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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2003

Commission file number 0-17254

NOVEN PHARMACEUTICALS, INC.

          Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X]  No [  ].

          Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act). Yes [X]  No [  ].

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

NOVEN PHARMACEUTICALS, INC.

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NOVEN PHARMACEUTICALS, INC.
Condensed Statements of Operations
Three Months Ended March 31,
(in thousands, except per share amounts)
(unaudited)

The accompanying notes are an integral part of these statements.

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NOVEN PHARMACEUTICALS, INC.
Condensed Balance Sheets
(in thousands, except share data)
(unaudited)

The accompanying notes are an integral part of these statements.

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NOVEN PHARMACEUTICALS, INC.
Condensed Statements of Cash Flows
Three Months Ended March 31,
(in thousands)
(unaudited)

The accompanying notes are an integral part of these statements.

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NOVEN PHARMACEUTICALS, INC.
Notes to Unaudited Condensed Financial Statements

1.

DESCRIPTION OF BUSINESS:

	Noven Pharmaceuticals, Inc. (“Noven”) was incorporated in Delaware in 1987 and is engaged in the research, development, manufacture and marketing of advanced transdermal drug delivery technologies and prescription transdermal products.

Noven and Novartis Pharmaceuticals Corporation (“Novartis”) entered into a joint venture, Vivelle Ventures LLC (d/b/a Novogyne Pharmaceuticals) (“Novogyne”), effective May 1, 1998, to market and sell women’s prescription healthcare products in the United States and Canada. These products include Noven’s transdermal estrogen delivery systems marketed under the brand names Vivelle® and Vivelle-Dot® and Noven’s transdermal combination estrogen/progestin delivery system marketed under the brand name CombiPatch®. Noven accounts for its 49% investment in Novogyne under the equity method and reports its share of Novogyne’s earnings as “Equity in earnings of Novogyne” on its Statements of Operations. Noven defers the recognition of 49% of its profit on products sold to Novogyne until the products are sold by Novogyne.

2.

BASIS OF PRESENTATION:

In management’s opinion, the accompanying unaudited condensed financial statements of Noven contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly, in all material respects, the financial position of Noven as of March 31, 2003, and the results of its operations for the three months ended March 31, 2003 and 2002. Noven’s business is subject to numerous risks and uncertainties including, but not limited to, those set forth in Noven’s Annual Report on Form 10-K/A for the year ended December 31, 2002 (“Form 10-K”) as well as the risk that the results of recent and ongoing studies on the adverse health effects of certain forms of hormone replacement therapy (“HRT”) may result in lower sales by Noven or Novogyne in future periods, the risk that MethyPatch® may not be approved by the United States Food and Drug Administration (“FDA”), particularly in light of Noven’s receipt of a “not approvable” letter from the FDA in April 2003, and the risk that Shire may elect to require Noven to repurchase the MethyPatch® rights for $5 million. Accordingly, the results of operations and cash flows for the three months ended March 31, 2003 and 2002 are not, and should not be construed as, necessarily indicative of the results of operations or cash flows which may be reported for the remainder of 2003.

The accompanying unaudited condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for reporting on Form 10-Q. Pursuant to such rules and regulations, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. The unaudited condensed financial statements should be read in conjunction with the financial statements and the notes to the financial statements included in Noven’s Form 10-K.

	The accounting policies followed for interim financial reporting are the same as those disclosed in Note 2 of the notes to the financial statements included in Noven’s Form 10-K.

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3.

RECLASSIFICATION:

	Certain reclassifications have been made to prior financial statements to conform to the current year’s presentation.

4.

INVENTORIES:

	The following are the major classes of inventories (in thousands):

5.

EMPLOYEE STOCK PLANS:

In accordance with the provisions of Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation”, as amended by Statement of Financial Accounting Standards No. 148 (“SFAS 148”), “Accounting for Stock-Based Compensation - Transition and Disclosure”, Noven may elect to continue to apply the provisions of the Accounting Principles Board’s Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees” and related interpretations in accounting for its employee stock option plans, or adopt the fair value method of accounting prescribed by SFAS 123. Noven has elected to continue to account for its stock plans using APB 25, and therefore no stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

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	The following table illustrates the effect on net income and earnings per share for the three months ended March 31, 2003 and 2002 if the company had applied the fair value recognition provisions of SFAS 123, as amended by SFAS 148 (in thousands, except per share amounts):

SFAS 123 requires the use of option valuation models that require the input of highly subjective assumptions, including expected stock price volatility. Because Noven’s stock options have characteristics significantly different from traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable measure of the fair value of its employee stock options.

	The effect of applying the fair value method of accounting for stock options on reported net income and earnings per share for the three months ending March 31, 2003 and 2002, respectively, may not be representative of the effects for future years because outstanding options vest over a period of several years and additional awards are generally made during each year.

6.

CASH FLOW INFORMATION:

	Cash payments for income taxes were $1.3 million and $1.7 million for the three months ended March 31, 2003 and 2002, respectively. Cash payments for interest were not material for the three months ended March 31, 2003 and 2002.

	In connection with the CombiPatch® transaction consummated in March 2001, the final $10.0 million quarterly installment of the purchase price was paid by Novogyne directly to Aventis in March 2002.

	Noven recorded $6,000 and $51,000 in income tax benefits to additional paid-in capital for the three months ended March 31, 2003 and 2002, respectively, which were derived from the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options.

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7.

LICENSE AGREEMENTS:

In the first quarter of 2003, Noven signed an agreement to license the exclusive global rights to market MethyPatch® to Shire Pharmaceuticals Group plc (“Shire”) for payments of up to $150 million and ongoing manufacturing revenue. Consideration for the transaction is as follows: (a) $25 million was paid upon closing of the transaction in April 2003; (b) $50 million is payable upon receipt of final marketing approval for MethyPatch® by the FDA; and (c) three installments of $25 million each are payable upon Shire’s achievement of $25 million, $50 million and $75 million in annual net sales of MethyPatch®, respectively. Shire’s annual net sales will be measured quarterly on a trailing 12-month basis, with each milestone payment due 45 days after the end of the first quarter during which trailing 12-month sales exceed the applicable threshold. Shire has agreed that it will not sell any other product containing methylphenidate as an active ingredient until the earlier of (a) five years from the closing date or (b) payment of all of the sales milestones.

Under the terms of the transaction, Noven remains responsible for securing final regulatory approval for MethyPatch®. On April 25, 2003, Noven received a not approvable letter from the FDA relating to its MethyPatch® New Drug Application (“NDA”). A not approvable letter is issued if the FDA believes that the application contains insufficient information for an approval action at the time of issuance. The letter cited clinical and other issues as the basis for non-approval. Under the agreement, receipt of the not approvable letter gives Shire the right to require Noven to repurchase the product rights for $5 million, but to date Shire has not exercised this right. For accounting purposes, $20 million of the initial $25 million payment is expected to be deferred and recognized as revenue over approximately 10 years beginning with the second quarter of 2003. The remaining $5 million has been deferred and is expected to be recognized as revenue beginning at the time Shire’s right to require us to repurchase the product rights expires. However, this accounting treatment would be expected to change if Shire were to exercise its right to require Noven to repurchase the product rights.

	On the closing date, Noven entered into a long-term supply agreement under which it will manufacture and supply MethyPatch® to Shire. The agreement gives Shire the right to qualify a second manufacturing source and purchase a portion of its requirements from the second source.

8.

INVESTMENT IN NOVOGYNE:

Noven shares in the earnings of Novogyne, after satisfaction of an annual preferred return of $6.1 million to Novartis, according to an established formula. Noven’s share of Novogyne’s earnings increases as Novogyne’s product sales increase, subject to a cap of 49%. Novogyne produced sufficient income in the first quarter of 2003 and 2002 to meet Novartis’ annual preferred return for those years and for Noven to recognize earnings from Novogyne under the formula.

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	During the three months ended March 31, 2003 and 2002, Noven had the following transactions with Novogyne (in thousands):

	As of March 31, 2003 and December 31, 2002, Noven had amounts due from Novogyne of $3.8 million and $2.6 million, respectively, for products sold to, and marketing expenses reimbursable by, Novogyne.

	The unaudited condensed Statements of Operations of Novogyne for the three months ended March 31, 2003 and 2002 are as follows (in thousands):

	Royalties due to Noven on sales of Vivelle® and Vivelle-Dot® for 2002 have been reclassified from selling, general and administrative expenses to cost of sales to conform to the current year’s presentation.

	Subject to the approval of Novogyne’s management committee, cash may be distributed to Novartis and Noven based upon a contractual formula. In March 2003, Noven received a distribution of $10.6 million from Novogyne. This amount was recorded as a reduction in the investment in Novogyne in the first quarter of 2003.

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9.

SHARE REPURCHASE PROGRAM:

	In the first quarter of 2003, Noven’s Board of Directors authorized a share repurchase program under which Noven may acquire up to $25 million of its common stock. As of March 31, 2003, Noven had repurchased 105,000 shares of its common stock at an aggregate price of approximately $1.3 million. These shares were retired on March 31, 2003.

10.

COMMITMENTS AND CONTINGENCIES:

	Noven is involved in certain litigation and claims incidental to its business. Noven does not believe, based on currently available information, that these matters will have a material adverse effect on the accompanying condensed financial statements.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

          The following discussion and analysis should be read in conjunction with the financial statements, the related notes and management’s discussion and analysis of financial condition and results of operations included in our Form 10-K for the year ended December 31, 2002 and the condensed financial statements and related notes included in Item 1 of this Quarterly Report on Form 10-Q. Except for historical information contained herein, the matters discussed in this report are “forward-looking statements” made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about our and our licensees’ respective plans, objectives, expectations, estimates, strategies, prospects, product approvals and development plans, and anticipated financial results. These statements are typically identified by the use of terms such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “could,” “should,” “will,” “would” and similar words. These statements are based on our current expectations and beliefs concerning future events and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed herein. We do not undertake to update any of these forward-looking statements or to announce the results of any revisions to these forward-looking statements except as required by law.

          In addition to the important factors described in our Form 10-K for the year ended December 31, 2002, the following important factors, among others, could cause our actual results to differ materially from those expressed in any forward-looking statements: uncertainties associated with the impact on the HRT market of published studies regarding the adverse health effects of certain forms of HRT and resulting label changes mandated by the FDA; uncertainties associated with future prescription trends for CombiPatch^®, Vivelle^® family products, Estalis^® and Estradot^®, including risks relating to declining physician or patient preference for HRT as a result of the published studies and label changes referred to above; risks associated with the commercialization of Noven’s products; risks and uncertainties associated with the potential impact on our business of the effectiveness as of April 2003 of the privacy regulations issued by the Department of Health and Human Services under the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”); risks and uncertainties associated with the impact of a Novogyne competitor’s strategy of increasing market share by heavily discounting product sales to managed care organizations; risks associated with the expected launches in 2003 and 2004 of estrogen cream and gel products, which are new dosage forms in this category; risks associated with higher than desired Vivelle^® returns to Novogyne and trade customer inventory levels of Vivelle^®; risks and uncertainties relating to our dependence on Novartis to monitor trade inventory levels for Novogyne; uncertainties concerning the timing and extent of Estradot^® regulatory approvals and launch orders and Estalis^® orders and commercialization efforts by Novartis AG, particularly in light of the significant pricing and reimbursement issues faced by Novartis AG in Europe; our limited ability to accurately forecast international product orders from Novartis AG; the risk that MethyPatch^® may not be approved by the FDA, particularly in light of the FDA’s issuance of a not approvable letter; uncertainties associated with the timing, cost and outcomes of clinical trials and product development, including the regulatory review process for MethyPatch^® and any future generations of our combination estrogen/progestin patch; risks and uncertainties associated with product liability claims that may be brought against us as a result of published studies regarding the adverse health effects of HRT; our dependence on strategic alliances and our relationships with our licensees, and our vulnerability to the risks and uncertainties of our licensees’ businesses, inventory requirements and marketing strategies; the risk that our licensees may favor their own competitive products over the products licensed from us; the risk that Shire may seek to exercise its right to require us to repurchase the rights to MethyPatch^® for $5 million, and the risk that such an exercise would change our method of accounting for the initial amount received from Shire; risks associated with the availability of a non-stimulant therapy to treat children with Attention Deficit Hyperactivity

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Disorder (“ADHD”); risks associated with our ability to meet Shire’s manufacturing requirements for MethyPatch^®; expected fluctuations in quarterly revenue and research and development expenses, including fluctuations in revenues resulting from factors not within our control and the timing of royalty reconciliations and payments under our license agreements; risks and uncertainties relating to the fact that a majority of our cash flow is dependent upon Novogyne’s ability to pay distributions to us; the effect of a recent change in New Jersey State tax law, which may increase Noven’s tax liability in future years; our reliance on Shire’s marketing efforts and success to achieve the MethyPatch^® sales levels necessary to trigger our milestone payments; the effect of changes in taxation or accounting principles generally accepted in the United States (including changes in accounting principles relating to the accounting treatment for employee stock options); and economic, competitive, governmental and technological factors affecting our operations, markets, products, prices and prospects.

          Based on information that we have received from Novartis, we believe that trade inventory levels of Vivelle^® are modestly higher than desired in light of current and expected demand. We believe that Novogyne’s inventories are at acceptable levels, primarily due to recent inventory management initiatives. We expect that sales of Vivelle^® in future periods may be impacted as trade customers are expected to reduce their Vivelle^® inventories.

          Our supply agreement with Novogyne for Vivelle^® and Vivelle-Dot^® expired in January 2003. The parties are negotiating an extension to the agreement. Since the expiration of the Vivelle^® and Vivelle-Dot^® supply agreement, the parties have continued to operate in accordance with the supply agreement’s commercial terms, and we expect that the supply agreement will be extended on satisfactory terms. However, we cannot assure that the agreement will be extended on satisfactory terms or at all. Failure to extend the supply agreement could have a material adverse effect on our business, results of operations, financial conditions and prospects. Designation of a new supplier and approval of a new supply agreement would require the affirmative vote of 4 of the 5 members of Novogyne’s Management Committee. Accordingly, both Novartis and Noven must agree on Novogyne’s supplier.

          In November 2000, we entered into an exclusive license agreement with Novartis AG pursuant to which we granted Novartis AG the right to market Vivelle-Dot^® under the name Estradot^® in all countries other than the United States, Canada and Japan. Under the terms of the agreement, Novartis AG is responsible for seeking approval to market Estradot^® in its territories. The product has been approved for marketing in over 30 foreign countries and the regulatory authorities of other countries are reviewing Novartis’ registration applications. Novartis AG has launched the product in Germany and a number of smaller countries. However, Novartis AG has informed us that pricing and reimbursement issues are adversely impacting its launch plans in many countries, including the United Kingdom, France, Spain and Italy. Accordingly, we cannot assure that Novartis AG will be successful in effecting additional registrations of Estradot^® or that Novartis AG will launch Estradot^® in any particular country. Novartis AG markets several other transdermal HRT products in addition to our products, which may limit the efforts Novartis AG devotes to our products. In some countries, including the United Kingdom and France, Novartis AG is seeking a marketing partner to launch the product but to date has been unsuccessful. We cannot assure that Novartis AG will be successful in securing a marketing partner or in launching Estradot^® in those countries.

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HRT Studies

          In July 2002, the National Institute of Health (“NIH”) released data from its Women’s Health Initiative (“WHI”) study on the risks and benefits associated with long-term use of oral HRT by healthy women. The NIH announced that it was discontinuing the arm of the study investigating the use of oral estrogen/progestin combination HRT products after an average follow-up period of 5.2 years because the oral HRT product used in the study was shown to cause an increase in the risk of invasive breast cancer. The study also found an increased risk of stroke, heart attacks and blood clots and concluded that overall health risks exceeded benefits from use of the orally delivered combined estrogen plus progestin product among healthy postmenopausal women. Also in July 2002, results of an observational study sponsored by the National Cancer Institute (“NCI”) on the effects of estrogen replacement therapy (“ERT”) were announced. The main finding of the study was that postmenopausal women who used ERT for 10 or more years had a higher risk of developing ovarian cancer than women who never used HRT. In October 2002, a significant HRT study being conducted in the United Kingdom was also halted. Our transdermal HRT products differ from the products used in the WHI study and the primary products observed in the NCI and United Kingdom studies. There are, however, no studies comparing the safety of our products against other HRT therapies.

          Although the range of consequences of these studies cannot be predicted, it is possible that they could result in a significant permanent decrease in the market for our HRT products, either as physicians withdraw their patients from HRT or as women elect to discontinue HRT on their own. In addition, the market growth that would have been expected if HRT had been found safe and effective for additional indications, such as heart disease, is now unlikely to materialize. In January 2003, the FDA announced that marketers of HRT products, including Novogyne, are required to modify their HRT product labels to include additional safety information and warnings. Among other things, the labels must indicate that HRT should be used for short-term therapy only and that, in the absence of clinical studies demonstrating that HRT products other than the oral product studied in the WHI are safe, physicians should assume that all HRT products carry the same risks. Novartis has informed us that it has submitted proposed revised labeling to the FDA and will begin using the revised label at the time it reaches agreement with the FDA on the language. Healthcare regulators also could delay the approval of new HRT products, such as those presently under development by Novartis AG and us, or require that any new HRT products be subject to more extensive or more rigorous study and testing prior to being approved. Further, because these studies show that certain uses of certain HRT products may result in a higher likelihood of certain adverse health effects, it is possible that we could be named as a defendant in product liability lawsuits relating to our HRT products.

          Other studies evaluating HRT are currently underway or in the planning stages. In particular, the estrogen-only arm of the WHI study is ongoing. We are unable to predict the effect of new study results, once available, on the short and long-term prospects for the HRT market or on the market for our transdermal HRT products. Since publication of the WHI and NCI study data, United States prescriptions have declined for substantially all HRT products, including our products, and prescriptions in Europe have also declined. In the first quarter of 2003, total prescriptions for Novogyne’s HRT products (in the aggregate) were lower than in the fourth quarter of 2002. The WHI safety board re-evaluates the risk/benefit profile of the estrogen-only arm as frequently as twice per year. If the estrogen-only study or any other currently ongoing HRT study is halted, the market for HRT products, including ours, both in the United States and abroad, could be further adversely impacted. The HRT label changes mandated by the FDA may also negatively impact our products, particularly with physicians and patients who now believe that transdermal HRT products are safer than orally delivered HRT products. Currently, our results of operations and business prospects are dependent on sales, license royalties and fees associated with transdermal HRT products. Accordingly, any further adverse change in the market for HRT products (including any adverse changes resulting from the foregoing studies) could have a material adverse impact on our liquidity, results of operations and business prospects.

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MethyPatch^®

          We have developed a once-daily transdermal methylphenidate delivery system for the treatment of ADHD, which is intended to be marketed under the trade name MethyPatch^®. We filed an NDA with the FDA in June 2002.

          In the first quarter of 2003, we signed an agreement to license the exclusive global rights to market MethyPatch^® to Shire for payments of up to $150 million and ongoing manufacturing revenue. Consideration for the transaction is as follows: (a) $25 million was paid upon closing of the transaction in April 2003; (b) $50 million is payable upon receipt of final marketing approval for MethyPatch^® by the FDA; and (c) three installments of $25 million each are payable upon Shire’s achievement of $25 million, $50 million and $75 million in annual net sales of MethyPatch^®, respectively. Shire’s annual net sales will be measured quarterly on a trailing 12-month basis, with each milestone payment due 45 days after the end of the first quarter during which trailing 12-month sales exceed the applicable threshold. Shire has agreed that it will not sell any other product containing methylphenidate as an active ingredient until the earlier of (a) five years from the closing date or (b) payment of all of the sales milestones.

          On the closing date, we entered into a long-term supply agreement under which we will manufacture and supply MethyPatch^® to Shire. The agreement gives Shire the right to qualify a second manufacturing source and purchase a portion of its requirements from the second source.

          Under the terms of the transaction, we remain responsible for securing final regulatory approval for MethyPatch^®. On April 25, 2003, we received a not approvable letter from the FDA relating to our MethyPatch^® NDA. A not approvable letter is issued if the FDA believes that the application contains insufficient information for an approval action at the time of issuance. Under the agreement, receipt of the not approvable letter gives Shire the right to require us to repurchase the product rights for $5 million, but to date Shire has not exercised this right. For accounting purposes, $20 million of the initial $25 million payment is expected to be deferred and recognized as revenue over approximately 10 years beginning with the second quarter of 2003. The remaining $5 million has been deferred and is expected to be recognized as revenue beginning at the time Shire’s right to require us to repurchase the product rights expires. However, this accounting treatment would be expected to change if Shire were to exercise its right to require Noven to repurchase the product rights.

          The FDA cited clinical and other issues as the basis for non-approval. We are developing a strategy for approval, and plan to meet with the FDA to clarify its concerns and to determine what additional studies, analysis or other actions would resolve the issues raised in the letter. We cannot assure that we will develop a strategy for approval that will be acceptable to the FDA, that we will successfully execute any strategy we develop or that successfully executing any strategy will result in approval. We also cannot assure that any additional requirements imposed by the FDA will not be cost-prohibitive, impair the commercial value of MethyPatch^®, or otherwise cause us and/or Shire to elect not to pursue commercialization of the product. Therefore, we cannot assure that MethyPatch^® will ever be approved by the FDA or ultimately commercialized.

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Results of Operations

Three months ended March 31, 2003 compared to three months ended March 31, 2002

Revenues:

          Total revenues for the three months ended March 31, 2003 and 2002 are summarized as follows (dollar amounts in thousands):