##### 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, 2006
 Commission file number 0-17254
 NOVEN PHARMACEUTICALS, INC.
  STATE OF DELAWARE
    
    59-2767632(State or other jurisdiction ofincorporation or organization)
    
    (I.R.S. EmployerIdentification Number)
  (Address of principal executive offices) (Zip Code)
  (Registrants telephone number, including area code)
 þ o
  o þ o
 o þ
  Class
    
    Outstanding at July 31, 2006Common stock $.0001 par value
    
    23,783,587




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##### 



NOVEN PHARMACEUTICALS, INC.
  Page No.PART I  FINANCIAL INFORMATIONItem 1  Unaudited Condensed Financial StatementsCondensed Statements of Operations for the Three and Six Months Ended
June 30, 2006 and 2005
    
    
    3Condensed Balance Sheets as of June 30, 2006 and December 31, 2005
    
    
    4Condensed Statements of Cash Flows for the Six Months Ended
June 30, 2006 and 2005
    
    
    5Notes to Unaudited Condensed Financial Statements
    
    
    6Item 2  Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    18Item 3  Quantitative and Qualitative Disclosures About Market Risk
    
    
    36Item 4  Controls and Procedures
    
    
    36PART II  OTHER INFORMATIONItem 1  Legal Proceedings
    
    
    38Item 1A  Risk Factors
    
    
    38Item 2  Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    40Item 4  Submission of Matters to a Vote of Security Holders
    
    
    40Item 6  Exhibits
    
    
    41SIGNATURES
    
    
    42EX-31.1 SECTION 302 CERTIFICATION OF CEOEX-31.2 SECTION 302 CERTIFICATION OF CFOEX-32.1 SECTION 906 CERTIFICATION OF CEOEX-32.2 SECTION 906 CERTIFICATION OF CFO
   ®  ® ® ® 
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##### Table of Contents



Item 1. Financial Statements
 NOVEN PHARMACEUTICALS, INC.
 
 
 Three Months
    
    
    Six Months2006
    
    
    2005
    
    
    2006
    
    
    2005Revenues:Product revenues  Novogyne:Product sales
    
    $
    5,630
    
    
    $
    4,714
    
    
    $
    8,717
    
    
    $
    9,692Royalties
    
    
    1,658
    
    
    
    1,713
    
    
    
    3,347
    
    
    
    2,827Total product revenues  Novogyne
    
    
    7,288
    
    
    
    6,427
    
    
    
    12,064
    
    
    
    12,519Product revenues  third parties
    
    
    6,016
    
    
    
    3,933
    
    
    
    9,887
    
    
    
    7,971Total product revenues
    
    
    13,304
    
    
    
    10,360
    
    
    
    21,951
    
    
    
    20,490Contract and license revenues:Contract
    
    
    404
    
    
    
    429
    
    
    
    1,068
    
    
    
    1,024License
    
    
    3,839
    
    
    
    982
    
    
    
    4,720
    
    
    
    1,993Contract and license revenues
    
    
    4,243
    
    
    
    1,411
    
    
    
    5,788
    
    
    
    3,017Net revenues
    
    
    17,547
    
    
    
    11,771
    
    
    
    27,739
    
    
    
    23,507Expenses:Cost of products sold  Novogyne
    
    
    4,459
    
    
    
    2,449
    
    
    
    6,602
    
    
    
    5,698Cost of products sold  third parties
    
    
    7,428
    
    
    
    2,787
    
    
    
    11,425
    
    
    
    5,412Total cost of products sold
    
    
    11,887
    
    
    
    5,236
    
    
    
    18,027
    
    
    
    11,110Research and development
    
    
    2,890
    
    
    
    3,033
    
    
    
    6,372
    
    
    
    5,926Marketing, general and administrative
    
    
    5,638
    
    
    
    4,189
    
    
    
    10,376
    
    
    
    8,244Total expenses
    
    
    20,415
    
    
    
    12,458
    
    
    
    34,775
    
    
    
    25,280Loss from operations
    
    
    (2,868
    )
    
    
    (687
    )
    
    
    (7,036
    )
    
    
    (1,773
    )Equity in earnings of Novogyne
    
    
    6,762
    
    
    
    8,101
    
    
    
    11,089
    
    
    
    9,013Interest income, net
    
    
    1,111
    
    
    
    593
    
    
    
    1,722
    
    
    
    1,096Income before income taxes
    
    
    5,005
    
    
    
    8,007
    
    
    
    5,775
    
    
    
    8,336Provision for income taxes
    
    
    1,672
    
    
    
    2,886
    
    
    
    1,938
    
    
    
    3,004Net income
    
    $
    3,333
    
    
    $
    5,121
    
    
    $
    3,837
    
    
    $
    5,332Basic earnings per share
    
    $
    0.14
    
    
    $
    0.22
    
    
    $
    0.16
    
    
    $
    0.23Diluted earnings per share
    
    $
    0.14
    
    
    $
    0.21
    
    
    $
    0.16
    
    
    $
    0.22Weighted average number of common shares
outstanding:Basic
    
    
    23,685
    
    
    
    23,565
    
    
    
    23,673
    
    
    
    23,537Diluted
    
    
    24,071
    
    
    
    24,068
    
    
    
    23,925
    
    
    
    24,017
 The accompanying notes are an integral part of these statements.
 3




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NOVEN PHARMACEUTICALS, INC.
 
 
 June 30, 2006
    
    
    December 31, 2005AssetsCurrent Assets:Cash and cash equivalents
    
    $
    11,570
    
    
    $
    66,964Short-term investments available-for-sale, at fair value
    
    
    114,660
    
    
    
    17,900Accounts receivable  trade (less allowance for doubtful
accounts of $42 in 2006 and $53 in 2005)
    
    
    5,866
    
    
    
    2,919Accounts receivable  Novogyne, net
    
    
    7,067
    
    
    
    8,912Inventories
    
    
    7,832
    
    
    
    7,861Net deferred income tax asset, current portion
    
    
    5,200
    
    
    
    6,000Prepaid income taxes
    
    
    6,245
    
    
    
    7,697Prepaid and other current assets
    
    
    2,414
    
    
    
    1,357160,854
    
    
    
    119,610Property, plant and equipment, net
    
    
    37,010
    
    
    
    34,455Other Assets:Investment in Novogyne
    
    
    21,910
    
    
    
    23,243Net deferred income tax asset
    
    
    7,356
    
    
    
    6,373Patent development costs, net
    
    
    2,377
    
    
    
    2,211Deposits and other assets
    
    
    222
    
    
    
    1831,865
    
    
    
    31,845$
    229,729
    
    
    $
    185,910Liabilities and Stockholders EquityCurrent Liabilities:Accounts payable and accrued expenses
    
    $
    4,702
    
    
    $
    5,812Capital lease obligation  current portion
    
    
    52
    
    
    
    121Accrued liability  Shire
    
    
    419
    
    
    
    5,488Accrued compensation and related liabilities
    
    
    3,607
    
    
    
    5,771Other accrued liabilities
    
    
    2,499
    
    
    
    2,124Deferred rent credit
    
    
    89
    
    
    
    89Deferred contract revenues
    
    
    551
    
    
    
    1,481Deferred license revenues  current portion
    
    
    11,279
    
    
    
    7,60223,198
    
    
    
    28,488Long-Term Liabilities:Deferred rent credit
    
    
    704
    
    
    
    748Deferred license revenues
    
    
    58,670
    
    
    
    16,053Deferred compensation liability
    
    
    92
    
    
    
    82,664
    
    
    
    45,289Commitments and Contingencies (Note 13)Stockholders Equity:Preferred stock  authorized 100,000 shares of $.01 par
value; no shares issued or outstanding
    
    
    
    
    
    
    Common stock  authorized 80,000,000 shares,
par value $.0001 per share; issued and
outstanding 23,719,753 at June 30, 2006 and
23,617,221 at December 31, 2005
    
    
    2
    
    
    
    2Additional paid-in capital
    
    
    92,453
    
    
    
    89,846Retained earnings
    
    
    54,610
    
    
    
    50,773147,065
    
    
    
    140,621$
    229,729
    
    
    $
    185,910
 The accompanying notes are an integral part of these statements.
 4




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NOVEN PHARMACEUTICALS, INC.
 
 
 2006
    
    
    2005Cash flows from operating activities:Net income
    
    $
    3,837
    
    
    $
    5,332Adjustments to reconcile net income to net cash flows
provided by operating activities:Depreciation and amortization
    
    
    1,850
    
    
    
    1,134Stock-based compensation expense
    
    
    1,529
    
    
    
    Amortization of patent costs
    
    
    250
    
    
    
    218Increase in cash surrender value of company-owned life insurance
    
    
    (4
    )
    
    
    Amortization of deferred rent credit
    
    
    (44
    )
    
    
    (31
    )Income tax benefits on exercise of stock options
    
    
    256
    
    
    
    154Deferred income tax (benefit) expense
    
    
    (183
    )
    
    
    57Recognition of deferred license revenues
    
    
    (4,720
    )
    
    
    (1,993
    )Equity in earnings of Novogyne
    
    
    (11,089
    )
    
    
    (9,013
    )Distributions from Novogyne
    
    
    10,210
    
    
    
    8,926Changes in operating assets and liabilities:(Increase) decrease in accounts receivable  trade, net
    
    
    (2,947
    )
    
    
    105Decrease in accounts receivable  Novogyne, net
    
    
    1,845
    
    
    
    2,720Decrease (increase) in inventories
    
    
    29
    
    
    
    (3,790
    )Decrease in prepaid income taxes
    
    
    3,664
    
    
    
    4,394Increase in prepaid and other current assets
    
    
    (1,057
    )
    
    
    (1,450
    )Increase in deposits and other assets
    
    
    (15
    )
    
    
    (1
    )Decrease in accounts payable
    
    
    (1,110
    )
    
    
    (5,881
    )Decrease in accrued liability  Shire
    
    
    (5,069
    )
    
    
    (5,608
    )Decrease in accrued compensation and related liabilities
    
    
    (2,164
    )
    
    
    (2,153
    )Increase (decrease) in other accrued liabilities
    
    
    375
    
    
    
    (281
    )Decrease in deferred contract revenue, net
    
    
    (930
    )
    
    
    (223
    )Increase in deferred license revenue
    
    
    51,000
    
    
    
    Increase in deferred compensation liability
    
    
    92
    
    
    
    Amounts recoverable from (reimburseable to) Shire and offset against
deferred license revenue related to Daytrana approval
    
    
    14
    
    
    
    (4,822
    )Cash flows provided by (used in) operating activities
    
    
    45,619
    
    
    
    (12,206
    )Cash flows from investing activities:Purchases of property, plant and equipment, net
    
    
    (4,405
    )
    
    
    (4,582
    )Payments for patent development costs, net
    
    
    (416
    )
    
    
    (241
    )Purchase of company-owned life insurance
    
    
    (185
    )
    
    
    Purchases of short-term investments
    
    
    (685,035
    )
    
    
    (201,665
    )Proceeds from sale of short-term investments
    
    
    588,275
    
    
    
    157,065Cash flows used in investing activities
    
    
    (101,766
    )
    
    
    (49,423
    )Cash flows from financing activities:Issuance of common stock from exercise of stock options
    
    
    822
    
    
    
    1,060Payments under capital leases
    
    
    (69
    )
    
    
    (56
    )Cash flows provided by financing activities
    
    
    753
    
    
    
    1,004Net decrease in cash and cash equivalents
    
    
    (55,394
    )
    
    
    (60,625
    )Cash and cash equivalents, beginning of period
    
    
    66,964
    
    
    
    93,958Cash and cash equivalents, end of period
    
    $
    11,570
    
    
    $
    33,333
 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:
  ®  ®
 2.
    
    BASIS OF PRESENTATION:
     6




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3.
    
    CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS:
  4.
    
    RECLASSIFICATIONS AND REVISIONS:
  5.
    
    CASH FLOW INFORMATION:
  Non-cash Operating Activities
  Non-cash Investing Activities
  6.
    
    RECENT ACCOUNTING PRONOUNCEMENTS:
  7




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##### Table of Contents



7.
    
    INVENTORIES:
  June 30, 2006
    
    
    December 31, 2005Commercial
    
    
    Pre-launch
    
    
    Total
    
    
    Commercial
    
    
    Pre-launch
    
    
    TotalFinished goods
    
    $
    399
    
    
    $
    
    
    
    $
    399
    
    
    $
    760
    
    
    $
    
    
    
    $
    760Work in progress
    
    
    2,118
    
    
    
    
    
    
    
    2,118
    
    
    
    1,278
    
    
    
    1,004
    
    
    
    2,282Raw materials
    
    
    5,315
    
    
    
    
    
    
    
    5,315
    
    
    
    3,422
    
    
    
    1,397
    
    
    
    4,819$
    7,832
    
    
    $
    
    
    
    $
    7,832
    
    
    $
    5,460
    
    
    $
    2,401
    
    
    $
    7,861
 
  
   
 8.
    
    EMPLOYEE STOCK PLANS:
  8




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9




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2006
    
    2005Volatility
    
    
    55.1
    %
    
    
    69.0
    %Risk free interest rate
    
    
    4.95
    %
    
    
    3.83
    %Expected life (years)
    
    
    5
    
    
    
    5
  Three
    
    
    SixMonths
    
    
    MonthsMarketing, general and administrative
    
    $
    745
    
    
    $
    1,142Research and development
    
    
    133
    
    
    
    224Cost of products sold
    
    
    102
    
    
    
    163$
    980
    
    
    $
    1,529Tax benefit recognized related to compensation expense
    
    $
    239
    
    
    $
    358
   10




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2006WeightedWeighted
    
    
    
    
    
    
    AverageAverage
    
    
    Aggregate
    
    
    RemainingOptions/
    
    
    Exercise
    
    
    Intrinsic
    
    
    ContractualSSARs
    
    
    Price
    
    
    Value
    
    
    TermOutstanding at beginning of the period
    
    
    4,004
    
    
    $
    17.23Granted
    
    
    26
    
    
    
    17.55Exercised
    
    
    (103
    )
    
    
    8.10
    
    
    $
    876Canceled and expired
    
    
    (42
    )
    
    
    19.61Outstanding at end of the period
    
    
    3,885
    
    
    $
    17.45
    
    
    $
    12,307
    
    
    
    4.1Outstanding and exercisable at end of period
    
    
    2,739
    
    
    $
    19.52
    
    
    $
    6,114
    
    
    
    3.7
  2006WeightedAverageGrant-DateShares
    
    Fair ValueNonvested at
December 31, 2005
    
    
    
    
    
    $
    Granted
    
    
    34
    
    
    
    17.47Vested
    
    
    (8
    )
    
    
    17.47Forfeited
    
    
    
    
    
    
    Nonvested at
June 30, 2006
    
    
    26
    
    
    $
    17.47
   11




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Three Months
    
    
    Six Months2005
    
    
    2005Net income:As reported
    
    $
    5,121
    
    
    $
    5,332Total stock-based employee
compensation expense determined
under fair value based method for all
awards, net of related tax effects
    
    
    (10,223
    )
    
    
    (11,970
    )Pro forma
    
    $
    (5,102
    )
    
    $
    (6,638
    )Basic earnings per share:As reported
    
    $
    0.22
    
    
    $
    0.23Pro forma
    
    $
    (0.22
    )
    
    $
    (0.28
    )Diluted earnings per share:As reported
    
    $
    0.21
    
    
    $
    0.22Pro forma
    
    $
    (0.22
    )
    
    $
    (0.28
    )
  9.
    
    DEFERRED COMPENSATION PLAN:
    12




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10.
    
    CONTRACT AND LICENSE AGREEMENTS:Shire
 
  Other
  11.
    
    INVESTMENT IN VIVELLE VENTURES LLC (d/b/a NOVOGYNE):
   Three Months
    
    
    Six Months2006
    
    
    2005
    
    
    2006
    
    
    2005Revenues:Product sales
    
    $
    5,630
    
    
    $
    4,714
    
    
    $
    8,717
    
    
    $
    9,692Royalties
    
    
    1,658
    
    
    
    1,713
    
    
    
    3,347
    
    
    
    2,827$
    7,288
    
    
    $
    6,427
    
    
    $
    12,064
    
    
    $
    12,519Reimbursed expenses
    
    $
    6,648
    
    
    $
    6,378
    
    
    $
    13,918
    
    
    $
    13,620
 13




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Three Months
    
    
    Six Months2006
    
    
    2005
    
    
    2006
    
    
    2005Gross revenues
    
    $
    35,665
    
    
    $
    35,211
    
    
    $
    72,934
    
    
    $
    62,545Sales allowances
    
    
    3,546
    
    
    
    3,676
    
    
    
    7,339
    
    
    
    7,071Sales return allowances
    
    
    1,487
    
    
    
    (401
    )
    
    
    3,383
    
    
    
    865Sales allowances and returns
    
    
    5,033
    
    
    
    3,275
    
    
    
    10,722
    
    
    
    7,936Net revenues
    
    
    30,632
    
    
    
    31,936
    
    
    
    62,212
    
    
    
    54,609Cost of sales1
    
    
    7,162
    
    
    
    7,307
    
    
    
    14,683
    
    
    
    13,407Selling, general and administrative expenses
    
    
    9,596
    
    
    
    7,770
    
    
    
    18,753
    
    
    
    16,440Income from operations
    
    
    13,874
    
    
    
    16,859
    
    
    
    28,776
    
    
    
    24,762Interest income
    
    
    162
    
    
    
    42
    
    
    
    314
    
    
    
    135Net income
    
    $
    14,036
    
    
    $
    16,901
    
    
    $
    29,090
    
    
    $
    24,897Novens equity in earnings of Novogyne
    
    $
    6,762
    
    
    $
    8,101
    
    
    $
    11,089
    
    
    $
    9,013
 
 1
    
    Included in Novogynes costs of sales for all periods presented in the table is the amortization of the
marketing rights Novogyne acquired for CombiPatch®, which in prior reports was listed
as a separate operating expense in Novogynes statement of operations.  Investment in Novogyne, beginning of period
    
    $
    23,243Equity in earnings of Novogyne
    
    
    11,089Cash distributions from Novogyne
    
    
    (10,210
    )Non-cash distribution from Novogyne (Note 5)
    
    
    (2,212
    )Investment in Novogyne, end of period
    
    $
    21,910
  14




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12.
    
    SHARE REPURCHASE PROGRAM:
  13.
    
    COMMITMENTS AND CONTINGENCIES:
 HT Studies
   ® ® ® ® ®
 Production Issues
  ® 
 15




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   
 ® ® ® ® ®
 ® ®  ® ®
  Supply Agreement
 ® 
 16




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Litigation, Claims and Assessments
 ®
 ®
 ® ®
  ® ®
   17




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
  
    
    An executive summary of our results of operations for the three months ended June 30, 2006;
    
    An overview of Noven and our Novogyne joint venture;
    
    A review of certain items that may affect the historical or future comparability of our
results of operations;
    
    An analysis of our results of operations and our liquidity and capital resources;
    
    An outlook that includes our current financial guidance;
    
    A discussion of how we apply our critical accounting estimates; and
    
    A discussion of recently-issued accounting standards.
  Executive Summary
 The following Executive Summary is qualified in its entirety by the more detailed discussion
and analysis of our financial condition and results of operations appearing in this Item 2 as well
as in our financial statements and related notes included in this Form 10-Q .
 
  
 
  
 18




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 ®
 
 Overview of Noven and Our Novogyne Joint Venture
 ®  ®
 ®  ® ® ®
 ®  ® ®  ®
  19




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®   ®
 ® ® ®
 Certain Items that May Affect Historical or Future Comparability
  Stock-Based Compensation
   20




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21




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Results of Operations
 Three and six months ended June 30, 2006 compared to the three and six months ended June 30,
2005
 Revenues
  Three Months
    
    
    Six Months2006
    
    
    2005
    
    
    % Change
    
    
    2006
    
    
    2005
    
    
    % ChangeProduct revenues  Novogyne:Product sales
    
    $
    5,630
    
    
    $
    4,714
    
    
    
    19
    %
    
    $
    8,717
    
    
    $
    9,692
    
    
    
    (10
    %)Royalties
    
    
    1,658
    
    
    
    1,713
    
    
    
    (3
    %)
    
    
    3,347
    
    
    
    2,827
    
    
    
    18
    %7,288
    
    
    
    6,427
    
    
    
    13
    %
    
    
    12,064
    
    
    
    12,519
    
    
    
    (4
    %)Product revenues  third parties:Product sales
    
    
    5,931
    
    
    
    3,858
    
    
    
    54
    %
    
    
    9,731
    
    
    
    7,823
    
    
    
    24
    %Royalties
    
    
    85
    
    
    
    75
    
    
    
    13
    %
    
    
    156
    
    
    
    148
    
    
    
    5
    %6,016
    
    
    
    3,933
    
    
    
    53
    %
    
    
    9,887
    
    
    
    7,971
    
    
    
    24
    %Total product revenues
    
    
    13,304
    
    
    
    10,360
    
    
    
    28
    %
    
    
    21,951
    
    
    
    20,490
    
    
    
    7
    %Contract and license revenues:Contract
    
    
    404
    
    
    
    429
    
    
    
    (6
    %)
    
    
    1,068
    
    
    
    1,024
    
    
    
    4
    %License
    
    
    3,839
    
    
    
    982
    
    
    
    291
    %
    
    
    4,720
    
    
    
    1,993
    
    
    
    137
    %4,243
    
    
    
    1,411
    
    
    
    201
    %
    
    
    5,788
    
    
    
    3,017
    
    
    
    92
    %Net revenues
    
    $
    17,547
    
    
    $
    11,771
    
    
    
    49
    %
    
    $
    27,739
    
    
    $
    23,507
    
    
    
    18
    %
 Net Revenues
 
 
 Product Revenues  Novogyne
  ® ® ®  ®
 22




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##### Table of Contents



 ® ® ®  ® ® ®
  ®  ®
 Product Revenues  Third Parties
 ® ® ® ® 
  ® ® 
  ® ®  ® ® ®
 Contract and License Revenues
  23




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##### Table of Contents




 Gross Margin
  Gross Margin  Total
  Three Months
    
    
    Six Months2006
    
    
    2005
    
    
    2006
    
    
    2005Gross Margin Total:Product revenues
    
    $
    13,304
    
    
    $
    10,360
    
    
    $
    21,951
    
    
    $
    20,490Cost of products sold
    
    
    11,887
    
    
    
    5,236
    
    
    
    18,027
    
    
    
    11,110Gross profit (product revenues
less cost of products sold)
    
    
    1,417
    
    
    
    5,124
    
    
    
    3,924
    
    
    
    9,380Gross margin (gross profit as a
percentage of product revenues)
    
    
    11
    %
    
    
    49
    %
    
    
    18
    %
    
    
    46
    %
     
  
 24




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##### Table of Contents



Gross Margin  Sales to Novogyne
 Three Months
    
    
    Six Months2006
    
    
    2005
    
    
    2006
    
    
    2005Gross Margin Novogyne:Product revenues
    
    $
    7,288
    
    
    $
    6,427
    
    
    $
    12,064
    
    
    $
    12,519Cost of products sold
    
    
    4,459
    
    
    
    2,449
    
    
    
    6,602
    
    
    
    5,698Gross profit (product revenues
less cost of products sold)
    
    
    2,829
    
    
    
    3,978
    
    
    
    5,462
    
    
    
    6,821Gross margin (gross profit as a
percentage of product revenues)
    
    
    39
    %
    
    
    62
    %
    
    
    45
    %
    
    
    54
    %Changes in deferred profit on
sales of product to Novogyne1
    
    
    71
    
    
    
    148
    
    
    
    (226
    )
    
    
    290Gross profit excluding changes in
deferred profit on sales of product
to Novogyne1
    
    
    2,900
    
    
    
    4,126
    
    
    
    5,236
    
    
    
    7,111Gross margin excluding impact
of deferred profit1
    
    
    40
    %
    
    
    64
    %
    
    
    43
    %
    
    
    57
    %
 
 1
    
    Novens cost of products sold may be affected in a given period by changes in
deferred profit on Novens sale of product to Novogyne. As a result of our 49% equity investment
in Novogyne, we are required to defer 49% of our profit on product that we sell to Novogyne until
that product is sold by Novogyne to trade customers. Since our cost of products sold is adjusted
to reflect changes in deferred profit, our gross margin can vary from period to period based on the
timing of our shipments to Novogyne and Novogynes sale of our products to trade customers. If
Novogyne sells more product than we provide it in a given period (i.e., if Novogynes inventories
decline), we will defer less profit from sales to Novogyne. In light of the significant historic
fluctuations in our deferred profit on sales of product to Novogyne, we have also disclosed our
gross margin net of the changes in deferred profit on sales of product to Novogyne, which, Novens
management believes, is useful to investors in order to meaningfully evaluate Novens ongoing,
underlying business and compare Novens financial results for the three and six months ended June
30, 2006 to those in the same period of 2005. For the same reasons, management uses these non-GAAP
financial measures to evaluate Novens ongoing, underlying business. These measures should not be
considered alternatives to measures computed in accordance with GAAP, nor should they be considered
indicators of our overall financial performance.  25




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##### Table of Contents



Gross Margin  Sales to third parties
 Three Months
    
    
    Six Months2006
    
    
    2005
    
    
    2006
    
    
    2005Gross Margin Third Parties:Product revenues
    
    $
    6,016
    
    
    $
    3,933
    
    
    $
    9,887
    
    
    $
    7,971Cost of products sold
    
    
    7,428
    
    
    
    2,787
    
    
    
    11,425
    
    
    
    5,412Gross (loss) profit (product revenues
less cost of products sold)
    
    
    (1,412
    )
    
    
    1,146
    
    
    
    (1,538
    )
    
    
    2,559Gross margin (gross profit as a
percentage of product revenues)
    
    
    (23
    %)
    
    
    29
    %
    
    
    (16
    %)
    
    
    32
    %
 
         
  
 
 26




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##### Table of Contents



Operating Expenses
  Three Months
    
    Six Months2006
    
    2005
    
    % Change
    
    2006
    
    2005
    
    % ChangeResearch and development
    
    $
    2,890
    
    
    $
    3,033
    
    
    
    (5
    %)
    
    $
    6,372
    
    
    $
    5,926
    
    
    
    8
    %Marketing, general and
administrative
    
    
    5,638
    
    
    
    4,189
    
    
    
    35
    %
    
    
    10,376
    
    
    
    8,244
    
    
    
    26
    %
 Research and Development
  
 
 Marketing, General and Administrative
   27




---



##### Table of Contents



Other Income and Expenses
 Interest Income
 
 Income Taxes
 
 Equity in Earnings of Novogyne
  28




---



##### Table of Contents



Three Months
    
    
    Six Months2006
    
    
    2005
    
    
    % Change
    
    
    2006
    
    
    2005
    
    
    % ChangeGross revenues1
    
    $
    35,665
    
    
    $
    35,211
    
    
    
    1
    %
    
    $
    72,934
    
    
    $
    62,545
    
    
    
    17
    %Sales allowances
    
    
    3,546
    
    
    
    3,676
    
    
    
    (4
    %)
    
    
    7,339
    
    
    
    7,071
    
    
    
    4
    %Sales returns allowances
    
    
    1,487
    
    
    
    (401
    )
    
    
    N/M
    
    
    
    3,383
    
    
    
    865
    
    
    
    291
    %Sales and returns allowances
    
    
    5,033
    
    
    
    3,275
    
    
    
    54
    %
    
    
    10,722
    
    
    
    7,936
    
    
    
    35
    %Net revenues
    
    
    30,632
    
    
    
    31,936
    
    
    
    (4
    %)
    
    
    62,212
    
    
    
    54,609
    
    
    
    14
    %Cost of sales2
    
    
    7,162
    
    
    
    7,307
    
    
    
    (2
    %)
    
    
    14,683
    
    
    
    13,407
    
    
    
    10
    %Gross profit
    
    
    23,470
    
    
    
    24,629
    
    
    
    (5
    %)
    
    
    47,529
    
    
    
    41,202
    
    
    
    15
    %Gross margin percentage
    
    
    77
    %
    
    
    77
    %
    
    
    
    
    
    
    76
    %
    
    
    75
    %Selling, general and
administrative expenses
    
    
    9,596
    
    
    
    7,770
    
    
    
    24
    %
    
    
    18,753
    
    
    
    16,440
    
    
    
    14
    %Income from operations
    
    
    13,874
    
    
    
    16,859
    
    
    
    (18
    %)
    
    
    28,776
    
    
    
    24,762
    
    
    
    16
    %Interest income
    
    
    162
    
    
    
    42
    
    
    
    286
    %
    
    
    314
    
    
    
    135
    
    
    
    133
    %Net income
    
    $
    14,036
    
    
    $
    16,901
    
    
    
    (17
    %)
    
    $
    29,090
    
    
    $
    24,897
    
    
    
    17
    %Novens equity in earnings of Novogyne
    
    $
    6,762
    
    
    $
    8,101
    
    
    
    (17
    %)
    
    $
    11,089
    
    
    $
    9,013
    
    
    
    23
    %
  
 1
    
    Novogynes gross revenues, which are calculated by adding sales allowances and sales
returns allowances to net revenues, are discussed in this section because Novens management
believes it is a useful measure to evaluate and compare Novogynes sales period to period in light
of the significant historic fluctuations in Novogynes sales allowances and returns.2
    
    Novogynes costs of sales for all periods presented include the amortization of
the marketing rights Novogyne acquired for CombiPatch® of $1.5 million and $3.1 million
for each of the three and six months ended June 30, 2006 and 2005, respectively. This amortization was
previously reported as a separate operating expense in Novogynes statement of operations. Novogyne Net Revenues
  ®  ® ® ®  ®
  29




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##### Table of Contents



® ®
  ®  ® ®  ® ®
   Three Months
    
    
    Six Months2006
    
    
    2005
    
    
    2006
    
    
    2005Changes in allowances for returns of expiring product
    
    $
    1,487
    
    
    $
    (338
    )
    
    $
    3,383
    
    
    $
    928Changes in allowances for returns for product recalls
    
    
    
    
    
    
    (63
    )
    
    
    
    
    
    
    (63
    )Net change in sales returns allowances
    
    $
    1,487
    
    
    $
    (401
    )
    
    $
    3,383
    
    
    $
    865Actual returns for expiring product
    
    $
    (1,149
    )
    
    $
    (767
    )
    
    $
    (2,320
    )
    
    $
    (1,695
    )Actual returns for product recalls
    
    
    
    
    
    
    (40
    )
    
    
    
    
    
    
    (40
    )Actual returns for the period
    
    $
    (1,149
    )
    
    $
    (807
    )
    
    $
    (2,320
    )
    
    $
    (1,735
    )
  ® ®
 Novogyne Gross Margin
  30




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##### Table of Contents



Novogyne Selling, General and Administrative Expenses
   Liquidity and Capital Resources
  June 30, 2006
    
    December 31, 2005Cash and cash equivalents
    
    $
    11,570
    
    
    $
    66,964Short-term investments
    
    
    114,660
    
    
    
    17,900Working capital
    
    
    137,656
    
    
    
    91,122
  Six Months2006
    
    2005Cash flows:Operating activities
    
    $
    45,619
    
    
    $
    (12,206
    )Investing activities
    
    
    (101,766
    )
    
    
    (49,423
    )Financing activities
    
    
    753
    
    
    
    1,004
 Operating Activities
  
 
 31




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##### Table of Contents



Investing Activities
   Financing Activities
  Short-Term and Long-Term Liquidity
    
   32




---



##### Table of Contents



Aggregate Contractual Obligations
  Critical Accounting Estimates
  Stock-Based Compensation
  33




---



##### Table of Contents



Recent Accounting Pronouncements
  34




---



##### Table of Contents



Outlook
  
    
    transactions;
    
    changes in Novens or Novogynes accounting or accounting principles (except as
indicated below with respect to Novens method of accounting for stock-based compensation) or
any of the estimates or judgments underlying our critical accounting policies;
    
    regulatory, technological or clinical study developments;
    
    changes in the supply of, demand for, or distribution of our
HT products or Daytrana,
(including any
changes resulting from competitive HT or ADHD products, product recalls, or new HT or ADHD study results);
    
    disruptions in supply of AMI necessary for the production
of Daytrana, whether due to the failure to receive sufficient procurement quota
from the DEA, Shires inability to provide us with AMI or otherwise;
    
    changes in our business relationships/collaborations; or
    
    changes in the economy or the health care sector generally.
  Stock-Based Compensation Expenses.
 Daytrana  
 35




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##### Table of Contents



HT Product Revenues
 Gross Margin.  
 Research and Development.
 Marketing, General and Administrative Expense.
 Novogyne.
 Effective Tax Rate.
 Capital Expenditures
 
 Item 3. Quantitative and Qualitative Disclosure About Market Risk
  
 Item 4. Controls and Procedures
  36




---



##### Table of Contents



37




---



##### Table of Contents



PART II. OTHER INFORMATION
 
 Item 1. Legal Proceedings
 ®
 ®
 ® ®
  ® ®
   
 Item 1A. Risk Factors
  38




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##### Table of Contents



If we are unable to improve our margins on Daytrana  our results of operations will
be adversely affected.
       
 39




---



##### Table of Contents



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  Total Number ofShares
    
    ApproximatePurchased as
    
    Dollar ValuePart of
    
    That May YetTotal Number of
    
    Average Price
    
    Publicly
    
    be PurchasedShares
    
    Paid
    
    Announced
    
    under thePurchased
    
    Per Share
    
    Program
    
    Program(1)April 1, 2006 to
April 30, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    23,711,040May 1, 2006 to
May 31, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    23,711,040June 1, 2006 to
June 30, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    23,711,040Totals
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    23,711,040
 
 (1)
    
    In March 2003, we announced a stock repurchase program authorizing the repurchase of up
to $25.0 million of our Common Stock. There is no expiration date specified for this
program. 
 Item 4. Submission of Matters to a Vote of Security Holders
  1.
    
    Election of Directors
 For
    
    WithheldSidney Braginsky
    
    
    21,220,785
    
    
    
    442,153John G. Clarkson, M.D.
    
    
    21,439,298
    
    
    
    223,640Donald A. Denkhaus
    
    
    21,547,119
    
    
    
    115,819Pedro P. Granadillo
    
    
    21,480,199
    
    
    
    182,739Robert G. Savage
    
    
    21,480,299
    
    
    
    182,639Robert C. Strauss
    
    
    21,530,540
    
    
    
    132,398Wayne P. Yetter
    
    
    21,533,445
    
    
    
    129,493
 2.
    
    Ratification of the Appointment of Deloitte & Touche LLP as Novens
Independent Registered Public Accounting Firm for 2006
 For
    
    Against
    
    Abstained21,608,167
    
    10,279
    
    44,492
 40




---



##### Table of Contents



Item 6. Exhibits
 10.1
    
    Form of Restricted Stock Agreement (incorporated by reference to Exhibit
10.1 of Novens Form 8-K dated May 22, 2006 (File No. 0-17254))10.2
    
    Changes to Compensation and Reimbursement Practices for Non-employee
Directors (incorporated by reference to Novens Form 8-K dated May 22, 2006 (File
No. 0-17254))31.1
    
    Certification of Robert C. Strauss, President, Chief Executive Officer
and Chairman of the Board, pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Diane M. Barrett, Vice President and Chief Financial
Officer, pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of
the Sarbanes-Oxley Act of 200232.1
    
    Certification of Robert C. Strauss, President, Chief Executive Officer
and Chairman of the Board, pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification of Diane M. Barrett, Vice President and Chief Financial
Officer, pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
 41




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##### Table of Contents



Signatures
  NOVEN PHARMACEUTICALS, INC.Date: August 9, 2006
    
    By:

/s/
Diane M.
BarrettDiane M. BarrettVice President andChief Financial Officer
 42