• A review of certain items that may affect the historical or future comparability of our consolidated results of operations;

• An analysis of our consolidated results of operations and our liquidity and capital resources; and

• An outlook that includes our current financial guidance for 2009.

This discussion should be read in conjunction with Noven's Unaudited Condensed Consolidated Financial Statements for the three months ended March 31, 2009 and 2008 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 Form 10-K. 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 Unaudited Condensed Consolidated Financial Statements and related notes included in this Form 10-Q.
For the 2009 Quarter, we reported net income of $4.5 million ($0.18 diluted earnings per share), compared to net income of $2.6 million ($0.11 diluted earnings per share) for the 2008 Quarter. Our net revenues in the 2009 Quarter were $27.6 million, a 29% increase over the 2008 Quarter. Contributing to this comparative increase, net revenues in the 2008 Quarter were negatively affected by an equipment failure in transdermal manufacturing. The increase in net revenues in the 2009 Quarter also reflected higher license and contract revenues, primarily due to amortization of deferred revenue from the additional Daytrana® sales milestone payment (received in the third quarter of 2008), as well as product sales of Stavzor®(commercially launched in August 2008).
Gross margin, as a percentage of net product revenues, was 47% in the 2009 Quarter compared to 30% in the 2008 Quarter. Gross margin for the 2009 Quarter benefited from new manufacturing processes and procedures implemented in the fourth quarter of 2008 designed to improve efficiencies associated with transdermal production. Gross margin for the 2008 Quarter was negatively affected by the impact of the equipment failure in transdermal manufacturing, as well as increased quality assurance activities and expenses, primarily related to Daytrana® production. Notwithstanding improvements following implementation of new manufacturing processes, we expect the peel force issue to continue to negatively affect margins unless and until this issue is resolved.
Research and development expenses in the 2009 Quarter increased $1.3 million, or 40%, compared to the 2008 Quarter, primarily reflecting expenses associated with the Mesafem™ Phase 2 clinical study and additional research and development expenses to support our long-term growth objectives. Compared to the 2008 Quarter, selling and marketing expenses increased $0.2 million, or 4%, and general and administrative expenses remained substantially unchanged.
We recognized $7.5 million in equity in earnings of Novogyne in the 2009 Quarter, a decrease of 9% compared to the 2008 Quarter. Net revenues at Novogyne increased 2% to $40.2 million in the 2009 Quarter compared to the 2008 Quarter, reflecting higher gross sales of Vivelle-Dot®, driven primarily by pricing and increased prescription demand, substantially offset by a decrease in sales volume resulting from inventory reductions in the distribution channel. The increase in gross revenues was also partially offset by higher sales deductions for product returns. Demand for Vivelle-Dot® increased for the period, with new and total prescriptions for the product increasing 6% and 3%, respectively, compared to the 2008 Quarter. Novogyne's gross margin percentage for the 2009 Quarter remained substantially unchanged at 80%. Novogyne's selling, general and administrative expenses for the 2009 Quarter were $10.7 million, a 19% increase over the 2008 Quarter, primarily due to the timing of sample shipments and other expenses in support of Vivelle-Dot®. Novogyne's net income for the 2009 Quarter decreased 6% to $21.5 million compared to the 2008 Quarter.

At March 31, 2009, we had $72.2 million in cash and cash equivalents and $11.8 million in investments in auction rate securities. This compares to $62.9 million in cash and cash equivalents and $15.5 million in investments in auction rate securities at December 31, 2008. Our investments in auction rate securities at March 31, 2009 had a fair value of $11.8 million, and all were classified as non-current on our balance sheet. We liquidated $3.7 million of these investments at par value in the 2009 Quarter. As of March 31, 2009, no amounts were outstanding under our $15.0 million revolving credit facility.
Total prescriptions for Vivelle-Dot® increased 3% in the 2009 Quarter compared to the 2008 Quarter, and total prescriptions for Novogyne's HT products, taken as a whole, increased 1% over the same period. By comparison, the United States HT market declined 5% for the same period. Total prescriptions for Daytrana® decreased 13% in the 2009 Quarter compared to the 2008 Quarter, while prescriptions for ADHD stimulant therapies as a class increased 9% over the same period. Total prescriptions for Pexeva® decreased 21% in the 2009 Quarter compared to the 2008 Quarter, while for the same period prescriptions for the selective serotonin re-uptake inhibitor ("SSRI") class increased 1%. Reflecting ongoing generic substitution, total prescriptions for Lithobid® decreased 32% in the 2009 Quarter compared to the 2008 Quarter. Certain Items that May Affect Historical or Future Comparability Set forth below are certain items that may affect the historical or future comparability of our consolidated results of operations and financial condition. Such disclosure is not intended to address every item that may affect the historical or future comparability of our consolidated results of operations or financial condition and such disclosure should be read in conjunction with the discussion and analysis of our consolidated results of operations, liquidity and capital resources and outlook appearing elsewhere in this Item 2. Daytrana®
Daytrana® is our transdermal methylphenidate system for the treatment of ADHD, which we have licensed globally to Shire. We and Shire have received reports from some consumers concerning the difficulty of removing the release liner from certain Daytrana® patches. In the first quarter of 2007, we, together with Shire, implemented enhancements to the Daytrana® release liner. While the enhanced release liner has reduced the level of consumer reports, some patients and caregivers continue to have difficulty in removing the release liner from some Daytrana® patches.
In July 2007, we received from the FDA a list of observations on Form 483 following an on-site inspection of our manufacturing facilities. The majority of the observations in the Form 483 related to the Daytrana® patch and difficulties experienced by some patients in removing the release liner, including certain product lots that utilize the enhanced release liner. In July 2007, we submitted to the FDA our response to the Form 483.
In the third quarter of 2007, Shire initiated two voluntary recalls of a portion of the Daytrana® product on the market primarily in response to feedback from patients and caregivers who experienced difficulty removing the release liner from some Daytrana®patches. We paid Shire $3.3 million in February 2008 related to those recalls. This payment was charged to operations in 2007.
In January 2008, we received a warning letter from the FDA in connection with the FDA's July 2007 inspection of our manufacturing facilities. In the warning letter, which is posted at the FDA's website, the FDA cited Current Good Manufacturing Practice deficiencies related to: (i) peel force specifications for removal of Daytrana's® release liner; and (ii) data supporting the peel force characteristics of Daytrana's® enhanced release liner throughout the product's shelf life. We submitted our response to the warning letter on January 30, 2008, which remains under review by the FDA.

In April 2008, a Noven stability protocol identified certain Daytrana® lots exhibiting high peel force characteristics. In June 2008, Shire initiated the voluntary recall of two lots of Daytrana® that did not meet the product's release liner removal specification. In August 2008, Shire initiated the voluntary recall of two additional lots of Daytrana® that did not meet the product's release liner removal specification. During 2008, we paid Shire $3.7 million related to its June and August 2008 recalls, of which approximately $3.1 million has been charged to general and administrative expenses, $0.4 million was recorded as a reduction in revenues and $0.2 million was charged to cost of products sold in 2008. For each of the recalls described above, the amount charged to general and administrative expenses represents amounts we are obligated to reimburse Shire for direct costs of the recalls, the amounts reflected as reductions of revenue represent the amounts recognized for product which is expected to be returned and the charge to cost of product sold represents the value of AMI included in such product for which we are required to reimburse Shire.
In the fourth quarter of 2008, we implemented: (i) new product release testing intended to predict which Daytrana® lots are at risk of developing peel force issues during the product's shelf life; and (ii) new manufacturing processes and procedures that helped improve efficiencies associated with existing Daytrana® production. Product that fails to meet the predictive release test will be destroyed, which will result in increased Daytrana®manufacturing costs, including reimbursements to Shire for the AMI included in the destroyed product. In the 2009 Quarter, Daytrana® cost of products sold exceeded our Daytrana® net revenues by $0.7 million. Although we have implemented new manufacturing processes and procedures that helped improve efficiencies associated with existing Daytrana® production in the fourth quarter of 2008, we expect the peel force issue to continue to negatively affect margins as a result of increased Daytrana® manufacturing costs, including reimbursements to Shire for the AMI included in destroyed product, unless and until the peel force issue is resolved.
In March 2009, Shire initiated a voluntary recall of certain lots of Daytrana® due to the failure of some of the patches to meet the product's release liner removal specification. We believe the reserve established in 2008 ($3.7 million at March 31, 2009) will be sufficient to cover our cost related to this recall. Although the new release testing is designed to reduce the likelihood that newly-manufactured product will be withdrawn or recalled in the future, we cannot assure that our predictive release testing will detect all production issues or that there will not be future Daytrana® market withdrawals or recalls.
In January 2009, we received from the FDA a list of observations on Form 483 following an on-site inspection of our manufacturing facilities. Like the warning letter and the prior Form 483, the majority of the observations in the Form 483 relate to the manufacture of Daytrana® product that exhibits high peel force characteristics, an issue which Noven and Shire continue to work to resolve. In February 2009, we submitted our response to the Form 483.
We believe we have identified the root cause of the peel force issue, and are testing manufacturing solutions intended to address the issue. Implementation of a solution will require the prior agreement of the FDA. We estimate that the steps necessary to begin manufacturing commercial product incorporating a solution, including obtaining the FDA's agreement, may carry over into 2010. We cannot assure, however, that we will receive the FDA's agreement on a timely basis or at all. Noven's January 2008 response to the warning letter remains under review by the FDA.
In March 2009, Shire announced its withdrawal of the European Marketing Authorization Application ("MAA") for Daytrana®. Shire indicated that its decision to withdraw the MAA was based on the fact that European regulatory authorities had requested an additional clinical study for Daytrana® in a European patient population, and that Shire planned to enter the European ADHD market through its previously-announced pending acquisition of an oral methylphenidate product that is already approved in Europe.

Results of Operations
As discussed in Note 15 - "Segment Data" to our Unaudited Condensed Consolidated Financial Statements, we operate in three segments distinguished along product categories and nature of the business unit: (i) Noven Transdermals, which currently engages in the manufacturing, licensing and sale to partners of prescription transdermal products; (ii) Novogyne, our women's health joint venture with Novartis in which we own a 49% equity interest; and
(iii) Noven Therapeutics, which currently engages in the marketing and sale of pharmaceutical products. 2009 Quarter compared to the 2008 Quarter Revenues Our revenues by segment and type for the 2009 Quarter and the 2008 Quarter are summarized as follows (dollar amounts in thousands):

                                         Three Months Ended March 31,
                                           2009                 2008          % Change
   Noven Transdermals
   Novogyne:
   Product sales                      $        5,480       $        2,431           125 %
   Royalties                                   2,222                2,180             2 %

   Product revenues - Novogyne                 7,702                4,611            67 %

   Third Parties:
   Product sales                               7,004                5,801            21 %
   Royalties                                      71                   79           -10 %

   Product revenues - third parties            7,075                5,880            20 %

   Total product revenues                     14,777               10,491            41 %
   License and contract revenues               6,289                5,286            19 %

   Total Transdermals                         21,066               15,777            34 %


   Noven Therapeutics
   Third Parties:
   Product sales                               6,574                5,705            15 %


   Net Revenues                       $       27,640       $       21,482            29 %

Net Revenues
As described in more detail below, our net revenues in the 2009 Quarter were $27.6 million, an increase of 29% compared to $21.5 million reported in the 2008 Quarter. The increase was primarily due to a $4.3 million increase in product revenues from our Noven Transdermals segment comprised primarily of a $2.9 million increase in sales of Vivelle-Dot® and a $1.2 million increase in transdermal product revenues from third parties in the 2009 Quarter. This increase was also due to a $1.0 million, or 19%, increase in license and contract revenues and a $0.9 million increase in product revenues from our Noven Therapeutics segment compared to the 2008 Quarter. Product Revenues - Novogyne
Product revenues - Novogyne consists of our sales of Vivelle-Dot®/Estradot® and CombiPatch® to Novogyne at a fixed price for resale and product sampling by Novogyne primarily in the United States as well as the royalties we receive as a result of Novogyne's sales of Vivelle-Dot®.

The $3.1 million increase in Novogyne product revenues for the 2009 Quarter compared to the 2008 Quarter was primarily due to the impact of an equipment failure in transdermal manufacturing which negatively affected product revenues in the 2008 Quarter, as well as the timing of orders from Novogyne. By product, Vivelle-Dot® increased $2.9 million primarily due to the equipment failure in the 2008 Quarter and CombiPatch® increased $0.3 million primarily due to the timing of orders.
Product Revenues - Third Parties
Product revenues - third parties primarily consist of: (i) sales of Estradot® and Estalis® HT patches to Novartis Pharma at a price based on a percentage of Novartis Pharma's net selling price (subject to certain minimum amounts) for resale primarily outside the United States and Japan, together with royalties generated from Novartis Pharma's sales of Estradot® in Canada; (ii) sales of Daytrana® to Shire for commercial resale in the United States; (iii) sales of Pexeva® and Lithobid® to trade customers, including wholesalers, distributors and chain pharmacies; and (iv) beginning in August 2008, sales of Stavzor® to trade customers, including wholesalers, distributors and chain pharmacies.
The $1.2 million increase in product revenues - third parties in our Noven Transdermals segment for the 2009 Quarter compared to the 2008 Quarter primarily consisted of a $0.8 million increase in unit sales and a $0.4 million increase related to pricing. The increase in unit sales was primarily due to the impact of an equipment failure in transdermal manufacturing which occurred in the 2008 Quarter, as well as the timing of orders from Novartis Pharma. With respect to pricing, we recognize the benefit from price increases for our third party HT product through periodic price reconciliation payments received from Novartis Pharma. We receive such payments from time to time upon Novartis Pharma's determination that its actual sales price of our product entitles us to receive amounts in excess of the minimum transfer price at which we initially sold the product to Novartis Pharma. We recognized $1.6 million and $1.2 million of such payments in the 2009 Quarter and 2008 Quarter, respectively.
Noven Therapeutics generated $6.6 million of net revenues in the 2009 Quarter from sales of Stavzor®, Pexeva® and Lithobid® compared to $5.7 million of net revenues in the 2008 Quarter from sales of Pexeva® and Lithobid®. By product, the addition of Stavzor® contributed to $0.7 million of the increase, Lithobid® increased $0.5 million due to the timing of orders from trade customers as prescriptions have declined. The increase in net revenues was partially offset by a $0.3 million decrease in net revenues for Pexeva® primarily due to lower prescriptions.
We sell Stavzor® to pharmaceutical wholesalers and chain drug stores. These companies have the right to return Stavzor® for up to one year after product expiration. As a result of the commercial launch of Stavzor® in the third quarter of 2008, we do not yet have sufficient sales history to reasonably estimate product returns of Stavzor®. Our customers are no longer permitted to return the product once it has been dispensed. Under SFAS No. 48, we cannot recognize revenue on product shipments until we can reasonably estimate returns relating to these shipments. In accordance with SFAS No. 48, we have deferred recognition of revenue on product shipments of Stavzor® to our customers until such time as Stavzor® units are dispensed through patient prescriptions. We estimate the volume of prescription units dispensed at pharmacies based on data provided by external, independent sources. These sources poll pharmacies, hospitals, mail order and other retail outlets for Stavzor® prescriptions and project this sample on a national level. We will recognize revenue based on prescription units dispensed until we have sufficient sales history to reasonably estimate product returns. We recognized $0.7 million of net revenues for Stavzor® in the 2009 Quarter, and $1.6 million of deferred product revenue relating to Stavzor® was reflected on our Condensed Consolidated Balance Sheet as of March 31, 2009.
License and Contract Revenues
License revenues consist of the recognition of non-refundable up-front, milestone and similar payments under license agreements. Contract revenues consist of the recognition of payments received as work is performed on research and development projects. The payments received may take the form of non-refundable up-front payments, payments received upon the completion of certain phases of development work and success milestone payments.

License and contract revenues increased $1.0 million for the 2009 Quarter compared to the 2008 Quarter, primarily attributable to a $1.3 million increase in amortization of milestone payments received from Shire related to the license of Daytrana®, partially offset by a $0.4 million decrease in contract revenues during the 2009 Quarter due to the timing of work performed on research and development projects.
Gross to Net Revenues
We record revenues net of sales allowances for rebates, chargebacks, cash and other discounts, as well as sales returns allowances. We establish return allowances on product sold through our Noven Transdermals segment when it is probable that such product will be recalled or withdrawn. Sales returns allowances in our Noven Therapeutics segment represent allowances for estimated product returns based on expiration dating and are estimated based on historical return rates, current sales levels and other factors on a product-by-product basis. The following table sets forth the reconciliation of our gross revenues to net revenues for the 2009 Quarter and 2008 Quarter, respectively (dollar amounts in thousands):

                                                             Three Months Ended March 31,
                                                                  % of                            % of
                                                                 gross                           gross
                                                 2009           revenues         2008           revenues
Noven Transdermals:
Gross revenues                                 $ 21,135             100 %      $ 16,013             100 %
Sales returns allowances                            (69 )             0 %          (236 )             1 %


Net revenues                                   $ 21,066             100 %      $ 15,777              99 %


Noven Therapeutics:
Gross revenues                                 $  9,531             100 %      $  9,508             100 %
Cash discounts                                     (172 )             2 %          (192 )             2 %
Medicaid, Medicare & State program
rebates and credits including redemption
offers                                           (2,038 )            21 %        (2,289 )            24 %
Chargebacks                                        (163 )             2 %          (267 )             3 %
Wholesaler fees                                    (389 )             4 %          (594 )             6 %
Sales returns allowances                           (195 )             2 %          (461 )             5 %

Sales and returns allowances                     (2,957 )            31 %        (3,803 )            40 %


Net revenues                                   $  6,574              69 %      $  5,705              60 %

The decrease in Medicaid, Medicare & state program rebates and credits for Noven Therapeutics (as a percentage of gross revenues) is attributable to our decision not to renew unprofitable managed care contracts. The decrease in sales returns allowances for Noven Therapeutics (as a percentage of gross revenues) was primarily attributable to a decrease in return reserves for Lithobid® due to lower actual returns of product.
Gross Margin
This section discusses gross margins relating to our product revenues:
(i) across all of our products ("Overall Gross Margin"); (ii) on our transdermal product revenues from Novogyne ("Gross Margin - Novogyne"), which for accounting purposes is considered a related party; (iii) on our transdermal product revenues from third parties ("Gross Margin - Third Parties"); and (iv) on our Noven Therapeutics products.

For our Noven Transdermals segment, the allocation of manufacturing expenses impacts our determination of inventory costs and, consequently, gross margins for each of our products. Manufacturing expenses, which totaled $7.0 million and $7.9 million in the 2009 Quarter and the 2008 Quarter, respectively, include compensation and benefits, supplies and tools, equipment costs, depreciation and amortization, and insurance costs, and represent a substantial portion of our inventory production costs. The allocation of manufacturing expenses among manufactured products requires us to make significant estimates that involve subjective and often complex judgments. Using different estimates would likely result in materially different results for Gross Margin - Novogyne and Gross Margin - Third Parties than are presented in the gross margin table below.
Our gross margins are summarized as follows (dollar amounts in thousands):

                                              Three Months Ended March 31,
                                               2009                   2008
            Noven Transdermals
            Novogyne:
            Product revenues            $    7,702              $  4,611
            Cost of products sold            3,648                 3,326

            Gross profit                     4,054       53 %      1,285       28 %


            Third parties:
            Product revenues                 7,075                 5,880
            Cost of products sold            5,737                 5,947

            Gross profit (loss)              1,338       19 %        (67 )     -1 %


            Total Noven Transdermals:
            Product revenues                14,777                10,491
            Cost of products sold            9,385                 9,273

            Gross profit                     5,392       36 %      1,218       12 %


            Noven Therapeutics
            Product revenues                 6,574                 5,705
            Cost of products sold            2,031                 2,036

            Gross profit                     4,543       69 %      3,669       64 %


            Total Company
            Product revenues                21,351                16,196
            Cost of products sold           11,416                11,309

            Gross profit                $    9,935       47 %   $  4,887       30 %

In general, Noven Therapeutics' products have higher gross margins than our transdermal products because we sell Noven Therapeutics' products directly to trade customers at wholesale and commercial prices. Our sales of HT products to Novogyne for resale in the United States have a higher gross margin than our other transdermal products, reflecting favorable pricing, larger production orders and other factors. Our sales of HT products to Novartis Pharma for resale in international markets generally have lower gross margins than sales of HT products sold to Novogyne due to, among other things, unfavorable pricing environments in foreign markets, and smaller production orders. Our gross margin on product sales of Daytrana® to Shire has been negatively affected by the factors described below.

. . .