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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K



|[X] |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934    
|--- |  | ----------------------------------------------------------------------------------------
|   
|    |  | For the Fiscal Year Ended December 31, 2002                                             
|   
|    |  | OR                                                                                      
|   
|[ ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the transition period from  to

Commission File Number 000-23467

PENWEST PHARMACEUTICALS CO.(Exact name of registrant as specified in its charter)

|                                                                                                                                                                         |  |                                                                          
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -------------------------------------------------------------------------
|Washington
(State or other jurisdiction of
incorporation or organization)
 
39 Old Ridgebury Road
Suite 11
Danbury, Connecticut
(Address of principal Executive Offices) |  | 91-1513032
(I.R.S. Employer
Identification No.)
 
 
06810-5120
(Zip Code)

Registrants telephone number, including area code: (877) 736-9378

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock, $.001 par value
(Including Associated Preferred Stock Purchase Rights)

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 at least the past 90 days.  Yes [X]    No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K.  [  ]

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

The aggregate market value of the Registrants Common Stock held by
non-affiliates as of June 28, 2002 was approximately $302 million based on the
last sale price of the Registrants Common Stock on the Nasdaq National Market.
The number of shares of the Registrants Common Stock outstanding as of March
20, 2003 was 15,510,880.

DOCUMENTS INCORPORATED BY REFERENCE

The Registrants definitive Proxy Statement relating to the 2003 Annual Meeting
of Shareholders to be held on June 4, 2003 is incorporated by reference into
portions of Part III of this Form 10-K.





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TABLE OF CONTENTS



|                                                                                                        |  |  |  |  |  |  |  | 
|------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  |  | 
|PART I                                                                                                 
|ITEM 1: BUSINESS                                                                                       
|ITEM 2: PROPERTIES                                                                                     
|ITEM 3: LEGAL PROCEEDINGS                                                                              
|ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                            
|ITEM 4a: EXECUTIVE OFFICERS OF THE REGISTRANT                                                          
|PART II                                                                                                
|ITEM 5: MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANTS COMMON STOCK AND RELATED SHAREHOLDER MATTERS 
|ITEM 6: SELECTED FINANCIAL DATA                                                                        
|ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS          
|ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                    
|ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                    
|ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE           
|PART III                                                                                               
|ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                            
|ITEM 11: EXECUTIVE COMPENSATION                                                                        
|ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                
|ITEM 14: CONTROLS AND PROCEDURES                                                                       
|PART IV                                                                                                
|ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                              
|SIGNATURES                                                                                             
|Certifications                                                                                         
|REPORT OF INDEPENDENT AUDITORS                                                                         
|CONSOLIDATED BALANCE SHEETS                                                                            
|CONSOLIDATED STATEMENTS OF OPERATIONS                                                                  
|CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY                                                        
|CONSOLIDATED STATEMENTS OF CASH FLOWS                                                                  
|EX-23 Consent of Ernst and Young LLP                                                                   
|EX-99.1 Section 906 Certification of CEO                                                               
|EX-99.1 Section 906 Certification of CFO                                                               



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PENWEST PHARMACEUTICALS CO.
INDEX TO FORM 10-K

|               |                                                                                                |  |      |    | 
|-------------- | ---------------------------------------------------------------------------------------------- |  | ---- | -- | 
|               |                                                                                                |  | Page
|               |                                                                                                |  |     
|PART I         |                                                                                                |  |      |    | 
|Item 1.        | Business                                                                                       |  |      | 1  | 
|Item 2.        | Properties                                                                                     |  |      | 11 | 
|Item 3.        | Legal Proceedings                                                                              |  |      | 11 | 
|Item 4.        | Submission of Matters to a Vote of Security Holders                                            |  |      | 11 | 
|Item 4a.       | Executive Officers of the Registrant                                                           |  |      | 12 | 
|PART II        |                                                                                                |  |      |    | 
|Item 5.        | Market
Price of and Dividends on the Registrants Common Stock and Related Stockholder Matters |  |      | 12 | 
|Item 6.        | Selected Financial Data                                                                        |  |      | 13 | 
|Item 7.        | Managements Discussion and Analysis of Financial Condition and Results of Operations          |  |      | 14 | 
|Item 7a.       | Quantitative and Qualitative Disclosures About Market Risk                                     |  |      | 28 | 
|Item 8.        | Financial Statements and Supplementary Data                                                    |  |      | 28 | 
|Item 9.        | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           |  |      | 28 | 
|PART III       |                                                                                                |  |      |    | 
|Item 10.       | Directors and Executive Officers of the Registrant                                             |  |      | 28 | 
|Item 11.       | Executive Compensation                                                                         |  |      | 28 | 
|Item 12.       | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |  |      | 29 | 
|Item 13.       | Certain Relationships and Related Transactions                                                 |  |      | 29 | 
|Item 14.       | Controls and Procedures                                                                        |  |      | 29 | 
|PART IV        |                                                                                                |  |      |    | 
|Item 15.       | Exhibits, Financial Statement Schedules and Reports on Form 8-K                                |  |      | 29 | 
|Signatures     |                                                                                                |  | 31   |   
|Certifications |                                                                                                |  | 32   |   

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PART I




ITEM 1: BUSINESS

Overview

Penwest develops pharmaceutical products based on innovative oral drug
delivery technologies. The foundation of Penwests technology platform is
TIMERx, an extended release delivery system that is adaptable to soluble and
insoluble drugs, and that is flexible for a variety of controlled release
profiles. The Company has also developed two additional oral drug delivery
systems, Geminex and SyncroDose. Geminex is a dual drug delivery system that
is designed to provide independent release of different active ingredients
contained in a drug, and SyncroDose is a chronotherapeutic drug delivery system
that is designed to release the active ingredient of a drug at the desired site
and time in the body.

Penwests product portfolio includes four products utilizing its
proprietary controlled release drug delivery technology, that were developed
with collaborators and have been approved in various countries. In addition,
the Company has a number of product candidates in its drug development
pipeline. The most advanced of these is oxymorphone ER, an extended release
formulation of oxymorphone incorporating TIMERx technology. The Company is
developing oxymorphone ER with Endo Pharmaceuticals Inc. The FDA accepted for
filing a new drug application, or NDA, submitted by Endo for oxymorphone ER in
February 2003.

Prior to February 27, 2003, Penwest also developed, manufactured and
distributed branded pharmaceutical excipients, which are the inactive
ingredients in tablets and capsules, primarily consisting of binders,
disintegrants and lubricants. On February 27, 2003, Penwest sold substantially
all of the assets used in the Companys excipient business to subsidiaries and
affiliates of Josef Rettenmaier Holding GmbH & Co. KG. The Company received
$39.5 million in cash and a promissory note for $2.25 million in consideration
for the excipient business.

Penwest Strategy

Penwests strategy is to develop pharmaceutical products utilizing the
Companys innovative extended release oral drug delivery technologies.



| |  |  | Leverage its drug delivery technologies into a portfolio of product
candidates for development.The Company believes that it has
significant expertise in drug formulation and in oral drug delivery
technologies. The Companys proprietary drug delivery technologies,
TIMERx extended release, Geminex dual delivery and SyncroDose
chronotherapeutic delivery, are applicable to a wide range of drugs with
different physical and chemical properties including water soluble and
insoluble drugs as well as high dose and low dose drugs. Using these
technologies, the Company can formulate drugs with precise release
profiles. In selecting product candidates for development, the Company
focuses on opportunities in which its drug delivery technologies can
provide benefits to patients and result in branded, proprietary
products. The Company does not limit the products it develops by
therapeutic area.                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Expand the product development pipeline to include drugs in various
stages of development.The Company intends to aggressively add product
candidates into its development pipeline and control more of the
clinical development process. Historically, the Company has formulated
product candidates and then relied upon third party collaborators to
complete the remainder of the clinical development program and market
the drugs. Although the Company will still have a portion of its product
portfolio it intends to out-license early on, the Company intends to
develop more products on its own or jointly in collaboration with third
parties. The Company has identified several product candidates that are
in the formulation stage or in clinical trials for which the Company
intends to complete the clinical trials through at least Phase II. The
Company believes that by controlling development through at least Phase
II, it will be better able to control the development timelines of its
portfolio of product candidates. The Company expects to continue to seek
to license at an early stage in the development process generic product
candidates, product candidates for which the Company believes that the
development process is too expensive or too risky and product candidates
that require early marketing input.
|
| |  |  | Increase participation in the funding of drug development to capture
an increased share of the economic value of the product when and if it
is marketed.Developing pharmaceutical products is expensive. If the
Company develops products on its own or jointly with third parties, it
will need to devote significant resources to the products. However, the
Company believes by assuming a larger role in the funding of a products
development, it will receive a greater share of the returns from the
product.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

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| |  |  | Expand the core drug delivery technologies.The Companys expertise
is in oral drug delivery technologies and drug formulation. The Company
intends to continue to develop its core technologies as well as to seek
to develop, in-license or acquire new technologies that are synergistic
with its product development pipeline.                                                                                                                                                                                                                                                                                                  
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Establish collaborations for development, manufacturing and
marketing.The Company does not anticipate establishing manufacturing
or sales and marketing capabilities in the next few years. As a result,
in addition to seeking to enter into collaborations to develop its
products, the Company also expects to seek to enter into collaborations
for the manufacturing and the selling and marketing of its products. The
Company is a party to collaborative agreements with Endo, Leiras OY,
Mylan Pharmaceuticals Inc., Sanofi-Synthelabo S.A., IVAX
Pharmaceuticals, First Horizon, Ranbaxy Laboratories, Ltd. and E. Merck.

Drug Delivery Technologies and Products

TIMERx® Extended Release Delivery Systems

The Company developed its TIMERx delivery system to address the
limitations of currently available oral extended release delivery systems. The
Company believes that the TIMERx system has advantages over other oral drug
delivery technology, as it is readily manufactured, adaptable to soluble and
insoluble drugs and flexible for a variety of controlled release profiles.
Pharmaceutical products containing TIMERx have been approved and are being
marketed, and the Company is developing additional products in its pipeline
using TIMERx.

The patented TIMERx drug delivery system is based on a hydrophilic matrix
combining a heterodispersed mixture primarily composed of two polysaccharides,
xanthan and locust bean gums, in the presence of dextrose. The gums are also
used in Penwests Geminex and SyncroDose drug delivery systems. The physical
interaction between these components works to form a strong, binding gel in the
presence of water. Drug release is controlled by the rate of water penetration
from the gastrointestinal tract into the TIMERx gum matrix, which expands to
form a gel and subsequently releases the active drug substance. The TIMERx
system can precisely control the release of the active drug substance in a
tablet by varying the proportion of the gums, together with the tablet coating
and the tablet manufacturing process. Drugs using TIMERx technology are
formulated by combining the active drug substance, the TIMERx drug delivery
system and additional excipients and compressing such materials into a tablet.

Marketed and Approved Products

To date, several drug formulations utilizing the TIMERx system have
received regulatory approval:



| |  |  | Cystrin CR, an extended release version of oxybutynin for the
treatment of urge urinary incontinence, is being marketed in Finland by
Leiras.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Slofedipine XL, an extended release version of nifedipine for the
treatment of angina, is being marketed in the United Kingdom and Italy
by Sanofi.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  |  | In December 1999, the FDA approved the 30 mg strength of Nifedipine
XL, a generic version of Procardia XL that is used for the treatment of
hypertension and angina. The 30 mg strength of Nifedipine XL is not
being marketed in the United States by the Companys collaborator Mylan.
In March 2000, Mylan signed a supply and distribution agreement with
Pfizer, Inc. to market a generic version of all three strengths (30 mg,
60 mg, 90 mg) of Pfizers Procardia XL. In connection with that
agreement, Mylan agreed to pay Penwest a royalty on net sales of
Pfizers 30 mg strength of generic Procardia XL. The royalties are
comparable to those called for in Penwests original agreement with
Mylan for Nifedipine XL. Mylan has retained the marketing rights to the
30 mg strength of Nifedipine XL.
|
| |  |  | Cronodipin, an extended release version of nifedipine for the
treatment of angina, is being marketed in Brazil by Merck S.A.
Industries Quimicas.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

Products in Pipeline

The Company also has a number of TIMERx products in its development
pipeline. The most advanced of these is an extended release formulation of
oxymorphone incorporating TIMERx technology, oxymorphone ER, which the Company
is developing with Endo. Oxymorphone ER is a narcotic analgesic that is being
developed for the treatment of moderate to severe pain. Oxymorphone,

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which is
currently given in the parenteral and suppository dosage form, is marketed by
Endo and had sales in the United States in 2002 of approximately $150,000.
Oxymorphone ER, if successfully developed, would represent the first oral
extended release version of oxymorphone and would compete in the moderate to severe
 long acting opioid market with products such as MS Contin, Purdue
Pharmas OxyContin® and Johnson & Johnsons Duragesic® patch, which had
aggregate sales in the United States in 2002 of approximately $2.5 billion.
Oxymorphone ER is being developed for twice-a-day dosing in patients suffering
moderate to severe pain. Endo, which is responsible for conducting the clinical
trials and seeking regulatory approval of the product, submitted the NDA to the
FDA in December 2002. The FDA accepted for filing the NDA submitted by Endo for
oxymorphone ER in February 2003.

The table below summarizes the principal products in the Companys drug
development pipeline, the therapeutic use, the development status of each
product and the Companys collaborator, if any, on each product:

|               |  |                                |  |                         |  |                               |  |  |  |  |  | 
|-------------- |  | ------------------------------ |  | ----------------------- |  | ----------------------------- |  |  |  |  |  | 
|PRODUCT        |  | INDICATION                     |  | DEVELOPMENT STATUS      |  | COLLABORATOR                 
|              
|OXYMORPHONE ER |  | Moderately Severe/Severe Pain  |  | NDA Accepted for Filing |  | Endo Pharmaceuticals         
|              
|PW3101         |  | Asthma                         |  | NDA Accepted for Filing |  | Ivax                         
|              
|METFORMIN ER   |  | Type II Diabetes               |  | Bioequivalence Studies  |  | Internal Development         
|              
|OXYBUTYNIN ER  |  | Urinary Incontinence           |  | Bioequivalence Studies  |  | Internal Development         
|              
|PW1101         |  | Chemo-induced Ermesis          |  | Pre-clinical            |  | Internal Development         
|              
|PW2101         |  | Hypertension                   |  | Phase I                 |  | Internal Development         
|              
|PW4102         |  | Neuropathic pain               |  | Pre-clinical            |  | Internal Development         
|              
|PW4103         |  | Menstrual Migraine Prophylaxis |  | Phase I                 |  | Internal Development         
|              
|PW4146         |  | Migraine Prophylaxis           |  | Phase II                |  | First Horizon Pharmaceuticals
|              
|PW9101(AD121)  |  | Rheumatoid Arthritis           |  | Phase I                 |  | Arakis, Ltd.                 
|              

GeminexTM Dual Release Technology

The Company developed its Geminex dual release technology to provide for
the independent release of different active ingredients contained in one
pharmaceutical product. The release of the active ingredients can each involve
two different controlled release profiles or involve controlled release and
immediate release profiles. The technology is based on a bi-layer tablet that
utilizes TIMERx in the controlled release layer. The Company is utilizing
Geminex technology in several product candidates that are currently in the
formulation stage.

SyncroDoseTM Chronotherapeutic Drug Delivery

The Company developed its SyncroDose drug delivery system to deliver drugs
chronotherapeutically in the body. The technology is timed with the bodys
biological clock to customize the delivery of a drug with the intent of
reducing the dose and improving efficacy. SyncroDose is a technology based on
the Companys underlying TIMERx platform. The Company believes that there are
several disease states that can benefit from chronotherapeutic delivery
including: arthritis, cardiovascular disorders, asthma and neurological
disorders. The SyncroDose technology utilizes the TIMERx gum matrix in the
coating combined with the active and various other excipients in the core. The
Company is currently developing a product candidate for rheumatoid arthritis
with Arakis utilizing the SyncroDose chronotherapeutic technology. This
product candidate is in phase I clinical trials.

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Collaborative Arrangements

The Company enters into collaborative agreements with pharmaceutical
companies to develop, market or manufacture products developed with its drug
delivery technologies.

The Company has two primary types of collaborative agreements. In the
first type, research and development are funded by Penwest and its
collaborator, and Penwest receives no up-front licensing fees or milestone
payments. In these arrangements, the Company will share in a pre-determined
percentage of the royalties. The second type of agreement involves the straight
licensing of the Companys technology to the collaborator. The Company has no
obligation to fund the ongoing clinical development or marketing costs of the
product. Under these collaborative agreements, the Company receives up-front
license fees and milestone payments. In addition, under all its current
collaborative arrangements, the Company is entitled to receive royalties on the
sale of the products covered by such collaborative arrangements and payments
for the purchase of formulated TIMERx material. The Companys principal
collaborative arrangements are described below.

Mylan Pharmaceuticals, Inc.

In August 1994, the Company entered into product development and supply
agreements with Mylan with respect to the development of generic versions of
Procardia XL (nifedipine) based on the Companys TIMERx technologies. Mylan is
one of the leading generic pharmaceutical companies in the United States.

On March 2, 2000, Mylan announced that it had signed a supply and
distribution agreement with Pfizer to market a generic version of all three
strengths (30 mg, 60 mg, 90 mg) of Pfizers Procardia XL. In connection with
that agreement, Mylan decided not to market Nifedipine XL and agreed to pay
Penwest a royalty on all future net sales of the 30 mg strength of Pfizers
generic Procardia XL. The royalty percentage was comparable to the percentage
called for in Penwests original agreement with Mylan for Nifedipine XL. Mylan
has retained the marketing rights for the 30 mg strength of Nifedipine XL.
Mylans sales in the United States in 2002 of the 30 mg dosage strength version
of Pfizers generic Procardia XL totaled approximately $34.9 million. The term
of this agreement continues until such time as Mylan permanently ceases to
market generic Procardia XL. In 2002, 2001 and 2000, royalties from Mylan
accounted for approximately 11%, 12% and 19%, respectively, of the Companys
total revenue, and 86%, 82% and 50% of the Companys total revenue that was not
associated with the excipient business that the Company sold in February 2003.

Endo Pharmaceuticals, Inc.

In September 1997, the Company entered into a strategic alliance agreement
with Endo with respect to the development of an extended release formulation of
oxymorphone based on the Companys TIMERx technology, oxymorphone ER. This
agreement was amended and restated in April 2002. Endo is a fully integrated
specialty pharmaceutical company with a market leadership position in pain
management. Endo has a broad product line with 12 branded products, including
established brands such as Percodan® and Percocet®. Endo is registered with
the U.S. Drug Enforcement Administration as a developer, manufacturer and
marketer of controlled narcotic substances.

Under the strategic alliance agreement, the responsibilities of the
Company and Endo with respect to oxymorphone ER are determined by a committee
comprised of an equal number of members from each of the Company and Endo (the
Alliance Committee). During the development of the product, the Company
formulated oxymorphone ER, and Endo conducted all clinical studies and prepared
and filed all regulatory applications. The Company has agreed to manufacture
and supply TIMERx material to Endo, and Endo has agreed to manufacture and
market oxymorphone ER in the United States. The manufacture and marketing of
oxymorphone ER outside of the United States may be conducted by the Company,
Endo or a third party, as determined by the Alliance Committee.

Prior to March 17, 2003, the Company and Endo shared the costs involved in
the development of oxymorphone ER. On March 17, 2003, the Company gave Endo
notice that it is discontinuing its participation in the funding of the
development and marketing of oxymorphone ER. The Company believes that its current strategic
focus should be on funding products in its development pipeline.
As a result of this termination, Endo has the right to complete the development
of oxymorphone ER and recoup the portion of development costs incurred by Endo
that otherwise would have been funded by Penwest. Endo may recoup such
development costs solely through a temporary adjustment in the royalty rate
payable to Penwest which shall return to its pre-adjustment level once Endo has
recovered such costs. The parties have agreed that the party marketing
oxymorphone ER will pay the other party royalties initially equal to 50% of the
net realization (as defined in the agreement). This percentage will decrease if
the aggregate U.S. net realization exceeds pre-determined thresholds. In
general, the royalty payable by the marketing party to the other party will not
drop below 40%. However, the royalty will be reduced by one-third in limited
circumstances, including termination of the agreement based on uncured material
breaches of the agreement by the royalty receiving party and certain bankruptcy
and insolvency events involving the royalty receiving
party. Under the
agreement, Endo will purchase formulated TIMERx material for use in oxymorphone
ER exclusively from the Company at specified prices. Such prices will be
reflected in the determination of net profits.

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Sanofi-Synthelabo S.A.

In February 1997, the Company entered into a product development and
supply agreement with Sanofi with respect to the development of a generic
version of Adalat LA, a drug that utilizes the same controlled release
technology as Procardia XL. This generic version is based on the
Companys TIMERx technology (the Sanofi Product). Sanofi is a research-based
international pharmaceutical company, based in Paris, France, which has a
European infrastructure from which to develop, register and market prescription
pharmaceuticals.

Under the product development and supply agreement, the Company was
responsible for conducting pilot bioequivalence studies of the Sanofi Product
and is responsible for manufacturing and supplying TIMERx material to Sanofi.
Sanofi was responsible for conducting all full scale bioequivalence and
clinical studies, preparing all regulatory applications and submissions and is
responsible for manufacturing and marketing the Sanofi Product in specified
countries in Europe and in South Korea. The Sanofi Product was approved and
Sanofi began marketing the Sanofi Product in the United Kingdom in November
1998. Sanofi also received regulatory approval in Italy in 2000 and is
marketing the product.

The product development and supply agreement expires with respect to each
specified country on the 10th, 13th, 16th or 19th anniversary of the date on
which the Sanofi Product is approved by the relevant regulatory authority in
such country for commercial sale if notice is provided by either party prior to
any of such anniversary dates that the agreement will expire with respect to
such country on such anniversary date. The agreement is also subject to earlier
termination by either party under specified circumstances, including
termination by the Company if Sanofi fails to meet minimum sales volume
requirements and termination by either party upon a material breach of the
agreement by the other party. If the Company does not satisfy its obligations
under the agreement, the Company will be in breach of the agreement and Sanofi
will be entitled to terminate the agreement.

The Company received milestone payments under the product development and
supply agreement. The Company is receiving royalties upon the sale of the
Sanofi Product. One-half of such payments will be paid to Mylan in accordance
with a distribution agreement signed with Mylan. In addition, Sanofi has agreed
that, during the term of the product development and supply agreement, it will
purchase, and Sanofi is purchasing, formulated TIMERx material for use in the
Sanofi Product exclusively from the Company at specified prices.

Leiras Oy

In July 1992, the Company entered into an agreement with Leiras with
respect to the development and commercialization of Cystrin CR, a controlled
release formulation of Cystrin based on the Companys TIMERx technology. In May
1995, the Company entered into a second agreement with Leiras clarifying
certain matters with respect to the collaboration. In addition, during 2001,
the Company reacquired the North American marketing rights to this product.

Under the agreements, the Company was responsible for the development and
formulation of Cystrin CR and is now responsible for supplying TIMERx material
to Leiras for use in the manufacture of Cystrin CR. Leiras is responsible for
preparing all regulatory applications and submissions and manufacturing and
marketing Cystrin CR on a worldwide basis, except for the marketing rights in
North America which have been licensed back to Penwest. Leiras has the right to
transfer its rights and responsibilities under the agreements and its related
product rights for specified territories, subject in certain circumstances to
the approval of the Company. Leiras transferred the European rights to Sanofi,
which is currently not marketing the product. Leiras received marketing
approval for Cystrin CR in Finland in October 1997 and began marketing the
product in Finland in 1998.

The agreements terminate upon the expiration of the TIMERx patents
licensed to Leiras (which will occur in 2014), subject to earlier termination
by either party under specified circumstances, including upon a material breach
of the agreement by a party or upon the bankruptcy of a party. If the Company
does not satisfy its obligations under either of these agreements, the Company
will be in breach of such agreement and Leiras will be entitled to terminate
such agreement. Leiras has also agreed to pay the Company royalties on the sale
of Cystrin CR and to purchase formulated TIMERx material exclusively from the
Company at specified prices.

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Other Collaborations

The
Company is a party to the following additional collaborative
agreements involving its TIMERx technology:



| |  |  | IVAX Pharmaceuticals.The Companys agreement with IVAX
relates to the development of a drug for the treatment of asthma.                                                                           
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | First Horizon.The Companys agreement with First Horizon
relates to the development of a drug for the treatment of migraine
prophylaxis.                                                           
|
| |  |  | Ranbaxy Laboratories Ltd.The Companys agreement with
Ranbaxy relates to an extended release version of nifedipine for the
treatment of angina.                                                    
|
| |  |  | E. Merck.The Companys agreement with E. Merck relates to
an extended release version of nifedipine for the treatment of
angina that is being marketed in Brazil by Merck S.A. Industries
Quimicas.

Research and Development

The Company conducts research and development activities with respect to
additional applications of TIMERx technology, advances in the TIMERx
technology, additional drug delivery technologies, and prior to the sale of the
excipient business additional novel excipients such as ProSolv. The Companys
research and development expenses in 2002, 2001, and 2000 were $17.6 million,
$17.0 million and $12.8 million. The drug delivery business accounted for
approximately 96%, 94% and 94%, respectively, of the Companys research and
development expense for 2002, 2001 and 2000. These expenses do
not include amounts incurred by the Companys collaborators in connection with
the development of products under the collaboration agreements such as expenses
for full-scale bioequivalence studies or clinical trials performed by the
collaborators.

Manufacturing

The Company has outsourced the commercial manufacture of TIMERx materials
to a third-party pharmaceutical company, Draxis Pharmaceuticals, Inc., under a
manufacturing agreement that expires in September 2004. The agreement will
automatically renew for successive one-year periods, unless either party gives
notice of its intent not to renew the contract at least six months prior to the
end of the then-current term. The Company is also currently validating and
finalizing an agreement with a second source. The Company believes that there
are a limited number of manufacturers that operate under cGMP regulations
capable of manufacturing the Companys products. There can be no assurance that
Draxis or any other third parties upon which the Company relies for supply of
its TIMERx material will perform, and any failures by third parties may delay
development or the submission of products for regulatory approval, impair the
Companys collaborators ability to commercialize products as planned and
deliver products on a timely basis, or otherwise impair the Companys
competitive position, which could have a material adverse effect on the
Companys business, financial condition and results of operations.

The Companys drug delivery systems are based on a hydrophilic matrix
combining a heterodispersed mixture primarily composed of two polysaccharides,
xanthan and locust bean gums, in the presence of dextrose. The Company
purchases these gums from a sole source supplier. Although the Company has
qualified alternate suppliers with respect to these gums and to date the
Company has not experienced difficulty acquiring these materials, there can be
no assurance that interruptions in supplies will not occur in the future or
that the Company will not have to obtain substitute suppliers. Any of these
events could have a material adverse effect on the Companys ability to
manufacture bulk TIMERx for delivery to its collaborators, which could have a
material adverse effect on the Companys business, financial condition and
results of operations.

As the Company develops products on its own, the Company has outsourced
and will seek to outsource the clinical and commercial manufacture of such
products to third parties. The Company believes there are many companies which
are capable of manufacturing these products.

Marketing and Distribution

Pursuant to the Companys collaborative agreements, the Companys
collaborators have, or are expected to have, responsibility for the marketing
and distribution of any extended release pharmaceuticals developed based on the
Companys drug delivery technologies. Because the Company does not currently
market any such pharmaceuticals without a collaborator, the Company has not
developed any sales force with respect to such products. As a result, the
Company is substantially dependent on the efforts of its collaborators to
market the products. In selecting a collaborator for a drug candidate, some of
the factors the Company considers include the collaborators market presence in
the therapeutic area targeted by the drug candidate and the collaborators
sales force and distribution network.

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Patents and Proprietary Rights

The Company believes that patent and trade secret protection of its drug
delivery technology is important to its business and that the Companys success
will depend in part on its ability to maintain existing patent protection,
obtain additional patents, maintain trade secret protection and operate without
infringing the proprietary rights of others.

Patents and Protection of Proprietary Information

As of March 20, 2003, the Company has been issued 30 U.S. and 147 foreign
patents, relating to the Companys controlled release drug delivery technology.
The U.S. patents issued to the Company principally cover the Companys TIMERx
technology and new technologies based on the TIMERx technology, including the
combination of the xanthan and locust bean gums, the oral solid dosage form of
TIMERx and the method of preparation, as well as the application (and
combination) of TIMERx technology to various active drug substances, including
both methods of treatment and methods of preparation. All these patents will
expire between 2008 and 2020.

The issuance of a patent is not conclusive as to its validity or as to the
enforceable scope of the claims of the patent. There is no assurance that the
Companys patents or any future patents will prevent other companies from
developing non-infringing similar or functionally equivalent products or from
successfully challenging the validity of the Companys patents. Furthermore,
there is no assurance that:



| |  |  | any of the Companys future processes or products will be patentable;                                                                   
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | any pending or additional patents will be issued in any or all appropriate jurisdictions;                                               
|
| |  |  | the Companys processes or products will not infringe upon the patents of third parties; or                                             
|
| |  |  | the Company will have the resources to defend against charges of
infringement by or protect its own patent rights against third parties.

The inability of the Company to protect its patent rights or infringement by
the Company of the patent or proprietary rights of others could have a material
adverse effect on the Companys business, financial condition and results of
operations.

The Company also relies on trade secrets and proprietary knowledge, which
it generally seeks to protect by confidentiality and non-disclosure agreements
with employees, consultants, licensees and pharmaceutical companies. There can
be no assurance, however, that these agreements have or in all cases will be
obtained, that these agreements will not be breached, that the Company will
have adequate remedies for any breach or that the Companys trade secrets will
not otherwise become known by competitors.

There has been substantial litigation in the pharmaceutical industry with
respect to the manufacture, use and sale of new products that are the subject
of conflicting patent rights. Some of the controlled release products that the
Company is developing with its collaborators are generic versions of brand name
controlled release products that are covered by one or more patents. Under the
Waxman-Hatch Act, when an applicant files an ANDA with the FDA for a generic
version of a brand name product covered by an unexpired patent listed with the
FDA, the applicant must certify to the FDA that such patent will not be
infringed by the applicants product or that such patent is invalid or
unenforceable. Notice of such certification must be given to the patent owner
and the sponsor of the NDA for the brand name product. If a patent infringement
lawsuit is filed within 45 days of the receipt of such notice, the FDA will
conduct a substantive review of the ANDA, but will not grant final marketing
approval of the generic product until a final judgment on the patent suit is
rendered in favor of the applicant or until 30 months (or such longer or
shorter period as a court may determine) have elapsed from the date of the
certification, whichever is sooner. Should a patent owner commence a lawsuit
with respect to alleged patent infringement by the Company or its
collaborators, the uncertainties inherent in patent litigation make the outcome
of such litigation difficult to predict. The Companys collaborators are
responsible for all legal costs under Waxman-Hatch lawsuits. The Company
evaluates the probability of patent infringement litigation with respect to its
collaborators ANDA submissions on a case by case basis. The delay in obtaining
FDA approval to market the Companys product candidates as a result of
litigation, whether or not the Company is successful, could have a material
adverse effect on the Companys business, financial condition and results of
operations.

Trademarks.TIMERx is a registered trademark of the Company. Geminex and
SyncroDose are also trademarks of the Company. Other tradenames and trademarks
appearing in this annual report are the property of their respective owners.

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Government Regulation

FDA Regulation of Pharmaceutical Products

All pharmaceutical manufacturers are subject to extensive regulation by
the federal government, principally the FDA, and, to a lesser extent, by state
and local governments. The Federal Food, Drug and Cosmetic Act (the FDCA) and
other federal statutes and regulations govern or influence the development,
testing, manufacture, safety, labeling, storage, record keeping, approval,
advertising, promotion, sale and distribution of prescription products.
Pharmaceutical manufacturers are also subject to certain record keeping and
reporting requirements, establishment registration, product listing and FDA
inspections.

Drugs can be approved by the FDA based on three types of marketing
applications: an NDA, an ANDA or a license application under the Public Health
Service Act. A full NDA must include complete reports of preclinical, clinical
and other studies to prove adequately that the product is safe and effective
for its intended use. The FDCA also provides for NDA submissions that may rely
in whole or in part on publicly available clinical and other data on safety and
efficacy under section 505(b)(2) of the FDCA. These types of NDAs may be
appropriate for certain drugs containing previously approved active ingredients
but differing with regard to other characteristics such as indications for use,
dosage form or method of delivery.

As an initial step in the FDA regulatory approval process for an NDA,
preclinical studies are typically conducted in animal models to assess the
drugs efficacy and to identify potential safety problems. The results of these
studies must be submitted to the FDA as part of an Investigational New Drug
Application, which must be reviewed by the FDA before proposed clinical testing
can begin. Typically, clinical testing involves a three-phase process. Phase I
trials are conducted with a small number of subjects and are designed to
provide information about both product safety and the expected dose of the
drug. Phase II trials are designed to provide additional information on dosing
and preliminary evidence of product efficacy. Phase III trials are large scale
studies designed to provide statistical evidence of efficacy and safety in
humans. The results of the preclinical testing and clinical trials of a
pharmaceutical product are then submitted to the FDA in the form of an NDA for
approval to commence commercial sales. Preparing such applications involves
considerable data collection, verification, analysis and expense. In responding
to an NDA, the FDA may grant marketing approval, request additional information
or deny the application if it determines that the application does not satisfy
its regulatory approval criteria.

This regulatory process can require many years and the expenditure of
substantial resources. Data obtained from preclinical testing and clinical
trials are subject to varying interpretations, which can delay, limit or
prevent FDA approval. In addition, changes in FDA approval policies or
requirements may occur or new regulations may be promulgated which may result
in delay or failure to receive FDA approval.

ANDAs may be submitted for generic versions of brand name drugs (Listed
Drugs) where the generic drug is the same as the Listed Drug with respect to
active ingredient(s) and route of administration, dosage form, strength, and
conditions of use recommended in the labeling. ANDAs may also be submitted for
generic drugs that differ with regard to certain changes from a Listed Drug if
the FDA has approved a petition from a prospective applicant permitting the
submission of an ANDA for the changed product.

Rather than safety and efficacy studies, the FDA requires data
demonstrating that the ANDA drug formulation is bioequivalent to the Listed
Drug. The FDA also requires labeling, chemistry and manufacturing information.
FDA regulations define bioequivalence as the absence of a significant
difference in the rate and the extent to which the active ingredient becomes
available at the site of drug action when administered at the same molar dose
under similar conditions in an appropriately designed study. If the approved
generic drug is both bioequivalent and pharmaceutically equivalent to the
Listed Drug, the agency will assign a code to the product in an FDA publication
entitled Approved Drug Products With Therapeutic Equivalence Evaluation.
These codes will indicate whether the FDA considers the product to be
therapeutically equivalent to the Listed Drug. The codes will be considered by
third parties in determining whether the generic drug is therapeutically
equivalent and fully substitutable for the Listed Drug and are relied upon by
Medicaid and Medicare formularies for reimbursement.

Although the FDA has approved the ANDA filed by the Companys collaborator
Mylan for the 30 mg dosage strength of a generic version of Procardia XL, there
can be no assurance that applications filed by the Companys collaborators with
respect to other products will be suitable or available for such products, or
that such products will receive FDA approval on a timely basis.

Certain ANDA procedures for generic versions of controlled release
products are the subject of petitions filed by brand name drug manufacturers,
which seek changes from the FDA in the approval process for generic drugs.
These requested changes include, among

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other things, tighter standards for
certain bioequivalence studies and disallowance of the use by a generic drug
manufacturer in its ANDA of proprietary data submitted by the original
manufacturer as part of an original new drug application. The Company is unable
to predict at this time whether the FDA will make any changes to its ANDA
procedures as a result of such petitions or any future petitions filed by brand
name drug manufacturers or the effect that such changes may have on the
Company. Any changes in FDA regulations which make ANDA approvals more
difficult could have a material adverse effect on the Companys business,
financial condition and results of operations.

Some products containing the Companys TIMERx formulation, such as
controlled release formulations of approved immediate release drugs, will
require the filing of an NDA. The FDA will not accept ANDAs when the delivery
system or duration of drug availability differs significantly from the Listed
Drug. However, the Company may be able to rely on existing publicly available
safety and efficacy data to support section 505(b)(2) NDAs for controlled
release products when such data exists for an approved immediate release
version of the same chemical entity. However, there can be no assurance that
the FDA will accept such section 505(b)(2) NDAs, or that the Company will be
able to obtain publicly available data that is useful. The section 505(b)(2)
NDA process is a highly uncertain avenue to approval because the FDAs policies
on section 505(b)(2) NDAs have not yet been fully developed. There can be no
assurance that an application submitted under section 505(b)(2) will be
approved, or will be approved in a timely manner.

Sponsors of ANDAs and section 505(b)(2) NDAs, with the exception of
applications for certain antibiotic drugs, must include, as part of their
applications, certifications with respect to certain patents on Listed Drugs
that may result in significant delays in obtaining FDA approvals. Sponsors who
believe that patents that are listed in an FDA publication entitled Approved
Drug Products With Therapeutic Equivalence Evaluations are invalid,
unenforceable, or not infringed, must notify the patent owner. If the patent
owner initiates an infringement lawsuit against the sponsor within 45 days of
the notice, the FDAs final approval of the ANDA or section 505(b)(2) NDA may
be delayed for a period of thirty months or longer. This delay may also apply
to other ANDAs or 505(b)(2) NDAs for the same Listed Drug. Moreover, the
approval of an ANDA involved in such a patent lawsuit may under certain
circumstances require a further delay in the final approval of other ANDAs for
the same Listed Drug for an additional 180 days. In addition, recent court
decisions have raised the possibility that, under some circumstances, ANDAs
other than the first ANDA for a Listed Drug may be delayed indefinitely and
thereby effectively denied approval if the drug that is the subject of the
first ANDA is not brought to market.

Under the Waxman-Hatch Act, an applicant who files the first ANDA with a
certification of patent invalidity or non-infringement with respect to a
product may be entitled to receive, if such ANDA is approved by the FDA,
180-day marketing exclusivity (a 180-day delay in approval of other ANDAs for
the same drug) from the FDA. However, there can be no assurance that the FDA
will not approve an ANDA filed by another applicant with respect to a different
dosage strength prior to or during such 180-day marketing exclusivity period.

ANDAs and section 505(b)(2) NDAs are also subject to so-called market
exclusivity provisions that delay the submission or final approval of the
applications. The submission of ANDAs and section 505(b)(2) NDAs may be delayed
for five years after approval of the Listed Drug if the Listed Drug contains a
new active molecular entity. The final approval of ANDAs and section 505(b)(2)
NDAs may also be delayed for three years where the Listed Drug or a
modification of the Listed Drug was approved based on new clinical
investigations. The three-year marketing exclusivity period would potentially
be applicable to Listed Drugs with novel drug delivery systems.

Sponsors of drug applications affected by patents may also be adversely
affected by patent term extensions provided under the FDCA to compensate for
patent protection lost due to time taken in conducting FDA required clinical
studies or during FDA review of data submissions. Patent term extensions may
not exceed five additional years nor may the total period of patent protection
following FDA marketing approval be extended beyond 14 years. In addition, by
virtue of the Uruguay Round Agreements Act of 1994 that ratified the General
Agreement on Tariffs and Trade, certain brand name drug patent terms have been
extended to 20 years from the date of filing of the pertinent patent
applications (which can be longer than the former 17-year patent term starting
from the date of patent issuance). Patent term extensions may delay the ability
of the Company and its collaborators to use the Companys proprietary
technology in the future, market new controlled release products, file section
505(b)(2) NDAs referencing approved products, or file ANDAs based on Listed
Drugs when those approved products or Listed Drugs have acquired patent term
extensions.

Manufacturers of marketed drugs must conform to the FDAs cGMP standard or
risk sanctions such as the suspension of manufacturing or the seizure of drug
products and the refusal to approve additional marketing applications. The FDA
conducts periodic inspections to implement these rules. There can be no
assurance that a manufacturers facility will be found to be in compliance with
cGMP or other regulatory requirements. Failure to comply could result in
significant delays in the development, testing and approval of products
manufactured at such facility, as well as increased costs.

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Noncompliance with applicable requirements can also result in total or
partial injunctions against production and/or distribution, refusal of the
government to enter into supply contracts or to approve NDAs, ANDAs or
biologics applications, criminal prosecution and product recalls. The FDA also
has the authority to revoke for cause drug or biological approvals previously
granted.

Foreign Regulatory Approval

Whether or not FDA approval has been obtained, approval of a
pharmaceutical product by comparable governmental regulatory authorities in
foreign countries must be obtained prior to the commencement of clinical trials
and subsequent marketing of such product in such countries. The approval
procedure varies from country to country, and the time required may be longer
or shorter than that required for FDA approval.

Under European Union (EU) law, either of two approval procedures may
apply to the Companys products: a centralized procedure, administered by the
EMEA (the European Medicines Evaluation Agency); or a decentralized procedure,
which requires approval by the medicines agency in each EU Member State where
the Companys products will be marketed. The centralized procedure is mandatory
for certain biotechnology products and available at the applicants option for
certain other products. Although the decentralized procedure requires approval
by the medicines agency in each EU Member State where the products will be
marketed, there is a mutual recognition procedure under which the holder of
marketing approval from one EU Member State may submit an application to one or
more other EU Member States, including a certification to the effect that the
application is identical to the application which was originally approved or
setting forth the differences between the two applications. Within 90 days of
such application, each EU Member State will be required to determine whether to
recognize the prior approval.

Whichever procedure is used, the safety, efficacy and quality of the
Companys products must be demonstrated according to demanding criteria under
EU law and extensive nonclinical tests and clinical trials are likely to be
required. In addition to premarket approval requirements, national laws in EU
Member States will govern clinical trials of the Companys products, adherence
to good manufacturing practice, advertising and promotion and other matters. In
certain EU Member States, pricing or reimbursement approval may be a legal or
practical precondition to marketing.

A procedure for abridged applications for generic products also exists in
the EU. The general effect of the abridged application procedure is to give
scope for the emergence of generic competition once patent protection has
expired and the original product has been on the market for at least six or ten
years. Independent of any patent protection, under the abridged procedure, new
products benefit in principle from a basic six or ten year period of protection
(commencing with the date of first authorization in the EU) from abridged
applications for a marketing authorization. The period of protection in respect
of products derived from certain biotechnological processes or other
high-technology medicinal products viewed by the competent authorities as
representing a significant innovation is ten years. Further, each EU Member
State has discretion to extend the basic six-year period of protection to a
ten-year period to all products marketed in its territory. Certain EU Member
States have exercised such discretion. The protection does not prevent another
company from making a full application supported by all necessary
pharmacological, toxicological and clinical data within the period of
protection. Abridged applications can be made principally for medicinal
products which are essentially similar to medicinal products which have been
authorized for either six or ten years. Under the abridged application
procedure, the applicant is not required to provide the results of
pharmacological and toxicological tests or the results of clinical trials. For
such abridged applications, all data concerning manufacturing quality and
bioavailability are required. The applicant submitting the abridged application

generally must provide evidence or information that the drug product subject to
this application is essentially similar to that of the referenced product in
that it has the same qualitative and quantitative composition with respect to
the active ingredient and the same dosage form, and is similar in
bioavailability as the referenced drug.

Other Regulations.The Company is governed by federal, state and local
laws of general applicability, such as laws regulating working conditions and
environmental protection. Oxymorphone ER and other drugs that the Company is developing are
subject to regulations under the Controlled Substances Act and related
statutes.

Competition

The pharmaceutical industry is highly competitive and is affected by new
technologies, governmental regulations, health care legislation, availability
of financing, litigation and other factors. Many of the Companys competitors
have longer operating histories and greater financial, marketing, legal and
other resources than the Company and certain of its collaborators. The Company
expects that it will be subject to competition from numerous other entities
that currently operate or intend to operate in the pharmaceutical industry,
including companies that engage in the development of controlled release
technologies.

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The Company faces competition from numerous public and private companies
and their controlled release technologies, including Johnson & Johnsons Oros
technology, multiparticulate systems marketed by Elan Corporation plc
and Biovail, traditional matrix systems marketed by SkyePharma, plc and other
extended release technologies marketed or under development by Andrx
Corporation, among others.

Most of the Companys products under development are extended release
versions of existing immediate release drugs. These drugs will face competition
from products with the same indication as the product developed by Penwest. For
instance, the Company expects that oxymorphone ER will face competition from
Purdue Pharmas OxyContin® and Johnson &
Johnsons Duragesic® patch.

A number of the products that the Company has developed and still will
selectively develop are generic versions of branded controlled release
pharmaceuticals. Typically, selling prices of immediate release drugs have
declined and profit margins have narrowed after generic equivalents of such
drugs are first introduced and the number of competitive products has
increased. Similarly, the success of generic versions of controlled release
products based on the Companys TIMERx technology will depend, in large part,
on the intensity of competition from currently marketed drugs and technologies
that compete with the branded pharmaceutical, as well as the timing of product
approvals. However, the Company believes that generic versions of controlled
release pharmaceuticals based on TIMERx technology are less likely to suffer
the same degree of price erosion as other generic pharmaceuticals because of
formulation, and the fact that analytical and manufacturing complexity of the
generic versions may be difficult for other companies to replicate, which could
limit competition. Competition may also arise from therapeutic products that
are functionally equivalent but produced by other methods.

Employees

As of March 20, 2003, the Company employed approximately 66 people, of
whom 46 were involved in research and development, and 20 were in selling,
general and administrative. As of March 20, 2003, none of the Companys
employees are covered by collective bargaining agreements. The Company
considers its employee relations to be good.

Information Available on the Internet

Penwests internet address is www.penwest.com. Penwest makes available
free of charge through its web site Penwests annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
these reports filed or furnished pursuant to Section 12(a) or 15(d) of the
Securities Exchange Act of 1934, as amended, as soon as reasonably practicable
after Penwest electronically files such materials with the Securities and
Exchange Commission.




ITEM 2: PROPERTIES

The
Companys has research  facilities,
comprising approximately 14,000 square feet, in Patterson, New
York. Prior to the sale of the excipient business, the Company owned the site
of the space in Patterson, New York, as well as a facility in Cedar Rapids,
Iowa, where it manufactured pharmaceutical excipients. As part of the sale of
the excipient business, the Company transferred these properties and assigned a
lease for a pharmaceutical excipient manufacturing facility in Nastola,
Finland. However, under its agreement with Rettenmaier, the Company has the
right to occupy approximately 14,000 square feet of office and research and
development space in the Patterson building until February 2008, initially on a
rent-free basis for two years and then pursuant to three successive one-year
options at a rental rate of $12 per square foot.

The Company has signed a lease agreement for approximately 11,000 square
feet of office space in Danbury, Connecticut. This lease expires on January
31, 2006, with renewal options through December 30, 2006. Effective March 31, 2003, the Company
relocated its executive and administrative offices to Danbury.




ITEM 3: LEGAL PROCEEDINGS

The Company is not a party to material legal proceedings.




ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of shareholders during the fourth
quarter of fiscal 2002.

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ITEM 4a: EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth the names, ages and positions of our
executive officers.

|                         |  |     |    |       |  |                                                                                                                      |  |                           
|------------------------ |  | --- | -- | ----- |  | -------------------------------------------------------------------------------------------------------------------- |  | --------------------------
|NAME                     |  | AGE |    | TITLE |  | DATES                                                                                                               
|                         |  |     |    |       |  |                                                                                                                     
|Tod R. Hamachek          |  |     | 57 |       |  | Chairman of the Board and Chief Executive Officer
President and Chief Executive Officer  Penford Corp.              |  | 1997 
current
1985  1997
|Anand R. Baichwal, Ph.D. |  |     | 48 |       |  | Senior Vice President, Research & New Technology
Development and Chief Scientific Officer
Vice President, Technology |  | 1997  current
1994  1997
|Jennifer L. Good         |  |     | 38 |       |  | Senior Vice President, Finance and Chief Financial
Officer Corporate Controller  Penford Corp.                      |  | 1997  current
1993  1997




PART II




ITEM 5: MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANTS COMMON STOCK AND
RELATED STOCKHOLDER MATTERS

Penwests common stock, $.001 par value, is listed with and trades on the
Nasdaq National Market under the symbol PPCO. The high and low closing prices
of the Companys common stock during 2002 and 2001 are set forth below.

|                           |  |      |       |     |  |   |       | 
|-------------------------- |  | ---- | ----- | --- |  | - | ----- | 
|PERIOD 2002                |  | HIGH |       | LOW
|                           |  |      |       |    
|Quarter Ended March 31     |  | $    | 19.75 |     |  | $ | 17.20 | 
|Quarter Ended June 30      |  | $    | 20.99 |     |  | $ | 17.00 | 
|Quarter Ended September 30 |  | $    | 17.25 |     |  | $ | 7.89  | 
|Quarter Ended December 31  |  | $    | 10.98 |     |  | $ | 7.01  | 

|                           |  |      |       |     |  |   |       | 
|-------------------------- |  | ---- | ----- | --- |  | - | ----- | 
|PERIOD 2001                |  | HIGH |       | LOW
|                           |  |      |       |    
|Quarter Ended March 31     |  | $    | 14.63 |     |  | $ | 9.81  | 
|Quarter Ended June 30      |  | $    | 16.05 |     |  | $ | 11.06 | 
|Quarter Ended September 30 |  | $    | 20.30 |     |  | $ | 14.20 | 
|Quarter Ended December 31  |  | $    | 20.19 |     |  | $ | 15.00 | 

On March 20, 2003 there were 823 shareholders of record.

The Company has never paid cash dividends on its common stock. The Company
presently intends to retain earnings, if any, for use in the operation of its
business, and therefore does not anticipate paying any cash dividends in the
foreseeable future.

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ITEM 6: SELECTED FINANCIAL DATA

The following selected financial data are derived from the consolidated
financial statements of Penwest Pharmaceuticals Co. The data should be read in conjunction
with the consolidated financial statements, related notes, and other financial
information included herein.

|                                                                                            |  |                                           |         |      |  |      |         |      |  |      |        |   |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------------------------- |  | ----------------------------------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------ | - |  | - | ------ | - |  | - | ------ | -
|                                                                                            |  | YEAR
ENDED DECEMBER 31,(a)               
|                                                                                            |  |                                          
|                                                                                            |  | 2002                                      |         | 2001 |  | 2000 |         | 1999 |  | 1998
|                                                                                            |  |                                           |         |      |  |      |         |      |  |     
|                                                                                            |  | (IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
|STATEMENT OF OPERATIONS DATA:                                                               |  |                                           |         |      |  |      |         |      |  |      |        |   |  |   |        |   |  |   |        |  
|Revenues (b)                                                                                |  | $                                         | 41,959  |      |  | $    | 40,003  |      |  | $    | 42,058 |   |  | $ | 37,307 |   |  | $ | 29,149 |  
|Cost of product sales (b)                                                                   |  |                                           | 25,407  |      |  |      | 24,810  |      |  |      | 25,303 |   |  |   | 25,889 |   |  |   | 21,183 |  
|Gross profit                                                                                |  |                                           | 16,552  |      |  |      | 15,193  |      |  |      | 16,755 |   |  |   | 11,418 |   |  |   | 7,966  |  
|Selling, general and administrative                                                         |  |                                           | 15,820  |      |  |      | 13,855  |      |  |      | 12,054 |   |  |   | 11,425 |   |  |   | 11,354 |  
|Research and product development                                                            |  |                                           | 17,567  |      |  |      | 17,003  |      |  |      | 12,820 |   |  |   | 7,371  |   |  |   | 6,054  |  
|Asset write-off (c)                                                                         |  |                                           |        |      |  |      |        |      |  |      |       |   |  |   |       |   |  |   | 1,341  |  
|Loss before cumulative effect of change in
accounting principle                             |  |                                           | (17,099 | )    |  |      | (15,981 | )    |  |      | (8,376 | ) |  |   | (7,681 | ) |  |   | (8,829 | )
|Cumulative effect of change in accounting principle (d)                                     |  |                                           |        |      |  |      |        |      |  |      | (410   | ) |  |   |       |   |  |   |       |  
|Net loss                                                                                    |  | $                                         | (17,099 | )    |  | $    | (15,981 | )    |  | $    | (8,786 | ) |  | $ | (7,681 | ) |  | $ | (8,829 | )
|                                                                                            |  |                                           |         |      |  |      |         |      |  |      |        |   |  |   |        |   |  |   |        |  
|Basic and diluted loss per share before cumulative
effect of change in accounting principle |  | $                                         | (1.11   | )    |  | $    | (1.15   | )    |  | $    | (0.68  | ) |  | $ | (0.69  | ) |  | $ | (0.80  | )
|Cumulative effect of change in accounting
principle per share                               |  |                                           |        |      |  |      |        |      |  |      | (0.03  | ) |  |   |       |   |  |   |       |  
|                                                                                            |  |                                           |         |      |  |      |         |      |  |      |        |   |  |   |        |   |  |   |        |  
|Net loss per share                                                                          |  | $                                         | (1.11   | )    |  | $    | (1.15   | )    |  | $    | (0.71  | ) |  | $ | (0.69  | ) |  | $ | (0.80  | )
|                                                                                            |  |                                           |         |      |  |      |         |      |  |      |        |   |  |   |        |   |  |   |        |  
|Weighted average shares of common stock outstanding                                         |  |                                           | 15,462  |      |  |      | 13,905  |      |  |      | 12,330 |   |  |   | 11,103 |   |  |   | 11,037 |  
|                                                                                            |  |                                           |         |      |  |      |         |      |  |      |        |   |  |   |        |   |  |   |        |  

|                          |  |              |         |      |  |      |         |      |  |                |         |   |  |   |         |   |  |   |         |  
|------------------------- |  | ------------ | ------- | ---- |  | ---- | ------- | ---- |  | -------------- | ------- | - |  | - | ------- | - |  | - | ------- | -
|                          |  | DECEMBER 31,
|                          |  |             
|                          |  | 2002         |         | 2001 |  | 2000 |         | 1999 |  | 1998 (e)      
|                          |  |              |         |      |  |      |         |      |  |               
|                          |  |              |         |      |  |      |         |      |  | (IN THOUSANDS) |         |   |  |   |         |   |  |  
|BALANCE SHEET DATA:       |  |              |         |      |  |      |         |      |  |                |         |   |  |   |         |   |  |   |         |  
|Cash and cash equivalents |  | $            | 4,420   |      |  | $    | 12,903  |      |  | $              | 2,204   |   |  | $ | 739     |   |  | $ | 1,476   |  
|Marketable securities     |  |              | 2,057   |      |  |      | 9,609   |      |  |                |        |   |  |   |        |   |  |   |        |  
|Working capital           |  |              | 10,329  |      |  |      | 27,059  |      |  |                | 11,129  |   |  |   | 7,713   |   |  |   | 7,648   |  
|Total assets              |  |              | 50,220  |      |  |      | 59,613  |      |  |                | 42,294  |   |  |   | 38,120  |   |  |   | 41,082  |  
|Long-term debt            |  |              |        |      |  |      |        |      |  |                |        |   |  |   | 6,700   |   |  |   |        |  
|Accumulated deficit       |  |              | (78,025 | )    |  |      | (60,926 | )    |  |                | (44,945 | ) |  |   | (36,159 | ) |  |   | (28,478 | )
|Shareholders equity      |  |              | 31,423  |      |  |      | 45,624  |      |  |                | 31,017  |   |  |   | 22,509  |   |  |   | 30,032  |  



---

|(a) |  | During the years ended December 31, 2002, 2001, 2000, 1999 and 1998, revenues from the sale of excipient
products were 87%, 86%, 79%, 95% and 97%, respectively, of total revenues. Effective February 27, 2003,
the Company will not derive any revenues from the excipient business.
See Note 18 to the
Companys consolidated financial statements.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(b) |  | Reclassification recorded of amounts prior to 2000 for the adoption of
EITF No. 00-10 Accounting for Shipping and Handling Fees and Costs.                                                                                                                                                                                                          
|   
|(c) |  | Represents a one-time charge relating to the write-off of costs
associated with the decision to outsource certain manufacturing as opposed
to constructing a new facility.                                                                                                                                                                            
|   
|(d) |  | Cumulative effect of adopting
Staff Accounting Bulletin No. 101 (SAB No. 101)
in 2000.                                                                                                                                                                                                                                                              
|   
|(e) |  | In conjunction with the August 31, 1998 distribution, in which the
Companys former parent, Penford Corporation, distributed to the
shareholders of record of Penford common stock on August 10, 1998 all of
the shares of the Companys common stock, Penford contributed to the
Companys capital, all existing intercompany indebtedness.          

13



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##### Table of Contents






ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Overview

Penwest develops pharmaceutical products based on innovative oral drug
delivery technologies. The foundation of Penwests technology platform is
TIMERx, an extended release delivery system that is adaptable to soluble and
insoluble drugs, and that is flexible for a variety of controlled release
profiles. The Company has also developed two additional oral drug delivery
systems, Geminex and SyncroDose. Geminex is a dual drug delivery system that
is designed to provide independent release of different active ingredients
contained in a drug, and SyncroDose is a chronotherapeutic drug delivery system
that is designed to release the active ingredient of a drug at the desired site
and time in the body.

Prior to February 27, 2003, Penwest also developed, manufactured and
distributed branded pharmaceutical excipients, which are the inactive
ingredients in tablets and capsules, primarily consisting of binders,
disintegrants and lubricants. On February 27, 2003, Penwest sold substantially
all of the assets used in the Companys excipient business to subsidiaries and
affiliates of Josef Rettenmaier Holding GmbH & Co. KG. The Company received
$39.5 million in cash and a promissory note of $2.25 million in consideration
for the excipient business. The Company intends to use the proceeds of the
sale of its excipient business to expand its drug delivery business. In the
first quarter of 2003, the Company will report the results of the excipient
business as a discontinued operation.

The Company has incurred net losses and has had negative cash flows since
1994. As of December 31, 2002, the Companys accumulated deficit was
approximately $78.0 million. The Company expects operating losses and negative
cash flows from operations to continue until substantial sales of products
commercialized utilizing TIMERx technology occur. A substantial portion of the
Companys revenues to date have been generated from the Companys
pharmaceutical excipient business. During 2001 and 2002, the Company derived
86% and 87%, respectively, of its revenues from the sales of its excipient
products, and sales of its excipient products generated substantial positive
cash flows from operations although the Company as a whole had negative cash
flows from operations. Effective February 27, 2003, the Company will not
derive any revenues from the excipient business. Accordingly, the Company
expects that its revenues for the balance of 2003 will be generated primarily from
Mylan royalties and payments under collaboration agreements. The Companys
future profitability will depend on several factors, including:



| |  |  | the successful commercialization of TIMERx controlled release
products, including in particular oxymorphone ER;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | the Companys ability to use the net proceeds from the sale of its
excipient business to expand its drug development and delivery
business;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | royalties from Mylans sales
of Pfizer, Inc.s 30 mg generic version of Procardia XL; and                                                  
|
| |  |  | the level of the Companys
investment in research and development activities.                                                              

The Companys strategy includes a significant commitment to spending on
research and development targeted at identifying and developing extended
release products that can be formulated using the Companys TIMERx and other
drug delivery technologies. The Company also expects to expend significant
resources on the development of new drug delivery technologies, both internally
and through in-licenses or acquisition. The Companys spending in the area of
new technology, however, is discretionary and is subject to the Company
identifying appropriate opportunities, as well as the availability of funds
from the Companys operations, cash resources, collaborative research and
development arrangements and external financing. There can be no assurance when
or if the Company will achieve profitability or if it will be able to sustain
profitability on a quarterly basis, if at all.

The Companys collaborative agreements include licensing arrangements in
which the Company is entitled to receive milestone payments, royalties on the
sale of the products covered by such collaborative agreements and payments for
the purchase of formulated TIMERx material, as well as licensing arrangements
which include revenue and cost sharing components in which the Company shares
in the costs and profitability at predetermined percentages, but does not
generally receive milestone payments. There can be no assurance that the
Companys controlled release product development efforts will be successfully
completed, that required regulatory approvals will be obtained or that approved
products will be successfully manufactured or marketed.

14



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The Companys excipient products were sold internationally and its results
of operations were affected by fluctuations in currency exchange rates, as well
as by governmental controls and other risks associated with international sales
(such as export licenses, collectibility of accounts receivable, trade
restrictions, and changes in tariffs). The Companys international subsidiaries
transacted a substantial portion of their sales and purchases in European
currencies other than their functional currency, which can result in the
Company having gains or losses from currency exchange rate fluctuations. The
Company does not use derivatives to hedge the impact of fluctuations in foreign
currencies. As part of the sale of the excipient business, the Company sold the
stock of its foreign subsidiaries. Accordingly, the Company expects that in the
future its results of operations will be less likely to be affected by currency
fluctuations.

The Companys results of operations may fluctuate from quarter to quarter
depending on the volume and timing of orders of formulated bulk TIMERx,
royalties on Mylans sales of Pfizers 30 mg generic version of Procardia XL
and variations in payments under the Companys collaborative agreements,
including payments upon the achievement of specified milestones.

Critical Accounting Policies and Estimates

The Companys discussion and analysis of
its financial condition and results of
operations are based upon the Companys consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The Companys significant accounting policies are more fully
described in the notes to the consolidated financial statements. These policies
are important to the portrayal of the Companys financial condition and results
of operations. The preparation of these financial statements requires the Company to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the financial statements included in the
Companys Annual Report on Form 10-K for the year ended December 31, 2002, and
the reported amounts of revenues and expenses during the reporting periods.
Areas where significant judgments are made include, but are not limited to,
revenue recognition, allowance for doubtful accounts, inventory, deferred
taxes-valuation allowance and impairment of intangible assets. Actual results
could differ materially from these estimates.

The following accounting policies meet these characteristics and are
considered most significant:

Revenue Recognition

Revenues from product sales are recognized when title transfers and
customer acceptance provisions have lapsed, provided collections of the related
accounts receivable are probable. Revenues received from non-refundable upfront
licensing fees are recognized ratably over the development period of the
collaboration agreement, when this period involves development risk associated
with the incomplete stage of a products development or over the estimated or
contractual licensing and supply term when there exists an obligation to supply
inventory for manufacture.
Non-refundable milestone fees received for the development funding of a product
are partially recognized upon receipt based on the Companys proportionate
development efforts achieved to date relative to the total expected development
efforts and the remainder is generally recognized ratably over the remaining
expected development period. The proportionate development efforts achieved
are measured by estimating the percentage of work completed that is required of
the Company in the development effort for the product. This estimate is
primarily derived from the underlying project plans and timelines, developed by
qualified personnel who work closely on such projects. Other contractual fees
received in connection with a collaborators launch of a product are also
recognized ratably over the estimated or contractual licensing and supply term.
Product royalty fees are recognized when earned.

Allowance for Doubtful Accounts

Allowances for doubtful accounts receivable are maintained based on
historical payment patterns, aging of accounts receivable and actual write-off
history. The Company expects that the allowance for doubtful accounts will not
be considered a critical estimate in the near future, because most of the
Companys accounts receivable and the related allowance were related to the
Companys excipient business.

Inventory

The Company writes down its inventory to net realizable value. Product
obsolescence may be caused by shelf-life expiration, replacement products in
the marketplace or other competitive situations.

15



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Deferred Taxes  Valuation Allowance

The Company records a valuation allowance to reduce its deferred tax
assets to the amount that is more likely than not to be realized. While the
Company may consider any potential future taxable income and ongoing prudent
and feasible tax planning strategies in assessing the need for the valuation
allowance, in the event the Company were to determine that it would be able to
realize its deferred tax assets in the future in excess of its net recorded
amount, an adjustment to the deferred tax asset would increase income in the
period such determination was made. At December 31, 2002, the Company had
recorded full valuation allowances totaling approximately $23.3 million against
its net deferred tax assets.

Impairment of Long-Lived Assets

In assessing the recoverability of the Companys intangible assets, the
Company must make assumptions regarding estimated future cash flows and other
factors to determine the fair value of the respective assets. If these
estimates or their related assumptions change in the future, the Company may be
required to record impairment charges for these assets.

Results of Operations

Years Ended December 31,
2002 and 2001

Total revenues increased 4.9% for the year ended December 31, 2002 to
$42.0 million from $40.0 million the year ended December 31, 2001. Product
sales increased by 5.2% to $36.6 million for the year ended December 31, 2002
compared to $34.8 million for the year ended December 31, 2001. The increase
in product sales was due to increased sales of excipient products, primarily in
Europe, which the Company believes was partially due to the Company beginning
to sell its products direct in certain countries, but was partially offset by
lower revenues on sales of formulated bulk TIMERx primarily due to the timing
of customer orders. During the third quarter of 2002,
the Company was notified by a major customer of excipient products that a
contract for purchasing microcrystalline cellulose will not be renewed
beginning January 1, 2003. Sales approximated $2 million to this customer of
the excipient business for the year ended December 31, 2002.
Royalties and licensing revenues increased slightly in 2002
to $5.4 million from $5.2 million in 2001.

Gross profit increased to $16.6 million, or 39.4% of total revenues, for
the year ended December 31, 2002 from $15.2 million, or 38.0% of total
revenues, for the year ended December, 31 2001. The increase in the gross
profit percentage was primarily due to changes in the product mix of excipient
products sold in 2002, primarily reflecting increased ProSolv and Pruv sales in
2002, as compared to 2001.

Selling, general and administrative expenses increased by 14.2% for the
year ended December 31, 2002, to $15.8 million as compared with $13.9 million
the year ended December 31, 2001. The increase was primarily due to marketing
costs paid to Endo for the joint development of oxymorphone ER, increased
compensation expense primarily due to hiring additional drug delivery
personnel and increased
business insurance costs.

Research and product development expenses increased by 3.3% for the year
ended December 31, 2002 to $17.6 million from $17.0 million for the year ended
December 31, 2001. This increase was primarily due to the Companys share of
the increased costs of clinical trials for oxymorphone ER being developed with
Endo and the Companys increased investment in the development of new products
utilizing TIMERx technology and in research involving new drug delivery
technologies.

The Companys most advanced product candidate is oxymorphone ER, which the
Company is developing with Endo. Endo, which is responsible for conducting the
clinical trials and seeking regulatory approval of the product, completed the
clinical trials of the product in July 2002 and the FDA accepted for filing an
NDA for oxymorphone ER in February 2003. The Company has incurred costs
relating to the research and development of oxymorphone ER of approximately $8.9 million and
$8.7 million for 2002 and 2001, respectively. These project costs reflect
amounts paid to Endo and do not include any pre-launch marketing costs or significant allocated internal
costs. On March 17, 2003, the Company gave Endo notice that it is
discontinuing its participation in the funding of the development of
oxymorphone ER. Accordingly, the Company anticipates the Companys research
and development expenses with respect to oxymorphone ER will decrease
significantly in 2003. The Company anticipates using the funds that otherwise would have been expended on
oxymorphone ER to increase its investment in the development of additional products utilizing TIMERx
technology and in research and development involving new drug delivery technologies.

As of December 31, 2002, the Company had several other product candidates
utilizing TIMERx technology in various stages of clinical trials. The
Companys costs of research and new technology development were approximately
$2.2 million and $1.4 million for 2002 and 2001, respectively. In addition,
the Company incurred research and development costs of approximately $611,000
and

16



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##### Table of Contents



$813,000 for 2002 and 2001, respectively, relating to its excipient
business.

Completion of clinical trials and commercialization of these product
candidates may take several years, and the length of time can vary
substantially according to the type, complexity and novelty of a product
candidate. Because these projects are in early stage of development and given
the technological and regulatory hurdles likely to be encountered in the
development and commercialization of these products, the future timing and
costs of these various research and development programs are uncertain. There
can be no assurance that any of the Companys products will be successfully
developed, will receive regulatory approval, or will be successfully
commercialized.

The effective tax rates for 2002 and 2001 were expenses of 2% and 3%,
respectively. The effective tax rates are higher than the federal statutory
rate of a 34% benefit due primarily to valuation allowances recorded to offset net
deferred tax assets relating to the Companys net operating losses, and state
and foreign income taxes.

Years Ended December 31,
2001 and 2000

Total revenues decreased 4.9% for the year ended December 31, 2001 to
$40.0 million from $42.1 million for the year ended December 31, 2000. Product
sales decreased to $34.8 million for 2001 compared to $37.1 million for 2000,
representing a decrease of 6.4%. The decrease in product sales was due to lower
revenues on sales of formulated bulk TIMERx during 2001, reflecting the
formulated bulk TIMERx shipments to Mylan in 2000, totaling $3.2 million, under
the Companys arrangement with Mylan relating to Nifedipine XL, which did not
recur in 2001. The lower revenues on sales of formulated bulk TIMERx was
partially offset by a $717,000 or 2.2% increase in excipient sales in 2001,
primarily in Europe. Royalties and licensing revenues increased 6.4% from $4.9
million in 2000 to $5.2 million in 2001, primarily as a result of increased
royalties earned on Mylans sales of the 30 mg strength of generic Procardia
XL, as Mylan captured greater market share in 2001. This royalty, however, did
trend down in the second quarter of 2001 compared to the previous two quarters,
due to the entrant of a competitor, and remained fairly flat through the
remainder of 2001.

Gross profit decreased to $15.2 million, or 38.0% of total revenues for
2001, from $16.8 million, or 39.8% of total revenues for 2000. Gross profit
percentage on product sales decreased to 28.7% for 2001, from 31.9% for 2000.
These decreases reflect competitive pressure on prices of the Companys
excipients during 2001, primarily in North America. Also contributing to the
lower gross profit in 2001 as compared with 2000, were the bulk TIMERx
shipments to Mylan in 2000, which did not recur in 2001.

Selling, general and administrative expenses increased by 14.9% for 2001,
to $13.9 million, from $12.1 million for 2000. The increase is primarily due to
increased expenses for market research, business insurance, professional fees,
including those associated with the Companys evaluation and pursuit of
financing alternatives, and increased information technology and hiring costs
associated with the Company strengthening its information technology
infrastructure to prepare for anticipated increasing drug development
activities.

Research and product development expenses increased by 32.6% for 2001 to
$17.0 million from $12.8 million for 2000. This increase was partly due to the
Companys share of increased expenses associated with clinical trials being
conducted for the development of oxymorphone ER under the Companys
collaboration with Endo. In addition, the Company increased its investment on
developing new products utilizing TIMERx technology for its drug development
pipeline and on the research of new drug delivery technologies.

The effective tax rates for 2001 and 2000 were expenses of 3% and 4%,
respectively. The effective tax rates are higher than the federal statutory
rate of a 34% benefit, due primarily to valuation allowances recorded to offset
deferred tax assets relating to the Companys net operating losses, and state
and foreign income taxes.

Liquidity and Capital Resources

Subsequent to August 31, 1998, the date the Company became an independent,
publicly-owned company, the Company has funded its operations and capital
expenditures with cash flows from the sale of excipients, sales of formulated
bulk TIMERx, royalties and milestone payments from Mylan and other
collaborators, advances under credit facilities and proceeds from the sale and
issuance of shares of common stock.

On February 27, 2003, the Company consummated the sale of its excipient
business to Rettenmaier. As a result of the sale, the

17



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##### Table of Contents



Company had
approximately $35 million of net cash proceeds available after the closing, which the
Company plans to use to fund development of products in its pipeline as well as
the rest of the Companys operations. However, as a result of the sale, the
Company will no longer derive cash flow from the sale of excipients.

Prior to the sale of the excipient business,
the Company had a revolving
line of credit with a financial institution. As of December 31, 2002, there
were approximately $2.8 million of outstanding borrowings under the revolving
line of credit. A portion of the net proceeds from the sale of the excipient
business was used to pay all outstanding borrowings under the line of credit,
which was terminated on February 27, 2003.

As of December 31, 2002, the Company had cash, cash equivalents, and
short-term investments of $6.5 million, which amount does not
include the approximately $35 million in net cash proceeds from the sale of the Companys excipient business
available after closing. The Company has no committed sources of capital other
than Rettenmaiers commitment to repay the Company pursuant to promissory
notes, $1.0 million in April 2003 and $1.25 million in May 2004 in connection
with the sale of the excipient business.

As part of the Companys agreement to acquire assets including trademarks
and other intellectual property related to the excipient product, Pruv, for
$3.0 million, on October 25, 2002, the Company issued a note to the seller,
AstraZeneca AB, in the principal amount of $2.25 million. The indebtedness
under the note did not bear interest. Under the agreement, the indebtedness
outstanding under the note was repaid upon the closing of the sale of the
excipient business.

The Company is a party to an agreement
with Endo with respect to the development of oxymorphone ER. The
Company paid Endo approximately $9.4 million and
$8.7 million in 2002 and 2001, respectively, for costs primarily relating
to the research and development and pre-launch marketing of oxymorphone ER. On March 17, 2003,
the Company gave Endo notice that the Company is discontinuing its
participation in the funding of the development and marketing of
oxymorphone ER. Accordingly, the Company anticipates its research and development expenses with
respect to
oxymorphone ER will decrease significantly in 2003. The Company
anticipates using the funds that otherwise would have been expended on oxymorphone ER
to increase its investment in the
development of additional products utilizing TIMERx technology and in
research and development involving new drug delivery technologies.

The Company had negative cash flow from operations for the year ended
December 31, 2002 of $13.3 million, primarily due to the net loss in the
period. The Company had negative cash flow from operations for the year ended
December 31, 2001 of $11.1 million, primarily due to the net loss in the
period, partially offset by net reductions of accounts receivable. Funds
expended in 2002 for the acquisition of fixed assets were primarily related to
additions at the Companys manufacturing facilities in Iowa and Finland,
laboratory equipment for drug development activities, the planned
implementation of a new information system in anticipation of the
sale of the excipient business, and information
technology associated with the Company strengthening its technology
infrastructure to prepare for increasing drug development activities. Funds
expended in 2001 for the acquisition of fixed assets were primarily related to
additions at the Companys manufacturing facilities in Iowa and Finland, and
information technology as described above. Funds expended for intangible assets
included costs to acquire trademarks and other intellectual property
related to Pruv, from AstraZeneca AB for $3.0 million, as well
as to secure patents on technology developed by the Company.

The Company expects that its cash flow in 2003
will differ from
its cash flow during 2002 and 2001 because the Company will no longer derive
revenues from sales of its excipient products nor will it incur expenses in
connection with its excipient business, except for the revenues and expenses
during the period ended February 26, 2003.

The Company anticipates that its existing capital resources, including the
proceeds from the sale of its excipient business, and anticipated internally
generated funds from the sale of formulated bulk TIMERx, royalties from Mylan
and other payments from collaborators, will enable the Company to fund its
currently planned operations, including its planned increase in drug
development and commercialization efforts, through late 2004.

The Companys requirements for capital in its business are substantial and
will depend on many factors, including:



| |  |  | the ongoing costs under the
Companys collaboration agreements;                                                                       
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the structure of any future collaborative or development agreements;                                                                  
|
| |  |  | the progress of the Companys collaborative and independent
development projects and funding obligations with respect to the
projects;
|
| |  |  | the costs to the Company of clinical studies for its products;                                                                        
|
| |  |  | the costs and timing of adding drug development capabilities;                                                                         
|
| |  |  | royalties received from Mylan;                                                                                                        
|
| |  |  | royalties from sales of TIMERx products;                                                                                              
|
| |  |  | the timing and amount of payments received under existing and
possible future collaborative agreements; and                           

18



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##### Table of Contents





| |  |  | the prosecution, defense and enforcement of potential patent claims
and other intellectual property rights.
| | - |  | -----------------------------------------------------------------------------------------------------------

If the Company needs to raise additional
funds to fund its operations, the
Company may seek to obtain additional funds through debt or equity financings.
The additional financing may not be available to the Company on acceptable
terms, if at all. If adequate funds are not available, Penwest may be required
to:



| |  |  | significantly curtail its product commercialization efforts, including
terminating existing collaborative agreements;                                                                                                                                                                                                              
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | obtain funds through one or more arrangements with collaborators or
others on
adverse terms to Penwest that may require Penwest to relinquish rights
to certain of its technologies, product candidates, or products which
Penwest would otherwise pursue on its own or that would significantly
dilute the Companys stockholders;
|
| |  |  | significantly scale back or terminate operations; and/or                                                                                                                                                                                                                                                                           
|
| |  |  | seek relief under the applicable bankruptcy laws.                                                                                                                                                                                                                                                                                  

Contractual Obligations

The Companys major outstanding contractual cash obligations relate to its
operating leases, primarily for equipment. Below is a table summarizing the
Companys contractual obligations and commercial commitments, including
non-cancelable operating leases having initial lease terms of more than one
year, as of December 31, 2002 (in thousands):

|                              |  |       |       |          |  |           |       |       |  |       |     |         |  |   |     |  |  |   |    | 
|----------------------------- |  | ----- | ----- | -------- |  | --------- | ----- | ----- |  | ----- | --- | ------- |  | - | --- |  |  | - | -- | 
|                              |  |       |       |          |  | Less than |       | 1-3   |  | 4-5   |     | After 5
|                              |  | Total |       | One Year |  | Years     |       | Years |  | Years
|                              |  |       |       |          |  |           |       |       |  |      
|Loans
and Notes Payable       |  | $     | 5,693 |          |  | $         | 5,693 |       |  | $     |    |         |  | $ |    |  |  | $ |   | 
|Operating Leases              |  |       | 2,083 |          |  |           | 792   |       |  |       | 882 |         |  |   | 381 |  |  |   | 28 | 
|                              |  |       |       |          |  |           |       |       |  |       |     |         |  |   |     |  |  |   |    | 
|Total Contractual Obligations |  | $     | 7,776 |          |  | $         | 6,485 |       |  | $     | 882 |         |  | $ | 381 |  |  | $ | 28 | 

Net Operating Loss Carryforwards

At December 31, 2002, the Company had federal net operating loss (NOL)
carryforwards of approximately $60.6 million for income tax purposes, of which
approximately $6.2 million, $8.4 million, $9.1 million, $17.8 million and $19.1
million expire in 2018, 2019, 2020, 2021 and 2022, respectively. In addition,
the Company had research and development tax credit carryforwards of
approximately $1.4 million of which $299,000, $306,000 and $777,000 expire in
2019, 2020, and 2021, respectively. The use of the NOLs and research and
development tax credit carryforwards are limited to future taxable earnings of
the Company. Due to the degree of uncertainty related to the ultimate
realization of such carryforwards, at December 31, 2002, a valuation allowance
of approximately $23.3 million has been recognized to offset net deferred tax
assets, primarily attributable to the NOL carryforward. Utilization of the
operating losses may be subject to a limitation due to the ownership change
provisions of the Internal Revenue Code. The Company expects to use
approximately $10.0 million of NOL carryforwards to offset the Companys
taxable capital gains and ordinary income from the sale of the excipient
business.

Market Risk and Risk Management Policies

Market risk is the risk of loss to future earnings, to fair values or to
future cash flows that may result from changes in the price of a financial
instrument. The value of a financial instrument may change as a result of
changes in interest rates, foreign currency exchange rates and other market
changes. Market risk is attributed to all market sensitive financial
instruments, including debt instruments. The operations of the Company are
exposed to financial market risks, including changes in interest rates and
foreign currency exchange rates. The Companys interest rate risk primarily
relates to its investments in marketable securities. The Companys foreign
currency exchange risk related primarily to its international
subsidiaries. As a result of the sale of the excipient business,
which included the Companys international subsidiaries, the Company
will have little, if any,  foreign
currency risk. The Company does not use derivatives to hedge
the impact of fluctuations in foreign currencies or interest rates.

The primary objectives for the Companys investment portfolio are liquidity and
safety of principal. Investments are made to achieve the highest rate of return
to the Company, consistent with these two objectives. The Companys investment
policy limits investments to certain types of instruments issued by
institutions with investment grade credit ratings and places restrictions on
maturities and

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concentration by issuer.

At December 31, 2002, marketable securities consisted of
corporate debt and approximated $2.1 million. These
securities have contractual maturity dates of up to eleven months. Due to the
relatively short-term maturities of these securities, management believes there
is no significant market risk. At December 31, 2002, market values approximated
carrying values. At December 31, 2002 the Company had approximately $6.5
million in cash, cash equivalents and investments in marketable securities, and
accordingly, a sustained decrease in the rate of interest earned of 1% would
cause a decrease in the annual amount of interest earned of up to approximately
$65,000. Proceeds from the sale of the excipient business available for investment will be
invested in accordance with the Companys investment policy.

At
December 31, 2001, marketable securities consisted of corporate
debt and U.S. Government-agency backed discounted notes and
approximated $9.6 million. These securities had contractual
maturity dates of up to two years. At December 31, 2001, market
values approximated carrying values. At December 31, 2001, the
Company had approximately $22.5 million in cash, cash
equivalents and investments in marketable securities, and
accordingly, a sustained decrease in the rate of interest earned of
1% would cause a decrease in the annual amount of interest earned of
up to approximately $225,000.

The Companys international operations
relating to its excipient business
transacted a substantial portion of
their sales and purchases in European currencies other than their functional
currency, which could have resulted in the Company having gains or losses from currency
exchange rate fluctuations. Where practical, the Company seeks to manage
expected local currency revenues in relation to local currency costs, and
manage local currency assets in relation to local currency liabilities. The
Company does not believe that the potential exposure is significant in light of
the size of the Company and its business. The effect of an immediate 10% change
in exchange rates would not have a material effect on the Companys results of
operations, financial position or cash flows.

Recent Accounting Pronouncements

In
November 2002, the Emerging Issues Task Force (EITF) finalized its tentative consensus on EITF issue
00-21, Revenue Arrangements with Multiple Deliverables, which provides
guidance on the timing and method of revenue recognition for arrangements that
include the delivery of more than one product or service. EITF 00-21 is
effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. The Company is currently evaluating the impact
of the adoption of this consensus on the Companys financial statements.

In April 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 145, Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections. SFAS No. 145 updates, clarifies and simplifies
existing accounting pronouncements and is generally effective for transactions
occurring after May 15, 2002. The adoption of this statement did not have a
material impact on the Companys financial position or results of operations.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. The standard addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies EITF Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and other Costs to Exit
an Activity (including Certain Costs Incurred in a Restructuring). SFAS No.
146 states that a liability for a cost associated with an exit or disposal
activity shall be recognized and measured initially at its fair value in the
period in which the liability is incurred, except for a liability for one-time
termination benefits that are incurred over a period of time. The standard
will apply to the Company effective for exit or disposal activities initiated
after December 31, 2002. The Company does not believe there will be a material
effect from the adoption of this new standard.

In
December 2002, the FASB issued SFAS No. 148,
Accounting for Stock-Based Compensation  Transition
and Disclosure, which amends SFAS No. 123, Accounting
for Stock-Based Compensation. SFAS No. 148 provides
alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee
compensation. The statement also improves the timeliness of
disclosures by requiring the information to be included in interim as
well as annual financial statements. The adoption of the statement
had no impact on the Companys financial position or results of
operations.

Forward Looking Statements

This annual report contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. All statements, other than statements of
historical facts, included or incorporated in this report regarding our
strategy, future operations, financial position, future revenues, projected
costs, prospects, plans and objectives of management are forward-looking
statements. The words believes, anticipates, estimates, plans,
expects, intends, may, projects, will, and would and similar
expressions are intended to identify forward-looking statements, although not
all forward-looking statements contain these identifying words. We cannot
guarantee that we actually will achieve the plans, intentions or expectations
disclosed in our forward-looking statements and you should not place undue
reliance on our forward-looking statements. In addition, any forward-looking
statements represent our estimates only as of the date this annual report is
filed with the SEC and should not be relied upon as representing our estimates
as of any subsequent date. We do not assume any obligation to update any
forward-looking statements.

Risk Factors

There are a number of important factors that could cause our actual
results to differ materially from those indicated or implied by forward-looking
statements. We believe that the material factors that we discuss below could
cause or contribute to such material differences.

20



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We have not been profitable and
expect to continue to incur substantial losses

We have incurred net losses since 1994, including net losses of $17.1
million, $16.0 million and $8.8 million, during 2002, 2001, and 2000,
respectively. As of December 31, 2002, our accumulated deficit was
approximately $78.0 million.

We expect net losses to continue until substantial sales of products
commercialized utilizing TIMERx technology occur. If we are unable to
successfully develop and commercialize these products, or generate substantial
sales from these products, we may never achieve profitability.

A substantial portion of our revenues since 1994 has been generated from
the sales of our pharmaceutical excipients. Our net losses in 2000, 2001 and
2002 were reduced as a result of the operating results of our excipient
business. Effective February 27, 2003, we no
longer generate any revenues from the sales of excipient products and our
business depends exclusively on our drug delivery business.

Our future profitability will depend on several factors, including:



| |  |  | the successful commercialization of TIMERx controlled release
products, including in particular oxymorphone ER, a narcotic analgesic
for the treatment of moderate to severe pain, being developed with Endo;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | our ability to use the net proceeds from the sale of our excipient
business to expand our drug development and delivery business;                                                                            
|
| |  |  | royalties from Mylans sales
of Pfizers 30 mg generic version of Procardia XL; and                                                                                                                          
|
| |  |  | the level of investment in
research and development activities.                                                                                                                                              

Our strategy includes a significant commitment to spending on
research and development targeted at identifying and developing extended
release products which can be formulated using our TIMERx and other drug
delivery technologies. We also expect to expend significant resources on the
development of new drug delivery technologies, both internally and through
in-licenses or acquisition. Our spending in the area of new technology,
however, is discretionary and is subject to the availability of appropriate
opportunities and funding.

We are dependent on collaborators to conduct full-scale bioequivalence studies
and clinical trials, obtain regulatory approvals for, and manufacture, market,
and sell our TIMERx controlled release products

Many of our TIMERx controlled release products have been or are being
developed and commercialized in collaboration with pharmaceutical companies.
Under these collaborations, depending on the structure of the collaboration, we
are dependent on our collaborators to fund some portion of development, to
conduct full-scale bioequivalence studies and clinical trials, obtain
regulatory approvals for, and manufacture, market and sell products utilizing
our TIMERx controlled release technology. For instance, we are dependent on
Endo to obtain the regulatory approvals required to market oxymorphone ER and
will be dependent on Endo to manufacture and market oxymorphone ER in the
United States. We are also dependent on Sanofi and Leiras to manufacture and
market Slofedipine XL and Cystrin CR, respectively. In addition, we are
dependent on Mylan with respect to the marketing and sale of the 30 mg strength
of Pfizers generic version of Procardia XL.

Our collaborators may not devote the resources necessary or may otherwise
be unable to complete development and commercialization of these potential
products. Our existing collaborations are subject to termination on short
notice under certain circumstances including, for example, if the collaborator
determines that the product in development is not likely to be successfully
developed or not likely to receive regulatory approval, if we breach the
agreement or upon a bankruptcy event.

If we cannot maintain our existing collaborations or establish new
collaborations, we would be required to terminate the development and

commercialization of products or undertake product development and
commercialization activities at our own expense. Moreover, we have limited
experience in conducting full-scale bioequivalence studies and clinical trials,
preparing and submitting regulatory applications and manufacturing, marketing
and selling the pharmaceutical products. We may not be successful in performing
these activities.

Our existing collaborations and any future collaborations with third
parties may not be scientifically or commercially successful.

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Factors that may
affect the success of our collaborations include the following:



| |  |  | our collaborators may be pursuing alternative technologies or
developing alternative products, either on their own or in collaboration
with others, that may be competitive with the product as to which they
are collaborating with us, which could affect our collaborators
commitment to the collaboration with us;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | reductions in marketing or sales efforts or a discontinuation of
marketing or sales of our products by our collaborators would reduce our
revenues, which may be based on a percentage of net sales by the
collaborator;                                                                                               
|
| |  |  | our collaborators may terminate their collaborations with us, which
could make it difficult for us to attract new collaborators or adversely
affect our perception in the business and financial communities; and                                                                                                      
|
| |  |  | our collaborators may pursue higher priority programs or change the
focus of their development programs, which could affect the
collaborators commitment to us.                                                                                                                                                       

We face significant competition, which may result in others discovering,
developing or commercializing products before or more successfully than we do

The pharmaceutical industry is highly competitive and is affected by new
technologies, governmental regulations, health care legislation, availability
of financing, litigation and other factors. Many of our competitors have longer
operating histories and greater financial, marketing, legal and other resources
than we do and than certain of our collaborators do.

Our TIMERx business faces competition from numerous public and private
companies and their controlled release technologies, including Johnson &
Johnsons oral osmotic pump (OROS®) technology, multiparticulate systems
marketed by Elan and Biovail, traditional matrix systems marketed by
SkyePharma, plc and other controlled release technologies marketed or under
development by Andrx Corporation, among others.

Our TIMERx products in development will face competition from products
with the same indication as the TIMERx products being developed by Penwest. For
instance, we expect extended release oxymorphone ER will face competition from
Purdue Pharmas OxyContin®.

In addition to developing controlled release versions of immediate release
products, we concentrated a significant portion of our initial development
efforts on generic versions of branded controlled release products. The success
of generic versions of branded controlled release products based on our TIMERx
technology will depend, in large part, on the intensity of competition from the
branded controlled release product, other generic versions of the branded
controlled release product and other drugs and technologies that compete with
the branded controlled release product, as well as the timing of product
approval.

The generic drug industry is characterized by frequent litigation between
generic drug companies and branded drug companies. Those companies with
significant financial resources will be better able to bring and defend any
such litigation.

We require additional funding,
which may be difficult to obtain

As of December 31, 2002, the Company had cash, cash equivalents, and
short-term investments of $6.5 million. In February 2003, the Company received
net proceeds from the sale of its excipient business available after closing of
approximately $35 million. The Company has no committed sources of capital other than
Rettenmaiers commitment to pay the Company $1.0 million in April 2003 and
$1.25 million in May 2004 in connection with the sale of the excipient
business.

We anticipate that our existing capital resources, including the proceeds
from the sale of the excipient business, and anticipated internally generated
funds from the sale of formulated bulk TIMERx, royalties from Mylan and other
payments from collaborators, will enable us to fund our currently planned
operations, including the planned increase in our drug development and
commercialization efforts, through late 2004.

We have had negative cash flows and net losses since 1994. See We have
not been profitable and expect to incur substantial losses for a discussion of
our risk of continued losses. We expect negative cash flows from operations to
continue until substantial sales of products commercialized utilizing TIMERx
technology occur, particularly because we expect our operating expenses to
continue to increase in the future, including our research and development
expenses, as our product development efforts accelerate.

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The proceeds from the
sale of our excipient business provided us with significant funding, but we
have lost the positive cash flows generated by our excipient business.

Our requirements for additional capital are substantial and will depend on
many factors, including:



| |  |  | the structure of any future collaborative or development agreements;                                                        
| | - |  | ----------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the progress of our collaborative and independent development
projects and funding obligations with respect to the projects;
|
| |  |  | the costs to us of clinical studies for our products;                                                                       
|
| |  |  | the costs and timing of adding drug development capabilities;                                                               
|
| |  |  | royalties received from Mylan;                                                                                              
|
| |  |  | royalties from sales of TIMERx products;                                                                                    
|
| |  |  | the timing and amount of payments received under existing and
possible future collaborative agreements; and                 
|
| |  |  | the prosecution, defense and enforcement of potential patent claims
and other intellectual property rights.                 

If we determine to seek additional funding, we may do so through
collaborative agreements or research and development arrangements and public or
private financings. Additional financing may not be available to us on
acceptable terms, if at all.

If we raise additional funds by issuing equity securities, further
dilution to our then existing stockholders will result. In addition, the terms
of the financing may adversely affect the holdings or the rights of such
stockholders.

If we are unable to obtain funding on a timely basis, we may be required
to (1) significantly curtail our product commercialization efforts, including
terminating or reducing our participation in existing collaborative agreements;
(2) obtain funds through arrangements with collaborators or others on adverse
terms to us that may require us to relinquish rights to certain of our
technologies, product candidates, or products which we would otherwise pursue
on our own or that would significantly dilute our shareholders; (3)
significantly scale back or terminate operations; and/or (4) seek relief under
applicable bankruptcy laws.

If our clinical trials are not successful or take longer to complete than we
expect, we may not be able to develop and commercialize certain of our products

In order to obtain regulatory approvals for the commercial sale of our
potential products, including controlled release versions of immediate release
drugs and new chemical entities, we or our collaborators will be required to
complete clinical trials in humans to demonstrate the safety and efficacy of
the products. We or our collaborators may not be able to obtain authority from
the FDA or other regulatory agencies to commence or complete these clinical
trials.

The results from preclinical testing of a product that is under
development may not be predictive of results that will be obtained in human
clinical trials. In addition, the results of early human clinical trials may
not be predictive of results that will be obtained in larger scale advanced
stage clinical trials. Furthermore, we, our collaborators or the FDA may
suspend clinical trials at any time if the subjects or patients participating
in such trials are being exposed to unacceptable health risks, or for other
reasons.

The rate of completion of clinical trials is dependent in part upon the
rate of enrollment of patients. Patient accrual is a function of many factors
including the size of the patient population, the proximity of patients to
clinical sites, the eligibility criteria for the study and the existence of
competitive clinical trials. Delays in planned patient enrollment may result in
increased costs and program delays.

We and our collaborators may not be able to successfully complete any
clinical trial of a potential product within any specified time period. In some
cases, we may not be able to complete the trial at all. Moreover, clinical
trials may not show any potential product to be safe or efficacious. Thus, the
FDA and other regulatory authorities may not approve any of our potential
products for any indication.

Our business, financial condition, or results of operations could be
materially adversely affected if:

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| |  |  | we or our collaborators are unable to complete a clinical trial of one of our potential products;
| | - |  | -------------------------------------------------------------------------------------------------
|
| |  |  | the results of any clinical trial are unfavorable; or                                            
|
| |  |  | the time or cost of completing the trial exceeds our expectations.                               

We may not obtain regulatory
approval; the approval process can be time-consuming and expensive

We are not able to market any of our products in the United States, Europe
or in any other jurisdiction without marketing approval from the United States
Food and Drug Administration, or FDA, the European Agency for the Evaluation of
Medicinal Products, or an equivalent foreign regulatory agency. The regulatory
process to obtain market approval for a new drug takes many years and requires
the expenditure of substantial resources. We have had only limited experience
in preparing applications and obtaining regulatory approvals.

To date, several drug formulations utilizing the TIMERx system have
received regulatory approval:



| |  |  | Cystrin CR was approved in Finland in 1997;                                      
| | - |  | ---------------------------------------------------------------------------------
|
| |  |  | Slofedipine XL was approved in the United Kingdom in 1998 and in Italy in 2001;  
|
| |  |  | The 30 mg strength of Nifedipine XL was approved by the FDA in December 1999; and
|
| |  |  | Cronodipin was approved in Brazil in 2001.                                       

We also have a number of TIMERx products in our development pipeline. The
most advanced of these is oxymorphone ER, which we are developing with Endo. In
February 2003, the FDA accepted for filing an NDA for oxymorphone ER.

We may encounter delays or rejections during any stage of the regulatory
approval process based upon the failure of clinical data to demonstrate
compliance with, or upon the failure of the product to meet, the FDAs
requirements for safety, efficacy and quality; and those requirements may
become more stringent due to changes in regulatory agency policy or the
adoption of new regulations. After submission of a marketing application, in
the form of an NDA or an Abbreviated New Drug Application, or ANDA, the FDA may
deny the application, may require additional testing or data and/or may require
post marketing testing and surveillance to monitor the safety or efficacy of a
product. While the U.S. Food, Drug and Cosmetic Act, or FDCA, provides for a
180-day review period, the FDA commonly takes one to two years to grant final
approval to a marketing application.

Further, the terms of approval of any marketing application, including the
labeling content, may be more restrictive than we desire and could affect the
marketability of products incorporating our controlled release technology.

Some of the controlled release products that we are developing with our
collaborators are generic versions of branded controlled release products,
which require the filing of ANDAs. Certain ANDA procedures for generic versions
of controlled release products are the subject of petitions filed by brand name
drug manufacturers, which seek changes from the FDA in the approval process for
generic drugs. These requested changes include, among other things, tighter
standards for certain bioequivalence studies and disallowance of the use by a
generic drug manufacturer in its ANDA of proprietary data submitted by the
original manufacturer as part of an original new drug application. Any changes
in FDA regulations that make ANDA approvals more difficult may have a material
adverse effect on our business, financial condition and results of operations.

Other products containing our TIMERx controlled release technology require
the filing of an NDA. A full NDA must include complete reports of preclinical,
clinical and other studies to prove adequately that the product is safe and
effective, which involves, among other things, full clinical testing, and as a
result requires the expenditure of substantial resources. In certain cases
involving controlled release versions of FDA-approved immediate release drugs,
we may be able to rely on existing publicly available safety and efficacy data
to support an NDA for controlled release products under Section 505(b)(2) of
the FDCA when such data exists for an approved immediate release version of the
same chemical entity. However, we can provide no assurance that the FDA will
accept such section 505(b)(2) NDA, or that we will be able to obtain publicly
available data that is useful. The section 505(b)(2) NDA process is a highly
uncertain avenue to approval because the FDAs policies on section 505(b)(2)
NDAs have not yet been fully developed. There can be no assurance that the FDA
will approve an application submitted under section 505(b)(2) in a timely
manner or at all.

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The FDA also has the authority to revoke or suspend approvals of
previously approved products for cause, to debar companies and individuals from
participating in the drug-approval process, to request recalls of allegedly
volatile products, to seize allegedly volatile products, to obtain injunctions
to close manufacturing plants allegedly not operating in conformity with
current Good Manufacturing Practices and to stop shipments of allegedly
volatile products. The FDA may seek to impose pre-clearance requirements on
products currently being marketed without FDA approval, and there can be no
assurance that the Company or its third-party manufacturers or collaborators
will be able to obtain approval for such products within the time period
specified by the FDA.

Even if we obtain marketing
approval, our products will be subject to ongoing regulatory review

If regulatory approval of a product is granted, such approval may be
subject to limitations on the indicated uses for which the product may be
marketed or contain requirements for costly post-marketing follow-up studies.
As to products for which marketing approval is obtained, the manufacturer of
the product and the manufacturing facilities will be subject to continual
review and periodic inspections by the FDA and other regulatory authorities.
The subsequent discovery of previously unknown problems with the product,
manufacturer or facility may result in restrictions on the product or
manufacturer, including withdrawal of the product from the market.

If we fail to comply with applicable regulatory requirements, we may be
subject to fines, suspension or withdrawal of regulatory approvals, product
recalls, seizure of products, operating restrictions and criminal prosecution.

Our controlled release products
that are generic versions of branded controlled release products that
are covered by one or more patents may be subject to litigation

We expect that our collaborators will file ANDAs for our controlled
release products that are generic versions of branded controlled release
products that are covered by one or more patents. It is likely that the owners
of the patents covering the brand name product or the sponsors of the NDA with
respect to the branded product will sue or undertake regulatory initiatives to
preserve marketing exclusivity, as Pfizer did with respect to our generic
version of Procardia XL that we developed with Mylan. Any significant delay in
obtaining FDA approval to market our product candidates as a result of
litigation, as well as the expense of such litigation, whether or not we or our
collaborators are successful, could have a material adverse effect on our
business, financial condition and results of operations.

The market may not be receptive
to products incorporating our drug delivery technologies

The commercial success of products incorporating our extended release
technology that are approved for marketing by the FDA and other regulatory
authorities will depend upon their acceptance by the medical community and
third party payors as clinically useful, cost-effective and safe. No product
based on our TIMERx or other extended release technology is marketed in the
United States, so there can be no assurance as to market acceptance.

Other factors that we believe could materially affect market acceptance of
these products include:



| |  |  | the timing of the receipt of marketing approvals and the countries in
which such approvals are obtained;
| | - |  | --------------------------------------------------------------------------------------------------------
|
| |  |  | the safety and efficacy of the product as compared to competitive products; and                         
|
| |  |  | the cost-effectiveness of the product and the ability to receive third party reimbursement.             

Our success depends on our
protecting our patents and patented rights

Our success depends in significant part on our ability to develop
patentable products, to obtain patent protection for our products, both in the
United States and in other countries, and to enforce these patents. The patent
positions of pharmaceutical firms, including us, are generally uncertain and
involve complex legal and factual questions. As a result, patents may not issue
from any patent applications that we own or license. If patents do issue, the
claims allowed may not be sufficiently broad to protect our technology. In
addition, issued patents that we own or license may be challenged, invalidated
or circumvented. Our patents also may not afford us protection against
competitors with similar technology.

Our success also depends on our not infringing patents issued to
competitors or others. We are aware of patents and patent

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applications
belonging to competitors and others that may require us to alter our products
or processes, pay licensing fees or cease certain activities.

We may not be able to obtain a license to any technology owned by a third
party that we require to manufacture or market one or more products. Even if we
can obtain a license, the financial and other terms may be disadvantageous.

Our success also depends on our maintaining the confidentiality of our
trade secrets and patented know-how. We seek to protect such information by
entering into confidentiality agreements with employees, consultants, licensees
and pharmaceutical companies. These agreements may be breached by such parties.
We may not be able to obtain an adequate, or perhaps, any remedy to such a
breach. In addition, our trade secrets may otherwise become known or be
independently developed by our competitors.

We may become involved in patent litigation or other intellectual property
proceedings relating to our products or processes which could result in
liability for damage or stop our development and commercialization efforts

The pharmaceutical industry has been characterized by significant
litigation and interference and other proceedings regarding patents, patent
applications and other intellectual property rights. The types of situations in
which we may become parties to such litigation or proceedings include:



| |  |  | We or our collaborators may initiate litigation or other proceedings
against third parties to enforce our patent rights.                                                                                                                                   
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We or our collaborators may initiate litigation or other proceedings
against third parties to seek to invalidate the patents held by such
third parties or to obtain a judgment that our products or processes do
not infringe such third parties patents.
|
| |  |  | If our competitors file patent applications that claim technology
also claimed by us, we or our collaborators may participate in
interference or opposition proceedings to determine the priority of
invention.                                            
|
| |  |  | If third parties initiate litigation claiming that our processes or
products infringe their patent or other intellectual property rights, we
and our collaborators will need to defend against such proceedings.                                           

An adverse outcome in any litigation or other proceeding could subject us
to significant liabilities to third parties and require us to cease using the
technology that is at issue or to license the technology from third parties. We
may not be able to obtain any required licenses on commercially acceptable
terms or at all.

The cost of any patent litigation or other proceeding, even if resolved in
our favor, could be substantial. Although the legal costs of defending
litigation relating to a patent infringement claim are generally the
contractual responsibility of our collaborators (unless such claim relates to
TIMERx in which case such costs are our responsibility), we could nonetheless
incur significant unreimbursed costs in participating and assisting in the
litigation. Some of our competitors may be able to sustain the cost of such
litigation and proceedings more effectively than we can because of their
substantially greater resources. Uncertainties resulting from the initiation
and continuation of patent litigation or other proceedings could have a
material adverse effect on our ability to complete in the marketplace. Patent
litigation and other proceedings may also absorb significant management time.

We have only limited manufacturing capabilities and will be dependent on third
party manufacturers

We lack commercial scale facilities to manufacture our TIMERx material or
any products we may develop in accordance with current GMP requirements
prescribed by the FDA. We currently rely on Draxis Pharma, Inc. for the bulk
manufacture of our TIMERx material for delivery to our collaborators under a
contract that expires in September 2004. The agreement shall be automatically
renewed for successive one-year periods, unless either party gives notice of
its intent not to renew the contract, at least six months prior to the end of
the then-current term.

There are a limited number of manufacturers that operate under GMP
regulations capable of manufacturing our TIMERx material. Although the Company
has qualified alternate suppliers with respect to these gums, if our current
manufacturer is unable to manufacture the TIMERx material in the required
quantities, on a timely basis or at all, we may be unable to obtain alternative
contract manufacturing, or obtain such manufacturing on commercially reasonable
terms.

If our
third party manufacturers fail to perform their obligations, we may
be adversely affected in a number of ways, including:

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| |  |  | our collaborators may not be able to meet commercial demands for our
products on a timely basis;                     
| | - |  | ---------------------------------------------------------------------------------------------------------------------
|
| |  |  | our collaborators may not be able to initiate or continue clinical
trials of products that are under development; and
|
| |  |  | our collaborators may be delayed in submitting applications for
regulatory approvals of our products.                

We have limited experience in manufacturing TIMERx material on a
commercial scale and no facilities or equipment to do so. If we determine to
develop our own manufacturing capabilities, we will need to recruit qualified
personnel and build or lease the requisite facilities and equipment. We may not
be able to successfully develop our own manufacturing capabilities. Moreover,
it may be very costly and time consuming for us to develop such capabilities.

The manufacture of any of our products is subject to regulation by the FDA
and comparable agencies in foreign countries. Any delay in complying or failure
to comply with such manufacturing requirements could materially adversely
affect the marketing of our products and our business, financial condition and
results of operations.

We are dependent upon a limited number of suppliers for the gums used in our
TIMERx material

Our drug delivery systems are based a hydrophilic matrix combining a
heterodispersed mixture primarily composed of two polysaccharides, xanthan and
locust bean gums, in the presence of dextrose. These gums are also used in our
Geminex and SyncroDose drug delivery systems. We purchase these gums from a
sole source supplier. We have qualified alternate suppliers with respect to
such materials, but we can provide no assurance that interruptions in supplies
will not occur in the future or that we will not have to obtain substitute
suppliers. Any interruption in these supplies could have a material adverse
effect on our ability to manufacture bulk TIMERx for delivery to our
collaborators.

If we or our collaborators fail to obtain an adequate level of reimbursement by third
party payors for our controlled release products, they may not be able to
successfully commercialize controlled release products in certain markets

The availability of reimbursement by governmental and other third party
payors affects the market for any pharmaceutical product. These third party
payors continually attempt to contain or reduce the costs of health care by
challenging the prices charged for medical products and services. In certain
foreign countries, particularly the countries of the European Union, the
pricing of prescription pharmaceuticals is subject to governmental control.

The generic versions of controlled release products being developed by us
and our collaborators may be assigned an AB rating if the FDA considers the
product to be therapeutically equivalent to the branded controlled release
drug. Failure to obtain an AB rating from the FDA would indicate that for
certain purposes the drug would not be deemed to be therapeutically equivalent,
would not be fully substitutable for the branded controlled release drug and
would not be relied upon by Medicaid and Medicare formularies for
reimbursement.

In both the U.S. and certain foreign jurisdictions, there have been a
number of legislative and regulatory proposals to change the health care
system. Further proposals are likely. The potential for adoption of these
proposals may affect our ability to raise capital, obtain additional
collaborative partners and market our products.

If we or our collaborators obtain marketing approvals for our products, we
expect to experience pricing pressure due to the trend toward managed health
care, the increasing influence of health maintenance organizations and
additional legislative proposals. We may not be able to sell our products
profitably if reimbursement is unavailable or limited in scope or amount.

We will be exposed to product liability claims and may not be able to obtain
adequate product liability insurance

Our business exposes us to potential product liability risks which are
inherent in the testing, manufacturing, marketing and sale of pharmaceutical
products. Product liability claims might be made by consumers, health care
providers, pharmaceutical companies, or others that sell our products. These
claims may be made even with respect to those products that are manufactured in
licensed and regulated facilities or that otherwise possess regulatory approval
for commercial sale.

We are currently covered by primary product liability insurance in the
amount of $1 million per occurrence and $2.0 million annually in the aggregate
on a claims-made basis and by umbrella liability insurance in excess of $25.0
million which can also be used for product liability insurance. This coverage
may not be adequate to cover any product liability claims. Product liability
coverage is

27



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expensive. In the future, we may not be able to maintain or obtain
such product liability insurance at a reasonable cost or in sufficient amounts
to protect us against losses due to liability claims. Any claims that are not
covered by product liability insurance could have a material adverse effect on
our business, financial condition and results of operations.

The market price of our common
stock may be volatile

The market price of our common stock, like the market prices for
securities of pharmaceutical, biopharmaceutical and biotechnology companies,
have historically been highly volatile. The market from time to time
experiences significant price and volume fluctuations that are unrelated to the
operating performance of particular companies. Factors such as fluctuations in
our operating results, future sales of our common stock, announcements of
technological innovations or new therapeutic products by us or our competitors,
announcements regarding collaborative agreements, clinical trial results,
government regulation, developments in patent or other proprietary rights,
public concern as to the safety of drugs developed by us or others, changes in
reimbursement policies, comments made by securities analysts and general market
conditions may have a significant effect on the market price of the common
stock.

Certain provisions of our Shareholder Rights Plan, Certificate of Incorporation
and Bylaws and of Washington law make a takeover of Penwest more difficult

We have adopted a shareholder rights plan, often referred to as a poison
pill. The rights issued under the plan will cause substantial dilution to a
person or group that attempts to acquire us on terms that are not approved by
our board of directors, unless the board first determines to redeem the rights.
Various provisions of our Certificate of Incorporation, our Bylaws and
Washington law may also have the effect of deterring hostile takeovers or
delaying or preventing changes in control or management of our company,
including transactions in which our stockholders might otherwise receive a
premium for their shares over then current market prices. In addition, these
provisions may limit the ability of stockholders to approve transactions that
they may deem to be in their best interest.




ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Reference is made to the disclosure under the caption Market Risk and
Risk Management Policies in Item 7  Managements Discussion and Analysis of
Financial Condition and Results of Operations.




ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

All financial statements required to be filed hereunder are filed as
Appendix A hereto, are listed under Item 15(a) included herein.




ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.




PART III




ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information set forth under Election of Directors and Section 16(a)
Beneficial Ownership Reporting Compliance in the Companys definitive Proxy
Statement for the 2003 Annual Meeting of Shareholders is incorporated herein by
reference.

Information regarding executive officers of the Company is set forth in
Part I, Item 4a above.




ITEM 11: EXECUTIVE COMPENSATION

The information set forth under Executive Compensation, Director
Compensation, and Compensation Committee Interlocks and Insider
Participation, in the Companys definitive Proxy Statement for the 2003 Annual
Meeting of Shareholders is incorporated herein by reference.

28



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ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

The information set forth under Security Ownership of Certain Beneficial
Owners and Management and Securities Authorized for Issuance Under the Equity
Compensation Plans in the Companys definitive Proxy Statement for the 2003
Annual Meeting of Shareholders is incorporated herein by reference.




ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information relating to certain relationships and related transactions
of the Company set forth under Certain Relationships and Related Transactions
in the Companys definitive Proxy Statement for the 2003 Annual Meeting of
Shareholders is incorporated herein by reference.




ITEM 14: CONTROLS AND PROCEDURES

Within the 90-day period prior to the filing of this Annual Report on Form
10-K, an evaluation was carried out under the supervision and with the
participation of our management, including Penwests Chief Executive Officer,
or CEO and Chief Financial Officer, or CFO, of the effectiveness of the design
and operation of our disclosure controls and procedures. Based on that
evaluation, Penwests CEO and CFO have concluded that our disclosure controls
and procedures are designed to ensure that information required to be disclosed
by the Company in reports that the Company files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized, and
reported within the time periods specified in SEC rules and form and are
operating in an effective manner.

There were no significant changes in the Companys internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their most recent evaluation.




PART IV




ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K



|(a)(1) |  | Financial Statements and Financial Statement Schedule
|------ |  | -----------------------------------------------------



| |  | The following documents are filed as Appendix A hereto and are included
as part of this Annual Report on Form 10-K.
| |  | -------------------------------------------------------------------------------------------------------------------



|       |  | The consolidated balance sheets as of December 31, 2002 and 2001 and the
related statements of operations, cash flows and shareholders equity for
each of the three years in the period ended December 31, 2002.                                                                                                                                
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      
|       |  | Schedule II  Valuation and Qualifying Accounts                                                                                                                                                                                                                                                                                                  
|      
|       |  | All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
omitted because they are not applicable or because the information is
presented in the financial statements or notes thereto.                                                                             
|      
|(a)(2) |  | Exhibits                                                                                                                                                                                                                                                                                                                                         
|      
|       |  | The list of Exhibits filed as part of this Annual Report on Form 10-K are
set forth on the Exhibit Index immediately preceding such exhibits, and
is incorporated herein by this reference. This list includes a subset
containing each management contract, compensatory plan, or arrangement
required to be filed as an exhibit to this report.

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| | (b) |  | Reports on Form 8-K.                                                                                                                                                                                                                                                                                                                                             
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |     |  | On November 5, 2002, the Company filed a report on Form 8-K announcing
that it had entered into a Purchase Agreement with Josef Rettenmaier
Holding GmbH & Co. KG, dated November 1, 2002 and that pursuant to the
Purchase Agreement, Penwest would sell its excipient business to
Rettenmaier for $39.5 million in cash and a promissory note of $2.25
million.
|
| |     |  | On December 3, 2002, the Company filed a report on Form 8-K announcing
its results for the third quarter ended September 30, 2002.                                                                                                                                                                                                                               

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SIGNATURES

Pursuant
to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.

|                     |  |                                                                                                                    
|-------------------- |  | -------------------------------------------------------------------------------------------------------------------
|                     |  | Penwest Pharmaceuticals Co.                                                                                        
|                    
|Date: March 31, 2003 |  | /s/ Tod R. HamachekTod R. Hamachek, Chairman of the Board
and Chief Executive Officer
(Principal Executive Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

|                     |  |                                                                                                                              
|-------------------- |  | -----------------------------------------------------------------------------------------------------------------------------
|Date: March 31, 2003 |  | /s/ Tod R. HamachekTod R. Hamachek, Chairman of the Board, Chief Executive
Officer and Director
(Principal Executive Officer)

|                     |  |                                                                                                                                           
|-------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|Date: March 31, 2003 |  | /s/ Jennifer L. GoodJennifer L. Good, Sr. Vice President,
Finance and Chief Financial Officer
(Principal Financial and Accounting Officer)
|                    
|Date: March 31, 2003 |  | /s/ Paul E. FreimanPaul E. Freiman, Director                                                                                              
|                    
|Date: March 31, 2003 |  | /s/ Jere E. GoyanJere E. Goyan, Ph.D., Director                                                                                           
|                    
|Date: March 31, 2003 |  | /s/ Rolf H. HenelRolf H. Henel, Director                                                                                                  
|                    
|Date: March 31, 2003 |  | /s/ Robert J. HennesseyRobert J. Hennessey, Director                                                                                      
|                    
|Date: March 31, 2003 |  | /s/ John N. StaniforthJohn N. Staniforth, Ph.D., Director                                                                                 
|                    
|Date: March 31, 2003 |  | /s/ Anne M. VanLentAnne M. VanLent, Director                                                                                              

31



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Certifications

I, Tod R. Hamachek, certify that:



| | 1. |    | I have reviewed this annual report on Form 10-K of Penwest
Pharmaceuticals Co.;                                                                                                                                                                                                                                                                                                       
| | -- | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |    | Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;                                                              
|
| | 3. |    | Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in
all material respects the financial condition, results of operations
and cash flows of the registrant as of, and for, the periods presented
in this annual report;                                                                                 
|
| | 4. |    | The registrants other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:                                                                                                                                                             
|
| |    | a) | designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this annual report is being prepared;                                                                                          
|
| |    | b) | evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this annual report (the Evaluation
Date); and                                                                                                                                                                                            
|
| |    | c) | presented in this annual report our conclusions
about the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation Date;                                                                                                                                                                                                                  
|
| | 5. |    | The registrants other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants auditors and
the audit committee of registrants board of directors (or persons
performing the equivalent function):                                                                                                                                        
|
| |    | a) | all significant deficiencies in the design or
operation of internal controls which could adversely affect
the registrants ability to record, process, summarize and
report financial data and have identified for the
registrants auditors any material weaknesses in internal
controls; and                                                                                        
|
| |    | b) | any fraud, whether or not material, that
involves management or other employees who have a significant
role in the registrants internal controls; and                                                                                                                                                                                                                                
|
| | 6. |    | The registrants other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.

|                      |  |                        
|--------------------- |  | -----------------------
|                      |  |                        
|                      |  |                        
|                      |  | /s/ Tod R.
Hamachek    
|Dated: March 31, 2003 |  | Tod R. Hamachek        
|                      |  | Chief Executive Officer

32



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I, Jennifer L. Good, certify that:



| | 1. |    | I have reviewed this annual report on Form 10-K of Penwest
Pharmaceuticals Co.;                                                                                                                                                                                                                                                                                                       
| | -- | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |    | Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;                                                              
|
| | 3. |    | Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in
all material respects the financial condition, results of operations
and cash flows of the registrant as of, and for, the periods presented
in this annual report;                                                                                 
|
| | 4. |    | The registrants other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:                                                                                                                                                             
|
| |    | a) | designed such disclosure controls and procedures to
ensure that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this annual report is being prepared;                                                                                          
|
| |    | b) | evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this annual report (the Evaluation
Date); and                                                                                                                                                                                            
|
| |    | c) | presented in this annual report our conclusions
about the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation Date;                                                                                                                                                                                                                  
|
| | 5. |    | The registrants other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrants auditors and
the audit committee of registrants board of directors (or persons
performing the equivalent function):                                                                                                                                        
|
| |    | a) | all significant deficiencies in the design or
operation of internal controls which could adversely affect
the registrants ability to record, process, summarize and
report financial data and have identified for the
registrants auditors any material weaknesses in internal
controls; and                                                                                        
|
| |    | b) | any fraud, whether or not material, that
involves management or other employees who have a significant
role in the registrants internal controls; and                                                                                                                                                                                                                                
|
| | 6. |    | The registrants other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.

|                      |  |                        
|--------------------- |  | -----------------------
|                      |  |                        
|                      |  |                        
|                      |  | /s/ Jennifer L.
Good   
|Dated: March 31, 2003 |  | Jennifer L. Good       
|                      |  | Chief Financial Officer

33



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APPENDIX A

PENWEST PHARMACEUTICALS CO.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

|                                                |                                                 |  |      |     |  |  |  |  | 
|----------------------------------------------- | ----------------------------------------------- |  | ---- | --- |  |  |  |  | 
|                                                |                                                 |  | Page |     |  |  | 
|                                                |                                                 |  |      |     |  |  | 
|Consolidated Financial Statements               |                                                 |  |      |     |  |  |  | 
|                                                | Report of Independent Auditors                  |  |      | F-2 |  |  |  |  | 
|                                                | Consolidated Balance Sheets                     |  |      | F-3 |  |  |  |  | 
|                                                | Consolidated Statements of Operations           |  |      | F-4 |  |  |  |  | 
|                                                | Consolidated Statements of Shareholders Equity |  |      | F-5 |  |  |  |  | 
|                                                | Consolidated Statements of Cash Flows           |  |      | F-6 |  |  |  |  | 
|                                                | Notes to Consolidated Financial Statements      |  |      | F-7 |  |  |  |  | 
|Schedule II  Valuation and Qualifying Accounts |                                                 |  | S-1  |     |  |  |  | 

F-1



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##### Table of Contents






REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders
Penwest Pharmaceuticals Co.

We have audited the accompanying consolidated balance sheets of Penwest
Pharmaceuticals Co. as of December 31, 2002 and 2001, and the related
consolidated statements of operations, shareholders equity, and cash flows for
each of the three years in the period ended December 31, 2002. Our audits also
included the financial statement schedule listed in the Index at Item 15(a).
These financial statements and schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Penwest
Pharmaceuticals Co. at December 31, 2002 and 2001, and the consolidated results
of its operations and its cash flows for each of the three years in the
period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.

As discussed in Note 3 to the consolidated financial statements, Penwest
Pharmaceuticals Co. changed its method of accounting for revenue recognition in
2000.



| | /s/ ERNST & YOUNG LLP
| | ---------------------

Stamford, Connecticut
March 17, 2003

F-2



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##### Table of Contents



PENWEST PHARMACEUTICALS CO.




CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

|                                     |                                                                                                                                                                       |                                            |        |              |        |      |        |         |        | 
|------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------------ | ------ | ---- | ------ | ------- | ------ | 
|                                     |                                                                                                                                                                       |                                            |        | DECEMBER 31,
|                                     |                                                                                                                                                                       |                                            |        |             
|                                     |                                                                                                                                                                       |                                            |        | 2002         |        | 2001
|                                     |                                                                                                                                                                       |                                            |        |              |        |     
|ASSETS                               |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|Current assets:                      |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|                                     | Cash and cash equivalents                                                                                                                                             |                                            | $      | 4,420        |        |      | $      | 12,903  |       
|                                     | Marketable securities                                                                                                                                                 |                                            |        | 2,057        |        |      |        | 9,609   |       
|                                     | Trade accounts receivable, net of allowance for
doubtful accounts of $175 and $220                                                                                    |                                            |        | 6,486        |        |      |        | 6,228   |       
|                                     | Inventories                                                                                                                                                           |                                            |        | 8,932        |        |      |        | 7,857   |       
|                                     | Prepaid expenses and other current assets                                                                                                                             |                                            |        | 2,121        |        |      |        | 1,166   |       
|                                     | Deferred transaction costs                                                                                                                                            |                                            |        | 1,741        |        |      |        |        |       
|                                     |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|                                     |                                                                                                                                                                       | Total current assets                       |        |              | 25,757 |      |        |         | 37,763 | 
|Fixed assets, net                    |                                                                                                                                                                       |                                            | 14,413 |              |        |      | 15,567 |        
|Intangible assets, net               |                                                                                                                                                                       |                                            | 7,190  |              |        |      | 3,545  |        
|Other assets                         |                                                                                                                                                                       |                                            | 2,860  |              |        |      | 2,738  |        
|                                     |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|                                     |                                                                                                                                                                       | Total assets                               |        | $            | 50,220 |      |        | $       | 59,613 | 
|                                     |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|LIABILITIES AND SHAREHOLDERS EQUITY |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|Current liabilities:                 |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|                                     | Accounts payable                                                                                                                                                      |                                            | $      | 3,133        |        |      | $      | 2,174   |       
|                                     | Accrued expenses                                                                                                                                                      |                                            |        | 3,579        |        |      |        | 2,275   |       
|                                     | Accrued development costs                                                                                                                                             |                                            |        | 2,785        |        |      |        | 3,139   |       
|                                     | Taxes payable                                                                                                                                                         |                                            |        | 238          |        |      |        | 448     |       
|                                     | Loans and notes payable                                                                                                                                               |                                            |        | 5,693        |        |      |        | 2,668   |       
|                                     |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|                                     |                                                                                                                                                                       | Total current liabilities                  |        |              | 15,428 |      |        |         | 10,704 | 
|Deferred income taxes                |                                                                                                                                                                       |                                            | 196    |              |        |      | 205    |        
|Deferred revenue                     |                                                                                                                                                                       |                                            | 284    |              |        |      | 369    |        
|Deferred compensation                |                                                                                                                                                                       |                                            | 2,889  |              |        |      | 2,711  |        
|                                     |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|                                     |                                                                                                                                                                       | Total liabilities                          |        |              | 18,797 |      |        |         | 13,989 | 
|Shareholders equity:                |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|                                     | Preferred stock, par value $.001, authorized
1,000,000 shares, none outstanding                                                                                       |                                            |        |             |        |      |        |        |       
|                                     | Common stock, par value $.001, authorized
39,000,000 shares, issued and outstanding
15,506,259 shares at December 31, 2002 and
15,276,630 shares at December 31, 2001 |                                            |        | 16           |        |      |        | 15      |       
|                                     | Additional paid in capital                                                                                                                                            |                                            |        | 110,000      |        |      |        | 108,054 |       
|                                     | Accumulated deficit                                                                                                                                                   |                                            |        | (78,025      | )      |      |        | (60,926 | )     
|                                     | Accumulated other comprehensive loss                                                                                                                                  |                                            |        | (568         | )      |      |        | (1,519  | )     
|                                     |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|                                     |                                                                                                                                                                       | Total shareholders equity                 |        |              | 31,423 |      |        |         | 45,624 | 
|                                     |                                                                                                                                                                       |                                            |        |              |        |      |        |        
|                                     |                                                                                                                                                                       | Total liabilities and shareholders equity |        | $            | 50,220 |      |        | $       | 59,613 | 
|                                     |                                                                                                                                                                       |                                            |        |              |        |      |        |        

See accompanying notes.

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PENWEST PHARMACEUTICALS CO.




CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |        |        | 
|-------------------------------------------------------------------------------- | --------------------------------------------------------------- | ------------------------ | ------- | ----------------------- | ------ | ---- | ------- | ------ | ------ | - | ------ | ------ | ------ | 
|                                                                                 |                                                                 |                          |         | YEAR ENDED DECEMBER 31,
|                                                                                 |                                                                 |                          |         |                        
|                                                                                 |                                                                 |                          |         | 2002                    |        | 2001 |         | 2000  
|                                                                                 |                                                                 |                          |         |                         |        |      |         |       
|Revenues                                                                         |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|                                                                                 | Product sales                                                   |                          | $       | 36,574                  |        |      | $       | 34,778 |        |   | $      | 37,148 |       
|                                                                                 | Royalties and licensing fees                                    |                          |         | 5,385                   |        |      |         | 5,225  |        |   |        | 4,910  |       
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|                                                                                 |                                                                 | Total revenues           |         |                         | 41,959 |      |         |        | 40,003 |   |        |        | 42,058 | 
|Cost of product sales                                                            |                                                                 |                          | 25,407  |                         |        |      | 24,810  |        |        |   | 25,303 |       
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|                                                                                 |                                                                 | Gross profit             |         |                         | 16,552 |      |         |        | 15,193 |   |        |        | 16,755 | 
|Operating expenses                                                               |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|                                                                                 | Selling, general and administrative                             |                          |         | 15,820                  |        |      |         | 13,855 |        |   |        | 12,054 |       
|                                                                                 | Research and product development                                |                          |         | 17,567                  |        |      |         | 17,003 |        |   |        | 12,820 |       
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|                                                                                 |                                                                 | Total operating expenses |         |                         | 33,387 |      |         |        | 30,858 |   |        |        | 24,874 | 
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|Loss from operations                                                             |                                                                 |                          | (16,835 | )                       |        |      | (15,665 | )      |        |   | (8,119 | )     
|Investment income                                                                |                                                                 |                          | 379     |                         |        |      | 477     |        |        |   | 217    |       
|Interest expense                                                                 |                                                                 |                          | 243     |                         |        |      | 290     |        |        |   | 172    |       
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|Loss before income taxes and cumulative effect
of change in accounting principle |                                                                 |                          | (16,699 | )                       |        |      | (15,478 | )      |        |   | (8,074 | )     
|Income tax expense                                                               |                                                                 |                          | 400     |                         |        |      | 503     |        |        |   | 302    |       
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|Loss before cumulative effect of change in
accounting principle                  |                                                                 |                          | (17,099 | )                       |        |      | (15,981 | )      |        |   | (8,376 | )     
|Cumulative effect of change in accounting
principle (Note 3)                     |                                                                 |                          |        |                         |        |      |        |        |        |   | (410   | )     
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|Net loss                                                                         |                                                                 | $                        | (17,099 | )                       |        | $    | (15,981 | )      |        | $ | (8,786 | )     
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|Basic and diluted amounts per share:                                             |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|                                                                                 | Loss before cumulative effect of change in
accounting principle |                          | $       | (1.11                   | )      |      | $       | (1.15  | )      |   | $      | (0.68  | )     
|                                                                                 | Cumulative effect of change in accounting
principle (Note 3)    |                          |         |                        |        |      |         |       |        |   |        | (0.03  | )     
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|Net loss                                                                         |                                                                 | $                        | (1.11   | )                       |        | $    | (1.15   | )      |        | $ | (0.71  | )     
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|Weighted average shares of common stock
outstanding                              |                                                                 |                          | 15,462  |                         |        |      | 13,905  |        |        |   | 12,330 |       
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|Pro forma amounts assuming the accounting change
is applied retroactively:       |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|Net loss                                                                         |                                                                 |                          |         |                         |        |      |         |        |        | $ | (8,376 | )     
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       
|Basic and diluted net loss per share                                             |                                                                 |                          |         |                         |        |      |         |        |        | $ | (0.68  | )     
|                                                                                 |                                                                 |                          |         |                         |        |      |         |        |        |   |        |       

See accompanying notes.

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##### Table of Contents



PENWEST PHARMACEUTICALS CO.




CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
(in thousands)

|                            |                                                               |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        |             |   |   |        |         |         |  
|--------------------------- | ------------------------------------------------------------- | ------------------ | ------ | ------ |  | ------ | -- | ------- |  | ---------- | ------- | ----------- |  | ------------- | ------- | ------- | - | - | ------ | ----------- | - | - | ------ | ------- | ------- | -
|                            |                                                               |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        | ACCUMULATED |   |   |        |        
|                            |                                                               |                    |        | COMMON |  |        |    |         |  | ADDITIONAL |         |             |  |               |         | OTHER   |   |   |        |            
|                            |                                                               |                    |        | STOCK  |  |        |    |         |  | PAID-IN    |         | ACCUMULATED |  | COMPREHENSIVE |         |         |   |  
|                            |                                                               |                    |        | SHARES |  | AMOUNT |    | CAPITAL |  | DEFICIT    |         | LOSS        |  | TOTAL        
|                            |                                                               |                    |        |        |  |        |    |         |  |            |         |             |  |              
|Balances, January 1, 2000   |                                                               |                    | 11,149 |        |  | $      | 11 |         |  | $          | 59,718  |             |  | $             | (36,159 | )       |   | $ | (1,061 | )           |   | $ | 22,509 |        
|                            | Net loss                                                      |                    |        |        |  |        |    |         |  |            |         |             |  |               |         | (8,786  | ) |   |        |             |   |   |        | (8,786  | )      
|                            | Translation adjustments                                       |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        | (266        | ) |   |        | (266    | )      
|                            |                                                               |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        |             |   |   |        |        
|                            |                                                               | Comprehensive loss |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        |             |   |   |        |         | (9,052  | )
|                            | Issuance of common stock -
private placement                  |                    |        | 1,399  |  |        |    | 2       |  |            |         | 16,823      |  |               |         |         |   |   |        |             |   |   |        | 16,825  |        
|                            | Issuance of common stock pursuant
to stock compensation plans |                    |        | 102    |  |        |    |        |  |            |         | 557         |  |               |         |         |   |   |        |             |   |   |        | 557     |        
|                            | Issuance of common stock pursuant
to Stock Purchase Plan      |                    |        | 20     |  |        |    |        |  |            |         | 178         |  |               |         |         |   |   |        |             |   |   |        | 178     |        
|                            |                                                               |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        |             |   |   |        |        
|Balances, December 31, 2000 |                                                               |                    | 12,670 |        |  |        | 13 |         |  |            | 77,276  |             |  |               | (44,945 | )       |   |   | (1,327 | )           |   |   | 31,017 |        
|                            | Net loss                                                      |                    |        |        |  |        |    |         |  |            |         |             |  |               |         | (15,981 | ) |   |        |             |   |   |        | (15,981 | )      
|                            | Translation adjustments                                       |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        | (244        | ) |   |        | (244    | )      
|                            | Unrealized gain on marketable securities                      |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        | 52          |   |   |        | 52      |        
|                            |                                                               |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        |             |   |   |        |        
|                            |                                                               | Comprehensive loss |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        |             |   |   |        |         | (16,173 | )
|                            | Issuance of common stock -
private placement                  |                    |        | 2,447  |  |        |    | 2       |  |            |         | 29,669      |  |               |         |         |   |   |        |             |   |   |        | 29,671  |        
|                            | Issuance of common stock pursuant
to stock compensation plans |                    |        | 149    |  |        |    |        |  |            |         | 985         |  |               |         |         |   |   |        |             |   |   |        | 985     |        
|                            | Issuance of common stock pursuant
to Stock Purchase Plan      |                    |        | 11     |  |        |    |        |  |            |         | 124         |  |               |         |         |   |   |        |             |   |   |        | 124     |        
|                            |                                                               |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        |             |   |   |        |        
|Balances, December 31, 2001 |                                                               |                    | 15,277 |        |  |        | 15 |         |  |            | 108,054 |             |  |               | (60,926 | )       |   |   | (1,519 | )           |   |   | 45,624 |        
|                            | Net loss                                                      |                    |        |        |  |        |    |         |  |            |         |             |  |               |         | (17,099 | ) |   |        |             |   |   |        | (17,099 | )      
|                            | Translation adjustments                                       |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        | 988         |   |   |        | 988     |        
|                            | Changes in unrealized gain on marketable
securities           |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        | (37         | ) |   |        | (37     | )      
|                            |                                                               |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        |             |   |   |        |        
|                            |                                                               | Comprehensive loss |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        |             |   |   |        |         | (16,148 | )
|                            | Issuance of common stock pursuant
to stock compensation plans |                    |        | 217    |  |        |    | 1       |  |            |         | 1,799       |  |               |         |         |   |   |        |             |   |   |        | 1,800   |        
|                            | Issuance of common stock pursuant
to Stock Purchase Plan      |                    |        | 12     |  |        |    |        |  |            |         | 147         |  |               |         |         |   |   |        |             |   |   |        | 147     |        
|                            |                                                               |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        |             |   |   |        |        
|Balances, December 31, 2002 |                                                               |                    | 15,506 |        |  | $      | 16 |         |  | $          | 110,000 |             |  | $             | (78,025 | )       |   | $ | (568   | )           |   | $ | 31,423 |        
|                            |                                                               |                    |        |        |  |        |    |         |  |            |         |             |  |               |         |         |   |   |        |             |   |   |        |        

See accompanying notes.

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PENWEST PHARMACEUTICALS CO.




CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

|                                                                            |                                                   |   |                         |         |      |   |         |         |   |   |        |        |  
|--------------------------------------------------------------------------- | ------------------------------------------------- | - | ----------------------- | ------- | ---- | - | ------- | ------- | - | - | ------ | ------ | -
|                                                                            |                                                   |   | YEAR ENDED DECEMBER 31,
|                                                                            |                                                   |   |                        
|                                                                            |                                                   |   | 2002                    |         | 2001 |   | 2000   
|                                                                            |                                                   |   |                         |         |      |   |        
|Operating activities:                                                       |                                                   |   |                         |         |      |   |         |         |   |   |        |       
|Net loss                                                                    |                                                   | $ | (17,099                 | )       |      | $ | (15,981 | )       |   | $ | (8,786 | )     
|Adjustments to reconcile net loss to net cash used in
operating activities: |                                                   |   |                         |         |      |   |         |         |   |   |        |       
|                                                                            | Depreciation                                      |   |                         | 2,934   |      |   |         | 2,831   |   |   |        | 2,879  |  
|                                                                            | Amortization                                      |   |                         | 313     |      |   |         | 265     |   |   |        | 213    |  
|                                                                            | Deferred income taxes                             |   |                         | (9      | )    |   |         |        |   |   |        | (18    | )
|                                                                            | Deferred revenue                                  |   |                         | (84     | )    |   |         | (10     | ) |   |        | 378    |  
|                                                                            | Deferred compensation                             |   |                         | 178     |      |   |         | 187     |   |   |        | 183    |  
|                                                                            | Stock compensation                                |   |                         | 105     |      |   |         | 119     |   |   |        | 105    |  
|Changes in operating assets and liabilities:                                |                                                   |   |                         |         |      |   |         |         |   |   |        |       
|                                                                            | Trade accounts receivable                         |   |                         | (258    | )    |   |         | 1,926   |   |   |        | (3,111 | )
|                                                                            | Inventories                                       |   |                         | (1,076  | )    |   |         | 340     |   |   |        | (547   | )
|                                                                            | Accounts payable, accrued expenses and other      |   |                         | 1,656   |      |   |         | (729    | ) |   |        | 1,378  |  
|                                                                            |                                                   |   |                         |         |      |   |         |         |   |   |        |       
|Net cash used in operating activities                                       |                                                   |   | (13,340                 | )       |      |   | (11,052 | )       |   |   | (7,326 | )     
|Investing activities:                                                       |                                                   |   |                         |         |      |   |         |         |   |   |        |       
|                                                                            | Acquisitions of fixed assets, net                 |   |                         | (1,751  | )    |   |         | (955    | ) |   |        | (1,412 | )
|                                                                            | Intangible asset costs                            |   |                         | (4,080  | )    |   |         | (1,078  | ) |   |        | (507   | )
|                                                                            | Deferred transaction costs                        |   |                         | (1,741  | )    |   |         |        |   |   |        |       |  
|                                                                            | Purchases of marketable securities                |   |                         |        |      |   |         | (11,511 | ) |   |        |       |  
|                                                                            | Proceeds from maturities of marketable securities |   |                         | 7,255   |      |   |         | 2,000   |   |   |        |       |  
|                                                                            |                                                   |   |                         |         |      |   |         |         |   |   |        |       
|Net cash used in investing activities                                       |                                                   |   | (317                    | )       |      |   | (11,544 | )       |   |   | (1,919 | )     
|Financing activities:                                                       |                                                   |   |                         |         |      |   |         |         |   |   |        |       
|                                                                            | Proceeds from loans
and notes payable             |   |                         | 28,983  |      |   |         | 29,616  |   |   |        | 2,800  |  
|                                                                            | Repayments of
loans and notes payable             |   |                         | (25,958 | )    |   |         | (26,947 | ) |   |        | (9,500 | )
|                                                                            | Issuance of common stock, net                     |   |                         | 1,841   |      |   |         | 30,661  |   |   |        | 17,454 |  
|                                                                            |                                                   |   |                         |         |      |   |         |         |   |   |        |       
|Net cash provided by financing activities                                   |                                                   |   | 4,866                   |         |      |   | 33,330  |         |   |   | 10,754 |       
|Effect of exchange rate changes on cash and cash equivalents                |                                                   |   | 308                     |         |      |   | (35     | )       |   |   | (44    | )     
|                                                                            |                                                   |   |                         |         |      |   |         |         |   |   |        |       
|Net (decrease) increase in cash and cash equivalents                        |                                                   |   | (8,483                  | )       |      |   | 10,699  |         |   |   | 1,465  |       
|Cash and cash equivalents at beginning of year                              |                                                   |   | 12,903                  |         |      |   | 2,204   |         |   |   | 739    |       
|                                                                            |                                                   |   |                         |         |      |   |         |         |   |   |        |       
|Cash and cash equivalents at end of year                                    |                                                   | $ | 4,420                   |         |      | $ | 12,903  |         |   | $ | 2,204  |       
|                                                                            |                                                   |   |                         |         |      |   |         |         |   |   |        |       

See accompanying notes.

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##### Table of Contents



PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BUSINESS

Penwest Pharmaceuticals Co. (Penwest or the Company) develops
pharmaceutical products based on innovative oral drug delivery technologies.
Based on its fundamental expertise in tabletting ingredients, the Company has
developed its proprietary TIMERx® controlled release drug delivery technology,
which is applicable to a broad range of orally administered drugs.

Prior to February 27, 2003, Penwest also developed, manufactured and
distributed branded pharmaceutical excipients, which are the inactive
ingredients in tablets and capsules, primarily consisting of binders,
disintegrants and lubricants. On February 27, 2003, Penwest sold substantially
all of the assets used in the Companys excipient business (the Asset Sale)
to subsidiaries and affiliates of Josef Rettenmaier Holding GmbH & Co. KG. The
Company received $39.5 million in cash and a promissory note of $2.25 million
in consideration for the excipient business. The Company intends to use the
proceeds of the sale of its excipient business to expand its drug delivery
business. In the first quarter of 2003, the Company will report the results of
the excipient business as a discontinued operation. During the years
ended December 31, 2002, 2001 and
2000, revenues from the sale of excipient products were 87%, 86% and 79%, respectively, of total
revenues (see Note 18).

Prior to the sale of its excipient business, the Company had revenues in
2002, 2001, and 2000, of $42.0, $40.0, and $42.1, million, respectively. The
Company had manufacturing facilities in Iowa and Finland and had customers
primarily throughout North America and Europe.

The Company has incurred recurring operating losses and has had negative
cash flows from operations for each of the three years in the period ended
December 31, 2002 and, based on anticipated levels of operations; management
expects operating losses and negative cash flows during 2003 and the first half
of 2004. Management anticipates that its existing capital resources, including
the proceeds from the sale of its excipient business, and anticipated
internally generated funds from the sale of formulated bulk TIMERx, royalties
from Mylan and other payments from collaborators, will enable the Company to
fund its currently planned operations, including its planned increase in drug
development and commercialization efforts, through late 2004. The Company may
require additional capital to fund its future operations and working capital
needs depending on its discretionary level of research and development spending
to develop new products for its drug development pipeline and for research of
new drug delivery technologies. Although the Company believes that it would be
successful in raising additional capital, there is no guarantee that it will be
able to raise such funds on terms that will be satisfactory to the Company.

The Company is subject to the risks and uncertainties associated with a
drug delivery company actively engaged in research and development. These risks
and uncertainties include, but are not limited to, a history of net losses, a
requirement for additional funding, technological changes, dependence on
collaborators and key personnel, the successful completion of development
efforts and of obtaining regulatory approval, the successful commercialization
of TIMERx controlled release products, compliance with government regulations,
patent infringement litigation and competition from current and potential
competitors, some with greater resources than the Company.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements include the accounts of
Penwest and its wholly owned subsidiaries. Material intercompany balances and
transactions have been eliminated. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.

Cash and Cash Equivalents

All highly liquid investments with maturities of three months or less when
purchased are considered cash equivalents.

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##### Table of Contents



Marketable Securities

The Company accounts for marketable securities in accordance with
Statement of Financial Accounting Standards No. 115 (SFAS No. 115),
Accounting for Certain Investments in Debt and Equity Securities. The Company
classifies its marketable securities as available-for-sale securities. Such securities are stated at
fair value and primarily consist of corporate bonds, commercial paper, and
discounted notes backed by U.S. government agencies. Unrealized holding gains
or losses are included in shareholders equity as a separate component of
accumulated other comprehensive loss. The specific identification method is
used to compute the realized gains and losses, if any, on marketable
securities.

Credit Risk and Fair Value of Financial Instruments

The Company performs ongoing credit evaluations of its customers and
generally does not require collateral. Revenues from product sales and
licensing fees are primarily derived from major pharmaceutical companies that
have significant cash resources. The Company maintains an allowance for
doubtful accounts which management believes is sufficient to cover potential
credit losses. Allowances for doubtful accounts receivable are maintained
based on historical payment patterns, aging of accounts receivable and actual
write-off history. One customer of the Company accounted for approximately
11%, 12% and 19% of total revenues in 2002, 2001 and 2000, respectively.

The primary objectives for the Companys investment portfolio are
liquidity and safety of principal. Investments are made to achieve the highest
rate of return to the Company, consistent with these two objectives. The
Companys investment policy limits investments to certain types of instruments
issued by institutions with investment grade credit ratings and places
restrictions on maturities, and concentration by issuer.

The carrying value of financial instruments, which includes cash, cash
equivalents, marketable securities, receivables, obligations under the
Companys loans and notes payable (see Note 10) and accounts payable, approximates fair
value due to the short term nature of these instruments.

Long-Lived Assets

Fixed assets are recorded at cost and depreciated by the straight-line
method over their estimated useful lives. Estimated useful lives by class of
assets are substantially as follows:

|                                         |  |            
|---------------------------------------- |  | -----------
|Buildings                                |  | 20-25 years
|Machinery and equipment                  |  | 10-12 years
|Office furniture, equipment and software |  | 5-10 years 

Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS No. 144). SFAS No. 144 supercedes Statement of
Financial Accounting Standards No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of, and the
accounting and reporting provisions of Accounting Principles Boards No. 30,
Reporting the Results of Operations  Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions. SFAS No 144 provides updated guidance concerning the
recognition and measurement of an impairment loss for certain types of
long-lived assets and expands the scope of a discontinued operation to include
a component of an entity. The adoption of SFAS No. 144 on January 1, 2002 did
not impact the Companys financial position or results of operations.

The Company reviews the recoverability of its long-lived assets, including
definite-lived intangible assets whenever facts and circumstances indicate that
the carrying amount may not be fully recoverable. For purposes of recognizing
and measuring impairment, the Company evaluates long-lived assets based upon
the lowest level of independent cash flows ascertainable to evaluate
impairment. If the sum of the undiscounted future cash flows expected over the
remaining asset life is less than the carrying value of the assets, the Company
may recognize an impairment loss. The impairment related to long-lived assets
is measured as the amount by which the carrying amount of the assets exceeds
the fair value of the asset. When fair values are not readily available, the
Company estimates fair values using expected discounted future cash
flows.

Foreign Currencies

Assets and liabilities of the Companys foreign operations are translated
into U.S. dollars at year-end exchange rates and revenue and expenses are
translated at average exchange rates. For each of the foreign operations, the
functional currency is the local currency. Accumulated other comprehensive loss
includes the cumulative translation adjustments, which is a component of other
comprehensive

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loss included in the Companys financial statements. Realized
gains and losses from foreign currency transactions are reflected in the
consolidated statements of operations. Foreign currency transaction gains
and losses were not significant in each year in the three year period ended
December 31, 2002.

Comprehensive Loss

Comprehensive loss is comprised of net loss and other comprehensive loss.
Other comprehensive loss includes certain changes in shareholders equity that
are excluded from net loss and include changes in unrealized gains on marketable
securities and foreign currency translation adjustments. Comprehensive loss for
the years ended December 31, 2002, 2001, and 2000 has been reflected in the
Consolidated Statements of Shareholders Equity.

Income Taxes

The liability method, prescribed by SFAS No. 109, Accounting for Income
Taxes, is used in accounting for income taxes. Under this method, deferred tax
assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities. The Company recorded no
income tax benefits relating to the net operating losses generated during 2002,
2001, and 2000, as such losses were offset by valuation allowances. Valuation
allowances are established against the recorded deferred income tax assets to
the extent that management believes it is more likely than not that a portion
of the deferred income tax assets are not realizable.

Revenue Recognition

Revenues from product sales are recognized when title transfers and
customer acceptance provisions have lapsed, provided collections of the related
accounts receivable are probable. Revenue received from non-refundable upfront
licensing fees are recognized ratably over the development period of the
collaboration agreement, when this period involves development risk associated
with the incomplete stage of a products development or over the estimated or
contractual licensing and supply term when there exists an obligation to supply
inventory for manufacture. Non-refundable milestone fees received for the
development funding of a product are partially recognized upon receipt based on
the Companys proportionate development efforts achieved to date relative to
the total expected development efforts and the remainder is generally
recognized ratably over the remaining expected development period. The
proportionate development efforts achieved are measured by estimating the
percentage of work completed that is required of the Company in the development
effort for the product. This estimate is primarily derived from the underlying
project plans and timelines, developed by qualified personnel who work closely
on such projects. Other contractual fees received in connection with a
collaborators launch of a product are also recognized ratably over the
estimated or contractual licensing and supply term. Product royalty fees are
recognized when earned.

Shipping and Handling

Shipping and handling costs incurred by the Company in connection with
products sold are included in cost of product sales on the Consolidated
Statements of Operations.

Advertising Costs

Advertising costs are accounted for as expenses in the period in which
they are incurred.

Research and Development

Research and development expenses consist of costs related to products
being developed internally as well as costs related to products subject to
licensing agreements. Research and development costs are charged to expense as
incurred. Certain reimbursements of costs, generally related to drug
formulation on feasibility studies, are netted against research and development
expense.

Per Share Data

Loss per common share is computed based on the weighted average number of
common shares outstanding during the period. For all years reported, diluted
loss per share was the equivalent of basic loss per share due to the respective
net losses. No dilution for common share equivalents is included in 2002, 2001,
and 2000, as the effects would be antidilutive.

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Stock Options

The Company adopted the disclosure provisions
of Statement of Financial
Accounting Standards (SFAS) No. 148, Accounting for Stock-Based Compensation
 Transition and Disclosure, which amends SFAS No. 123,
Accounting for Stock-Based Compensation, in 2002. SFAS No.
148 provides alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation,
which was originally provided under SFAS No. 123. The Statement also improves
the timeliness of disclosures by requiring the information to be included in
interim as well as annual financial statements. The adoption of these
disclosure provisions had no impact on the Companys 2002 consolidated results
of operations, financial position or cash flows.

At December 31, 2002, the Company maintained two stock-based employee
compensation plans (see Note 11). The Company accounts for these employee
stock compensation plans in accordance with the intrinsic value-based method
prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees. No stock-based employee compensation expense is reflected
in net loss as all options granted under these plans had an exercise price
equal to the fair market value of the underlying common stock on the date of
grant.

Consistent with the method described in SFAS No. 123, if compensation
expense for the Companys plans had been determined based on the fair value at
the grant dates for awards under its plans, net loss and loss per share would
have been increased to the pro forma amounts indicated below:

|                                                    |  |                                       |         |      |  |      |         |   |  |   |        |  
|--------------------------------------------------- |  | ------------------------------------- | ------- | ---- |  | ---- | ------- | - |  | - | ------ | -
|                                                    |  | YEAR ENDED DECEMBER 31,              
|                                                    |  |                                      
|                                                    |  | 2002                                  |         | 2001 |  | 2000
|                                                    |  |                                       |         |      |  |     
|                                                    |  | (IN THOUSANDS, EXCEPT PER SHARE DATA)
|Net loss  as reported                              |  | $                                     | (17,099 | )    |  | $    | (15,981 | ) |  | $ | (8,786 | )
|Net loss  pro forma                                |  | $                                     | (19,903 | )    |  | $    | (17,602 | ) |  | $ | (9,579 | )
|Net loss per share, basic and diluted  as reported |  | $                                     | (1.11   | )    |  | $    | (1.15   | ) |  | $ | (0.71  | )
|Net loss per share, basic and diluted  pro forma   |  | $                                     | (1.29   | )    |  | $    | (1.27   | ) |  | $ | (0.78  | )

3. CHANGE IN ACCOUNTING PRINCIPLE

Prior to the fourth quarter of 2000, the Company recognized revenue for
upfront non-refundable fees when received and when all contractual obligations
of the Company relating to the fees had been fulfilled. In addition, the
Company previously recognized revenue relating to development milestones and
other contractual fees as achieved, in accordance with the terms of the
collaboration agreements. Effective January 1, 2000, the Company changed its
method of accounting for upfront non-refundable fees and milestone fees.
Revenue received from non-refundable upfront licensing fees are recognized
ratably over the development period of the collaboration agreement, when this
period involves development risk associated with the incomplete state of a
products development or over the estimated or contractual licensing and supply
term when there exists an obligation to supply inventory for manufacture. Non-refundable milestone fees
received for the development funding of a product are partially recognized upon
receipt based on the Companys proportionate development efforts achieved to
date relative to the total expected development efforts and the remainder is
generally recognized ratably over the remaining expected development period.
The proportionate development efforts achieved are measured by estimating the
percentage of work completed that is required of the Company in the development
effort for the product. This estimate is primarily derived from the underlying
project plans and timelines, developed by qualified personnel who work closely
on such projects. Other contractual fees received in connection with a
collaborators launch of a product are also recognized ratably over the
estimated or contractual licensing and supply term. The Company believes the
change in accounting principle is preferable based on guidance provided in SEC
Staff Accounting Bulletin No. 101, Revenue Recognition in Financial
Statements (SAB No. 101).

In the fourth quarter of 2000, the Company adopted SAB No. 101 effective
January 1, 2000. The cumulative effect of the change in accounting principle
was reported as a change in the year ended December 31, 2000. The cumulative
effect was initially recorded as deferred revenue that will be recognized as
revenue over the remaining related collaborative or licensing and supply
agreements, as appropriate. For the year ended December 31, 2000, the
cumulative effect of the change on prior years was to increase the net loss by
$410,000 or $0.03 per share. The effect of the change on loss before cumulative
effect of the change for the year ended December 31, 2000 was to decrease the
net loss by $32,000. The pro forma amounts presented on the statement of
operations were calculated assuming the accounting change was made
retroactively to prior years. During the years ended December 31, 2002, 2001
and 2000,

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the Company recognized $41,000, $59,000 and $204,000, respectively,
of revenue/income that is included in its cumulative effect adjustment as of
January 1, 2000.

4. RECENT ACCOUNTING PRONOUNCEMENTS

In November 2002, the Emerging Issues Task Force (EITF) finalized its
tentative consensus on EITF Issue 00-21, Revenue Arrangements with Multiple
Deliverables, which provides guidance on the timing and method of revenue
recognition for arrangements that include the delivery of more than one product
or service. EITF 00-21 is effective prospectively for arrangements entered
into in fiscal periods beginning after June 15, 2003. The Company is currently
evaluating the impact of the adoption of this consensus on the Companys
financial statements.

In April 2002, the
Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 145,
Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections. SFAS No. 145 updates, clarifies and simplifies
existing accounting pronouncements and is generally effective for transactions
occurring after May 15, 2002. The adoption of this statement did not have a
material impact on the Companys financial position or results of operations.

In June 2002, the FASB issued
SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. The statement addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). SFAS No. 146 states
that a liability for a cost associated with an exit or disposal activity shall
be recognized and measured initially at its fair value in the period in which
the liability is incurred, except for a liability for one-time termination
benefits that are incurred over a period of time. The statement will apply to
the Company effective for exit or disposal activities initiated after December
31, 2002. The Company does not believe there will be a material effect from
the adoption of this new statement.

In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure, which amends SFAS No.
123, Accounting for Stock-Based Compensation. SFAS No. 148 provides
alternative methods of transition for a voluntary change to the fair value
based method of accounting for stock-based employee compensation. The
statement also improves the timeliness of disclosures by requiring the
information to be included in interim as well as annual financial statements.
The adoption of the statement had no impact on the Companys financial position
or results of operations (see Note 2).

Other pronouncements issued by the FASB or other authoritative accounting
standards groups with future effective dates are either not applicable or not
significant to the financial statements of the Company.

5. MARKETABLE SECURITIES

The amortized costs and estimated fair values of marketable securities are
as follows:

|                                               |                       |   |           |       |            |   |                |    |       |   |           |   |  |   |       |       | 
|---------------------------------------------- | --------------------- | - | --------- | ----- | ---------- | - | -------------- | -- | ----- | - | --------- | - |  | - | ----- | ----- | 
|                                               |                       |   |           |       |            |   | Gross          |    | Gross |   | Estimated
|                                               |                       |   | Amortized |       | Unrealized |   | Unrealized     |    | Fair 
|                                               |                       |   | Cost      |       | Gains      |   | Losses         |    | Value
|                                               |                       |   |           |       |            |   |                |    |      
|                                               |                       |   |           |       |            |   | (IN THOUSANDS) |    |       |   |          
|December 31, 2002                              |                       |   |           |       |            |   |                |    |       |   |           |   |  |   |       |      
|Corporate debt securities                      |                       | $ | 2,042     |       |            | $ | 15             |    |       | $ |          |   |  | $ | 2,057 |      
|                                               |                       |   |           |       |            |   |                |    |       |   |           |   |  |   |       |      
|December 31, 2001                              |                       |   |           |       |            |   |                |    |       |   |           |   |  |   |       |      
|Corporate debt securities                      |                       | $ | 7,562     |       |            | $ | 52             |    |       | $ |          |   |  | $ | 7,614 |      
|U.S. government agency-backed discounted notes |                       |   | 1,995     |       |            |   |               |    |       |   |          |   |  |   | 1,995 |      
|                                               |                       |   |           |       |            |   |                |    |       |   |           |   |  |   |       |      
|                                               | Total debt securities |   | $         | 9,557 |            |   | $              | 52 |       |   | $         |  |  |   | $     | 9,609 | 
|                                               |                       |   |           |       |            |   |                |    |       |   |           |   |  |   |       |      

Maturities of debt securities at fair value as of December 31, 2002, are
as follows (in thousands):

|                      |                              |  |   |       | 
|--------------------- | ---------------------------- |  | - | ----- | 
|Contractual maturity: |                              |  |   |      
|                      | Maturing in one year or less |  | $ | 2,057 | 
|                      |                              |  |   |      

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The primary objectives for the Companys investment portfolio are
liquidity and safety of principal. Investments are made to achieve the highest
rate of return to the Company, consistent with these two objectives. The
Companys investment policy limits
investments to certain types of instruments issued by institutions with
investment grade credit ratings and places restrictions on maturities, and
concentration by issuer.

6. INVENTORIES

Inventories, which consist of raw materials, pharmaceutical excipients
manufactured by the Company, and pharmaceutical excipients held for distribution,
including manufactured bulk TIMERx, are stated at the lower of cost (first-in,
first-out) or market.

Inventories are summarized as follows:

|                  |                   |   |                |       |      |   |       |       | 
|----------------- | ----------------- | - | -------------- | ----- | ---- | - | ----- | ----- | 
|                  |                   |   | DECEMBER
31,  
|                  |                   |   |               
|                  |                   |   | 2002           |       | 2001
|                  |                   |   |                |       |     
|                  |                   |   | (IN THOUSANDS)
|Raw materials     |                   | $ | 1,511          |       |      | $ | 1,558 |      
|Finished products |                   |   | 7,421          |       |      |   | 6,299 |      
|                  |                   |   |                |       |      |   |       |      
|                  | Total inventories |   | $              | 8,932 |      |   | $     | 7,857 | 
|                  |                   |   |                |       |      |   |       |      

Included in inventories are approximately $461,000 and $191,000 of TIMERx
raw materials and bulk TIMERx as of December 31, 2002 and 2001, respectively.

The Company periodically reviews and quality tests its inventory to
identify obsolete, slow moving or otherwise unsaleable inventories. Inventories
at December 31, 2002 and 2001 are net of allowances of $104,000 and $255,000,
respectively.

In September 1999, the Company entered into a five-year contract (plus
automatic renewals of one year each) for the manufacturing of TIMERx material
with another third party pharmaceutical company. There are a limited number of
third party manufacturers capable of producing the TIMERx material. There can
be no assurance that third parties upon which the Company relies for supply of
its TIMERx materials will perform and any failures by third parties may delay
development, or the submission of products for regulatory approval, impair the
Companys collaborators ability to commercialize products as planned and
deliver products on a timely basis or otherwise impair the Companys
competitive position, which could have a material adverse effect on the
Companys business, financial condition, cash flows and results of operations.

The Companys TIMERx drug delivery system is a hydrophilic matrix
combining primarily two natural polysaccharides, xanthan and locust bean gums,
in the presence of dextrose. The Company purchases these gums from a sole
source supplier. Most of the Companys other excipients are manufactured from a
specialty grade of wood pulp, which the Company also purchases from a sole
source supplier. Although the Company has qualified alternate suppliers with
respect to these materials, there can be no assurance that interruptions in
supplies will not occur in the future or that the Company will not have to
obtain substitute suppliers. Any of these events could have a material adverse
effect on the Companys ability to manufacture bulk TIMERx for delivery to its
collaborators or manufacture its other excipients, which could have a material
adverse effect on the Companys business, financial condition, cash flows and
results of operations.

7. FIXED ASSETS

Fixed assets, at cost, summarized by major categories, consist of the
following:

|                                  |  |                |        |      |  |   |        | 
|--------------------------------- |  | -------------- | ------ | ---- |  | - | ------ | 
|                                  |  | DECEMBER 31,  
|                                  |  |               
|                                  |  | 2002           |        | 2001
|                                  |  |                |        |     
|                                  |  | (IN THOUSANDS)
|Buildings, equipment and software |  | $              | 35,618 |      |  | $ | 34,264 | 
|Land                              |  |                | 696    |      |  |   | 696    | 
|Construction in progress          |  |                | 901    |      |  |   | 700    | 
|                                  |  |                |        |      |  |   |        | 
|                                  |  |                | 37,215 |      |  |   | 35,660 | 
|Less: accumulated depreciation    |  |                | 22,802 |      |  |   | 20,093 | 
|                                  |  |                |        |      |  |   |        | 
|                                  |  | $              | 14,413 |      |  | $ | 15,567 | 
|                                  |  |                |        |      |  |   |        | 

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The Company capitalizes certain costs associated with developing or
obtaining internal-use software. These costs include external direct costs of
materials and services used in developing or obtaining the software and payroll
and payroll-related costs for employees directly associated with the software
development project. For the year ended December 31, 2002, the Company
capitalized $606,000 of software development costs that are primarily related
to the development of the Companys enterprise-wide software systems. No such
costs were capitalized for the year ended December 31, 2001. The Company
includes these costs within buildings, equipment, and software and generally depreciates
the software development costs over a period of five to seven years, once the systems are
placed in service.

8. INTANGIBLE ASSETS

Intangible assets, net of accumulated amortization, consist of the
following:

|                                                                                                                                              |  |                |       |      |  |   |       | 
|--------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ----- | ---- |  | - | ----- | 
|                                                                                                                                              |  | DECEMBER 31,  
|                                                                                                                                              |  |               
|                                                                                                                                              |  | 2002           |       | 2001
|                                                                                                                                              |  |                |       |     
|                                                                                                                                              |  | (IN THOUSANDS)
|Patents, net of accumulated amortization of $990 and $770                                                                                     |  | $              | 4,240 |      |  | $ | 3,545 | 
|Other intangibles including acquired trademarks and other intellectual property, net
of accumulated amortization of $50 in 2002 (see Note 18) |  |                | 2,950 |      |  |   |      | 
|                                                                                                                                              |  |                |       |      |  |   |       | 
|                                                                                                                                              |  | $              | 7,190 |      |  | $ | 3,545 | 
|                                                                                                                                              |  |                |       |      |  |   |       | 

Patents include costs to secure patents on technology developed by the
Company. Patents are amortized on a straight-line basis over their useful
lives of 17 to 20 years. Amortization expense of $313,000, $193,000, and
$155,000, was recorded in the years ended December 31, 2002, 2001, and 2000,
respectively.

Other intangibles include the cost to acquire assets including trademarks
and other intellectual property related to an excipient product, Pruv, for $3
million, from AstraZeneca AB on October 25, 2002. These assets are amortized
on a straight-line basis over their estimated useful lives of 10 years. Amortization
expense of $50,000 was recorded in the year ended December 31, 2002.

Recorded intangibles are evaluated for potential impairment whenever
events or circumstances indicate that the undiscounted cash flows are not
sufficient to recover their carrying amounts. An impairment loss is recorded to
the extent the assets carrying value is in excess of related discounted cash
flows. During the fourth quarters of 2002 and 2001, the Company recorded an
impairment loss of $121,000 and $167,000,
respectively, net of accumulated amortization, relating to its patents. Such
impairment loss is reflected in research and product development expense on the
consolidated statements of operations.

Goodwill was amortized on a straight-line basis over ten years and was
recorded upon the acquisition of the Company by its former parent company.
There is no goodwill as of December 31, 2002. Amortization expense for
goodwill approximated $72,000 for 2001 and $58,000 for 2000.

9. OTHER ASSETS

Other assets relate to cash surrender values of officers life insurance
policies, and totaled $2,860,000, and $2,738,000 as of December 31, 2002 and
2001, respectively.

10. LOANS AND NOTES PAYABLE

Amounts
outstanding under loans and notes payable are summarized below:

|                                     |  |                |       |      |  |   |       | 
|------------------------------------ |  | -------------- | ----- | ---- |  | - | ----- | 
|                                     |  | DECEMBER 31,  
|                                     |  |               
|                                     |  | 2002           |       | 2001
|                                     |  |                |       |     
|                                     |  | (IN THOUSANDS)
|Revolving line of credit             |  | $              | 2,807 |      |  | $ | 2,668 | 
|Note payable to AstraZeneca AB       |  |                | 2,250 |      |  |   |      | 
|Business insurance premium financing |  |                | 636   |      |  |   |      | 
|                                     |  |                |       |      |  |   |       | 
|                                     |  | $              | 5,693 |      |  | $ | 2,668 | 
|                                     |  |                |       |      |  |   |       | 

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Credit Facilities

On January 17, 2001, the Company completed arrangements for a revolving
line of credit (Revolver) with a financial institution. Under the terms of
the Revolver, the Company may borrow up to $10.0 million (Line of Credit) as
determined by a formula based on the Companys Eligible Accounts Receivable and
Eligible Saleable Inventory, as defined in the agreement. Under the formula,
generally 85% of the Companys U.S. and Canadian receivables, as well as
generally 60% of the Companys U.S. saleable inventories, are included in the
borrowing base. Amounts outstanding under the Revolver are collateralized by
the Companys U.S. and Canadian accounts receivable, and its inventory and
general intangibles. The Revolver has an initial term of three years, and
provides for annual renewals thereafter. On February 27, 2003, the Company
paid off and terminated the Revolver in connection with the sale of its
excipient business (see Note 18).

The Revolver bears interest at a specified banks prime rate plus 1% per
annum, on the greater of $3.0 million or on the average outstanding balance.
The Revolver also requires fees be paid of 0.5% per annum on unused portions of
the Line of Credit and provides for early termination fees of up to 0.75%, in
the event the Company terminates the Revolver prior to the end of the initial
term.

The Revolver contains covenants, including the requirement that the
Company maintain at all times, certain minimum levels of tangible net worth as
defined, at varying specified amounts during the initial term of the agreement,
and restrictions on the incurrence of additional indebtedness and the payment
of dividends. The Revolver includes a lockbox requirement under the control of
the lender, whereby collections of certain trade receivables are used to
immediately reduce the balance of the Revolver.

As of December 31, 2002, the interest rate on the Revolver was 5.25% and
approximately $2.8 million was outstanding.

A $15 million unsecured revolving credit facility, previously obtained by
the Company in July 1998, was repaid in March 2000 in connection with the
Companys private placement of common stock (see Note 11).

Note Payable to AstraZeneca AB

As part of the Companys agreement to acquire assets including trademarks
and other intellectual property related to an excipient product, Pruv, for $3
million (see Note 8), on October 25, 2002, the Company issued a note to the
seller, AstraZeneca AB, in the principal amount of $2.25 million. Under the
agreement, the note required the Company to pay all indebtedness outstanding
under the note upon the closing of the Asset Sale, which occurred in February
2003. As a result, this note was paid in full in February 2003 (see Note 18).

Business Insurance Premium Financing

On September 24, 2002, the Company entered into a Premium Finance
Agreement (a Finance Agreement) through which it financed approximated $1.1
million of premiums payable in connection with the annual renewal of its
general business insurance. Under the Finance Agreement, Penwest is required
to repay the amount financed in equal monthly installments through June 2003,
plus interest at a rate of 3.11% per annum. In addition, the Company assigned,
as a security interest, any and all unearned premiums or other amounts which
may become payable to the Company under the insurance policies.

Approximately $243,000, $214,000, and $147,000, of total interest was paid in
2002, 2001, and 2000, respectively. The weighted average interest rate for all short term borrowings at
December 31, 2002 was 2.94%.

11. SHAREHOLDERS EQUITY

On March 6, 2000, the Company completed a private placement of its common
stock to selected institutional and other accredited investors, resulting in
the sale of 1,399,232 shares for approximately $18.2 million, less expenses.
Approximately $7.7 million was used to repay the existing outstanding balance
under a credit facility as required by its terms. Such credit facility is no
longer available to the Company.

On July 11, 2001, the Company completed a private placement of 2,447,187
shares of common stock to selected institutional investors, resulting in
proceeds of approximately $30 million, less expenses. The Company is using the
net proceeds of this offering primarily for the development of drug delivery
products as well as to fund the research and development of new oral drug
delivery technologies.

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Penwest Stock Option Plans

As of December 31, 2001 the Company had two stock option plans: the 1997
Equity Incentive Plan (the 1997 Plan), and the 1998 Spin-off Option Plan (the
Spin-off Plan). The 1997 Plan provides for the grant of incentive stock
options, nonstatutory stock options, restricted stock awards and other
stock-based awards, including the grant of securities convertible into Common
Stock and the grant of stock appreciation rights (collectively Awards). A
total of 2,660,000 shares of Common Stock may be issued pursuant to Awards
granted under the 1997 Plan. Awards may be granted at an exercise price which
may be less than, equal to or greater than the fair market value of the Common
Stock on the date of grant subject to certain limitations. Restricted stock
awards entitle recipients to acquire shares of Common Stock, subject to the
right of the Company to purchase all or part of such shares from the recipient
in the event that the conditions specified in the applicable Award are not
satisfied prior to the end of the applicable restriction period established for
such Award. In 1998, a total of 52,500 restricted shares were granted. No such
shares were granted in 2002, 2001, 2000 or 1999.

On August 31, 1998, Penford Corporation (Penford) distributed to the
shareholders of Penford common stock, all of the outstanding shares of the
Companys common stock (the Distribution). In connection with such
transaction, the Companys 1998 Spin-off Option Plan was adopted in June 1998
to provide for the grant of stock options to employees of Penwest and
non-employee directors of Penford who held options to purchase Penford Common
Stock as of the Distribution date and who ceased to be employees of Penford
under the terms of Penfords stock option plans. As of the Distribution date,
options to purchase 1,000,722 shares of Common Stock were granted to the
Companys employees and non-employee directors of Penford under the Spin-off
Plan. The exercise price and number of options was calculated so as to preserve
the Penford options approximate value as of the Distribution date. The Board
may not grant any additional options under the Spin-off Plan. If any option
expires or is terminated, surrendered, canceled or forfeited, the unused Common
Stock covered by such option will cease to be available for grant under the
Spin-off Plan.

The following table presents a summary of the Companys stock option
activity and related information for the years ended December 31:

|                           |  |        |           |       |  |                |                |              |  |   |       | 
|-------------------------- |  | ------ | --------- | ----- |  | -------------- | -------------- | ------------ |  | - | ----- | 
|                           |  |        |           |       |  | OPTION PRICE   |                | WTD. AVERAGE
|                           |  | SHARES |           | RANGE |  | EXERCISE PRICE
|                           |  |        |           |       |  |               
|BALANCE, DECEMBER 31, 1999 |  |        | 1,906,743 |       |  | $              | 3.70 -   9.21  |              |  | $ | 6.41  | 
|2000                       |  |        |           |       |  |                |                |              |  |   |       | 
|Granted                    |  |        | 597,925   |       |  | $              | 7.35 - 14.38   |              |  | $ | 11.82 | 
|Exercised                  |  |        | (105,302  | )     |  | $              | 4.06 -   8.67  |              |  | $ | 5.98  | 
|Cancelled                  |  |        | (136,010  | )     |  | $              | 5.26 - 12.75   |              |  | $ | 7.59  | 
|                           |  |        |           |       |  |                |                |              |  |   |       | 
|Balance, December 31, 2000 |  |        | 2,263,356 |       |  | $              | 3.70 - 14.38   |              |  | $ | 7.77  | 
|                           |  |        |           |       |  |                |                |              |  |   |       | 
|Options Exercisable        |  |        | 1,072,947 |       |  | $              | 3.70 - 10.78   |              |  | $ | 6.30  | 
|                           |  |        |           |       |  |                |                |              |  |   |       | 
|2001                       |  |        |           |       |  |                |                |              |  |   |       | 
|Granted                    |  |        | 382,501   |       |  | $              | 8.58 - 18.18   |              |  | $ | 12.65 | 
|Exercised                  |  |        | (135,842  | )     |  | $              | 3.70 -   8.88  |              |  | $ | 6.38  | 
|Cancelled                  |  |        | (230,000  | )     |  | $              | 6.38 - 11.81   |              |  | $ | 11.72 | 
|                           |  |        |           |       |  |                |                |              |  |   |       | 
|Balance, December 31, 2001 |  |        | 2,280,015 |       |  | $              | 3.70 - 18.18   |              |  | $ | 8.26  | 
|                           |  |        |           |       |  |                |                |              |  |   |       | 
|Options Exercisable        |  |        | 1,381,264 |       |  | $              | 3.70 - 14.38   |              |  | $ | 7.28  | 
|                           |  |        |           |       |  |                |                |              |  |   |       | 
|2002                       |  |        |           |       |  |                |                |              |  |   |       | 
|Granted                    |  |        | 291,087   |       |  | $              | 6.15  - 19.76  |              |  | $ | 15.89 | 
|Exercised                  |  |        | (163,113  | )     |  | $              | 4.06 - 11.81   |              |  | $ | 8.51  | 
|Cancelled                  |  |        | (8,875    | )     |  | $              | 15.47  - 19.76 |              |  | $ | 18.85 | 
|                           |  |        |           |       |  |                |                |              |  |   |       | 
|Balance, December 31, 2002 |  |        | 2,399,114 |       |  | $              | 3.70 - 19.76   |              |  | $ | 9.37  | 
|                           |  |        |           |       |  |                |                |              |  |   |       | 
|Options Exercisable        |  |        | 1,566,988 |       |  | $              | 3.70 - 18.18   |              |  | $ | 7.66  | 
|                           |  |        |           |       |  |                |                |              |  |   |       | 

The weighted average fair value of options granted during the years ended
December 31, 2002, 2001, and 2000, was $11.51, $8.03, and $11.92, respectively.
The weighted average remaining contractual life of options outstanding at
December 31, 2002 is 5.5 years. The weighted effect of applying SFAS No. 123
for providing pro forma disclosures for the years ended December 31, 2002,
2001, 2000, is not likely to be representative of the effects in future years
because the amounts above reflect only the options granted before 1995 that
vest over four to five years. No additional Penford shares were granted to the
Company employees subsequent to December 31, 1997.

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The fair value of each option grant was estimated using the Black-Scholes
option-pricing model with the following weighted average assumptions:

|                         |  |           |     |           |  |           |     |   |  |  |     |  
|------------------------ |  | --------- | --- | --------- |  | --------- | --- | - |  |  | --- | -
|                         |  | 2002      |     | 2001      |  | 2000     
|                         |  |           |     |           |  |          
|Expected dividend yield  |  | None      |     | None      |  | None     
|Risk free interest rate  |  |           | 4.9 | %         |  |           | 5.5 | % |  |  | 6.1 | %
|Expected volatility      |  |           | 69  | %         |  |           | 52  | % |  |  | 82  | %
|Expected life of options |  | 7.5 years |     | 7.5 years |  | 7.5 years

Employee Stock Purchase Plan

The Employee Stock Purchase Plan was approved in October 1997 and enables
all employees to subscribe during specified offering periods to purchase
shares of common stock at the lower of 85% of the fair market value of the
shares on the first or last day of such offering period. A maximum of 228,000
shares are authorized for issuance under the Plan. There were 12,282 shares,
10,696 shares, and 20,415 shares issued under the Plan during 2002, 2001, and
2000, respectively.

Rights Agreement

On June 25, 1998, the Companys Board of Directors declared a dividend of
one right for each outstanding share of the Companys Common Stock (the
Right) to shareholders of record at the close of business on July 28, 1998.
Each Right entitles the registered holder to purchase from the Company one
one-thousandth of a share of the Series A Preferred Stock, at a purchase price
of $60 in cash, subject to adjustment.

The Rights are not currently exercisable and will not be exercisable until
the earlier of (i) 10 business days (or such later date as may be determined by
the Board) following the later of (a) a public announcement that a person or
group of affiliated or associated persons (a Rights Acquiring Person) has
acquired, or obtained the right to acquire, beneficial ownership of 15% or more
of the outstanding shares of Common Stock or (b) the first date on which an
executive officer of the Company has actual knowledge that a Rights Acquiring
Person has become such, or (ii) 10 business days (or such later date as may be
determined by the Board) following the commencement of a tender offer or
exchange offer that would result in a person or group beneficially owning 15%
or more of such outstanding shares of Common Stock. The Rights will expire upon
the close of business on July 27, 2008 unless earlier redeemed or exchanged.

12. COMMITMENTS

Leases

The Companys manufacturing facility in Finland is leased under a
three-year operating lease which includes renewal options with annual rental
expense of approximately $216,000 plus additional charges determined on a
month-to-month basis for equipment and warehouse usage. In addition, certain of
the Companys property, plant and equipment is leased under operating leases
ranging from one to fifteen years and includes periodic escalation clauses
based on rental market conditions as well as insurance rent payments. Rental
expense under operating leases was $828,000, $683,000, and $583,000, for the
years ended December 31, 2002, 2001, and 2000, respectively.

Future minimum lease payments as of December 31, 2002 for noncancellable
operating leases having initial lease terms of more than one year are as
follows:

|                             |            |      |       |                |     | 
|---------------------------- | ---------- | ---- | ----- | -------------- | --- | 
|                             |            |      |       | OPERATING     
|                             |            |      |       | LEASES        
|                             |            |      |       |               
|                             |            |      |       | (IN THOUSANDS)
|                             |            | 2003 |       |                | 792 | 
|                             |            | 2004 |       |                | 515 | 
|                             |            | 2005 |       |                | 367 | 
|                             |            | 2006 |       |                | 353 | 
|                             |            | 2007 |       |                | 28  | 
|                             | Thereafter |      |       | 28             |    
|                             |            |      |       |               
|Total minimum lease payments |            | $    | 2,083 |               
|                             |            |      |       |               

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13. INCOME TAXES

The provision (benefit) for federal, state and foreign income taxes
consists of the following:

|         |          |   |                |     |      |   |      |     |  |   |     |     |  
|-------- | -------- | - | -------------- | --- | ---- | - | ---- | --- |  | - | --- | --- | -
|         |          |   | 2002           |     | 2001 |   | 2000
|         |          |   |                |     |      |   |     
|         |          |   | (IN THOUSANDS)
|Federal: |          |   |                |     |      |   |      |     |  |   |     |    
|         | Deferred |   | $              |    |      |   | $    |    |  |   | $   |    |  
|Foreign: |          |   |                |     |      |   |      |     |  |   |     |    
|         | Current  |   |                | 386 |      |   |      | 473 |  |   |     | 290 |  
|         | Deferred |   |                | (9  | )    |   |      |    |  |   |     | (18 | )
|State:   |          |   |                |     |      |   |      |     |  |   |     |    
|         | Current  |   |                | 23  |      |   |      | 30  |  |   |     | 30  |  
|         | Deferred |   |                |    |      |   |      |    |  |   |     |    |  
|         |          |   |                |     |      |   |      |     |  |   |     |     |  
|         |          | $ | 400            |     |      | $ | 503  |     |  | $ | 302 |    
|         |          |   |                |     |      |   |      |     |  |   |     |     |  

The reconciliation between the statutory tax rate and those reflected in
the Companys income tax provision (benefit) is as follows:

|                    |  |      |     |      |  |      |     |    |  |  |     |   
|------------------- |  | ---- | --- | ---- |  | ---- | --- | -- |  |  | --- | --
|                    |  | 2002 |     | 2001 |  | 2000
|                    |  |      |     |      |  |     
|Statutory tax rate  |  |      | (34 | )%   |  |      | (34 | )% |  |  | (34 | )%
|Valuation allowance |  |      | 37  |      |  |      | 40  |    |  |  | 36  |   
|Foreign taxes       |  |      | (1  | )    |  |      | (1  | )  |  |  | 1   |   
|Other               |  |      |    |      |  |      | (2  | )  |  |  | 1   |   
|                    |  |      |     |      |  |      |     |    |  |  |     |   
|                    |  |      | 2   | %    |  |      | 3   | %  |  |  | 4   | % 
|                    |  |      |     |      |  |      |     |    |  |  |     |   

The components of deferred income tax (assets) and liabilities at December
31 are as follows:

|                                                  |                                |   |                |         |      |   |         |         |  
|------------------------------------------------- | ------------------------------ | - | -------------- | ------- | ---- | - | ------- | ------- | -
|                                                  |                                |   | 2002           |         | 2001
|                                                  |                                |   |                |         |     
|                                                  |                                |   | (IN THOUSANDS)
|Trade accounts receivable allowance               |                                | $ | (68            | )       |      | $ | (85     | )      
|Inventory allowance and basis differences         |                                |   | (274           | )       |      |   | (331    | )      
|Deferred compensation and SERP liability          |                                |   | (1,115         | )       |      |   | (1,047  | )      
|Deferred revenue                                  |                                |   | (110           | )       |      |   | (142    | )      
|Tax credit carryforward                           |                                |   | (1,396         | )       |      |   | (467    | )      
|Net operating loss carryforwards                  |                                |   | (23,393        | )       |      |   | (16,021 | )      
|Other                                             |                                |   | (151           | )       |      |   | (164    | )      
|                                                  |                                |   |                |         |      |   |         |        
|                                                  | Total deferred tax assets      |   |                | (26,507 | )    |   |         | (18,257 | )
|                                                  |                                |   |                |         |      |   |         |        
|Depreciation and amortization                     |                                |   | 2,934          |         |      |   | 3,232   |        
|Other                                             |                                |   | 477            |         |      |   | 337     |        
|                                                  |                                |   |                |         |      |   |         |        
|                                                  | Total deferred tax liabilities |   |                | 3,411   |      |   |         | 3,569   |  
|                                                  |                                |   |                |         |      |   |         |        
|Net deferred tax asset before valuation allowance |                                |   | (23,096        | )       |      |   | (14,688 | )      
|                                                  | Valuation allowance            |   |                | 23,292  |      |   |         | 14,893  |  
|                                                  |                                |   |                |         |      |   |         |        
|                                                  | Net deferred tax liability     |   | $              | 196     |      |   | $       | 205     |  
|                                                  |                                |   |                |         |      |   |         |        

The Companys income tax payments, primarily
comprised of foreign income
taxes, approximated $655,000, $342,000, and $371,000, for the years ended
December 31, 2002, 2001, and 2000, respectively.

At December 31, 2002, the
Company has federal net operating loss (NOL)
carryforwards of $60,573,000 for income tax purposes, of which approximately
$6,188,000, $8,407,000, $9,135,000, $17,752,000 and $19,091,000 expire in 2018,
2019, 2020, 2021, and 2022 respectively. In addition, the Company has research
and development tax credit carryforwards of approximately $1,382,000, of which
$299,000 $306,000 and $777,000 expire in 2019, 2020, and 2021 respectively. The
use of the NOLs and

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research and development tax credit carryforwards are
limited to future taxable earnings of the Company. For financial reporting
purposes at December 31, 2002, a valuation allowance of $23.3 million has been
recognized to offset net deferred tax assets, primarily
attributable to the NOL carry-forward. Utilization of the operating losses
are subject to a limitation due to the ownership change provisions of the
Internal Revenue Code.

The Companys policy is to permanently reinvest foreign earnings.
Accumulated foreign earnings, for which no deferred taxes have been provided,
amounted to $5,922,000, $5,043,000, and $3,794,000 as of December 31, 2002,
2001, and 2000, respectively. If such earnings were to be repatriated, the
income tax effect would not be significant (see Note 18).

Included in the loss before income taxes is
foreign income of $1,247,000,
$1,651,000, and $977,000 for the years ended December 31, 2002, 2001, and
2000, respectively.

14. RETIREMENT PLANS AND OTHER EMPLOYEE BENEFITS

Savings Plan

Company employees participate in the Penwest Pharmaceuticals Co. Savings
Plan, a defined contribution plan generally covering all of its U.S. employees.
Under the Plan, the Company may make quarterly employer matching contributions
as defined in the Plan agreement, in an amount equal to a percentage of each
participants pre-tax contributions to the Plan up to 6% of earnings.
Participants are immediately vested in their contributions, as well as any
earnings thereon. Vesting in the employer contribution portion of their
accounts, as well as any earnings thereon is based on years of credited service
and vest over a four-year period. The Companys expense under the Plan was
$296,000, $227,000, and $237,000 for 2002, 2001 and 2000, respectively.

The Plan also includes a discretionary annual profit-sharing component
that is awarded by Penwests Board of Directors generally based on achievement
of predetermined corporate goals. This feature is available to all employees
who meet the eligibility requirements of the Plan. There was no profit sharing
expense in 2002, 2001, or 2000.

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Supplemental Executive Retirement Plan

The Company has a Supplemental Executive Retirement Plan (SERP), a
nonqualified plan, which covers the Chairman and Chief Executive Officer of
Penwest. For 2002, 2001, and 2000, the net expense for the SERP incurred by
Penwest was $106,000, $125,000, and $122,000, respectively. The Company does
not fund this liability and no assets are held by the Plan. The following
disclosures summarize information relating to the Plan.

Change in benefit obligation (in thousands):

|                                          |  |      |       |      |  |   |       |  
|----------------------------------------- |  | ---- | ----- | ---- |  | - | ----- | -
|                                          |  | 2002 |       | 2001
|                                          |  |      |       |     
|Benefit obligation at beginning of period |  | $    | 1,580 |      |  | $ | 1,453 |  
|Service cost                              |  |      | (22   | )    |  |   | (19   | )
|Interest cost                             |  |      | 113   |      |  |   | 108   |  
|Actuarial gains                           |  |      | 168   |      |  |   | 38    |  
|                                          |  |      |       |      |  |   |       |  
|Benefit obligation at December 31,        |  | $    | 1,839 |      |  | $ | 1,580 |  
|                                          |  |      |       |      |  |   |       |  

Funded status (in thousands):

|                                                                          |  |      |        |      |  |   |        |  
|------------------------------------------------------------------------- |  | ---- | ------ | ---- |  | - | ------ | -
|                                                                          |  | 2002 |        | 2001
|                                                                          |  |      |        |     
|Funded status (unfunded)                                                  |  | $    | (1,839 | )    |  | $ | (1,580 | )
|Unrecognized net transition obligation                                    |  |      | 100    |      |  |   | 160    |  
|Unrecognized prior service cost                                           |  |      | 31     |      |  |   | 51     |  
|Unrecognized net actuarial gain                                           |  |      | (318   | )    |  |   | (550   | )
|                                                                          |  |      |        |      |  |   |        |  
|Net amount recognized at December 31,
(included in deferred compensation) |  | $    | (2,026 | )    |  | $ | (1,919 | )
|                                                                          |  |      |        |      |  |   |        |  

Components of net periodic benefit cost (in thousands):

|                                                   |  |      |     |      |  |   |     |  
|-------------------------------------------------- |  | ---- | --- | ---- |  | - | --- | -
|                                                   |  | 2002 |     | 2001
|                                                   |  |      |     |     
|Service cost                                       |  | $    | (22 | )    |  | $ | (19 | )
|Interest cost                                      |  |      | 113 |      |  |   | 108 |  
|Amortization of unrecognized transition obligation |  |      | 60  |      |  |   | 60  |  
|Amortization of prior service cost                 |  |      | 20  |      |  |   | 49  |  
|Amortization of gains                              |  |      | (65 | )    |  |   | (73 | )
|                                                   |  |      |     |      |  |   |     |  
|Net periodic benefit cost                          |  | $    | 106 |      |  | $ | 125 |  
|                                                   |  |      |     |      |  |   |     |  

The Plans accumulated benefit obligation at December 31, 2002 and 2001
was $1,363,000 and $1,356,000, respectively. The Companys benefit obligation
was measured using a weighted average discount rate of 6.75% and 7.25% in 2002
and 2001, respectively, and a compensation increase of 4% and 4% in 2002 and
2001, respectively. The amortization of prior service cost is determined using
a straight-line amortization of the cost over the average remaining service
period of the employee expected to receive benefits under the Plan.

Health Care and Life Insurance Benefits

The Company offers health care and life insurance benefits to most active
employees. Costs incurred for these benefits were $873,000, $732,000, and
$682,000, in 2002, 2001, and 2000, respectively.

15. LICENSING AGREEMENTS

The Company enters into collaborative arrangements with pharmaceutical
companies for the completion of late-stage clinical development, manufacturing
and marketing of its products under development.

In September 1997, the Company entered into a strategic alliance agreement
with Endo with respect to the development of an extended release formulation of
oxymorphone based on the Companys TIMERx technology. Endo is a fully
integrated specialty

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pharmaceutical company with a market leadership in pain management. Endo
has a broad product line including 20 branded products that include the
established brands such as Percodan ®, Percocet®, and
Lidoderm®. Endo is registered with the U.S. Drug Enforcement
Administration as a developer, manufacturer and marketer of controlled narcotic
substances.

Under the strategic alliance agreement, the responsibilities of the
Company and Endo with respect to the Endo Product are determined by a committee
comprised of an equal number of members from each of the Company and Endo (the
Alliance Committee). During the development of the product, the Company
formulated oxymorphone ER and Endo conducted all clinical studies and prepared
and filed all regulatory applications. The Company has agreed to manufacture
and supply TIMERx material to Endo, and Endo has agreed to manufacture and
market oxymorphone ER in the United States. The manufacture and marketing
outside of the United States may be conducted by the Company, Endo or a third
party, as determined by the Alliance Committee.

Prior to March 17, 2003, the Company
and Endo shared the costs involved in
the development of oxymorphone ER. On March 17, 2003, the Company gave Endo
notice that it is discontinuing its participation in the funding of the
development and marketing of oxymorphone ER. The Company believes that its current strategic
focus should be on funding products in its development pipeline.
As a result of this termination, Endo has the right to complete the development of oxymorphone ER
and recoup the portion of development costs incurred by Endo that otherwise would have been
funded by Penwest. Endo may recoup such development costs solely through a temporary adjustment in the
royalty rate payable to Penwest which shall return to its pre-adjustment level once Endo has recovered
such costs. The parties have agreed
that the party marketing
oxymorphone ER will pay the other party royalties initially equal to 50% of the
net realization (as defined in the agreement). This percentage will decrease if the aggregate U.S. net
realization exceeds pre-determined thresholds. In general, the royalty payable
by the marketing party to the other party will not drop below 40%. However, the
royalty will be reduced by one-third in limited circumstances, including
termination of the agreement based on uncured material breaches of the
agreement by the royalty receiving party and certain bankruptcy and insolvency
events involving the royalty receiving party. Under the agreement, Endo will purchase formulated
TIMERx material for use in oxymorphone ER exclusively from the Company at specified prices, such prices will be reflected in the determination of net profits.

On March 2, 2000, Mylan announced that it had signed a supply and
distribution agreement with Pfizer to market a generic version of all three
strengths (30 mg, 60 mg, 90 mg) of Pfizers Procardia XL. In connection with
that agreement, Mylan decided not to market Nifedipine XL and agreed to pay
Penwest a royalty on all future net sales of the 30 mg strength of Pfizers
generic Procardia XL. The royalty percentage was comparable to the percentage
called for in Penwests original agreement with Mylan for Nifedipine XL. Mylan
has retained the marketing rights to the 30 mg strength of Nifedipine XL.
Mylans sales in the United States in 2002 of the 30 mg dosage strength version
of Pfizers generic Procardia XL totaled approximately $34.9 million. The term
of this agreement continues until such time as Mylan permanently ceases to
market generic Procardia XL.

Approximately $16,958,000, 16,093,000,
and $12,102,000 for the years
ended December 31, 2002, 2001, and 2000, respectively, of research and
development expense principally related to applications of TIMERx technology to
products covered by the Companys collaborative agreements. Since the
collaborative agreements can be terminated by either party, the costs
associated with such agreements could be discontinued by the Company. Such
costs are typically incurred prior to the receipt of milestones, royalties and
other payments.

16. CONTINGENCIES

Substantial patent litigation exists in the pharmaceutical industry.
Patent litigation generally involves complex legal and factual questions, and
the outcome frequently is difficult to predict. An unfavorable outcome in any
patent litigation affecting the Company could cause the Company to pay
substantial damages, alter its products or processes, obtain licenses and/or
cease certain activities. Even if the outcome is favorable to the Company, the
Company could incur substantial litigation costs. Although the legal costs of
defending litigation relating to a patent infringement claim (unless such claim
relates to TIMERx) are generally the contractual responsibility of the
Companys collaborators, the Company could nonetheless incur significant
unreimbursed costs in participating and assisting in the litigation.

17. SEGMENT INFORMATION

The Company is engaged in the research, development and commercialization
of novel oral drug delivery products and technologies, and has extensive
expertise in developing, manufacturing, and selling excipient ingredients for
the pharmaceutical industry. The Companys product portfolio ranges from
excipients that are sold in bulk, to more technically advanced and patented

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excipients that are licensed to customers, and conducts its business
primarily in North America and Europe. The European operations consist of a
manufacturing facility in Nastola, Finland and sales offices in Reigate,
England, and Bodenheim, Germany. None of the European locations, other than
Finland, is individually significant. Intercompany sales include a profit
component for the selling company. Intercompany sales and profits are
eliminated in consolidation. Corporate operating expenses are not allocated to
the European operations. Operating profit represents gross profit less selling,
general and administrative expenses and, for North America, research and
development expense.

The Companys geographic area data for each of the three years
ended December 31, 2002, 2001, and 2000 were as follows:

|                  |  |                |        |         |  |                |       |              |  |       |        |  |  |   |        |   |  |   |        | 
|----------------- |  | -------------- | ------ | ------- |  | -------------- | ----- | ------------ |  | ----- | ------ |  |  | - | ------ | - |  | - | ------ | 
|                  |  | NORTH          |        |         |  |                |       | GERMANY AND  |  |       |        |  |  |   |        |  
|                  |  | AMERICA        |        | FINLAND |  | UNITED KINGDOM |       | ELIMINATIONS |  | TOTAL
|                  |  |                |        |         |  |                |       |              |  |      
|                  |  | (IN THOUSANDS)
|DECEMBER 31, 2002 |  |                |        |         |  |                |       |              |  |       |        |  |  |   |        |   |  |   |        | 
|Total Revenues    |  | $              | 32,069 |         |  | $              | 6,699 |              |  | $     | 12,284 |  |  | $ | (9,093 | ) |  | $ | 41,959 | 
|Long-lived Assets |  | $              | 23,800 |         |  | $              | 626   |              |  | $     | 37     |  |  |   |        |   |  | $ | 24,463 | 
|DECEMBER 31, 2001 |  |                |        |         |  |                |       |              |  |       |        |  |  |   |        |   |  |   |        | 
|Total Revenues    |  | $              | 38,412 |         |  | $              | 6,912 |              |  | $     | 3,650  |  |  | $ | (8,971 | ) |  | $ | 40,003 | 
|Long-lived Assets |  | $              | 21,268 |         |  | $              | 557   |              |  | $     | 25     |  |  |   |        |   |  | $ | 21,850 | 
|DECEMBER 31, 2000 |  |                |        |         |  |                |       |              |  |       |        |  |  |   |        |   |  |   |        | 
|Total Revenues    |  | $              | 40,922 |         |  | $              | 5,708 |              |  | $     | 2,948  |  |  | $ | (7,520 | ) |  | $ | 42,058 | 
|Long-lived Assets |  | $              | 22,371 |         |  | $              | 604   |              |  | $     | 20     |  |  |   |        |   |  | $ | 22,995 | 

Neither the revenues nor long-lived assets in Germany or the United
Kingdom, individually or in the aggregate, exceed 10% of total revenues or
long-lived assets, respectively, of the Company.

18. Subsequent Events

On February 27, 2003, Penwest sold substantially all of the assets used in
the Companys excipient business (the Asset Sale) to subsidiaries and
affiliates of Josef Rettenmaier Holding GmbH & Co. KG (Rettenmaier) for
$41.75 million, plus the assumption of specified liabilities, subject to a
working capital adjustment. The Assets of the excipient business were sold to
Rettenmaier, either directly or through the sale of the outstanding capital
stock of the three subsidiaries of Penwest that do business in the UK, Germany
and Finland. The purchase price included $39.5 million in cash and a
promissory note of $2.25 million, with $1.0 million due April 25, 2003 and
$1.25 million due May 25, 2004. In the first quarter of 2003, the Company
expects to record a gain on the Asset Sale of approximately $9.5 million
before taxes, and to report the operating results of the excipient business as
a discontinued operation in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets.
The net carrying amount of the assets and liabilities at December 31, 2002 was approximately $29 million.
The approximate carrying values of the major classes were: property, plant and equipment of $11.4 million;
inventory of $8.3 million; receivables of $6.0 million; and
intangible assets of $4.2 million. The estimated gain on the Asset
Sale is net of transaction related costs, primarily consisting of professional
and advisory fees. As of December 31, 2002 these costs approximated $1.7
million and are reflected in the deferred transaction costs on the consolidated
balance sheet.
During the years ended December 31, 2002, 2001 and 2000, revenues from the sale of excipient
products were 87%, 86% and 79%, respectively.

Prior to the sale of the excipient business, the Company had a revolving
line of credit with a financial institution. On February 27, 2003, the Company
fully paid down and terminated the Revolver in connection with the Asset Sale.

As part of the Companys agreement with AstraZeneca AB to acquire assets
including trademarks and other intellectual property related to an excipient
product, Pruv, for $3 million, on October 25, 2002, the Company issued a note
to AstraZeneca AB in the principal amount of $2.25 million. These assets were
included in the Asset Sale (see above).
The note required
the Company to pay all indebtedness outstanding under the note upon the closing
of the Asset Sale. As a result, this note was paid in full on February 27,
2003.

Prior to the sale of the excipient business, the Company owned its office,
laboratory and warehouse facility in Patterson, New York, as well as a facility
in Cedar Rapids, Iowa, where it manufactured pharmaceutical excipients. As
part of the sale of the excipient business, the Company transferred these
properties and assigned its lease of a pharmaceutical excipient manufacturing
facility in Nastola, Finland. Under a lease agreement signed with Rettenmaier
on February 27, 2003, the Company has the right to occupy approximately 14,000
square feet of office, and research and development space in the Patterson
facility until February 2008, initially on a rent-free basis (plus operating
expenses) for two years and then pursuant to three successive one-year options
at monthly rent payments approximating $14,000, plus operating expenses. In
addition, in February 2003, the Company signed a lease agreement for
approximately 11,000 square feet of office space in Danbury, Connecticut. This
lease has an initial term expiring January 31, 2006, with renewal options
through December 30, 2006, and requires that monthly base rents of
approximately $20,000 be paid through the initial lease term. The Company
plans to move its corporate offices to Danbury effective March 31, 2003.

F-21



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##### Table of Contents



19. QUARTERLY FINANCIAL DATA (UNAUDITED)

Summarized quarterly financial data for the years ended December 31, 2002 and
2001 is as follows (in thousands, except per share data):

|                   |  |               |        |               |  |                |        |               |  |   |        |   |  |   |        |  
|------------------ |  | ------------- | ------ | ------------- |  | -------------- | ------ | ------------- |  | - | ------ | - |  | - | ------ | -
|                   |  | Quarter Ended
|                   |  |              
|                   |  | Mar. 31, 2002 |        | June 30, 2002 |  | Sept. 30, 2002 |        | Dec. 31, 2002
|                   |  | (Unaudited)   |        | (Unaudited)   |  | (Unaudited)    |        | (Unaudited)  
|                   |  |               |        |               |  | (a)           
|Total revenues     |  | $             | 10,313 |               |  | $              | 10,261 |               |  | $ | 11,049 |   |  | $ | 10,336 |  
|Gross profit       |  |               | 3,719  |               |  |                | 4,031  |               |  |   | 4,604  |   |  |   | 4,198  |  
|Net loss           |  | $             | (4,318 | )             |  | $              | (5,318 | )             |  | $ | (4,476 | ) |  | $ | (2,987 | )
|                   |  |               |        |               |  |                |        |               |  |   |        |   |  |   |        |  
|Net loss per share |  | $             | (0.28  | )             |  | $              | (0.34  | )             |  | $ | (0.29  | ) |  | $ | (0.19  | )
|                   |  |               |        |               |  |                |        |               |  |   |        |   |  |   |        |  

|                   |  |               |        |               |  |                |        |               |  |   |        |   |  |   |        |  
|------------------ |  | ------------- | ------ | ------------- |  | -------------- | ------ | ------------- |  | - | ------ | - |  | - | ------ | -
|                   |  | Quarter Ended
|                   |  |              
|                   |  | Mar. 31, 2001 |        | June 30, 2001 |  | Sept. 30, 2001 |        | Dec. 31, 2001
|                   |  | (Unaudited)   |        | (Unaudited)   |  | (Unaudited)    |        | (Unaudited)  
|                   |  |               |        |               |  | (b)           
|Total revenues     |  | $             | 10,939 |               |  | $              | 9,515  |               |  | $ | 9,801  |   |  | $ | 9,748  |  
|Gross profit       |  |               | 4,376  |               |  |                | 3,698  |               |  |   | 3,633  |   |  |   | 3,486  |  
|Net loss           |  | $             | (2,123 | )             |  | $              | (3,166 | )             |  | $ | (4,125 | ) |  | $ | (6,567 | )
|                   |  |               |        |               |  |                |        |               |  |   |        |   |  |   |        |  
|Net loss per share |  | $             | (0.17  | )             |  | $              | (0.25  | )             |  | $ | (0.28  | ) |  | $ | (0.43  | )
|                   |  |               |        |               |  |                |        |               |  |   |        |   |  |   |        |  

|    |  |                                                                             |  |                                                                                                                                                           
|--- |  | --------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | During the fourth quarter of 2002, the following adjustments were
recorded:
|    |  |                                                                             |  |                                                                                                                                                           
|    |  | i)                                                                          |  | The Company recorded the reimbursement of approximately $780,000 of
costs from one of its collaborators, as a reduction of research &
development expense.
|    |  |                                                                             |  |                                                                                                                                                           
|    |  | ii)                                                                         |  | The Company recorded an adjustment of approximately $317,000 to
reduce the accrual for 2002 bonuses.                                                      
|    |  |                                                                             |  |                                                                                                                                                           
|    |  | iii)                                                                        |  | The Company recorded an impairment loss of approximately $121,000,
net of accumulated amortization, relating to its patents.                              
|    |  |                                                                             |  |                                                                                                                                                           
|(b) |  | During the fourth quarter of 2001, the following adjustment was
recorded:  
|    |  |                                                                             |  |                                                                                                                                                           
|    |  | i)                                                                          |  | The Company recorded an impairment loss of approximately $167,000,
net of accumulated amortization, relating to its patents.                              

During years ended December 31, 2002 and 2001, revenues from the sale
of excipient products were 87% and 86%,
respectively,  of total
revenues. See Note 18 for further details.

F-22



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##### Table of Contents



SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS

PENWEST PHARMACEUTICALS CO.
DECEMBER 31, 2002

(IN THOUSANDS)

|                             |                                 |  |            |     |            |  |           |     |             |  |            |   |  |  |   |     |            |  |  |    |   |  |   |     | 
|---------------------------- | ------------------------------- |  | ---------- | --- | ---------- |  | --------- | --- | ----------- |  | ---------- | - |  |  | - | --- | ---------- |  |  | -- | - |  | - | --- | 
|                             |                                 |  |            |     |            |  |           |     |             |  | Charged to |   |  |  |   |     |            |  |  |    |   |  |  
|                             |                                 |  | Balance at |     | Charged to |  | Other     |     |             |  |            |   |  |  |   |     | Balance at
|                             |                                 |  | Beginning  |     | Costs and  |  | Accounts- |     | Deductions- |  | End of    
|                             |                                 |  | of Period  |     | Expenses   |  | Describe  |     | Describe    |  | Period    
|                             |                                 |  |            |     |            |  |           |     |             |  |           
|Year ended December 31, 2002 |                                 |  |            |     |            |  |           |     |             |  |            |   |  |  |   |     |            |  |  |    |   |  |   |    
|                             | Allowance for Doubtful Accounts |  | $          | 220 |            |  | $         | 12  |             |  |            |  |  |  | $ | 57  |            |  |  | (a | ) |  | $ | 175 | 
|                             | Inventory Allowances            |  | $          | 255 |            |  | $         | 64  |             |  |            |  |  |  | $ | 215 |            |  |  | (b | ) |  | $ | 104 | 
|Year ended December 31, 2001 |                                 |  |            |     |            |  |           |     |             |  |            |   |  |  |   |     |            |  |  |    |   |  |   |    
|                             | Allowance for Doubtful Accounts |  | $          | 235 |            |  | $         | 25  |             |  |            |  |  |  | $ | 40  |            |  |  | (a | ) |  | $ | 220 | 
|                             | Inventory Allowances            |  | $          | 26  |            |  | $         | 324 |             |  |            |  |  |  | $ | 95  |            |  |  | (b | ) |  | $ | 255 | 
|Year ended December 31, 2000 |                                 |  |            |     |            |  |           |     |             |  |            |   |  |  |   |     |            |  |  |    |   |  |   |    
|                             | Allowance for Doubtful Accounts |  | $          | 245 |            |  | $         | (31 | )           |  |            |  |  |  | $ | (21 | )          |  |  | (a | ) |  | $ | 235 | 
|                             | Inventory Allowances            |  | $          | 277 |            |  | $         | 334 |             |  |            |  |  |  | $ | 585 |            |  |  | (b | ) |  | $ | 26  | 



---

|(a) |  | Uncollectible accounts written off, net of recoveries.
|--- |  | ------------------------------------------------------
|   
|(b) |  | Disposals of unrecoverable inventory costs.           

S-1



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##### Table of Contents



INDEX TO EXHIBITS

|           |  |                                                                                                                                                                                      
|---------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|EXHIBIT    |  |                                                                                                                                                                                      
|NO.        |  | DESCRIPTION                                                                                                                                                                          
|           |  |                                                                                                                                                                                      
|2.1(1)     |  | Purchase Agreement by and between Penwest Pharmaceuticals Co. and Josef Rettenmaier Holding GmBh &

Co. KG, dated November 1, 2002.                                                  
|2.2(2)     |  | Amendment to Purchase Agreement made as of February 26, 2003, by and among Penwest Pharmaceuticals
Co., Josef Rettenmaier Holding GmbH & Co. KG, and the other parties named therein.
|3.1(3)     |  | Amended and Restated Articles of Incorporation                                                                                                                                       
|3.2(4)     |  | Articles of Amendment to the Amended and Restated Articles of Incorporation filed on June 19, 1998.                                                                                  
|3.3(3)     |  | Amended and Restated Bylaws of the Company.                                                                                                                                          
|3.4(4)     |  | Designation of Rights and Preference of Series A Junior Participating Preferred
Stock of the Company filed on July 17, 1998.                                                         
|4.1(3)     |  | Specimen certificate representing the Common Stock.                                                                                                                                  
|4.2(4)     |  | Form of Rights Agreement dated as of July 27, 1998 between the Company and the Rights Agent.                                                                                         
|10.1(3)+   |  | Product Development and Supply Agreement dated August 17, 1994 by and between the Registrant and
Mylan Pharmaceuticals Inc.                                                          
|10.2(3)+   |  | Sales and Distribution Agreement dated January 3, 1997 by and between the Registrant and Mylan
Pharmaceuticals, Inc.                                                                 
|10.3(4)    |  | Form of Separation and Distribution Agreement entered into between Registrant and Penford Corporation                                                                                
|10.4(3)+   |  | Product Development, License and Supply Agreement dated February
28, 1997 by and between the Registrant and Sanofi Winthrop S.A.,
as amended.                                        
|10.5(3)+   |  | Agreement dated May 26, 1995 by and between the Registrant and
Leiras OY.                                                                                                            
|+10.6(3)   |  | Agreement dated July 27, 1992 by and between the Registrant and Leiras, OY.                                                                                                          
|+10.7(5)   |  | Amended and Restated Strategic Alliance Agreement, dated as of April 2, 2002, by and between Endo
Pharmaceuticals Holdings Inc. and the Company                                      
|10.8(3)++  |  | 1997 Equity Incentive Plan.                                                                                                                                                          
|10.9(3)++  |  | 1997 Employee Stock Purchase Plan.                                                                                                                                                   
|10.10(3)++ |  | 1998 Spinoff Option Plan.                                                                                                                                                            
|10.11(3)   |  | Form of Excipient Supply Agreement entered into between the Registrant and Penford Corporation.                                                                                      
|10.12(4)   |  | Form of Tax Allocation Agreement entered into between the Registrant and Penford Corporation                                                                                         
|10.13(3)   |  | Recognition and Incentive Agreement dated as of May 14, 1990 between the Registrant and Anand
Baichwal, as amended.                                                                  
|10.14(4)+  |  | License Agreement dated December 17, 1997 between Synthelabo and the Registrant.                                                                                                     
|10.15(4)+  |  | Supply Agreement dated December 17, 1997 between Synthelabo and the Registrant.                                                                                                      
|10.16(6)   |  | Manufacturing Agreement dated September 27, 2001 between the Company and Draxis Pharma, Inc.                                                                                         
|10.17(7)   |  | Royalty Agreement dated September 25, 1992 between the Company and John N. Staniforth.                                                                                               
|10.18(7)   |  | Confidentiality, Consulting and Noncompetition Agreement dated September 25, 1992 between the
Company and John N. Staniforth.                                                        
|23         |  | Consent of Ernst & Young LLP                                                                                                                                                         
|99.1       |  | 906 CEO Certification                                                                                                                                                                
|99.2       |  | 906 CFO Certification                                                                                                                                                                



---

|(1) |  | Incorporated by reference to Exhibit A to the Registrants definitive
proxy statement filed with the Securities and Exchange Commission on
January 31, 2003.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Incorporated by reference to Exhibits to the Registrants Current Report
on Form 8-K (No. 000-23467) filed with the Commission on February 28,
2003.         
|   
|(3) |  | Incorporated by reference to Exhibits to the Registrants Registration
Statement on Form S-1 (File No. 333-38389).                                          
|   
|(4) |  | Incorporated by reference to Exhibits to the Registrants Registration
Statement on Form 10 filed with the Commission on June 22, 1998 and July
31, 1998.   





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##### Table of Contents



|(5) |  | Incorporated by reference to Exhibits to the Registrants Quarterly
Report on Form 10Q (No. 000-23467) for the quarterly period ended June 30,
2002.     
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(6) |  | Incorporated by reference to Exhibits to the Registrants Quarterly
Report on Form 10Q (No. 000-23467) for the quarterly period ended
September 30, 2001.
|   
|(7) |  | Incorporated by reference to Exhibits to the Registrants Quarterly
Report on Form 10Q (No. 000-23467) for the quarterly period ended March
31, 2002.    
|   
|+   |  | Confidential treatment granted as to certain portions, which portions
are omitted and filed separately with the Commission.                              
|   
|++  |  | Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this annual report on Form 10-K.