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, 2004

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    [   ].

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the 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

Trademark information: Vivelle, Vivelle Dot, Estalis, Estradot and Menorest are trademarks of Novartis AG or its affiliated companies; CombiPatch is a registered trademark of Vivelle Ventures, LLC; MethyPatch is a registered trademark of Noven Pharmaceuticals, Inc.; Duragesic is a registered trademark of Johnson & Johnson; Intrinsa is a trademark of Procter & Gamble Pharmaceuticals, Inc.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

NOVEN PHARMACEUTICALS, INC.

The accompanying notes are an integral part of these statements.

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NOVEN PHARMACEUTICALS, INC.

The accompanying notes are an integral part of these statements.

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NOVEN PHARMACEUTICALS, INC.

The accompanying notes are an integral part of these statements.

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NOVEN PHARMACEUTICALS, INC.

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, effective March 30, 2001, 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 to third party customers.

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, 2004, and the results of its operations for the three months ended March 31, 2004 and 2003. 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 for the year ended December 31, 2003 (“Form 10-K”), and in Item 2 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this quarterly report on Form 10-Q. Accordingly, the results of operations and cash flows for the three months ended March 31, 2004 and 2003 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 2004.

     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.

3. RECENT ACCOUNTING PRONOUNCEMENTS:

     In December 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46R, Consolidation of Variable Interest Entities (“FIN 46”). This Interpretation of Accounting Research Bulletin 51, Consolidated Financial Statements, addresses consolidation by business enterprises of variable interest entities which have one or both of the following characteristics: (i) the equity investment at risk is not sufficient to permit

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the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity, and (ii) the equity investors lack one or more of the characteristics of a controlling financial interest. This interpretation applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies no later than the first reporting period ending after March 15, 2004 to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. Noven’s investment in Novogyne is not considered a variable interest in a Variable Interest Entity (“VIE”) under the provisions of FIN 46. Therefore, the consolidation and disclosure rules of FIN 46 are not applicable to Noven and Noven does not expect any impact on its financial statements from adopting this interpretation. These conclusions are based on currently available information and require Noven to assess its investment interest and ownership rights in Novogyne. If Noven’s conclusions or underlying assumptions of factual information concerning its investment in Novogyne were to change, Novogyne may be considered a VIE and Noven’s investment in Novogyne could become subject to the consolidation and disclosure rules of FIN 46. In that case, a determination would have to be made as to the primary beneficiary of Novogyne’s interest. The primary beneficiary would then consolidate Novogyne. Noven believes that, even if a determination were made that Novogyne was a VIE at March 31, 2004, Novartis is the primary beneficiary due to its preferred return and 51% equity interest in Novogyne and would continue to consolidate Novogyne.

4. RECLASSIFICATIONS:

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

5. INVENTORIES:

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

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.

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     The following table illustrates the effect on net income and earnings per share for the three months ended March 31, 2004 and 2003 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 months ended March 31, 2004 and 2003, 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 $2.9 million and $1.3 million for the three months ended March 31, 2004 and 2003, respectively. Cash payments for interest were not material for the three months ended March 31, 2004 and 2003.

     Non-cash Investing Activities

     During the three months ended March 31, 2004, Noven entered into a capital lease obligation of $0.3 million for new equipment.

8. LICENSE AND CONTRACT AGREEMENTS:

     Endo License of Fentanyl Patch

     On February 25, 2004, Noven licensed its developmental generic fentanyl patch to Endo Pharmaceuticals Inc. (“Endo”). Noven’s fentanyl patch is intended to be the generic equivalent of Johnson & Johnson’s Duragesic® fentanyl patch.

     Noven received an $8.0 million non-refundable up-front payment from Endo on signing. Upon Endo’s first commercial sale of the fentanyl patch, Noven is entitled to receive an

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additional payment ranging from $5.0 million to $10.0 million, depending on the timing of launch and the number of generic fentanyl competitors in the market. Noven will manufacture and supply the product at its cost and will share in Endo’s profit from net product sales.

     Based on the current patent and exclusivity status of Johnson & Johnson’s Duragesic patch, Noven believes that the earliest its generic fentanyl patch could be launched is January 2005, assuming Food and Drug Administration (“FDA”) approval is received by that time, but Noven cannot assure that it will receive FDA approval by that time or at all. Noven and Endo may elect to manufacture launch supplies prior to receipt of tentative FDA approval. If launch supplies are manufactured and approval is not ultimately received or is delayed, the agreement provides that Noven and Endo will share the cost of manufacturing product that cannot be sold by Endo in accordance with an agreed-upon formula. However, in that case, Noven would not be able to offset all of its up-front production costs with sales of the product. If the product has not been approved or Noven has not supplied Endo’s launch requirements by May 2005, Endo may have the right to terminate the license, depending on the number of generic competitors in the market.

     In addition to the fentanyl license, Noven has established a collaboration with Endo to identify and develop new transdermal therapies. Of the $8.0 million up-front payment, $1.5 million has been allocated to fund feasibility studies to determine whether certain compounds identified by the parties can be delivered using Noven’s transdermal technology. Noven believes the $1.5 million represents the fair value of such services. Endo is expected to fund and manage clinical development of those compounds proceeding into clinical trials.

     Of the $8.0 million received at signing, $6.5 million will be recognized as revenues over a 10-year period, which is the estimated product life cycle. The remaining $1.5 million is expected to be recognized as revenues over the course of feasibility development of any additional patches developed under the Noven/Endo collaboration.

     P&G Pharmaceuticals Contract

     In April 2003, Noven established a collaboration with P&G Pharmaceuticals, Inc. (“P&GP”), a subsidiary of The Procter & Gamble Company, for the development of new prescription patches. The products under development explore follow-on product opportunities for Intrinsa^TM, P&GP’s in-licensed investigational transdermal testosterone patch designed to help restore desire in menopausal women who have Hypoactive Sexual Desire Disorder. P&GP has initiated studies of the first product in humans. In the first quarter of 2004, Noven received and recognized as contract revenues a $0.4 million development milestone under this collaboration. Potential development milestones totaling $4.4 million remain to be received under the P&GP collaboration, a portion of which is expected to be received in the remainder of 2004.

9. INVESTMENT IN VIVELLE VENTURES LLC (d/b/a 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 2004 and 2003 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, 2004 and 2003, Noven had the following transactions with Novogyne (in thousands):

     As of March 31, 2004 and December 31, 2003, Noven had amounts due from Novogyne of $5.1 million and $6.3 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, 2004 and 2003 are as follows (in thousands):

     The activity in the Investment in Novogyne account for the three months ended March 31, 2004 is as follows (in thousands):

     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 months ended March 31, 2004 and 2003, Noven received distributions of $6.0 million and $10.6 million from Novogyne,

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respectively. These amounts were recorded as reductions in the investment in Novogyne when deemed received.

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 a result, Noven had repurchased 105,000 shares of its common stock at an aggregate price of approximately $1.3 million during the three months ended March 31, 2003. These shares were retired on March 31, 2003. No shares were repurchased during the three months ended March 31, 2004.

11. COMMITMENTS AND CONTINGENCIES:

     HT 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 the use of oral combination hormone therapy (“HT”). The study revealed an increase in the risk of developing breast cancer and increased risks of stroke, heart attack and blood clots. The WHI study was followed by publication in 2002 and 2003 of the results of a number of other studies that found that the overall health risks from the use of certain HT products exceed the benefits from the use of those products. In the first quarter of 2004, the NIH discontinued the estrogen-only arm of the WHI study because of an increased risk of stroke and because, after nearly seven years of follow-up, the NIH determined that it had sufficient data to assess the risks and benefits of estrogen use in the trial. This arm of the WHI study also found that the use of an estrogen-only oral formulation appeared to decrease the risk of hip fracture, and did not appear to affect heart disease or to increase the risk of breast cancer. Researchers continue to analyze data from both arms of the WHI study and other studies, and other publications may be forthcoming.

     These studies and others have caused the HT market, and the market for Noven’s products, to significantly decline. Prescriptions for CombiPatch®, our combination estrogen/progestin patch, continue to decline in the post-WHI environment. Novogyne recorded the acquisition of the marketing rights for Noven’s CombiPatch product at cost and tests this asset for impairment on a periodic basis. Further adverse change in the market for HT products could have a material adverse impact on the ability of Novogyne to recover its investment in these rights, which could require Novogyne to record an impairment loss on the CombiPatch intangible asset. Impairment of the CombiPatch intangible asset would adversely affect Novogyne’s and Noven’s financial results. Management cannot predict whether these or other studies will have additional adverse effects on Noven’s liquidity and results of operations, or Novogyne’s ability to recover the net carrying value of the CombiPatch intangible asset.

     Production Issues

     In 2003, Noven’s product stability testing program revealed that certain lots of CombiPatch and Vivelle Dot patches did not maintain required specifications throughout the products’ shelf lives, resulting in product recalls.

     The CombiPatch stability failures resulted from a production issue related to a problematic raw material supplied by one vendor. After addressing the issues with the specific raw material, Noven continues to manufacture and ship CombiPatch to Novogyne and there was no interruption of trade supplies.

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     Based on results of Noven’s testing and analysis to date, Noven believes the probable cause of the Vivelle Dot production issue related to the use of certain rolls of patch backing material provided by a raw material supplier. Based on this testing and analysis, Noven further believes that the Vivelle Dot product that is currently in distribution and in its inventory will maintain required stability. If the root cause determination or additional testing indicates that the production issue affects more product than Noven’s current testing and analysis suggests, additional recalls may be required. If Noven’s estimate concerning the scope of, or amount of, the product returns is incorrect or if Novartis should initiate further unexpected recalls, then Noven’s results of operations could be materially different.

     Supply Agreement

     Noven’s supply agreement with Novogyne for Vivelle and Vivelle Dot patches expired in January 2003. Since expiration, the parties have continued to operate in accordance with the supply agreement’s commercial terms. There is no assurance that the agreement’s non-commercial terms would be enforceable with respect to post-expiration occurrences. Failure to extend the agreement or to continue to operate under the agreement’s commercial terms could have a material adverse effect on Noven’s financial position and results of operations.

     Litigation, Claims and Assessments

     On August 7, 2003, an individual filed a lawsuit on behalf of a purported class of purchasers of Noven’s common stock during the period from October 29, 2001 through April 28, 2003. 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 and misleading statements in its public disclosures regarding Noven’s MethyPatch product. Following the filing of Plaintiff’s complaint, five other substantially similar complaints were filed against Noven and its officers named as defendants in the above referenced action. In response to a joint motion, on or about January 6, 2004, the Court entered an order consolidating the six related actions. Pursuant to this order, plaintiffs must file a consolidated class action complaint not later than 60 days after the entry of an order appointing lead plaintiff and lead counsel. An order appointing lead plaintiff and lead counsel has not yet been entered. This development did not have a material effect on the action or on Noven’s financial position or results of operations.

     Noven believes the lawsuit is without merit, and intends to vigorously defend the lawsuit, but its outcome cannot be predicted. The lawsuit, if determined adversely to Noven, could have a material adverse effect on Noven’s financial position and results of operations. Noven’s ultimate liability, if any, with respect to the lawsuit is presently not 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 financial statements.

     License Agreements

     In certain circumstances, Noven is required to indemnify its licensees from damages caused by the products Noven manufactures as well as claims or losses related to patent infringement.

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

     The following section addresses material aspects of Noven’s financial condition at March 31, 2004, and the results of operations for the three months then ended. The contents of this section include:

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An overview of Noven and:

°		the license of our fentanyl patch to Endo during the first quarter of 2004,
°		our collaboration with P&G Pharmaceuticals, and
°		MethyPatch®, our methylphenidate patch for the treatment of ADHD;

•		An analysis of our results of operations and our liquidity and capital resources;
•		A review of recent accounting pronouncements;
•		An outlook that includes our current financial guidance and certain factors that we believe may influence our financial results for the remainder of 2004; and
•		A discussion of “forward-looking statements” used in this report and a summary review of cautionary factors that could have a material adverse effect on our business, financial condition and results of operations.

     This discussion should be read in conjunction with Noven’s financial statements for the three months ended March 31, 2004 and the related notes included elsewhere in this Form 10-Q, as well as the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations” from our Annual Report on Form 10-K for the year ended December 31, 2003.

Overview

     We develop and manufacture advanced transdermal patches and presently derive substantially all of our revenues from sales of transdermal patches for use in menopausal hormone therapy (“HT”). In the United States, our HT products are marketed and sold by Novogyne, the joint venture that we formed with Novartis in 1998. In all countries other than the United States, Canada and Japan, our HT products are marketed and sold by Novartis Pharma AG (“Novartis Pharma”), an affiliate of Novartis. Our business, financial position and results of operations currently depend on Novogyne and its marketing of our three principal HT products — Vivelle®, Vivelle Dot® and CombiPatch® — in the United States. A discussion of Novogyne’s results and their impact on our results can be found under the caption “ — Results of Operations — Equity in Earnings of Novogyne.”

     The market for HT products, including our transdermal HT products, has contracted since the July 2002 publication of the WHI study that found adverse health risks associated with HT products. Comparing the second quarter of 2002 (the quarter immediately preceding the discontinuation of the combined arm of the WHI study) to the first quarter of 2004, total prescriptions dispensed in the HT market in the United States declined by 45%. For the same period, aggregate prescriptions for Noven’s United States products decreased 15%. The estrogen segment of the HT market in the United States declined 39%, while our Vivelle product family decreased 8%. Vivelle Dot, which represented 75% of our total United States prescriptions in the first quarter of 2004, increased 8% from the second quarter of 2002 to the first quarter of 2004. We believe Vivelle Dot patch prescriptions have benefited from patient conversions from original Vivelle. At the end of the first quarter of 2004, the Vivelle family held a 41% share of total estrogen patch prescriptions, compared to a 35% share at the end of the second quarter of 2002. Our Vivelle Dot estrogen patch is currently the most frequently dispensed estrogen patch in the United States. We believe this is due in part to the beneficial wear characteristics made possible by our technology.

     United States prescriptions for our CombiPatch product (which represented approximately 15% of our total United States prescriptions in the first quarter of 2004) declined 40% from the second quarter of 2002 to the first quarter of 2004, while prescriptions for the total United States market for fixed combination hormone therapy declined 60%. The combination therapy arm of WHI involved an

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oral combination estrogen/progestin product and, accordingly, that segment of the HT market has experienced the most significant decline. As noted above, prescriptions for our CombiPatch combination estrogen/progestin patch, like most combination HT therapies, have declined significantly since WHI. Further declines for our CombiPatch product could require Novogyne (which holds the CombiPatch marketing rights) to record an impairment loss related to the these marketing rights, which would harm both our and Novogyne’s results of operations.

Endo

     An important part of our business strategy is to seek to diversify our product offerings beyond the HT market through strategic collaborations and new product developments. On February 25, 2004, we licensed our developmental generic fentanyl patch to Endo. Our fentanyl patch is intended to be the generic equivalent of Johnson & Johnson’s Duragesic® fentanyl patch.

     We received an $8.0 million non-refundable up-front payment from Endo on signing. Upon Endo’s first commercial sale of the fentanyl patch, we are entitled to receive an additional payment ranging from $5.0 million to $10.0 million, depending on the timing of launch and the number of generic fentanyl competitors in the market. We will manufacture and supply the product at our cost and will share in Endo’s profit from product sales.

     Based on the current patent and exclusivity status of Johnson & Johnson’s Duragesic® patch, we believe that the earliest our generic fentanyl patch could be launched is January 2005, assuming FDA approval is received by that time, but we cannot assure that we will receive FDA approval by that time or at all. Noven and Endo may elect to manufacture launch supplies prior to receipt of tentative FDA approval. If launch supplies are manufactured and approval is not ultimately received or is delayed, the agreement provides that Noven and Endo will share the cost of manufacturing product that cannot be sold by Endo in accordance with an agreed-upon formula, but we would be unable to offset all of our up-front production costs with sales of the product. If the product has not been approved or we have not supplied Endo’s launch requirements by May 2005, Endo may have the right to terminate the license, depending on the number of generic competitors in the market.

     In addition to the fentanyl license, we have established a collaboration with Endo to seek to identify and develop new transdermal therapies. Of the $8.0 million up-front payment, $1.5 million will be allocated to fund feasibility studies to determine whether certain compounds identified by the parties can be delivered using our transdermal technology. Endo is expected to fund and manage clinical development of those compounds proceeding into clinical trials.

     Of the $8.0 million received at signing, $6.5 million will be recognized as revenues over a 10-year period, which is the estimated product life cycle. The remaining $1.5 million is expected to be recognized as revenues over the course of feasibility development of any additional patches developed under the Noven/Endo collaboration.

P&G Pharmaceuticals

     In April 2003, we established a collaboration with P&G Pharmaceuticals, Inc. (“P&GP”), a subsidiary of The Procter & Gamble Company, for the development of new prescription patches. The products under development explore follow-on product opportunities for Intrinsa^TM, P&GP’s in-licensed investigational transdermal testosterone patch designed to help restore desire in menopausal women who have Hypoactive Sexual Desire Disorder. P&GP has initiated studies of the first product in humans. In the first quarter of 2004, Noven received and recognized as contract revenues a $0.4 million development milestone under this collaboration. Potential development milestones totaling $4.4 million remain to be received under the P&GP collaboration, a portion of which is expected to be received in the remainder of 2004.

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Shire

     In April 2003, we received a not approvable letter from the FDA relating to our MethyPatch New Drug Application (“NDA”). Together with Shire, we have been in dialogue with the FDA regarding our strategy to address the clinical risk-benefit and other issues raised in the not approvable letter, and we expect to meet with the FDA in the second quarter of 2004 in this regard. Assuming we can reach agreement with the FDA on an appropriate strategy, Noven and Shire expect to undertake additional MethyPatch clinical studies during 2004. Noven has committed to fund the additional studies. Noven’s direct costs incurred in pursuit of approval are expected to be deferred and offset against a portion of the $25 million deferred revenue previously received from Shire, and therefore such expenses are not expected to impact our research and development expenses in 2004. It is possible that we will not reach agreement with the FDA on an appropriate strategy, development will not be completed and/or that our MethyPatch product will not be approved or launched, and we may not receive additional milestone payments or manufacturing revenues from Shire.

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Results of Operations

Three months ended March 31, 2004 compared to the three months ended March 31, 2003

Revenues

     Total revenues for the three months ended March 31, 2004 and 2003 are summarized as follows (dollar amounts in thousands):