Except for the historical information contained herein, the following discussion contains forward-looking statements that are subject to known and unknown risks, uncertainties and other factors that may cause actual results to differ materially from those expressed or implied by such forward-looking statements. We discuss such risks, uncertainties and other factors throughout this report and specifically under the caption "Cautionary Note Regarding Forward-Looking Statements" under "Item 1A. Risk Factors" in this annual report on Form 10-K ("Annual Report"). In addition, the following discussion of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report.

EXECUTIVE SUMMARY

Overview of Watson

Watson Pharmaceuticals, Inc. ("Watson", the "Company", "we", "us" or "our") was incorporated in 1985 and is engaged in the development, manufacturing, marketing, sale and distribution of brand and off-patent (generic) pharmaceutical products. Watson operates manufacturing, distribution, research and development ("R&D"), and administrative facilities predominantly in the United States of America ("U.S.") and India with our key commercial market being the U.S.

As of December 31, 2008, we marketed approximately 150 generic pharmaceutical product families and 27 brand pharmaceutical product families and distributed approximately 8,000 stock-keeping units ("SKUs") through our Distribution business (also known as "Anda"). Prescription pharmaceutical products in the U.S. are generally marketed as either generic or brand pharmaceuticals. Generic pharmaceutical products are bioequivalents of their respective brand products and provide a cost-efficient alternative to brand products. Brand pharmaceutical products are marketed under brand names through programs that are designed to generate physician and consumer loyalty. Our Distribution business, primarily distributes generic pharmaceutical products to independent pharmacies, alternate care providers (hospitals, nursing homes and mail order pharmacies) and pharmacy chains, and generic products and certain selective brand products to physicians' offices.

2008 Financial Highlights

Among the significant consolidated financial highlights for 2008 were the following:

• Net revenues grew to $2,535.5 million from $2,496.7 million in 2007, an increase of $38.8 million or 1.6%;

• Gross profit increased by $40.8 million to $1,032.7 million from $991.9 million in 2007. Gross margins increased to 40.7% from 39.7% in 2007;

• Amortization expense declined $95.7 million due to a reduction in product right amortization. Our Ferrlecit® product rights were fully amortized during 2007;

• Operating income increased by $102.5 million or 40.0% to $358.1 million from $255.7 million in 2007; and

• Net income increased to $238.4 million ($2.09 per diluted share) from $141.0 million ($1.27 per diluted share) in 2007.

Segments

Watson has three reportable operating segments: Generic, Brand and Distribution. The Generic segment includes off-patent pharmaceutical products that are therapeutically equivalent to proprietary products. The Brand segment includes the Company's Specialty Products and Nephrology product lines. Watson has aggregated its Brand product lines in a single segment because of similarities in regulatory environment, methods of distribution and types of customer. This segment includes patent-protected products and certain trademarked off-patent products that Watson sells and markets as brand pharmaceutical products. The Company sells its Brand and Generic products primarily to pharmaceutical wholesalers, mail order, government programs, drug distributors and national retail drug and food store chains. The Distribution segment mainly distributes generic pharmaceutical products manufactured by third parties, as well as by Watson, primarily to independent pharmacies, pharmacy chains, pharmacy buying groups and physicians' offices under the Anda trade name. Sales are principally generated through an in-house telemarketing staff and through internally developed ordering systems. The Distribution segment operating results exclude sales by Anda of products developed, acquired, or licensed by Watson's Generic and Brand segments.

The Company evaluates segment performance based on segment net revenues, gross profit and contribution. Segment contribution represents segment gross profit less direct R&D expenses and selling and marketing

expenses. The Company does not report total assets, capital expenditures, corporate general and administrative expenses, amortization, in process research and development ("IPR&D") charges, gains on disposal or impairment losses by segment as such information has not been used by management, or has not been accounted for at the segment level.

Global Supply Chain Initiative

The Company completed several cost reduction initiatives during 2007 which included the closure of our Puerto Rico manufacturing facility and the divestiture of our Phoenix, Arizona injectable manufacturing facility.

During 2008, we took additional steps to improve our operating cost structure and achieve operating efficiencies. We initiated a plan to close our Carmel, New York manufacturing facility and our Brewster, New York distribution center. We are in the process of moving production from the Carmel site to our manufacturing sites in Florida, California and India.

We also have initiated a plan to increase our India-based annual manufacturing capacity from one billion to three billion units. By the end of 2009, we expect to be able to manufacture one-third of our production requirements in India.

YEAR ENDED DECEMBER 31, 2008 COMPARED TO 2007

Results of operations, including segment net revenues, segment gross profit and
segment contribution information for the Company's Generic, Brand and
Distribution segments, consisted of the following:


                                                                                                 Years Ended December 31,
                                                                           2008                                                             2007
                                                 Generic         Brand        Distribution         Total          Generic         Brand        Distribution         Total

Product sales                                  $ 1,403,975     $ 397,025     $      606,190     $ 2,407,190     $ 1,408,885     $ 375,202     $      566,053     $ 2,350,140
Other                                               70,358        57,953                  -         128,311          92,991        53,520                  -         146,511

Net revenues                                     1,474,333       454,978            606,190       2,535,501       1,501,876       428,722            566,053       2,496,651
Cost of sales(1)                                   883,832       107,079            511,911       1,502,822         917,863        99,913            486,980       1,504,756

Gross profit                                       590,501       347,899             94,279       1,032,679         584,013       328,809             79,073         991,895
Gross margin                                          40.1 %        76.5 %             15.6 %          40.7 %          38.9 %        76.7 %             14.0 %          39.7 %
Research and development                           119,218        50,904                  -         170,122         102,426        42,367                  -         144,793
Selling and marketing                               55,230       118,198             59,514         232,942          55,350       108,061             52,023         215,434

Contribution                                   $   416,053     $ 178,797     $       34,765         629,615     $   426,237     $ 178,381     $       27,050         631,668

Contibution margin                                    28.2 %        39.3 %              5.7 %          24.8 %          28.4 %        41.6 %              4.8 %          25.3 %
General and administrative                                                                          190,486                                                          205,717
Amortization                                                                                         80,690                                                          176,409
Loss (gain) on asset sales and impairments                                                              311                                                           (6,118 )

Operating income                                                                                $   358,128                                                      $   255,660

Operating margin                                                                                       14.1 %                                                           10.2 %

(1) Excludes amortization of acquired intangibles including product rights.

Generic Segment

Net Revenues

Our Generic segment develops, manufactures, markets, sells and distributes generic products that are the therapeutic equivalent to their brand name counterparts and are generally sold at prices significantly less than the brand product. As such, generic products provide an effective and cost-efficient alternative to brand

products. When patents or other regulatory exclusivity no longer protect a brand product, opportunities exist to introduce off-patent or generic counterparts to the brand product. Additionally, we distribute generic versions of third parties' brand products (sometimes known as "Authorized Generics") to the extent such arrangements are complementary to our core business. Our portfolio of generic products includes products we have internally developed, products we have licensed from third parties, and products we distribute for third parties.

Net revenues in our Generic segment includes product sales and other revenue. Our Generic segment product line includes a variety of products and dosage forms. Indications for this line include pregnancy prevention, pain management, depression, hypertension and smoking cessation. Dosage forms include oral solids, transdermals, injectables and transmucosals.

Other revenues consist primarily of royalties and commission revenue.

Net revenues from our Generic segment during the year ended December 31, 2008 decreased 1.8% or $27.5 million to $1,474.3 million compared to net revenues of $1,501.9 million from the prior year. The decrease in net revenues was attributable to a decrease in other revenues ($22.6 million), a decline in sales of certain Authorized Generic products ($49.8 million), a decrease in net revenues from the sale of oral contraceptives and price erosion for existing products. Sales of Authorized Generics in the prior year period included Tiliatm Fe and balsalazide disodium (both launched in the fourth quarter of 2007), oxycodone HCl controlled release tablets and pravastatin sodium tablets. Sales of Authorized Generics in the current year period included Tiliatm Fe and balsalazide disodium (both launched in the fourth quarter of 2007), alendronate sodium tablets (launched in the first quarter of 2008), dronabinol (launched in the second quarter of 2008) and pravastatin sodium tablets. The decline in sales of oxycodone HCl controlled-release tablets was due to the termination of the distribution agreement in the first quarter of 2007. Net revenues from the sale of oral contraceptives (excluding Tiliatm Fe) declined $32.3 million from the prior year period. These decreases in net revenues were offset in part by an increase in net product sales from recent product launches ($137.9 million), including fentanyl transdermal patch (launched at the end of the third quarter of 2007), albuterol sulfate (launched in the fourth quarter of 2007), clarithromycin extended-release tablets (launched in the first quarter of 2008) and omeprazole delayed-release capsules (launched in the third quarter of 2008).

The $22.6 million decrease in other revenues for the year ended December 31, 2008, compared to the prior year, was primarily due to reductions in commission revenues earned on sales of fentanyl citrate troche, royalties earned on GlaxoSmithKline's ("GSK's") sales of Wellbutrin XL® 150mg and royalties on sales by Sandoz of metoprolol succinate 50 mg extended-release tablets which were all negatively impacted by the introduction of competing products. Revenue from these arrangements decreased $41.3 million for the year ended December 31, 2008 compared to the prior year. These decreases in other revenues were offset in part by the recognition of a $15.0 million milestone obligation for a 1999 Schein Pharmaceutical, Inc. ("Schein") litigation settlement with Barr Pharmaceuticals, Inc. ("Barr") related to Cenestin. Schein was acquired by Watson in 2000.

Gross Profit and Gross Margin

Gross profit represents net revenues less cost of sales. Cost of sales includes production and packaging costs for the products we manufacture, third party acquisition costs for products manufactured by others, profit-sharing or royalty payments for products sold pursuant to licensing agreements, inventory reserve charges and excess capacity utilization charges, where applicable. Cost of sales does not include amortization costs for acquired product rights or other acquired intangibles.

Gross profit for our Generic segment increased $6.5 million to $590.5 million in the year ended December 31, 2008 compared to $584.0 million in the prior year. Gross profit was higher in the current year period due to gross profit contribution from new product launches ($96.4 million) including fentanyl transdermal patch, albuterol sulfate, clarithromycin and omeprazole. These increases to gross profit in the current year period were partially offset by lower gross profit contribution from certain Authorized Generics ($17.4 million), lower gross profit contribution from oral contraceptives (excluding Tiliatm Fe) ($22.0 million), lower other revenues ($22.6 million) and costs associated with our Global Supply Chain Initiative ($27.8 million).

Gross margins for our Generic segment increased 1.2 percentage points to 40.1% for the year ended December 31, 2008 from 38.9% in the prior year. The increase in gross margins is primarily due to higher margins on newly launched products.

Research and Development Expenses

Generic R&D expenses consist mainly of personnel-related costs, active pharmaceutical ingredient costs, contract research, biostudy and facilities costs associated with the development of our products.

R&D expenses within our Generic segment increased 16.4% or $16.8 million to $119.2 million for the year ended December 31, 2008 compared to $102.4 million from the prior year, mainly due to higher test chemical and biostudy costs ($5.4 million), higher pre-launch validation costs ($5.3 million), increased R&D expenditures in India ($4.3 million) and costs associated with our Global Supply Chain Initiative ($1.4 million).

Selling and Marketing Expenses

Generic selling and marketing expenses consist mainly of personnel-related costs, distribution costs, professional services costs, insurance, depreciation and travel costs.

Generic segment selling and marketing expenses were $55.2 million for the year ended December 31, 2008 compared to $55.4 million from the prior year.

Brand Segment

Net Revenues

Our Brand segment develops, manufactures, markets, sells and distributes products within two sales and marketing groups: Specialty Products and Nephrology.

Our Specialty Products product line includes promoted urology products such as Trelstar® and Oxytrol® and a number of non-promoted products.

Our Nephrology product line consists of products for the treatment of iron deficiency anemia and is generally marketed to nephrologists and dialysis centers. The major products of the Nephrology group are Ferrlecit® and INFeD®, which are used to treat low iron levels in patients undergoing hemodialysis in conjunction with erythropoietin therapy.

Other revenues in the Brand segment consist primarily of co-promotion revenue, royalties and the recognition of deferred revenue relating to our obligation to manufacture and supply brand products to third parties. Other revenues also include revenue recognized from R&D and licensing agreements.

Net revenues from our Brand segment for the year ended December 31, 2008 increased 6.1% or $26.3 million to $455.0 million compared to net revenues of $428.7 million from the prior year. The increase in net revenues was primarily attributable to higher sales within the Specialty Products group ($14.1 million), higher sales within the Nephrology group ($7.7 million) and higher other revenues ($4.4 million). The increase in the Specialty Products group was primarily attributable to higher unit sales of Trelstar® as a result of promotional efforts and the introduction of the Mixjecttm delivery system. The increase within the Nephrology group was primarily attributable to customer buying patterns and lower sales in the prior year period due to the loss of a customer.

Gross Profit

Gross profit from our Brand segment increased $19.1 million in the year ended December 31, 2008 to $347.9 million compared to $328.8 million in the prior year. The year-over-year increase in gross profit was primarily the result of higher product sales within both the Specialty Products group and the Nephrology group partially offset by a $7.7 million charge related to our INFeD® product. Higher other revenues ($4.4 million) also contributed to higher gross profit in the current year.

Research and Development Expenses

Brand R&D expenses consist mainly of personnel-related costs, contract research, clinical costs and facilities costs associated with the development of our products.

R&D expenses within our Brand segment increased 20.2% or $8.5 million to $50.9 million compared to $42.4 million from the prior year primarily due to higher license and filing fees ($8.3 million) and higher payroll costs ($2.7 million) which were partially offset by decreased clinical costs related to the development of Rapaflotm and Gelniquetm as these studies neared completion during 2008.

Selling and Marketing Expenses

Brand selling and marketing expenses consist mainly of personnel-related costs, product promotion costs, distribution costs, professional services costs, insurance and depreciation.

Selling and marketing expenses within our Brand segment increased 9.4% or $10.1 million to $118.2 million compared to $108.1 million from the prior year primarily due to higher expenditures in the current year to support pre-launch activities related to Rapaflotm and Gelniquetm.

Distribution Segment

Net Revenues

Our Distribution segment distributes generic and certain select brand pharmaceutical products manufactured by third parties, as well as by Watson, primarily to independent pharmacies, pharmacy chains, pharmacy buying groups and physicians' offices. Sales are principally generated through an in-house telemarketing staff and through internally developed ordering systems. The Distribution segment operating results exclude sales by Anda of products developed, acquired, or licensed by Watson's Generic and Brand segments.

Net revenues from our Distribution segment for the year ended December 31, 2008 increased 7.1% or $40.1 million to $606.2 million compared to net revenues of $566.1 million in the prior year primarily due to an increase in net revenues from new products launched during 2008 ($116.8 million) which was partially offset by price erosion and volume decreases from prior period product launches ($74.8 million).

Gross Profit and Gross Margin

Gross profit for our Distribution segment increased $15.2 million to $94.3 million in the year ended December 31, 2008 compared to $79.1 million in the prior year due to higher product sales. Gross margin increased to 15.6% during the year ended December 31, 2008 compared to 14.0% in the prior year period primarily due to lower product acquisition costs.

Selling and Marketing Expenses

Selling and marketing expenses consist mainly of personnel costs, facilities costs, insurance and freight costs, which support the Distribution segment sales and marketing functions.

Distribution segment selling and marketing expenses increased 14.4% or $7.5 million to $59.5 million in the year ended December 31, 2008 as compared to $52.0 million in the prior year primarily due to an increase in variable selling expense including higher freight costs ($4.2 million) and higher commissions and other selling expenses ($1.6 million).

Segment Contribution


                                 Years Ended December 31,               Change
                                   2008              2007         Dollars        %
                                                      ($ in thousands):

        Segment contribution
        Generic                $     416,053       $ 426,237     $ (10,184 )     (2.4 )%
        Brand                        178,797         178,381           416        0.2 %
        Distribution                  34,765          27,050         7,715       28.5 %

                               $     629,615       $ 631,668     $  (2,053 )     (0.3 )%

        as % of net revenues            24.8 %          25.3 %

For more information on segment contribution, refer to above "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Annual Report.

Corporate General and Administrative Expenses


                                                      Years Ended December 31,                Change
                                                        2008              2007          Dollars         %
                                                                       ($ in thousands):

Corporate general and administrative expenses       $     190,486       $ 205,717      $ (15,231 )      (7.4 )%
as % of net revenues                                          7.6 %           8.2 %

Corporate general and administrative expenses consist mainly of personnel-related costs, facilities costs, insurance, depreciation, litigation costs and professional services costs which are general in nature and not directly related to specific segment operations.

Corporate general and administrative expenses decreased 7.4% or $15.2 million to $190.5 million compared to $205.7 million from the prior year due to a favorable settlement of a tax-related liability in the current year period as a result of the resolution of the Internal Revenue Service ("IRS") federal income tax return examination (the "Exam") ($5.9 million) and the prior year period was negatively impacted by the cost of legal settlements ($8.5 million).

Amortization


                                Years Ended December 31,               Change
                                  2008              2007         Dollars         %
                                                    ($ in thousands):

       Amortization           $     80,690       $  176,409     $ (95,719 )     (54.3 )%
       as % of net revenues            3.2 %            7.1 %

The Company's amortizable assets consist primarily of acquired product rights. Amortization in 2008 decreased as our Ferrlecit® product rights were fully amortized as of December 2007.

Loss (Gain) on Asset Sales and Impairments

Loss (gain) on asset sales and impairments $ 311 $ (6,118 ) $ 6,429 (105.1 )%

For the year ended December 31, 2007, we recorded a gain on sale of our Phoenix facility in the amount of $10.6 million. This gain was offset in part by a $4.5 million impairment charge relating to our facility in Puerto Rico.

Loss on Early Extinguishment of Debt


                                                          Years Ended December 31,                 Change
                                                           2008               2007          Dollars          %
                                                                           ($ in thousands):

Loss on early extinguishment of debt                   $      1,095       $      5,553      $ (4,458 )      (80.3 )%

In November 2006, we entered into a Senior Credit Facility with Canadian Imperial Bank of Commerce, acting through its New York agency, as Administrative Agent, Wachovia Capital Markets, LLC, as Syndication Agent, and a syndicate of banks ("2006 Credit Facility"). The 2006 Credit Facility was entered into in connection with the acquisition of Andrx Corporation ("Andrx") on November 3, 2006 (the "Andrx Acquisition").

For the year ended December 31, 2008, the Company prepaid $75.0 million of outstanding debt on the 2006 Credit Facility. As a result of this prepayment, our results for the year ended December 31, 2008 reflect debt repurchase charges of $1.1 million which consist of unamortized debt issue costs associated with the repurchased amount.

For the year ended December 31, 2007, the Company prepaid $325.0 million of outstanding debt on the 2006 Credit Facility resulting in the recognition of debt repurchase charges of $5.6 million associated with the repurchased amount.

Interest Income

Interest income $ 9,055 $ 8,886 $ 169 1.9 %

Interest income increased during the year ended December 31, 2008 as compared to the prior year as higher balances of cash and marketable securities were invested. On average, these higher cash and marketable securities balances were invested at lower rates of return in 2008.

Interest Expense


                                                        Years Ended December 31,                  Change
                                                         2008               2007           Dollars          %
                                                                          ($ in thousands):
. . .