Back to GetFilings.com

Table of Contents

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

FORM 10-Q

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

For the quarterly period ended June 30, 2003

Commission file number 0-17254

NOVEN PHARMACEUTICALS, INC.

11960 S.W. 144th Street, Miami, FL 33186

(305) 253-5099

     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    o

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

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

Table of Contents

NOVEN PHARMACEUTICALS, INC.

INDEX

2

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NOVEN PHARMACEUTICALS, INC.

The accompanying notes are an integral part of these statements.

3

Table of Contents

NOVEN PHARMACEUTICALS, INC.

The accompanying notes are an integral part of these statements.

4

Table of Contents

NOVEN PHARMACEUTICALS, INC.

The accompanying notes are an integral part of these statements.

5

Table of Contents

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 June 30, 2003, and the results of its operations for the three and six months ended June 30, 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 Pharmaceuticals Group plc. (“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 and six months ended June 30, 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.

6

Table of Contents

3. RECLASSIFICATIONS:

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

4. INVENTORIES:

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

5. REVENUE RECOGNITION:

Substantially all of Noven’s product revenues were to its licensees, Novogyne, Novartis Pharma AG (“Novartis AG”) and Aventis Pharma AG. Revenues from product sales are recognized at the time of shipment when both title and the risks and rewards of ownership have been transferred to the buyer. Certain of our license agreements provide that the ultimate supply price is based on a percentage of the licensee’s net selling price. Each of those agreements also establishes a fixed minimum supply price per unit that represents the lowest price Noven would receive on sales to the licensee. Noven receives the minimum price at the time of shipment with the possibility of an upward adjustment later when the licensee’s net selling price is known. Revenues under these agreements are recorded at the minimum price. Noven records any upward adjustments to revenues at the time that the information necessary to make the determination is received from the licensee. If the upward adjustments are not determinable, Noven records the adjustments (which historically have not been significant) on a cash basis. These fees are included in product revenues.

	Royalty revenues consist of royalties payable by Novogyne and Novartis AG from sales of Vivelle® and Vivelle-Dot®/Estradot® in the United States and Canada. Noven accrues royalties from Novogyne’s and Novartis AG’s product sales each quarter based on Novogyne’s and Novartis AG’s net sales for that quarter. Royalties are included in product revenues.

	License revenues consist of up-front, milestone and similar payments under license agreements and are recognized when earned under the terms of the applicable agreements. In most cases, license revenues are deferred and recognized over the estimated product life cycle or the length of relevant patents, whichever is shorter.

	Contract revenues consist of contract payments related to research and development projects performed for third parties. The work performed by Noven includes feasibility studies to determine if a specific drug is amenable to transdermal drug delivery, the actual formulation of a

7

Table of Contents

	specific drug into a transdermal drug delivery system, studies to address the ongoing stability of the drug in a transdermal drug delivery system, and manufacturing of batches of product that can be used in human clinical trials. Noven receives contract payments for the work it performs in the following forms:

	• Nonrefundable up-front payments prior to commencing the work (or certain phases of the work).

	• Additional payments upon completion of additional phases.

	• In some cases, success milestone payments based on achievement of specified performance criteria.

As prescribed by EITF 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables”, Noven analyzes each contract in order to separate each deliverable into separate units of accounting and then recognizes revenues for those separated units at their fair value, as delivered, based on the proportionate share of the work performed by Noven as it performs the specified acts under the contract. The difference between the amount of the payments received and the amount recognized is recorded as deferred revenues until that amount is earned in accordance with Staff Accounting Bulletin 101, “Revenue Recognition in Financial Statements” (“SAB 101”).

	Milestone payments are recorded when the specified performance criteria are achieved, as determined by the customer. Each contract may have different payment terms. Therefore, the revenues recognized may vary from contract to contract.

	Noven’s revenue recognition policy is in compliance with the requirements of SAB 101.

6. EMPLOYEE STOCK PLANS:

In accordance with the provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation - -Transition and Disclosure” (“SFAS 148”), Noven may elect to continue to apply the provisions of the Accounting Principles Board’s Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) 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.

8

Table of Contents

	The following table illustrates the effect on net income and earnings per share for the three and six months ended June 30, 2003 and 2002 if Noven 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 and six months ending June 30, 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.

7. CASH FLOW INFORMATION:

	Cash payments for income taxes were $3.2 million and $2.6 million for the six months ended June 30, 2003 and 2002, respectively. Cash payments for interest were not material for the six months ended June 30, 2003 and 2002.

       Non-cash Operating Activities

	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 on Noven’s behalf directly to Aventis in March 2002.

	In 2002, the State of New Jersey enacted legislation that requires Novogyne to remit estimated state tax payments on behalf of its owners, Noven and Novartis. In April 2003,

9

Table of Contents

	Novogyne paid $1.7 million to the New Jersey Department of Revenue, representing Noven’s portion of Novogyne’s estimated state tax payment. This payment was deemed a distribution to Noven.

	Noven recorded $17,000 and $165,000 in income tax benefits to additional paid-in capital for the six months ended June 30, 2003 and 2002, respectively, which were derived from the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options.

8. LICENSE AGREEMENTS:

In the first quarter of 2003, Noven signed an agreement to license the exclusive global rights to market MethyPatch® to Shire for payments of up to $150 million and ongoing manufacturing revenues. 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 does not consider the application approvable because one or more deficiencies in the application preclude the FDA from approving it. The letter cited clinical and other issues as the basis for non-approval. Pursuant to the agreement, under certain circumstances Shire has the right to require Noven to repurchase the product rights for $5 million. For accounting purposes, $20 million of the initial $25 million payment has been deferred and is being recognized as revenues over 10 years beginning in the second quarter of 2003. The remaining $5 million has been deferred and is expected to be recognized as revenues 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 and Noven had no further obligations to Shire.

	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.

9. 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.

10

Table of Contents

	During the three and six months ended June 30, 2003 and 2002, Noven had the following transactions with Novogyne (in thousands):

	As of June 30, 2003 and December 31, 2002, Noven had amounts due from Novogyne of $6.0 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 and six months ended June 30, 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. For the three and six months ended June 30, 2003, Noven received distributions of $1.3 million and $12.0 million from Novogyne, respectively. For the three and six months ended June 30, 2002, Noven received a distribution of $11.7 million from Novogyne. In addition, as discussed in Note 6, a $1.7 million tax payment to the New Jersey Department of Revenue made by Novogyne on Noven’s behalf in April 2003 was deemed a distribution from Novogyne to Noven. These amounts were recorded as reductions in the investment in Novogyne when deemed received.

11

Table of Contents

10. 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 June 30, 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.

11. COMMITMENTS AND CONTINGENCIES:

       HRT Studies

In July 2002, the National Institutes of Health released data on studies concerning the risks and benefits associated with use of oral hormone replacement therapy. The study revealed an increase in the risk of developing breast cancer and increased risk of stroke, heart attacks and blood clots. Also in July 2002, results of an observational study sponsored by the National Cancer Institute on the effects of estrogen replacement therapy were announced. The main finding of the study was that postmenopausal women who used estrogen replacement therapy for 10 or more years had a higher risk of developing ovarian cancer than women who never used hormone replacement therapy. In June 2003, a new analysis of study data indicated that use of combination HRT may increase the frequency of abnormal mammograms beginning in the first year of therapy and/or may cause tumors at the time of diagnosis to be more advanced. In August 2003, further WHI data analysis suggested that the use of combination therapy increased the risk of heart disease beginning in the first year of therapy, and a large U.K. study suggested that the use of both estrogen-only and combination therapy increased the risk of breast cancer, and the risk of death from breast cancer, whether administered orally, transdermally or via implant. These studies and others have caused the hormone replacement therapy market, and the market for Noven’s products, to significantly decline. Management can not predict whether the studies or other studies will have additional adverse effects on Noven’s results of operations, or Novogyne’s ability to recover the value of the CombiPatch® intangible asset.

       Supply Agreement

Noven’s supply agreement with Novogyne for Vivelle® and Vivelle-Dot® expired in January 2003. The parties are negotiating an extension to the agreement. Since expiration, the parties have continued to operate in accordance with the supply agreement’s commercial terms. Failure to extend the agreement could have a material adverse effect on Noven’s financial statements. Noven expects that the agreement will be extended on satisfactory terms.

       Litigation, Claims and Assessments

On August 7, 2003, a law firm issued a press release announcing that it had filed a complaint on behalf of Miller Donovan (Plaintiff), who, the law firm claimed, represents a purported class of purchasers of Noven’s common stock during the period from October 29, 2001 through April 28, 2003. Noven has not been served with a complaint in this matter. According to the law firm’s press release, the complaint alleges that, during the subject period, Noven and its officers named as defendants violated the Securities Exchange Act of 1934 by making false

12

Table of Contents

	and misleading statements regarding Noven’s rationale and marketing strategies for approval of its MethyPatch® product. The press release states that Plaintiff is seeking to recover damages on behalf of all purchasers of Noven common stock during the subject period.

	If served in the above-referenced matter, Noven intends to vigorously defend it, but its outcome cannot be predicted. Noven’s ultimate liability with respect to the foregoing matter, if any, is not presently determinable.

	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.

13

Table of Contents

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, 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; 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 mandated by the FDA; uncertainties related to the FDA’s willingness to permit us, Novogyne and trade participants to deplete HRT product inventory bearing the old labels; 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; risks and uncertainties relating to our dependence on Novartis to monitor trade inventory levels for Novogyne and to perform Novogyne’s financial, accounting, inventory and sales deductions functions; the risk that Novogyne’s revenues could fluctuate based on trade customer buying patterns, which may not coincide with prescription trends; 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, product development and product launch, including the regulatory review process for MethyPatch® (together with any additional clinical trials that may be required or advisable in connection with that review process) 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

14

Table of Contents

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 Disorder (“ADHD”); risks associated with our ability to meet Shire’s manufacturing requirements for MethyPatch®; expected fluctuations in quarterly revenues 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; 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.

     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. Novartis AG has launched the product in Germany and a number of smaller countries. However, Novartis AG has informed us that pricing, reimbursement and post-WHI regulatory issues are adversely impacting its launch plans in many countries, including the United Kingdom, France, and Italy. Accordingly, we cannot assure that Novartis AG will launch Estradot® in any particular country within its territory. 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, and we do not expect additional major market launches of Estradot® in the remainder of 2003.

15

Table of Contents

HRT Studies

     In July 2002, the National Institutes 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 NCI 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 June 2003, a further analysis of data from the discontinued combination therapy arm of the WHI study indicated that use of combination HRT may also increase the frequency of abnormal mammograms beginning in the first year of therapy and/or may cause tumors to be more advanced at the time of diagnosis. In August 2003, further WHI data analysis suggested that the use of combination therapy increased the risk of heart disease beginning in the first year of therapy, and a large U.K. study suggested that the use of both estrogen-only and combination therapy increased the risk of breast cancer, and the risk of death from breast cancer, whether administered orally, transdermally or via implant. The data from the WHI and other studies continue to be analyzed and we cannot predict what further findings, if any, those analyses may yield.

     Although the range of consequences of these studies cannot be predicted, they have to date significantly and adversely impacted our results of operations. It is possible that these studies 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 study 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 after reaching agreement with the FDA on label language. Based on industry practice, we expect that Noven, Novogyne and trade participants will be permitted to deplete product inventory bearing the old label concurrently with the introduction of product with revised labeling. If depletion of inventory with old labeling is not permitted or does not otherwise occur, revised labeling could cause an increase in sales returns to Novogyne, and could have a material adverse impact on the financial results of Noven and Novogyne. 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.

16

Table of Contents

     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, although Vivelle® family total monthly prescriptions have returned to approximately pre-WHI levels. Demand for our products in Europe has declined as well. Any increase in returns of products to Novogyne (including any such changes resulting from the results of the recent or ongoing HRT studies or the pending product label changes) would have a material adverse effect on our results of operations and financial condition.

     The WHI safety board re-evaluates the risk/benefit profile of the estrogen-only arm as frequently as twice per year. In addition, researchers continue to analyze data from the discontinued arm of the WHI study and other studies. If the estrogen-only study or any other currently ongoing HRT study is halted, or if ongoing analyses yield additional safety concerns, 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 may 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.

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 revenues. 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 does not consider the application approvable because one or more deficiencies in the application preclude the FDA from approving it.

17

Table of Contents

Pursuant to the agreement, under certain circumstances Shire has the right to require us to repurchase the product rights for $5 million. For accounting purposes, $20 million of the initial $25 million payment has been deferred and is being recognized as revenues over 10 years beginning in the second quarter of 2003. The remaining $5 million has been deferred and is expected to be recognized as revenues 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 working with the FDA to clarify its concerns and to determine what additional studies, analyses or other actions would resolve the issues raised in the letter. We are presently conducting additional analyses of data from MethyPatch® clinical studies in an effort to address the FDA’s clinical issues regarding the MethyPatch® NDA without undertaking an additional Phase III clinical study. In parallel with that analysis, we also expect to begin a large-scale clinical trial before year-end, reflecting our belief that an additional pre-approval study will likely be required. 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.

18

Table of Contents

Results of Operations

Three and six months ended June 30, 2003 compared to three and six months ended June 30, 2002

Revenues:

     Total revenues for the three and six months ended June 30, 2003 and 2002 are summarized as follows (dollar amounts in thousands):

Total Revenues

     The decline in total revenues for the three and six months ended June 30, 2003 as compared to the same periods in 2002 was primarily attributable to lower unit sales for both our U.S. and international products, and lower royalties due to lower Novogyne sales of Vivelle® family products.

     A further decline in prescriptions of Novogyne’s HRT products, or an increase in returns, whether as a result of the HRT studies, related product label changes, or otherwise, would adversely impact our future revenues. We are unable to predict the timing or impact of any further decline in future sales on our results of operations.

19

Table of Contents

Product Revenues — Novogyne

     The decline in revenues from Novogyne for the three months ended June 30, 2003 as compared to the prior year primarily relates to a volume decline for Vivelle®, which reflects lower prescription trends due to product maturity and the impact of inventory reduction initiatives intended to align inventories with post-WHI demand. Since the 1999 launch of Vivelle-Dot®, which is a newer, improved version of Vivelle®, Vivelle® prescriptions and sales have been steadily declining. In addition, royalty revenues declined due to lower unit sales by Novogyne of Vivelle® family products. These declines were partially offset by an increase in volume of CombiPatch® sold to Novogyne. In the first three months of 2003, a production issue relating to material supplied by one vendor caused us to temporarily suspend shipments of CombiPatch® to Novogyne. We believe we have resolved this production issue, and we resumed shipments of CombiPatch® late in the second quarter of 2003.

     The decline in revenues from Novogyne for the six months ended June 30, 2003 as compared to the prior year primarily relates to volume declines of all products sold to Novogyne and lower royalty payments from Novogyne, which reflects lower prescription trends following the publication of the HRT studies.

Product Revenues – Third Parties

     The decline in revenues from third parties for the three and six months ended June 30, 2003 as compared to the prior year primarily related to lower unit sales of Menorest® and, to a lesser extent, Estradot®. The decline in sales of Estradot® compared to the prior year is primarily a result of the effect of the sale to Novartis AG of launch quantities for Germany in 2002. Germany remains the only major European country in which Novartis AG has launched Estradot®.

License and Contract Revenues

     The increase in license revenues for the three and six months ended June 30, 2003 as compared to the prior year is due to the closing of the MethyPatch® license transaction with Shire and Noven’s receipt of $25 million, of which $20 million is being recognized as revenues over 10 years beginning in the second quarter of 2003. The reduction in contract revenues is primarily attributable to the attainment of certain milestones and the completion of certain contracts in the prior year.

20

Table of Contents

Gross Margin:

     The declines in gross margin for the three and six months ended June 30, 2003 were primarily due to (i) lower overhead absorption due to lower production volumes, (ii) lower royalty revenues from Novogyne, and (iii) an increase in deferred profit on sales to Novogyne. Novogyne had higher end-of-period inventories as a result of lower sales for the three and six months ended June 30, 2003. We defer 49% of the profit on product we sell to Novogyne until that product is sold by Novogyne to trade customers. We did not ship CombiPatch to Novogyne in the 2003 first quarter due to a production issue. Shipping resumed late in the second quarter. Because much of this product did not sell through to trade customers in the second quarter, our deferred profit increased, contributing to the decline in Noven’s quarterly gross margin.

Operating Expenses:

     Operating expenses for the three and six months ended June 30, 2003 and 2002 are summarized as follows (dollar amounts in thousands):