, which is equal to a conversion rate of approximately 34.4234 shares per $1,000 principal amount of Old Notes, subject to adjustment;
	•		if the Company has called the Old Notes for redemption;
	•		during the five trading day period immediately following any nine consecutive day trading period in which the trading price of the Old Notes per $1,000 principal amount for each day of such period was less than 95% of the product of the closing sale price of the Company’s Class A common stock on that day multiplied by the number of shares of the Company’s Class A common stock issuable upon conversion of $1,000 principal amount of the Old Notes; or
	•		upon the occurrence of specified corporate transactions.

     The Old Notes, which are unsecured, do not contain any restrictions on the payment of dividends, the incurrence of additional indebtedness or the repurchase of the Company’s securities and do not contain any financial covenants.

     The Company incurred $12.6 million of fees and other origination costs related to the issuance of the Old Notes. The Company is amortizing these costs over the five-year Put period, which runs through May 2007.

     On August 14, 2003, the Company exchanged approximately $230.8 million in principal amount of its Old Notes for approximately $283.9 million in principal amount of its 1.5% Contingent Convertible Senior Notes Due 2033 (the “New Notes”). Holders of Old Notes that accepted the Company’s exchange offer received $1,230 in principal amount of New Notes for each $1,000 in principal amount of Old Notes. The terms of the New Notes are similar to the terms of the Old Notes, but have a different interest rate,

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conversion rate and maturity date. Holders of Old Notes that chose to not exchange continue to be subject to the terms of the Old Notes.

     The New Notes bear interest at a rate of 1.5% per annum, which is payable on June 4 and December 4 of each year, beginning December 4, 2003. The Company will also pay contingent interest at a rate of 0.5% per annum during any six-month period, with the initial six-month period commencing June 4, 2008, if the average trading price of the New Notes reaches certain thresholds. The New Notes mature on June 4, 2033.

     The Company may redeem some or all of the New Notes at any time on or after June 11, 2008, at a redemption price, payable in cash, of 100% of the principal amount of the New Notes, plus accrued and unpaid interest, including contingent interest, if any. Holders of the New Notes may require the Company to repurchase all or a portion of their New Notes on June 4, 2008, 2013 and 2018, and upon a change in control, as defined in the indenture governing the New Notes, at 100% of the principal amount of the New Notes, plus accrued and unpaid interest to the date of the repurchase, payable in cash.

     The New Notes are convertible, at the holders’ option, prior to the maturity date into shares of the Company’s Class A common stock in the following circumstances:

	•		during any quarter commencing after September 30, 2003, if the closing price of the Company’s Class A common stock over a specified number of trading days during the previous quarter, including the last trading trading day of such quarter, is more than 120% of the conversion price of the New Notes, or $46.51. The Notes are initially convertible at a conversion price of $38.76 per share, which is equal to a conversion rate of approximately 25.7998 shares per $1,000 principal amount of New Notes, subject to adjustment;
	•		if the Company has called the New Notes for redemption;
	•		during the five trading day period immediately following any nine consecutive day trading period in which the trading price of the New Notes per $1,000 principal amount for each day of such period was less than 95% of the product of the closing sale price of the Company’s Class A common stock on that day multiplied by the number of shares of the Company’s Class A common stock issuable upon conversion of $1,000 principal amount of the New Notes; or
	•		upon the occurrence of specified corporate transactions.

     The New Notes, which are unsecured, do not contain any restrictions on the incurrence of additional indebtedness or the repurchase of the Company’s securities and do not contain any financial covenants. The New Notes require an adjustment to the conversion price if cash dividends of more than $0.025 per quarter (after giving effect to the stock split described in Note 1) are paid by the Company on its outstanding common stock.

     As a result of the exchange, the outstanding principal amounts of the Old Notes and the New Notes are $169.2 million and $283.9 million, respectively. Both the New Notes and Old Notes are reported in aggregate on the Company’s condensed consolidated balance sheets. During the fiscal first quarter ended September 30, 2003, the Company recognized a loss on early extinguishment of debt totaling $58.7 million, consisting of a $53.1 million premium and a $5.6 million write-off of corresponding Old Notes fees. The Company incurred approximately $5.1 million of fees and other origination costs related to the issuance of the New Notes. The Company is amortizing these costs over the five-year Put period, which runs through August 2008.

     During the quarters ended March 31, 2004 and December 31, 2003, the Old Notes met the criteria for the right of conversion into shares of the Company’s Class A common stock. This right of conversion of the Holders of Old Notes was triggered by the stock closing above $31.96 on 20 of the last 30 trading days and the last trading day of the quarters ending March 31, 2004 and December 31, 2003. The Holders of Old Notes have this conversion right only until June 30, 2004. At such time and at the end of all future quarters, the conversion rights will be reassessed in accordance with the bond indenture agreement to determine if the conversion trigger rights have been achieved. During the three months ended March 31,

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2004, outstanding principal amounts of $6,000 of Old Notes were converted into shares of the Company’s Class A common stock. As of May 10, 2004, no other Old Notes had been converted.

10. INCOME TAXES

     Income taxes have been provided for using the liability method in accordance with Statement of Financial Accounting Standard No. 109, “Accounting for Income Taxes.” The provision for income taxes reflects management’s estimate of the effective tax rate expected to be applicable for the full fiscal year. This estimate is re-evaluated by management each quarter based on the Company’s estimated tax expense for the year.

     At March 31, 2004, the Company had federal net operating loss carryforwards of approximately $73.4 million that begin expiring in varying amounts in the years 2008 through 2021. The net operating losses are solely attributable to the Company’s merger with Ascent and are limited under Internal Revenue Code Section 382. The Internal Revenue Service issued Notice 2003-65 in September 2003 providing taxpayers additional guidance regarding the computations under Internal Revenue Code Section 382. The application of Notice 2003-65 to Ascent’s net operating losses has resulted in an increase in the Company’s estimate of the amount of Ascent’s net operating losses it will utilize from $16.7 million to $27.0 million. As a result, the Company has reclassified approximately $4.1 million from goodwill to deferred tax assets to reflect the increased estimate of the income tax benefit it will realize from utilization of Ascent’s net operating loss carryforwards. The June 30, 2003 goodwill and deferred tax asset amounts have also been reclassified to conform to the March 31, 2004 presentation.

     The Company took advantage of additional tax deductions available relating to the exercise of non-qualified stock options and disqualified dispositions of incentive stock options. Accordingly, the Company recorded a $10.5 million and $15.3 million increase to equity with a corresponding $10.5 million and $15.3 million reduction to income taxes payable for the three and nine months ended March 31, 2004, respectively. Quarterly adjustments for the exercise of non-qualified stock options and disqualified dispositions of incentive stock options may vary as they relate to the actions of the option holder or shareholder.

11. DIVIDENDS DECLARED ON COMMON STOCK

     On March 16, 2004, the Company’s Board of Directors declared a cash dividend on Medicis common stock. The quarter-end cash dividend of $0.025 per issued and outstanding share of the Company’s common stock was paid on April 30, 2004 to stockholders of record at the close of business on April 1, 2004. The $1.4 million dividend was recorded as a reduction of accumulated earnings, and is included in other current liabilities in the accompanying condensed consolidated balance sheets as of March 31, 2004.

12. COMPREHENSIVE INCOME

     Total comprehensive income includes net income and other comprehensive income, which consists of foreign currency translation adjustments and unrealized gains and losses on available-for-sale investments. Total comprehensive income for the three months and nine months ended March 31, 2004, was $20.7 million and $6.0 million, respectively. Total comprehensive income for the three months and nine months ended March 31, 2003, was $10.2 million and $38.6 million, respectively.

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13. EARNINGS PER COMMON SHARE

     The following table sets forth the computation of basic and diluted earnings per common share (in thousands, except per share amounts):