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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

WATSON PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)

Securities registered pursuant to Section 12(b) of the Act:

        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 ý    No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

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

Aggregate market value of Common Stock held by non-affiliates of the Registrant, as of June 28, 2002:
$2,695,265,200 based on the last reported sales price on the New York Stock Exchange

Number of shares of Registrant's Common Stock outstanding on February 26, 2003: 106,940,973

DOCUMENTS INCORPORATED BY REFERENCE

        Part III incorporates certain information by reference from the registrant's proxy statement for the 2003 Annual Meeting of Stockholders, to be held on May 19, 2003. Such proxy statement will be filed no later than 120 days after the close of the registrant's fiscal year ended December 31, 2002.

WATSON PHARMACEUTICALS, INC

INDEX TO FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2002

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PART I

ITEM 1. BUSINESS

Business Overview

        Watson Pharmaceuticals, Inc. (Watson, which may be referred to as we, us or our) is engaged in the development, manufacture, marketing, sale and distribution of branded and off-patent (generic) pharmaceutical products. We also develop advanced drug delivery systems designed to enhance the therapeutic benefits of existing drug forms. Watson operates manufacturing, distribution, research and development, and administrative facilities primarily in the United States of America (U.S.).

        Watson was incorporated in 1985 and began operations as a manufacturer and marketer of off-patent pharmaceuticals. In February 1993, we completed our initial public offering. Through internal product development and synergistic acquisitions of products and businesses, we have grown into a diversified specialty pharmaceutical company. As of December 31, 2002, we marketed more than 30 branded pharmaceutical products and approximately 130 generic pharmaceutical products.

        Our principal executive offices are located at 311 Bonnie Circle, Corona, California, 92880. Our internet website address is www.watsonpharm.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and all amendments thereto, from 1998 to present, are available free of charge on our internet website. These reports are posted on our website as soon as reasonably practicable after such reports are electronically filed with the Securities and Exchange Commission (SEC).

Business Developments

        In January 2002, we acquired the U.S. rights to Actigall® from Novartis Pharmaceuticals Corporation (Novartis). Actigall® contains ursodiol, a naturally occurring bile acid, and was introduced in the U.S. in 1988. Actigall® is indicated for the dissolution of certain types of gallbladder stones and the prevention of gallstone formation in obese patients experiencing rapid weight loss.

        Effective March 2002, we entered into an agreement with Baxter Healthcare Corporation (Baxter) for co-promotion of Ferrlecit® in the U.S. renal market. In December 2002, we received notification from Baxter that this relationship will terminate effective March 2004 as a result of its acquisition of a majority stake in ESI Lederle (ESI), a manufacturer of generic injectable products. Prior to the acquisition, ESI was a division of Wyeth.

        In August 2002, we acquired the exclusive U.S. rights to the 30mg and 60mg dosage strengths of nifedipine extended release tablets (nifedipine ER) from Elan Corporation, PLC. Nifedipine ER is the generic version of Bayer AG's Adalat CC®, indicated for the treatment of hypertension.

        In August 2002, our subsidiary, Rugby Laboratories, Inc., expanded its line of over-the-counter products to include nicotine polacrilex gum, 2mg and 4mg. Our nicotine gum is the generic equivalent to Glaxo SmithKline Consumer Healthcare's Nicorette® gum, which is used as an aid to smoking cessation. We also manufacture and sell our nicotine gum to chain drug stores under private label supply arrangements.

        In October 2002, we expanded our oral contraceptive portfolio by entering into a supply agreement with OMJ Pharmaceutical Inc. (OMJ), an affiliate of Ortho-McNeil Pharmaceutical Inc. The agreement provides us with the ability to launch generic versions of three oral contraceptives when market exclusivity

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on the branded products ends. Under the terms of the agreement, we will market and distribute the following brand equivalents through our Women's Health division:

        We recently launched Necon® 7/7/7 and Mononessa™ products as part of our supply arrangement with OMJ.

        In December 2002, we entered into a strategic alliance with Cipla, Ltd. (Cipla) to develop, manufacture and commercialize ten generic pharmaceutical products, many of which are currently under development. The agreement also provides for the development of additional products, as mutually agreed upon by the two companies. Under the terms of the agreement, Watson will have exclusive U.S. marketing rights to all developed products and will own the regulatory filings. Following approval from the Food and Drug Administration (FDA), Cipla will manufacture and supply certain products to Watson.

        In February 2003, we acquired the U.S. rights to the Fioricet® and Fiorinal® product lines from Novartis. These products are indicated for the treatment of tension headaches.

        In February 2003, we received final FDA approval of our New Drug Application (NDA) for Oxytrol™.

Business Description

        Prescription pharmaceutical products in the U.S. are generally marketed as either brand or generic pharmaceuticals. Branded pharmaceutical products are marketed under brand names through programs that are designed to generate physician and consumer loyalty. Generic pharmaceutical products are bioequivalents of their respective branded products and provide a cost-efficient alternative to branded products. As a result of the differences between the two types of products, we operate and manage our business as two segments: branded and generic pharmaceutical products.

Branded Pharmaceutical Products

        Newly developed pharmaceutical products are normally patented and, as a result, generally are offered by a single provider when first introduced to the market. We currently market a number of patented products to physicians, hospitals, and other markets that we serve. We also market certain trademarked off-patent products directly to healthcare professionals. We classify these patented and off-patent trademarked products as our branded pharmaceutical products. Net revenues from our branded products accounted for approximately 55% of our total product net revenues in 2002.

        Our branded pharmaceutical business currently develops, manufactures, markets, sells and distributes products primarily through our three marketing divisions:

•

Women's Health



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Urology/General Products



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Nephrology

        We market our branded products through three specialty sales groups, which are organized by division. Each of our specialized sales groups focus on physicians who specialize in the diagnosis and treatment of different medical conditions and each sales group offers products to satisfy certain needs of these physicians. We believe this focused marketing approach enables us to foster close professional relationships with physicians. We generally sell our branded products under the "Watson Pharma" and the "Oclassen® Dermatologics" labels.

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        We have targeted these three divisions based predominately on their potential growth opportunities. We believe that the nature of these markets and the identifiable base of physician prescribers provide us with the opportunity to achieve significant market penetration through our specialized sales forces. Many of our branded products generally realize higher profit margins than our generic products. We intend to continue to expand our branded product portfolio through internal product development, strategic alliances and acquisitions.

Women's Health

        Our Women's Health division products include oral contraceptives, a venereal disease treatment, a hormone replacement therapy and a visual cervical screening device. Our Women's Health division is the largest division within our branded business, based on net revenues and gross profit, and remains a key area of focus and growth potential for us. Currently, we have a total of 15 oral contraceptives in our product portfolio. We market our Women's Health products primarily to obstetricians and gynecologists through our specialized sales force of approximately 145 professionals. Our Women's Health branded portfolio currently consists of the following:

2002 Developments—Women's Health

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In October 2002, we expanded our oral contraceptive portfolio by entering into a supply agreement with OMJ. As previously discussed, the agreement provides us with the ability to launch generic versions of three oral contraceptives when market exclusivity on the branded products end.



•

In April 2002, the FDA approved our new indication and a new strength (0.025mg/day) of Alora® for the prevention of postmenopausal osteoporosis.



•

In January 2002, we added PapSure®, a visual cervical screening exam, and Speculite®, a visual cervical screening device, to our Women's Health product offering. PapSure® combines the results of a typical pap smear and a speculoscopy using Speculite®, a proprietary disposable chemiluminescent light for vaginal illumination, which enhances physicians' ability to visually identify possible cervical abnormalities.

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Urology/General Products

        Our Urology/General Products division currently includes urology, anti-hypertensive, neurology, psychiatry, pain management and dermatology products. The sales of our Urology/General Products division products are supported by a sales force of approximately 165 professionals. These sales and marketing professionals primarily market our products to urologists and primary care physicians, as well as endocrinologists.

        As of December 31, 2002, we marketed a total of 12 branded products through our Urology/General Products division, including the following:

Nephrology

        Our Nephrology division consists of products for the treatment of iron deficiency anemia. Currently, we have approximately 70 sales and marketing professionals supporting our Nephrology products. These sales professionals primarily market our products to nephrologists and dialysis centers. The key products within our Nephrology branded product line currently consist of the following:

        INFeD® and Ferrlecit® are injectable products that treat iron deficient anemia. INFeD® is indicated for iron replacement in patients refractory to oral iron. Ferrlecit® is indicated for patients undergoing hemodialysis in conjunction with erythropoietin therapy. INFeD® (iron dextran injection), which was introduced in 1992, is not under patent protection and does not have marketing exclusivity. Ferrlecit® (sodium ferric gluconate complex in sucrose injection), which was introduced in 1999, was granted a five-year exclusivity period by the FDA as a new chemical entity. This exclusivity period runs through February 2004. We are conducting a pediatric study with Ferrlecit® which could extend this exclusivity period for an additional six months. For the year ended December 31, 2002, sales of Ferrlecit® accounted for approximately 11% of our total net revenues.

        We continue to seek to broaden our Nephrology products and extend our customer base from dialysis centers and nephrologists to other areas where intravenous (IV) iron therapy is needed.

Generic Pharmaceutical Products

        When patents or other regulatory exclusivity no longer protect a branded product, opportunities exist for third parties to introduce off-patent or generic counterparts to the branded product. These generic products are the therapeutic equivalent to their brand name counterparts and are generally sold at prices

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significantly less than the branded product. As such, generic pharmaceuticals provide a safe, effective and cost-efficient alternative to branded products.

        Watson is a leader in the development, manufacture and sale of generic pharmaceutical products. We currently market approximately 130 generic pharmaceutical products in more than 750 packaging sizes and/or dosage strengths. With respect to generic products, our strategy is to continue to target generic drugs that are difficult to formulate or manufacture or that will complement or broaden our existing product lines. Since the prices and unit volumes of our branded products will likely decrease upon the introduction of generic alternatives, we also intend to develop generic alternatives to our branded products where market conditions and the competitive environment justify such activities. Net revenues from our generic products accounted for approximately 45% of our product net revenues in 2002.

        Our portfolio of generic pharmaceutical products includes the following products, which represented 58% of total generic product net revenues in 2002:

        We primarily market our generic products to various drug wholesalers and national retail drugstore chains through a team of approximately 18 sales and marketing professionals. We sell our generic products primarily under the "Watson Laboratories" label, except for our over-the-counter products that we sell under our "Rugby" label or under private label.

        Increasingly aggressive tactics employed by brand pharmaceutical companies to delay generic competition have increased the risks and uncertainties regarding the timing of approval of generic products. Expansion of our generic product line in recent years has been largely attributable to acquisitions rather than internal product development.

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2002 Developments—Generic Pharmaceutical Products

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As of December 31, 2002, we had 16 Abbreviated New Drug Applications (ANDA) pending FDA approval for various forms of generic pharmaceutical products.



•

In August 2002, our subsidiary, Rugby Laboratories, Inc., expanded its line of over-the-counter products to include nicotine polacrilex gum, 2mg and 4mg.



•

Key generic products launched during 2002 include the following:

•

In December 2002, we entered into a strategic alliance with Cipla to develop, manufacture and commercialize ten generic pharmaceutical products, many of which are currently under development.

Financial Information About Segments

        Watson primarily evaluates the performance of its branded and generic segments based on net revenues and gross profit. Summarized net revenues and gross profit information for each of the last three fiscal years is presented in Note 13 in the accompanying Notes to Consolidated Financial Statements.

Research and Development

        We devote significant resources to the research and development of branded and generic products and proprietary drug delivery technologies. We incurred research and development expenses of $81.6 million in 2002, $63.5 million in 2001, and $67.3 million in 2000. Our research and development strategy focuses primarily on the following product development areas:

•

the development of sustained-release technologies and the application of these technologies to existing drug forms;



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the application of proprietary drug-delivery technology for new product development in specialty areas;



•

the expansion of existing oral immediate-release products with respect to additional dosage strengths;



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the acquisition of mid-to-late stage branded drugs;



•

off-patent drugs that are difficult to develop or manufacture, or that complement or broaden our existing product lines; and



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off-patent drugs that target smaller specialized or under-served markets.

        As of December 31, 2002, we maintained research and development facilities in Corona, California; Danbury, Connecticut; Cincinnati, Ohio; Copiague, New York; and Salt Lake City, Utah. In 2003, we intend to consolidate our Cincinnati research and development operations into our Corona facility.

        We are presently developing a number of branded products, some of which utilize novel drug-delivery systems, through a combination of internal and collaborative programs, including joint ventures.

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        Our current branded product development efforts include:

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Oxytrol™ (oxybutynin patch).  We have developed a proprietary oxybutynin patch for the treatment of overactive bladder with symptoms of urge urinary incontinence, urgency and frequency. In February 2003, we received final FDA approval of our NDA for Oxytrol™. We expect to launch Oxytrol™ during the second quarter of 2003.



•

Onychomycosis Patch.  We are developing a proprietary transdermal patch for the treatment of onychomycosis (fungal infection of the toe and fingernails). In our Phase II trial, 78% of patients using the onychomycosis patch reported an improvement in their fungal infection after three months, compared to 40% in the placebo group. The incidence of side effects with the patch were extremely low as reported in the trial. Nail disorders were the most commonly reported adverse events, occurring in 22% of the active treatment group and 59% of the placebo group. Based upon these positive Phase II clinical results, we have initiated two Phase III clinical trials involving approximately 300 patients each in 48 U.S. centers. These one-year, in-life studies with active and placebo groups will include six months follow-up. Assuming positive results from the Phase III clinical program, we anticipate filing a NDA for the onychomycosis patch in the first half of 2004.



•

Female-T Patch.  We are collaborating with Procter & Gamble on the development of a testosterone patch for the treatment of sexual dysfunction in women. Under the terms of the development agreement, Procter & Gamble is responsible for clinical and regulatory activities and Watson is responsible for formulation, development and eventual patch manufacturing. This product is currently in Phase III clinical trials.



•

Ferrlecit® Expanded Indication.  In 2001, the results from a physician initiated pilot trial evaluating the benefits of IV iron (using iron dextran, primarily INFeD®) administration for the treatment of anemia in cancer patients receiving concomitant erythropoietin therapy were presented at a scientific symposium. The study demonstrated significantly greater increases in hemoglobin as well as energy and activity measurements for patients receiving IV iron and erythropoietin therapies, relative to patients receiving erythropoietin therapy alone and patients receiving erythropoietin and oral iron therapies. Based upon these results, we initiated a feasibility trial in late 2001 evaluating the effects of our second generation IV iron product, Ferrlecit®, in the treatment of anemia with cancer patients on erythropoietin therapy. We plan to conduct additional studies in this new patient population and, based on such studies, will assess the feasibility of seeking approval for this new indication.



•

Prestara™.  In August 2002, the FDA issued an approvable letter to Genelabs Technologies, Inc. (Genelabs), for its NDA for Prestara™ (formerly Aslera™ or GL701). Based upon the results of an additional bone mineral density trial, the FDA agreed to a prevention of osteoporosis indication for women with systemic lupus erythematosus (SLE or lupus). In a prior Genelabs study, a positive effect on bone mineral density was observed in women with mild to moderate SLE on low-dose glucocorticoids. Final approval is contingent upon the successful completion of the additional clinical trial confirming this positive effect and submission of data for the qualification of a manufacturing site. Watson holds exclusive North American marketing rights to Prestara™.



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EmSam™.  Through Somerset Pharmaceuticals, Inc. (Somerset), our joint venture with Mylan Laboratories, Inc., in which we hold a 50% interest, we are developing EmSam™, a selegeline patch for depression. In March 2002, the FDA issued to Somerset a "not-approvable" letter with respect to Somerset's NDA for EmSam™. Somerset is continuing efforts toward approval of this product.



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Other Products in Development.  We are currently working on the development of a contraception patch, in addition to other products within our Women's Health and Urology/General Products divisions.

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•

Discontinued R&D Projects.  As a result of the National Institute of Health's early retirement of the Women's Health Initiative trial and its impact on the hormone replacement therapy market as well as the reactions of the medical community, we have terminated our oral estradiol plus progesterone combination hormone replacement Phase III study. Additionally, as a result of the FDA's recently adopted guidelines applicable to products containing fentanyl, and the increased time and expense that compliance with such guidelines will cause, we have terminated our fentanyl lozenge clinical trial.

        During 2002, we expanded our investment in branded and generic research and development. Our goal is to increase the number of NDAs we submit to the FDA in the future. However, product development is inherently risky and uncertain. See "Risks Related to Our Business—If we are unable to successfully develop or commercialize new products, our operating results could suffer."

Growth Strategy

        We intend to grow our business through a combination of internal research and development, strategic alliances and strategic acquisitions. We believe that our three-pronged growth strategy will allow us to expand both our branded and generic product offerings, with the long-term goal of a mix favoring branded products. Based upon business conditions, our financial strength and other factors, we regularly reexamine our growth strategies and may change them at any time. See "Risks Related to Our Business."

Customers

        We sell our branded and generic pharmaceutical products primarily to drug wholesalers, retailers and distributors, including large chain drug stores, hospitals, clinics, government agencies and managed healthcare providers such as health maintenance organizations and other institutions. These customers comprise a significant part of the distribution network for pharmaceutical products in the U.S. This distribution network is continuing to undergo significant consolidation marked by mergers and acquisitions among wholesale distributors and the growth of large retail drug store chains. As a result, a small number of large, wholesale distributors control a significant share of the market, and the number of independent drug stores and small drug store chains has decreased. We expect that consolidation of drug wholesalers and retailers will impact pricing and create other competitive pressures on drug manufacturers.

        Sales to certain of our customers accounted for 10% or more of our annual net revenues during the past three years. The following table illustrates those customers and the respective percentage of our net revenues for which they account:

*

In August 2001, AmeriSource Health Corporation merged with Bergen Brunswig. Prior to the merger, Amerisource accounted for 7% of our net revenues in 2001. These pre-merger revenues from Amerisource are not included in the amount above for AmerisourceBergen Corp.

        The loss of any of these customers could materially and adversely affect our business, results of operations, financial condition and cash flows.

Competition

        The pharmaceutical industry is highly competitive. We compete with different companies depending upon product categories, and within each product category, upon dosage strengths and drug delivery

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systems. Such competitors include the major brand name and generic manufacturers of pharmaceuticals, especially those doing business in the U.S. In addition to product development, other competitive factors in the pharmaceutical industry include product quality and price, reputation and service and access to proprietary and technical information. It is possible that developments by others will make our products or technologies noncompetitive or obsolete.

        Competing in the branded product business requires us to identify and quickly bring to market new products embodying technological innovations. Successful marketing of branded products depends primarily on the ability to communicate the effectiveness, safety and value of branded products to healthcare professionals in private practice, group practices and managed care organizations. We anticipate that our branded product offerings will support our existing areas of therapeutic focus. Based upon business conditions and other factors, we regularly reexamine our business strategies and may from time to time reallocate our resources from one therapeutic area to another, withdraw from a therapeutic area or add an additional therapeutic area in order to maximize our overall growth opportunities.

        Our competitors in branded products include the major brand name manufacturers of pharmaceuticals such as Johnson & Johnson and Wyeth (formerly American Home Products). Based on total assets, annual revenues and market capitalization, we are considerably smaller than these and other national competitors in the branded product area. These competitors, as well as others, have been in business for a longer period of time, have a greater number of products on the market and have greater financial and other resources than we do. If we directly compete with them for the same markets and/or products, their financial strength could prevent us from capturing a meaningful share of those markets.

        We also compete in the generic pharmaceutical business. Revenues and gross profit derived from the sales of generic pharmaceutical products tend to follow a pattern based on certain regulatory and competitive factors. As patents and regulatory exclusivity for brand name products expire, the first off-patent manufacturer to receive regulatory approval for generic equivalents of such products is generally able to achieve significant market penetration. As competing off-patent manufacturers receive regulatory approvals on similar products, market share, revenues and gross profit typically decline, in some cases dramatically. Accordingly, the level of market share, revenues and gross profit attributable to a particular generic product is normally related to the number of competitors in that product's market and the timing of that product's regulatory approval and launch, in relation to competing approvals and launches. Consequently, we must continue to develop and introduce new products in a timely and cost-effective manner to maintain our revenues and gross margins. In addition to competition from other generic drug manufacturers, we face competition from brand name companies in the generic market. Many of these companies seek to participate in sales of generic products by, among other things, collaborating with other generic pharmaceutical companies or by marketing their own generic equivalent to their branded products. Our major competitors in generic products include Teva Pharmaceutical Industries, Ltd., Barr Laboratories, Inc., Mylan Laboratories, Inc., Andrx Corporation, IVAX Corporation and Geneva Pharmaceuticals, a division of Novartis. See "Risks Related to Our Business—The pharmaceutical industry is highly competitive."

Manufacturing, Suppliers and Materials

        We manufacture many of our own finished products at our plants in Corona, California; Danbury, Connecticut; Miami, Florida; Carmel, New York; Copiague, New York; Salt Lake City, Utah; Phoenix, Arizona; and Humacao, Puerto Rico. Our Phoenix, Arizona manufacturing facility is classified as an asset held for disposition on our balance sheet and we are actively pursuing the possible sale of this facility. Our manufacturing operations are subject to extensive regulatory oversight and could be interrupted at any time.

        For certain of our finished products, we contract with third parties for the manufacture of the products, some of which are currently available only from sole or limited suppliers. These third-party

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manufactured products include products that have historically accounted for a significant portion of our revenues, such as Ferrlecit®, and a number of our oral contraceptive products. Third-party manufactured products accounted for approximately 47%, 43% and 37% of our product net revenues in 2002, 2001 and 2000, respectively.

        We are dependent on third parties for the supply of the raw materials necessary to develop and manufacture our products, including the active and inactive pharmaceutical ingredients used in our products. We are required to identify the supplier(s) of all the raw materials for our products in the drug applications that we file with the FDA. If raw materials for a particular product become unavailable from an approved supplier specified in a drug application, we would be required to qualify a substitute supplier with the FDA, which would likely interrupt manufacturing of the affected product. To the extent practicable, we attempt to identify more than one supplier in each drug application. However, some raw materials are available only from a single source and, in some of our drug applications, only one supplier of raw materials has been identified, even in instances where multiple sources exist.

        In addition, we obtain a significant portion of our raw materials from foreign suppliers. Arrangements with international raw material suppliers are subject to, among other things, FDA regulation, various import duties and other government clearances. Acts of governments outside the U.S. may affect the price or availability of raw materials needed for the development or manufacture of our products. In addition, any changes in patent laws in jurisdictions outside the U.S. may make it increasingly difficult to obtain raw materials for research and development prior to the expiration of the applicable U.S. or foreign patents. See "Risks Related to Our Business—If we are unable to obtain sufficient supplies from key suppliers that in some cases may be the only source of finished products or raw materials, our ability to deliver our products to the market may be impeded."

Patents and Proprietary Rights

        We believe patent protection of our proprietary products is important to our business. Our success with our branded products will depend, in part, on our ability to obtain, and successfully defend if challenged, patent or other proprietary protection for such products. We currently have a number of U.S. and foreign patents issued or pending. However, the issuance of a patent is not conclusive as to its validity or as to the enforceable scope of the claims of the patent. Accordingly, our patents may not prevent other companies from developing similar or functionally equivalent products or from successfully challenging the validity of our patents. If our patent applications are not approved or, even if approved, if such patents are circumvented or not upheld in a court of law, our ability to competitively exploit our patented products and technologies may be significantly reduced. Also, such patents may or may not provide competitive advantages for their respective products or they may be challenged or circumvented by competitors, in which case our ability to commercially exploit these products may be diminished. From time to time, we may need to obtain licenses to patents and other proprietary rights held by third parties to develop, manufacture and market our products. If we are unable to timely obtain these licenses on commercially reasonable terms, our ability to commercially exploit such products may be inhibited or prevented.

        We also rely on trade secrets and proprietary know-how that we seek to protect, in part, through confidentiality agreements with our partners, customers, employees and consultants. It is possible that these agreements will be breached or will not be enforceable in every instance, and that we will not have adequate remedies for any such breach. It is also possible that our trade secrets will otherwise become known or independently developed by competitors.

        We may find it necessary to initiate litigation to enforce our patent rights, to protect our trade secrets or know-how or to determine the scope and validity of the proprietary rights of others. Litigation concerning patents, trademarks, copyrights and proprietary technologies can often be protracted and expensive and, as with litigation generally, the outcome is inherently uncertain.

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        Pharmaceutical companies with branded products are increasingly suing companies that produce off-patent forms of their brand name products for alleged patent and/or copyright infringement or other violations of intellectual property rights which may delay or prevent the entry of such a generic product into the market. For instance, when we file an ANDA seeking approval of a generic equivalent to a branded drug, we may certify under the Drug Price Competition and Patent Restoration Act of 1984 (the Hatch-Waxman Act) to the FDA that we do not intend to market our generic drug until any patent listed by the FDA as covering the branded drug has expired, in which case, the ANDA will not be approved by the FDA until no earlier than the expiration of such patent(s). On the other hand, we could certify that any patent listed as covering the branded drug is invalid and/or will not be infringed by the manufacture, sale or use of our generic form of the branded drug. In that case, we are required to notify the branded product holder or the patent holder that such patent is invalid or is not infringed. The patent holder has 45 days from receipt of the notice in which to sue for patent infringement. The FDA is then prevented from approving our ANDA for 30 months after receipt of the notice unless a shorter period is deemed appropriate by a court. In addition, increasingly aggressive tactics employed by brand companies to delay generic competition have increased the risks and uncertainties regarding the timing of approval of generic products.

        Some companies have expressed an interest over the last several years in reopening the Hatch-Waxman Act and renegotiating some of the compromises reached between the brand and generic pharmaceutical industries that resulted in the creation of the modern generic pharmaceutical industry. Reopening the Hatch-Waxman Act could disturb the delicate balance achieved in 1984, but may also offer the generic industry the opportunity to include drug products not currently covered under the Hatch-Waxman Act.

        Because a balanced and fair legislative and regulatory arena is critical to the pharmaceutical industry, we will continue to devote management time and financial resources on government activities. We currently maintain an office and staff a full-time government affairs function in Washington, D.C. that maintains responsibility for keeping abreast of state and federal legislative activities.

        Litigation alleging infringement of patents, copyrights or other intellectual property rights may be costly and time consuming. See "Risks Related to Our Business—Third parties may claim that we infringe their proprietary rights and may prevent us from manufacturing and selling some of our products."

Government Regulation and Regulatory Matters

        All pharmaceutical manufacturers, including Watson, are subject to extensive, complex and evolving regulation by the federal government, principally the FDA, and to a lesser extent, by the U.S. Drug Enforcement Administration (DEA) and state government agencies. The Federal Food, Drug and Cosmetic Act, the Controlled Substances Act and other federal statutes and regulations govern or influence the testing, manufacturing, packing, labeling, storing, record keeping, safety, approval, advertising, promotion, sale and distribution of our products.

        FDA approval is required before any dosage form of any new drug, including an off-patent equivalent of a previously approved drug, can be marketed. The process for obtaining governmental approval to manufacture and market pharmaceutical products is rigorous, time-consuming and costly, and the extent to which it may be affected by legislative and regulatory developments cannot be predicted. We are dependent on receiving FDA and other governmental approvals prior to manufacturing, marketing and shipping new products. Consequently, there is always the risk the FDA or other applicable agency will not approve our new products, or the rate, timing and cost of such approvals will adversely affect our product introduction plans or results of operations. See "Risks Related to Our Business—If we are unable to develop or commercialize new products, our operating results will suffer" and "—Extensive industry regulation has had, and will continue to have, a significant impact on our business, especially our product development and manufacturing capabilities."

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        All applications for FDA approval must contain information relating to product formulation, raw material suppliers, stability, manufacturing processes, packaging, labeling and quality control. There are generally two types of applications for FDA approval that would be applicable to our new products:

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New Drug Application (NDA).  We file a NDA when we seek approval for drugs with active ingredients and/or with dosage strengths, dosage forms, delivery systems or pharmacokinetic profiles that have not been previously approved by the FDA. Generally, NDAs are filed for newly developed branded products or for a new dosage form of previously approved drugs.



•

Abbreviated New Drug Application (ANDA).  We file an ANDA when we seek approval for off-patent, or generic, equivalents of a previously approved drug.

        The process required by the FDA before a previously unapproved pharmaceutical product may be marketed in the U.S. generally involves the following:

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preclinical laboratory and animal tests;



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submission of an investigational new drug application (IND), which must become effective before clinical trials may begin;



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adequate and well-controlled human clinical trials to establish the safety and efficacy of the proposed product for its intended use;



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submission of a NDA containing the results of the preclinical and clinical trials establishing the safety and efficacy of the proposed product for its intended use; and



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FDA approval of a NDA.

        Preclinical tests include laboratory evaluation of the product, its chemistry, formulation and stability, as well as animal studies to assess the potential safety and efficacy of the product. We then submit the results of these studies to the FDA as part of an IND, which must become effective before we may begin human clinical trials. The IND automatically becomes effective 30 days after receipt by the FDA unless the FDA, during that 30-day period, raises concerns or questions about the conduct of the trials as outlined in the IND. In such cases, the IND sponsor and the FDA must resolve any outstanding concerns before clinical trials can begin. In addition, an independent Institutional Review Board at the medical center proposing to conduct the clinical trials must review and approve any clinical study.

        Human clinical trials are typically conducted in three sequential phases:

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Phase I.  During this phase, the drug is initially introduced into a relatively small number of healthy human subjects or patients and is tested for safety, dosage tolerance, absorption, metabolism, distribution and excretion.



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Phase II.  This phase involves studies in a limited patient population to identify possible adverse effects and safety risks, to determine the efficacy of the product for specific targeted diseases or conditions, and to determine dosage tolerance and optimal dosage.



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Phase III.  When Phase II evaluations demonstrate that a dosage range of the product is effective and has an acceptable safety profile, Phase III trials are undertaken to further evaluate dosage, clinical efficacy and to further test for safety in an expanded patient population at geographically dispersed clinical study sites.

        The results of product development, preclinical studies and clinical studies are then submitted to the FDA as part of a NDA, for approval of the marketing and commercial shipment of the new product. The NDA drug development and approval process currently averages approximately five to ten years.

        FDA approval of an ANDA is required before we may begin marketing an off-patent or generic equivalent of a drug that has been approved under a NDA, or a previously unapproved dosage form of a

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drug that has been approved under a NDA. The ANDA approval process generally differs from the NDA approval process in that it does not require new preclinical and clinical studies; instead, it relies on the clinical studies establishing safety and efficacy conducted for the previously approved NDA drug. The ANDA process, however, requires data to show that the ANDA drug is bioequivalent (i.e., therapeutically equivalent) to the previously approved drug. "Bioequivalence" compares the bioavailability of one drug product with another and, when established, indicates whether the rate and extent of absorption of a generic drug in the body are substantially equivalent to the previously approved drug. "Bioavailability" establishes the rate and extent of absorption, as determined by the time dependent concentrations of a drug product in the bloodstream needed to produce a therapeutic effect. The ANDA drug development and approval process generally takes less time than the NDA drug development and approval process since the ANDA process does not require new clinical trials establishing the safety and efficacy of the drug product.

        Supplemental NDAs or ANDAs are required for, among other things, approval to transfer products from one manufacturing site to another and may be under review for a year or more. In addition, certain products may only be approved for transfer once new bioequivalency studies are conducted or other requirements are satisfied.

        To obtain FDA approval of both NDAs and ANDAs, our manufacturing procedures and operations must conform to FDA quality system and control requirements generally referred to as current Good Manufacturing Practices (cGMP), as defined in Title 21 of the U.S. Code of Federal Regulations. These regulations encompass all aspects of the production process from receipt and qualification of components to distribution procedures for finished products. They are evolving standards; thus, we must continue to expend substantial time, money and effort in all production and quality control areas to maintain compliance. The evolving and complex nature of regulatory requirements, the broad authority and discretion of the FDA, and the generally high level of regulatory oversight results in the continuing possibility that we may be adversely affected by regulatory actions despite our efforts to maintain compliance with regulatory requirements.

        We are subject to the periodic inspection of our facilities, procedures and operations and/or the testing of our products by the FDA, the DEA and other authorities, which conduct periodic inspections to assess compliance with applicable regulations. In addition, in connection with its review of our applications for new products, the FDA conducts pre-approval and post-approval reviews and plant inspections to determine whether our systems and processes comply with cGMP and other FDA regulations. Among other things, the FDA may withhold approval of NDAs, ANDAs or other product applications of a facility if deficiencies are found at that facility. Vendors that supply finished products or components to us that we use to manufacture, package and label products are subject to similar regulation and periodic inspections.

        Following such inspections, the FDA may issue notices on Form 483 and Warning Letters that could cause us to modify certain activities identified during the inspection. A Form 483 notice is generally issued at the conclusion of an FDA inspection and lists conditions the FDA investigators believe may violate cGMP or other FDA regulations. FDA guidelines specify that a Warning Letter be issued only for violations of "regulatory significance" for which the failure to adequately and promptly achieve correction may be expected to result in an enforcement action.

        Our Corona, California facility and our Steris facility located in Phoenix, Arizona are each currently subject to a consent decree of permanent injunction. See "Risks Related to Our Business—Extensive industry regulation has had, and will continue to have, a significant impact on our business, especially our product development and manufacturing capabilities." See also "Item 3. Legal Proceedings."

        Failure to comply with FDA and other governmental regulations can result in fines, unanticipated compliance expenditures, recall or seizure of products, total or partial suspension of production and/or distribution, suspension of the FDA's review of NDAs, ANDAs or other product applications enforcement actions, injunctions and criminal prosecution. Under certain circumstances, the FDA also has the authority

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to revoke previously granted drug approvals. Although we have internal compliance programs, if these programs do not meet regulatory agency standards or if our compliance is deemed deficient in any significant way, it could have a material adverse effect on us. See "Risks Related to Our Business—Extensive industry regulation has had, and will continue to have, a significant impact on our business, especially our product development and manufacturing capabilities."

        The Generic Drug Enforcement Act of 1992 established penalties for wrongdoing in connection with the development or submission of an ANDA. Under this Act, the FDA has the authority to permanently or temporarily bar companies or individuals from submitting or assisting in the submission of an ANDA, and to temporarily deny approval and suspend applications to market generic drugs. The FDA may also suspend the distribution of all drugs approved or developed in connection with certain wrongful conduct and/or withdraw approval of an ANDA and seek civil penalties. The FDA can also significantly delay the approval of any pending NDA, ANDA or other regulatory submissions under the Fraud, Untrue Statements of Material Facts, Bribery and Illegal Gratuities Policy Act.

        Reimbursement levels include Medicare, Medicaid and other federal and state medical assistance programs established according to statute and government regulations and policy. Federal law requires that all pharmaceutical manufacturers rebate a percentage of their revenues arising from Medicaid-reimbursed prescription drug programs. Such rebates are made to individual states, based on applicable sales in each state. The required rebate is currently 11% of the average manufacturer price for sales of Medicaid-reimbursed products marketed under ANDAs. For sales of Medicaid-reimbursed single source products and/or products marketed under NDAs, manufacturers are required to rebate the greater of approximately 15.1% of the average manufacturer price, or the difference between the average manufacturer price and the lowest net sales price to a non-government customer during a specified period.

        There has been enhanced political attention and governmental scrutiny at the federal and state levels of the prices paid or reimbursed for pharmaceutical products under Medicaid, Medicare and other government programs. See "Risks Related to Our Business—Investigations into average wholesale prices may adversely affect our business."

        In order to assist us in commercializing products, we have obtained from government authorities and private health insurers and other organizations, such as Health Maintenance Organizations (HMOs) and Managed Care Organizations (MCOs), authorization to receive reimbursement at varying levels for the cost of certain products and related treatments. Third party payors increasingly challenge pricing of pharmaceutical products. The trend toward managed healthcare in the U.S., the growth of organizations such as HMOs and MCOs and legislative proposals to reform healthcare and government insurance programs could significantly influence the purchase of pharmaceutical products, resulting in lower prices and a reduction in product demand. Such cost containment measures and healthcare reform could affect our ability to sell our products and may have a material adverse effect on our business, results of operations, financial condition and cash flows. Due to the uncertainty surrounding reimbursement of newly approved pharmaceutical products, reimbursement may not be available for some of our products. Additionally, any reimbursement granted may not be maintained or limits on reimbursement available from third-party payors may reduce the demand for, or negatively effect the price of, those products.

        Federal, state and local laws of general applicability, such as laws regulating working conditions, also govern us. In addition, we are subject, as are all manufacturers generally, to various federal, state and local environmental protection laws and regulations, including those governing the discharge of material into the environment. We do not expect the costs of complying with such environmental provisions to have a material effect on our earnings, cash requirements or competitive position in the foreseeable future.

        In July 2002, the U.S. Federal Trade Commission (FTC) published a study of whether brand name and generic drug manufacturers have entered into agreements, or have used other strategies, to delay competition from generic versions of patent-protected drugs. We, along with other pharmaceutical companies, received a request for information from the FTC pursuant to this study. The FTC's study, and

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any changes to existing laws and regulations that result from the study, could affect the manner in which generic drug manufacturers resolve intellectual property litigation with branded pharmaceutical companies, and could result generally in an increase in private-party litigation against pharmaceutical companies. The impact of the FTC's study, and the potential private-party lawsuits associated with arrangements between brand name and generic drug manufacturers is uncertain, and could adversely affect our business.

        Continuing studies of the proper utilization, safety and efficacy of pharmaceuticals and other health care products are being conducted by industry, government agencies and others. Such studies, which increasingly employ sophisticated methods and techniques, can call into question the utilization, safety and efficacy of previously marketed products and in some cases have resulted, and may in the future result, in the discontinuance of their marketing.

Seasonality

        Our business is not materially affected by seasonal factors.

Backlog

        Due to the relatively short lead-time required to fill orders for our products, backlog of orders is not material to our business.

Employees

        As of December 31, 2002, we had 3,729 employees, none of whom are represented by labor unions. Of our employees, approximately 391 are engaged in research and development, 1,337 in manufacturing, 809 in quality assurance and quality control, 751 in sales and marketing, and 441 in administration. We believe our relations with our employees are good.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

        Any statements made in this report that are not statements of historical fact or that refer to estimated or anticipated future events are forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that we may not be able to predict or quantify with precision. Such forward-looking statements reflect our current perspective of existing trends and information as of the date of this filing. These include, but are not limited to, prospects related to our strategic initiatives and business strategies, expressed or implied assumptions about government regulatory action or inaction, anticipated product approvals and launches, business 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 other variations thereof or comparable terminology are intended to identify forward-looking statements.

        We caution the reader that 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 Securities and Exchange Commission filings, may affect our actual results.

        We disclaim any obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. We also may make additional disclosures in our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K that we may file from time to time with the Securities and Exchange Commission. Other factors besides those listed here

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could also adversely affect us. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995.

Risks Related to Our Business

        We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. The following discussion highlights some of these risks and others are discussed elsewhere in this report. These and other risks could materially and adversely affect our business, financial condition, operating results or cash flows.

Risks Associated With Investing In The Business Of Watson

If we are unable to successfully develop or commercialize new products, our operating results will suffer.

        Our future results of operations will depend to a significant extent upon our ability to successfully commercialize new branded and generic products in a timely manner. There are numerous difficulties in developing and commercializing new products, including:

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developing, testing and manufacturing products in compliance with regulatory standards in a timely manner;



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receiving requisite regulatory approvals for such products in a timely manner;



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the availability, on commercially reasonable terms, of raw materials, including active pharmaceutical ingredients and other key ingredients;



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developing and commercializing a new product is time consuming, costly and subject to numerous factors that may delay or prevent the development and commercialization of new products, including legal actions brought by our competitors;



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experiencing delays or unanticipated costs; and



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commercializing generic products may be substantially delayed by the listing with the FDA of patents that have the effect of potentially delaying approval of the off-patent product by up to 30 months, and in some cases, such patents have issued and been listed with the FDA after the key chemical patent on the branded drug product has expired or been litigated, causing additional delays in obtaining approval.

        As a result of these and other difficulties, products currently in development by Watson may or may not receive the regulatory approvals necessary for marketing by Watson or other third-party partners. This risk particularly exists with respect to the development of proprietary products because of the uncertainties, higher costs and lengthy time frames associated with research and development of such products and the inherent unproven market acceptance of such products. If any of our products, when acquired or developed and approved, cannot be successfully or timely commercialized, our operating results could be adversely affected. We cannot guarantee that any investment we make in developing products will be recouped, even if we are successful in commercializing those products.

Our branded pharmaceutical expenditures may not result in commercially successful products.

        During 2002, we increased our planned expenditures for the development and marketing of our branded business. During 2003 and thereafter, we may further increase the amounts we expend for our branded pharmaceutical business. In addition, we expect to launch Oxytrol™, our proprietary oxybutynin patch for the treatment of overactive bladder, during the second quarter of 2003. In connection with the launch, we will establish a contract sales organization which will require us to make additional ongoing expenditures. As a result of these increased expenditures, our earnings in the short-term may be adversely

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affected. Furthermore, we cannot be sure these business expenditures will result in the successful discovery, development or launch of branded products that will prove to be commercially successful or will improve the long-term profitability of our business.

Our gross profit may fluctuate from period to period depending upon our product sales mix, our product pricing, and our costs to manufacture or purchase products.

        Our future results of operations, financial condition and cash flows depend to a significant extent upon our branded and generic product sales mix. Our sales of branded products tend to create higher gross margins than do our sales of generic products. As a result, our sales mix (the proportion of total sales between branded products and generic products) will significantly impact our gross profit from period to period. During 2002, sales of our branded products and generic products accounted for approximately 55% and 45%, respectively, of our net product sales. During that same period, branded products and generic products contributed approximately 80% and 20%, respectively, to our gross profits. Factors that may cause our sales mix to vary include:

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the amount of new product introductions;



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marketing exclusivity, if any, which may be obtained on certain new products;



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the level of competition in the marketplace for certain products;



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the availability of raw materials and finished products from our suppliers; and



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the scope and outcome of governmental regulatory action that may involve us.

        The profitability of our product sales is also dependent upon the prices we are able to charge for our products, the costs to purchase products from third parties, and our ability to manufacture our products in a cost effective manner.

Loss of revenues from significant products could have a material adverse effect on our results of operations, financial condition and cash flows.

        We currently have one product, Ferrlecit®, with annual sales in excess of 10% of our net revenues. If this product, or a combination of certain of our Women's Health or General and Pain Management Products (none of which individually account for more than 10% of our net revenues), were to be subject to loss of exclusivity, unexpected side effects, regulatory proceedings, or pressure from competitive products, among other factors, our net revenues could significantly decline, which could have a material adverse effect on our results of operations, financial condition and cash flows.

If we are unsuccessful in our joint ventures and other collaborations, our operating results could suffer.

        We have made substantial investments in joint ventures and other collaborations and may use these and other methods to develop or commercialize products in the future. These arrangements typically involve other pharmaceutical companies as partners that may be competitors of ours in certain markets. In many instances, we will not control these joint ventures or collaborations or the commercial exploitation of the licensed products, and cannot assure you that these ventures will be profitable. Although restrictions contained in certain of these programs have not had a material adverse impact on the marketing of our own products to date, any such marketing restrictions could affect future revenues and have a material adverse effect on our operations. For example, in March 2002, the FDA issued to Somerset Pharmaceuticals, Inc., a joint venture in which we hold a 50% interest, a "not approvable" letter with respect to Somerset's NDA for EmSam™, a selegeline patch for depression. Somerset is continuing its efforts toward approval of this product. Our results of operations may suffer if existing joint ventures or

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collaboration partners withdraw, or if these products are not timely developed, approved or successfully commercialized.

If we are unable to adequately protect our technology or enforce our patents, our business could suffer.

        Our success with the branded products that we develop will depend, in part, on our ability to obtain patent protection for these products. We currently have a number of U.S. and foreign patents issued and pending. We cannot be sure that we will receive patents for any of our patent applications. If our current and future patent applications are not approved or, if approved, if such patents are not upheld in a court of law, it may reduce our ability to competitively exploit our patented products. Also, such patents may or may not provide competitive advantages for their respective products or they may be challenged or circumvented by our competitors, in which case our ability to commercially exploit these products may be diminished.

        We also rely on trade secrets and proprietary know-how that we seek to protect, in part, through confidentiality agreements with our partners, customers, employees and consultants. It is possible that these agreements will be breached or that they will not be enforceable in every instance, and that we will not have adequate remedies for any such breach. It is also possible that our trade secrets will become known or independently developed by our competitors.

        If we are unable to adequately protect our technology or enforce our patents, our results of operations, financial condition and cash flows could suffer.

If branded pharmaceutical companies are successful in limiting the use of generics through their legislative and regulatory efforts, our sales of generic products may suffer.

        Many branded pharmaceutical companies increasingly have used state and federal legislative and regulatory means to delay generic competition. These efforts have included:

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pursuing new patents for existing products which may be granted just before the expiration of one patent which could extend patent protection for additional years or otherwise delay the launch of generics;



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using the Citizen Petition process to request amendments to FDA standards;



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seeking changes to U.S. Pharmacopeia, an organization which publishes industry recognized compendia of drug standards;



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attaching patent extension amendments to non-related federal legislation; and



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engaging in state-by-state initiatives to enact legislation that restricts the substitution of some generic drugs, which could have an impact on products that we are developing.

        If branded pharmaceutical companies are successful in limiting the use of generic products through these or other means, our sales of generic products may decline. If we experience a material decline in generic product sales, our results of operations, financial condition and cash flows will suffer.

From time to time we may need to rely on licenses to proprietary technologies, which may be difficult or expensive to obtain.

        We may need to obtain licenses to patents and other proprietary rights held by third parties to develop, manufacture and market products. If we are unable to timely obtain these licenses on commercially reasonable terms, our ability to commercially exploit our products may be inhibited or prevented.

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Third parties may claim that we infringe their proprietary rights and may prevent us from manufacturing and selling some of our products.

        The manufacture, use and sale of new products that are the subject of conflicting patent rights have been the subject of substantial litigation in the pharmaceutical industry. These lawsuits relate to the validity and infringement of patents or proprietary rights of third parties. We may have to defend against charges that we violated patents or proprietary rights of third parties. This is especially true in the case of generic products on which the patent covering the branded product is expiring, an area where infringement litigation is prevalent, and in the case of new branded products where a competitor has obtained patents for similar products. Litigation may be costly and time-consuming, and could divert the attention of our management and technical personnel. In addition, if we infringe on the rights of others, we could lose our right to develop or manufacture products or could be required to pay monetary damages or royalties to license proprietary rights from third parties. Although the parties to patent and intellectual property disputes in the pharmaceutical industry have often settled their disputes through licensing or similar arrangements, the costs associated with these arrangements may be substantial and could include ongoing royalties. Furthermore, we cannot be certain that the necessary licenses would be available to us on terms we believe to be acceptable. As a result, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling a number of our products, which could harm our business, financial condition, results of operations and cash flows.

As a part of our business strategy, we plan to consider, and as appropriate, make acquisitions of technologies, products and businesses, which may result in us experiencing difficulties in integrating the technologies, products and businesses that we acquire and/or experiencing significant charges to earnings that may adversely affect our stock price and financial condition.

        We regularly review potential acquisitions of technologies, products and businesses complementary to our business. Acquisitions typically entail many risks and could result i