##### Table of Contents



UNITED
    STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C.
    20549
  Form 10-K
   þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) 
    OF THE SECURITIES EXCHANGE ACT OF 1934For the Fiscal Year Ended
    December 31, 2006ORo

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period
    from          to   Commission File Number
    000-23467
  PENWEST PHARMACEUTICALS
    CO.
 (Exact name of registrant as
    specified in its charter)
  Washington

91-1513032(State or other jurisdiction
    of
    incorporation or organization)

(I.R.S. Employer
    Identification No.)39 Old Ridgebury Road
    Suite 11
    Danbury, Connecticut(Address of Principal
    Executive Offices)

06810-5120(Zip Code)   Registrants telephone number, including area code:
 (877) 736-9378
  SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE
    ACT:
  Common Stock, $.001 par value
 (Including Associated Preferred
    Stock Purchase Rights)
  SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE
    ACT:
 None
   o þ
  o þ
  þ o
  Regulation S-K Form 10-K Form 10-K. o
  Rule 12b-2
 Large Accelerated
    Filer o     Accelerated
    Filer þ     Non-Accelerated
    Filer o
  Rule 12b-2 o þ
    DOCUMENTS INCORPORATED BY REFERENCE
  Form 10-K.




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PENWEST
    PHARMACEUTICALS CO.
  INDEX TO
    FORM 10-K
  PagePART IItem 1.

Business


1Item 1A.

Risk
    Factors


13Item 1B.

Unresolved Staff
    Comments


22Item 2.

Properties


22Item 3.

Legal
    Proceedings


22Item 4.

Submission of
    Matters to a Vote of Security Holders


22Executive Officers of the
    Registrant


23PART IIItem 5.

Market for
    Registrants Common Equity, Related Stockholder Matters and
    Issuer Purchases of Equity Securities


23Item 6.

Selected Financial
    Data


24Item 7.

Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations


25Item 7A.

Quantitative and
    Qualitative Disclosures About Market Risk


37Item 8.

Financial
    Statements and Supplementary Data


37Item 9.

Changes in and
    Disagreements with Accountants on Accounting and Financial
    Disclosure


37Item 9A.

Controls and
    Procedures


37Item 9B.

Other
    Information


40PART IIIItem 10.

Directors,
    Executive Officers and Corporate Governance


40Item 11.

Executive
    Compensation


40Item 12.

Security Ownership
    of Certain Beneficial Owners and Management and Related
    Stockholder Matters


40Item 13.

Certain
    Relationships and Related Transactions, and Director
    Independence


40Item 14.

Principal
    Accounting Fees and Services


40PART IVItem 15.

Exhibits and
    Financial Statement Schedules


41Signatures


42   Forward
    Looking Statements
   i




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PART I  ITEM 1.
    BUSINESS  Overview
  ® ®
  Opana ER. twice-a-day around-the-clock
    Additional Product Candidates.
  
    Nalbuphine ER.  We are developing nalbuphine
    ER, a controlled release formulation of nalbuphine
    hydrochloride, for the treatment of pain. Nalbuphine ER, which
    we are developing using our TIMERx drug delivery technology, is
    designed to be taken as a tablet twice daily. We expect that
    nalbuphine ER, if approved, would compete in the moderate pain
    market with products such as
    Nubain®,
    Tramadol®
    ER, codeine and
    Demerol®.
    We have completed a Phase I pharmacokinetic study of
    nalbuphine ER in which the formulation achieved the targeted
    blood levels, as well as a Phase IIa trial in which a
    single dose of nalbuphine ER positively reduced mean pain
    intensity in a dose-dependent manner over the
    12-hour
    study period when compared to placebo. In January 2007, we
    commenced a Phase I dose escalation to steady state trial.
    The intent of this trial is to collect additional safety and
    pharmacokinetic data to assist us in designing a Phase IIa
    trial of the product candidate for chronic pain that we plan to
    commence in the third quarter of 2007.
    Torsemide ER.  We are developing torsemide ER,
    a controlled release formulation of torsemide, a loop diuretic
    for the treatment of chronic edema, a condition involving excess
    fluid accumulation resulting from congestive heart failure, or
    CHF. Torsemide ER, which we are developing using our TIMERx drug
    delivery technology, is designed to be taken as a tablet once
    daily. We expect that torsemide ER, if approved, would compete
    with furosemide and other loop diuretics. We have completed
    several Phase I pharmacokinetic studies of torsemide ER and
    completed a Phase IIa study in which torsemide ER caused
    prolonged urinary sodium excretion in CHF patients. We intend to
    further refine our formulation and complete an additional
    Phase I pharmacokinetic study for torsemide ER in the first
    half of 2007. If the data from this Phase I study confirms
    the formulation and achieves the targeted blood level profiles,
    we intend to conduct a Phase II study comparing torsemide
    ER to Lasix, which we plan to commence in the second half of
    2007.




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Our
    Strategies
    
    Focus on products that address disorders of the nervous
    system.  We are focusing on products that address
    disorders of the nervous system because we believe many of the
    currently approved products for the treatment of nervous system
    disorders can be enhanced by drug delivery technologies. In
    addition, we believe the market for treating nervous system
    disorders is an attractive market because many of these
    disorders are chronic in nature and are largely treated by
    specialist physicians that can be addressed with a relatively
    small sales force. If, however, we believe that we could develop
    a product that would address an unmet medical need and have a
    substantial market value, we may also selectively develop
    product candidates for diseases outside of the nervous system.
    Reformulate existing drugs using drug delivery
    technologies.  We develop products by
    reformulating existing drugs utilizing proprietary drug delivery
    technologies. These drug delivery technologies include our own
    internally developed oral extended release technologies, as well
    as drug delivery technologies we may access through
    collaborations. When appropriate, we intend to utilize a
    505(b)(2) regulatory strategy to seek approval for
    our reformulations of existing drugs. Under this strategy, we
    will file a section 505(b)(2) New Drug Application, or a
    section 505(b)(2) NDA, which will rely on the FDAs
    previous findings for the safety and effectiveness of the
    existing drug in addition to the data we generate regarding our
    reformulated drug. Because a section 505(b)(2) NDA may rely
    on the FDAs previous findings, the trials that need to be
    conducted are generally more limited. Therefore, the development
    of a drug using the 505(b)(2) regulatory strategy is generally
    less costly and time consuming than the full NDA process.
    Develop product candidates that have the potential for at
    least five years of exclusivity in the
    marketplace.  We intend to expand our portfolio to
    include product candidates for which we or our collaborators
    could obtain at least five years of exclusivity in the
    marketplace following marketing approval. This exclusivity could
    arise from meeting certain regulatory criteria for market
    exclusivity with the FDA, for example, in connection with the
    approval of new chemical entities or orphan drugs, or from
    intellectual property protection.
    Continue to leverage and expand our proprietary drug delivery
    technologies.  We believe that we have significant
    expertise in drug formulation and in oral drug delivery
    technologies. Our proprietary drug delivery technologies, TIMERx
    controlled release,
    Geminex®
    dual delivery,
    SyncroDose®
    site-specific delivery and the gastroretentive system, 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, we believe that we can formulate drugs with
    precise release profiles and improve the characteristics of
    existing drugs. In selecting product candidates for development,
    we intend to continue to focus on opportunities in which either
    our drug delivery technologies or other drug delivery
    technologies that we can access, can provide benefits to
    patients and result in branded, proprietary products. We intend
    to expand our proprietary drug delivery technologies by
    continuing to develop our core technologies, in-licensing or
    acquiring new technologies.
    Commercialize product candidates independently and in
    collaboration with third parties.  We currently do
    not have any sales infrastructure. Opana ER is marketed by Endo;
    other of our marketed products are marketed by other
    collaborators. We expect that in the future, we will
    independently seek regulatory approval for most of our product
    candidates designed for the treatment of disorders of the
    nervous system. By retaining the rights to these products
    through approval, we believe that we can retain more value of
    such products if they are approved. In addition, we may retain
    marketing rights, or co-promotion rights, for our products that
    would be marketed to specialist physicians and build a
    relatively small specialty sales force to market these products.
    For those products that we selectively develop for the treatment
    of diseases outside of the nervous system, we plan to seek
    collaborators for the marketing of those products. The timing of
    seeking a collaborator will depend on a number of factors,
    including the costs of clinical development and our financing
    needs. 2




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Drug
    Delivery Technologies
    TIMERx
      Geminex
    SyncroDose
    Gastroretentive
   3




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Products
  Approved
    Products
  Opana ER. twice-a-day around-the-clock
  ® ® ® ®
    
    Nifedipine XL, a generic version of Pfizer, Inc.s
    Procardia®
    XL for the treatment of hypertension and angina that we
    developed with Mylan Pharmaceuticals Inc., is approved for sale
    in the United States. Mylan, which has the marketing rights for
    Nifedipine XL, is not marketing Nifedipine XL as a result of its
    acquisition from Pfizer of the right to market Pfizers
    generic versions of three strengths of Procardia XL under
    Pfizers NDA.
    Cystrin CR, an extended release version of oxybutynin for the
    treatment of urge urinary incontinence, is approved for sale in
    Finland and has been licensed to Schering Oy.
    Slofedipine XL, an extended release version of nifedipine for
    the treatment of angina, is approved for sale in the United
    Kingdom and Italy, and has been licensed to Sanofi-Aventis S.A.
    This product is no longer being marketed.
    Cronodipin, an extended release version of nifedipine for the
    treatment of angina, is approved for sale in Brazil and has been
    licensed to Merck S.A. Industries Quimicas. We do not believe
    this product is being marketed any longer.  Products
    in Our Pipeline
    Product

Therapeutic CategoryClinical DevelopmentNalbuphine ER (PW4142)

Moderate Chronic PainTorsemide ER (PW2132)

Edema/Congestive Heart FailureFormulation and Phase 1
    BiostudiesPW4110

EpilepsyPW4153

Parkinsons DiseasePW4158

Parkinsons DiseasePW4159

Spasticity   Nalbuphine
    ER (PW4142)
   4




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165-patient twelve-hour twelve-hour twelve-hour twelve-hour
    Torsemide
    ER (PW2132)
      once-a-day,
 5




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24-hour 24-hour 24-hour
    Additional
    Product Opportunities
    Collaborative
    Agreements
     6




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Joint
    Development Collaborative Agreements
  Endo
    Pharmaceuticals Inc.
  ® ® ® ® ® tm .
        
    Endo will pay us royalties on U.S. sales of Opana ER
    calculated based on a tiered royalty rate starting at 22% of
    annual net sales of the product up to $150 million of
    annual net sales, with the royalty rate increasing, based on
    agreed-upon
    levels of annual net sales achieved, from 25% up to a maximum of
    30%.
    No royalty payments will be due to us for the first
    $41 million of royalties that would otherwise have been
    payable beginning from the time of the product launch in July
    2006.
    Endo will pay us a percentage of any sublicense income it
    receives.
    Endo will also pay us milestone payments up to $90 million
    based upon the achievement of
    agreed-upon
    annual sales thresholds.
    Our share of the development costs for Opana ER that we opted
    out of funding in April 2003 is fixed at $28 million and
    will be recouped by Endo through a temporary 50% reduction in
    royalties. This temporary reduction in royalties will not apply
    until the threshold for the $41 million royalty holiday
    referred to above has been met. 7




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Technology
    Licensing Collaborative Agreements
  Mylan
    Pharmaceuticals Inc.
  ®
    Research
    and Development
    Manufacturing
     8




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Marketing
    and Distribution
      Patents
    and Proprietary Rights
    Patents
    and Protection of Proprietary Information
         9




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Trademarks
  Form 10-K
  Government
    Regulation
  and/or
    NDAs:
       10




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505(b)(2) NDAs:
    ANDAs:
    Other
    FDA Requirements:
   11




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Competition
      
    the safety and efficacy of our products;
    the relative speed with which we can develop products;
    generic competition for any product that we develop;
    our ability to protect the intellectual property surrounding our
    products;
    our ability to differentiate our products from our
    competitors products; and
    external factors affecting pricing
    and/or
    reimbursement.    Employees
    Information
    Available on the Internet
  Form 10-K, Form 10-Q, Form 8-K
 12




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ITEM 1A. 
    RISK FACTORS  Investing in our common stock involves a high degree of risk,
    and you should carefully consider the risks and uncertainties
    described below in addition to the other information included or
    incorporated by reference in this annual report on
    Form 10-K.
    If any of the following risks actually occurs, our business,
    financial condition or results of operations would likely
    suffer, possibly materially. In that case, the trading price of
    our common stock could fall.
  We
    have not been profitable and expect to continue to incur
    substantial losses
        
    the commercial success of Opana ER, and the timing and amount of
    royalties from Endos sales of Opana ER;
    the level of our investment in research and development
    activities;
    the successful development and commercialization of product
    candidates in our portfolio;
    the level of investment for acquisitions or in-licensing of
    technologies or compounds intended to support our growth; and
    royalties from Mylans sales of Pfizers generic
    Procardia XL 30 mg.  We may
    require additional funding, which may be difficult to
    obtain
      
    the commercial success of Opana ER;
    the timing and amount of payments received under collaborative
    agreements, including in particular our agreement with Endo with
    respect to Opana ER and our agreement with Mylan with respect to
    Pfizers generic Procardia XL 30 mg;
    the progress of our collaborative and internal development
    projects, funding obligations with respect to the projects, and
    the related costs to us of clinical studies for our product
    candidates;
    the level of investment for the acquisition or in-licensing of
    technologies or compounds intended to support our growth;
    the structure and terms of any future collaborative agreements; 13




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
    the prosecution, defense and enforcement of our patents and
    other intellectual property rights; and
    the level of our investments in capital expenditures for
    facilities and equipment.      We
    depend heavily on the success of Opana ER, which may not be
    widely accepted by physicians, patients, third-party payors, or
    the medical community in general
    
    the safety and efficacy of Opana ER as compared to competitive
    products;
    Endos ability to educate the medical community about the
    safety and effectiveness of Opana ER;
    the effectiveness of Endos sales and marketing activities;
    Endos ability to manufacture and maintain suitable
    inventory for sale on an ongoing basis;  
  
    the pricing of Opana ER; and
    the level of stocking of Opana ER by wholesalers and retail
    pharmacies.     14




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We are
    dependent on our collaborator Endo to manufacture, market and
    sell Opana ER, and in the future expect to be dependent on other
    collaborators to manufacture, market, and sell our other
    products
  and/or
        
    Our collaborators may be pursuing alternative technologies or
    developing alternative products, either on their own or in
    collaboration with others, that may be competitive to the
    product on which we are collaborating, which could affect our
    collaborators commitment to our collaboration.
    Our collaborators may reduce marketing or sales efforts, or
    discontinue marketing or sales of our products. This could
    reduce the revenues we receive on the products.
    Our collaborators may terminate their collaborations with us
    under certain circumstances. As a result, we may have to
    terminate the development of some drug candidates. This could
    also adversely affect perception of us in the business and
    financial communities and make it difficult for us to attract
    new collaborators.
    Our collaborators may pursue higher priority programs or change
    the focus of their development programs, which could affect the
    collaborators commitment to us. Pharmaceutical and
    biotechnology companies re-evaluate their priorities from time
    to time, including following mergers and consolidations, which
    have been common in recent years in these industries.
    Disputes may arise between us and our collaborators from time to
    time regarding contractual or other matters. In 2006, we were
    engaged in a dispute with Endo with regard to the sharing of
    marketing expenses during the period prior to when Opana ER
    reaches profitability. In January 2007, we resolved our dispute
    as part of an amendment to the agreement. Any other such
    disputes with Endo or other collaborators could be time
    consuming and expensive, and could impact our anticipated rights
    under our agreements with those collaborators.  The
    Drug Enforcement Agency, or DEA, limits the availability of the
    active drug substances used in Opana ER. As a result,
    Endos procurement quota may not be sufficient to meet
    commercial demand
   15




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We
    face significant competition, which may result in others
    discovering, developing or commercializing products before us or
    more successfully than we do
    
    significantly greater financial, technical and human resources
    than we have and may be better equipped to develop, manufacture
    and commercialize drug products;
    more extensive experience than we have in conducting preclinical
    studies and clinical trials, obtaining regulatory approvals, and
    manufacturing and marketing pharmaceutical products;
    competing products that have already received regulatory
    approval or are in late-stage development; and
    collaborative arrangements in our target markets with leading
    companies and research institutions.          If our
    clinical trials are not successful or take longer to complete
    than we expect, we may not be able to develop and commercialize
    our products
   16




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
    be delayed in obtaining marketing approval for our products;
    not be able to obtain marketing approval for our products; or
    not be able to obtain approval for indications that are as broad
    as intended.    Our
    controlled release drug delivery technologies rely on the
    ability to control the release of the active drug substances and
    our business would be harmed if it was determined that there
    were circumstances under which the active drug substances from
    one of our extended release products would be released rapidly
    into the blood stream
    ®
 17




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in vitro in vitro
  We are
    subject to extensive government regulation including the
    requirement of approval before our products may be marketed.
    Even if we obtain marketing approval, our products will be
    subject to ongoing regulatory review
          Opana
    ER contains a narcotic ingredient. As a result of reported
    misuse and abuse of prescription narcotics, the sale of Opana ER
    is subject to additional regulations, including the compliance
    with risk management programs, which may prove difficult or
    expensive to comply with; and we and Endo may face
    lawsuits
   18




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Our
    success depends on our ability to protect our patents and other
    intellectual property rights
        We may
    become involved in patent litigation or other proceedings
    relating to our products or processes, which could result in
    liability for damages or termination of our development and
    commercialization programs
    
    We or our collaborators may initiate litigation or other
    proceedings against third parties to enforce our intellectual
    property rights.
    If our competitors may 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 our rights
    in such proceedings.  and/or
   19




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We
    have only limited manufacturing capabilities and will be
    dependent on third party manufacturers
        
    we or our collaborators may not be able to meet commercial
    demands for Opana ER or our other products;
    we may not be able to initiate or continue clinical trials for
    products that are under development; and
    we may be delayed in submitting applications for regulatory
    approvals of our products.      We are
    dependent upon a limited number of suppliers for the gums used
    in our TIMERx materials
   20




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If we
    or our collaborators fail to obtain an adequate level of
    reimbursement by governmental or third party payors for Opana ER
    or any other products we develop, we may not be able to
    successfully commercialize the affected product
        We
    will be exposed to product liability claims and may not be able
    to obtain adequate product liability insurance
      If we
    are unable to retain our key personnel, and continue to attract
    additional professional staff, we may not be able to maintain or
    expand our business
   21




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The
    market price of our common stock may be volatile
    Specific
    provisions of our Shareholder Rights Plan, Certificate of
    Incorporation and Bylaws and law of Washington State make a
    takeover of Penwest or a change in control or management of
    Penwest more difficult
    ITEM 1B.
    UNRESOLVED
    STAFF COMMENTS    ITEM 2.
    PROPERTIES        ITEM 3.
    LEGAL
    PROCEEDINGS    ITEM 4.
    SUBMISSION
    OF MATTERS TO A VOTE OF SECURITY HOLDERS   22




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EXECUTIVE
    OFFICERS OF THE REGISTRANT
    Name

Age

Title

DatesJennifer L. Good


42


President and Chief Executive
    Officer

2006  currentPresident, Chief Operating Officer
    and Chief Financial Officer

2005  2006Senior Vice President, Finance and
    Chief Financial Officer

1997  2005Anand R. Baichwal, Ph.D.


52


Senior Vice President, Licensing
    and Chief Scientific Officer

2006  currentSenior Vice President,
    Research & New Technology Development and Chief
    Scientific Officer

1997  2006Benjamin L. Palleiko


41


Senior Vice President, Corporate
    Development and Chief Financial Officer

2006  currentDirector, Investment Banking,
    SunTrust Robinson Humphrey

2003  2006Vice President, Investment
    Banking, Robertson Stephens, Inc.

2000  2002Thomas Sciascia, M.D.


53


Senior Vice President and Chief
    Medical Officer

2001  current  PART II  ITEM 5.
    MARKET
    FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS
    AND ISSUER PURCHASES OF EQUITY SECURITIES  mark-up,
  High


LowPERIOD 2006Quarter Ended March 31

$
23.70


$
19.00Quarter Ended June 30

$
23.10


$
15.73Quarter Ended September 30

$
22.74


$
16.20Quarter Ended December 31

$
19.35


$
15.67PERIOD 2005Quarter Ended March 31

$
12.91


$
9.75Quarter Ended June 30

$
13.80


$
10.29Quarter Ended September 30

$
17.59


$
10.20Quarter Ended December 31

$
20.00


$
15.02      23




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ITEM 6.
    SELECTED
    FINANCIAL DATA    Year Ended December 31,2006


2005


2004


2003


2002(In thousands, except for per share data)STATEMENT OF OPERATIONS
    DATA:Revenues

$
3,499


$
6,213


$
5,108


$
4,678


$
5,537Cost of revenues


231



39



104



169



170Gross profit


3,268



6,174



5,004



4,509



5,367Selling, general and administrative


14,075



13,247



9,485



10,361



7,568Research and product development


22,857



17,797



20,205



20,590



16,955Loss from continuing operations
    before cumulative effect of change in accounting principle


(31,312
)


(22,898
)


(23,785
)


(26,006
)


(19,028
)Earnings from discontinued
    operations, net of income tax expense














177



1,929Gain on sale of discontinued
    operations














9,894



Total discontinued operations














10,071



1,929Net loss

$
(31,312
)

$
(22,898
)

$
(23,785
)

$
(15,935
)

$
(17,099
)Basic and diluted loss per share:Continuing operations

$
(1.38
)

$
(1.05
)

$
(1.28
)

$
(1.56
)

$
(1.23
)Discontinued operations














0.60



0.12Net loss per share

$
(1.38
)

$
(1.05
)

$
(1.28
)

$
(0.96
)

$
(1.11
)Weighted average shares of common
    stock outstanding


22,751



21,711



18,627



16,678



15,462   December 31,2006


2005


2004


2003


2002(In thousands)BALANCE SHEET DATA:Cash and cash equivalents

$
16,182


$
15,917


$
14,249


$
8,241


$
1,629Marketable securities


24,408



39,377



60,121



55,652



2,057Working capital


38,254



53,912



71,946



60,697



26,355Total assets


52,742



67,021



87,522



78,503



50,220Long term obligations-deferred
    compensation


2,763



2,977



3,314



3,104



2,889Accumulated deficit


(172,428
)


(141,116
)


(118,218
)


(94,433
)


(78,025
)Shareholders equity


45,121



60,411



78,801



67,696



31,423  24




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ITEM 7.
    MANAGEMENTS
    DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
    OPERATIONS  Overview
  ®
  twice-a-day around-the-clock
      
    the commercial success of Opana ER, and the timing and amount of
    royalties from Endos sales of Opana ER;
    the level of our investment in research and development
    activities;
    the successful development and commercialization of product
    candidates, other than Opana ER, in our portfolio;
    the level of investment for acquisitions or in-licensing of
    technologies or compounds intended to support our
    growth; and
    royalties from Mylans sales of Pfizers generic
    version of Procardia XL 30 mg.       25




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Critical
    Accounting Policies and Estimates
    Revenue
    Recognition
  Royalties
    and Licensing Fees
  scale-up, proof-of-principle
     26




---



##### Table of Contents



Product
    Sales
    Research
    and Development Expenses
      Deferred
    Taxes  Valuation Allowance
    Impairment
    of Long-Lived Assets
  and/or
  Share-Based
    Compensation
   27




---



##### Table of Contents




    the stock option exercise price;
    the expected term of the option;
    the grant date price of our common stock, which is issuable upon
    exercise of the option;
    the expected volatility of our common stock;
    expected dividends on our common stock (we do not anticipate
    paying dividends for the foreseeable future); and
    the risk free interest rate for the expected option term.    Form 10-K.
   28




---



##### Table of Contents



Results
    of Operations for Years Ended December 31, 2006, 2005 and
    2004
  Revenues
  Percentage





PercentageIncrease





Increase(Decrease) from





(Decrease) from2006


2005


2005


2004


2004(In thousands, except percentages)Royalty and Licensing Fees

$
3,118



(50
)%

$
6,213



27
%

$
4,882Product Sales


381



n/a







(100
)%


226Total Revenues

$
3,499



(44
)%

$
6,213



22
%

$
5,108       Selling,
    General and Administrative Expense
      Research
    and Product Development Expenses
   29




---



##### Table of Contents



Percentage





PercentageIncrease





Increase(Decrease) from





(Decrease) from2006


2005


2005


2004


2004(In thousands, except percentages)Nalbuphine ER

$
4,211



256
%

$
1,184



451
%

$
215Torsemide ER


2,196



111
%


1,043



181
%


371Venlafaxine ER


639



(31
)%


921



232
%


277PW2101






(100
)%


1,817



(80
)%


9,228Phase I Products, Internal
    Costs and Other


13,596



22
%


11,154



53
%


7,296Research and New Technology
    Development


2,215



32
%


1,678



(40
)%


2,818Total Research and Product
    Development Expense

$
22,857



28
%

$
17,797



(12
)%

$
20,205     
    Nalbuphine ER  These expenses reflect our
    direct external expenses relating to the development of
    nalbuphine ER. These expenses approximated 18% of our R&D
    expenses in 2006, and consisted primarily of payments to third
    parties in connection with clinical trials of nalbuphine ER,
    including payments for drug active. The expenses for this
    compound increased in 2006 as compared to 2005 as we advanced
    the drug from Phase I through Phase IIa clinical
    trials and completed additional preparation for further clinical
    trials in 2007. We expect our R&D expenses on nalbuphine ER
    to increase in 2007 as we commence additional clinical trials,
    including a Phase I safety trial and Phase II chronic
    efficacy trial.
    Torsemide ER  These expenses reflect our
    direct external expenses relating to the development of
    torsemide ER. These expenses consisted primarily of payments to
    third parties in connection with clinical trials of torsemide
    ER, including payments for drug active, and approximated 10% of
    our R&D expenses in 2006. The expenses for this compound
    increased in 2006 as compared to 2005 as we conducted
    reformulation work and two additional Phase I studies to
    optimize the formulation and the delivery of the drug. We expect
    our expenses on torsemide ER to increase in 2007 if the
    Phase I study we conduct in the first half of 2007 confirms
    the targeted blood level profile and we commence a planned
    Phase II comparative trial.
    Venlafaxine ER  These expenses reflect our
    direct external expenses related to the development of
    venlafaxine ER. These expenses consisted primarily of payments
    to third parties in connection with the manufacture of
    venlafaxine ER, including payments for the drug active, and
    approximated 3% of our R&D expenses in 2006. During the
    second quarter of 2006, we ceased development work on this
    compound based on an assessment of the market opportunity and
    our estimated financial returns. We do not expect to incur
    additional R&D expenses with respect to venlafaxine ER in
    future periods. 30




---



##### Table of Contents




    PW2101  These expenses reflect our direct
    external expenses relating to the development of PW2101. These
    expenses consisted primarily of payments to third parties in
    connection with clinical trials of PW2101, the manufacturing of
    PW2101, including our development work related to the
    qualification of an alternative manufacturing site, and the
    preparation of an NDA for PW2101. We received a nonapprovable
    letter on this drug in 2005, and we discontinued development
    work on PW2101 in the second quarter of 2005. We do not expect
    to incur additional R&D expenses with respect to PW2101 in
    future periods.
    Phase I Products, Internal Costs and
    Other  These expenses primarily reflect expenses
    such as salaries and benefits for our product development
    personnel, including our formulation, clinical and regulatory
    groups, and other costs primarily related to our laboratory
    facilities that are not allocated to specific programs. These
    expenses also reflect both our direct external expenses and our
    allocated internal expenses relating to the development of
    Phase I product candidates, and expenses incurred to
    support the approval of Opana ER of approximately $866,000 in
    2006, which included expenses related to manufacturing process
    characterization of TIMERx for FDA compliance and in connection
    with our obligations under our agreement with Endo. Our direct
    external expenses primarily reflect payments to third parties
    for the drug active and
    proof-of-principle
    biostudies conducted on our Phase I products. These costs
    increased in 2006 as compared to 2005, primarily as a result of
    the recording of compensation expense related to employee stock
    options resulting from our adoption of SFAS 123R effective
    January  1, 2006. The increase was partially offset by
    a write-off of TIMERx inventory in the second quarter of 2005,
    primarily related to a change in specifications for TIMERx. We
    continually evaluate the Phase I product candidates we are
    developing, and may terminate or accelerate development of
    product candidates based on study results, product development
    risk, commercial opportunity, perceived time to market and other
    factors.
    Research and New Technology Development  These
    expenses reflect both our direct external expenses and our
    allocated internal expenses relating to research on new or
    existing technologies within the Company that support the
    product pipeline. These direct external expenses consist
    primarily of payments to third parties in connection with
    consulting and outside laboratory fees. Our internal expenses
    primarily include salaries and benefits of our research and new
    technology development group, and other costs such as
    depreciation on purchased equipment, and the amortization or any
    write-downs of patent costs, other than product patent
    write-offs charged directly to a product development project or
    amortization of patent costs relating to commercialized products
    which are included in cost of revenues. These expenses increased
    in 2006 as compared to 2005, primarily due to increased
    professional fees and amortization of patents associated with
    development programs.    Tax
    Rates
   31




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##### Table of Contents



Liquidity
    and Capital Resources
  Sources
    of Liquidity
        Cash
    Flows
     32




---



##### Table of Contents



Funding
    Requirements
      
    the commercial success of Opana ER and royalties received from
    Endo on sales of Opana ER;
    the timing and amount of payments received under collaborative
    agreements, including in particular our agreement with Endo with
    respect to Opana ER and our agreement with Mylan with respect to
    Pfizers generic Procardia XL 30 mg;
    the progress of our collaborative and independent development
    projects, funding obligations with respect to the projects, and
    the related costs to us of clinical studies for our products;
    the level of investment for the acquisition or in-licensing of
    technologies or compounds intended to support our growth;
    the structure and terms of any future collaborative agreements;
    the prosecution, defense and enforcement of our patents and
    other intellectual property rights; and
    the level of our investment in capital expenditures for
    facilities or equipment. 33




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##### Table of Contents



Form S-3
    Contractual
    Obligations
    Less than








AfterTotal


One Year


1-3 Years


4-5 Years


5 YearsOperating Leases

$
797


$
765


$
32


$



$
Purchase Obligations


3,645



3,645











Deferred Compensation, including
    current portion


3,053



294



588



588



1,583Total

$
7,495


$
4,704


$
620


$
588


$
1,583     
    We have a Supplemental Executive Retirement Plan, or SERP, a
    nonqualified plan which covers our former Chairman and Chief
    Executive Officer, Tod R. Hamachek. Under the SERP, effective in
    May 2005, we became obligated to pay Mr. Hamachek
    approximately $12,600 per month over the lives of
    Mr. Hamachek and his spouse.
    We also have a Deferred Compensation Plan, or DCP, a
    nonqualified plan which covers Mr. Hamachek. Under the DCP,
    effective in May 2005, we became obligated to pay
    Mr. Hamachek approximately $140,000 per year,
    including interest, in ten annual installments. However, these
    installments are recalculated annually based on market interest
    rates as provided for under the DCP.   34




---



##### Table of Contents



Net
    Operating Loss Carryforwards
    Market
    Risk and Risk Management Policies
          Recent
    Accounting Pronouncements
     35




---



##### Table of Contents



,
   36




---



##### Table of Contents



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    ITEM 9A.
    CONTROLS
    AND PROCEDURES  Evaluation of Disclosure Controls and
    Procedures. Rules 13a-15(e) 15d-15(e)
  Changes in Internal Control Over Financial
    Reporting. Rules 13a-15(f) 15d-15(f)
  Reports on Internal Control Over Financial
    Reporting
  Managements
    Annual Report on Internal Control Over Financial
    Reporting
  Rule 13a-15(f) 15d-15(f)
  
    Pertain to the maintenance of records that in reasonable detail
    accurately and fairly reflect the transactions and dispositions
    of our assets; 37




---



##### Table of Contents




    Provide reasonable assurance that transactions are recorded as
    necessary to permit preparation of financial statements in
    accordance with generally accepted accounting principles, and
    that our receipts and expenditures are being made only in
    accordance with authorizations of our management and
    directors; and
    Provide reasonable assurance regarding prevention or timely
    detection of unauthorized acquisition, use or disposition of our
    assets that could have a material effect on the financial
    statements.       38




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##### Table of Contents



Report of
    Independent Registered Public Accounting Firm
                 
    39




---



##### Table of Contents



ITEM 9B.
    OTHER
    INFORMATION   PART III  ITEM 10.
    DIRECTORS,
    EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE    www.penwest.com.
  Form 8-K
  Form 10-K
  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, AND DIRECTOR
    INDEPENDENCE    ITEM 14.
    PRINCIPAL
    ACCOUNTANT FEES AND SERVICES   40




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##### Table of Contents



PART IV  ITEM 15.
    EXHIBITS AND
    FINANCIAL STATEMENT SCHEDULES    Form 10-K:
          Form 10-K
 41




---



##### Table of Contents



SIGNATURES      
   President and Chief Executive Officer
      /s/  Jennifer
    L. GoodJennifer
    L. Good

President and Chief Executive
    Officer, Director
    (principle executive officer)

Date: March 13, 2007/s/  Benjamin
    L. PalleikoBenjamin
    L. Palleiko

Senior Vice President, Corporate
    Development and
    Chief Financial Officer
    (principal financial and
    accounting officer)

Date: March 13, 2007/s/  Paul
    E. FreimanPaul
    E. Freiman

Chairman of the Board

Date: March 13, 2007/s/  Peter
    F. DrakePeter
    F. Drake, Ph.D.

Director

Date: March 13, 2007/s/  Rolf
    H. HenelRolf
    H. Henel

Director

Date: March 13, 2007/s/  Robert
    J. HennesseyRobert
    J. Hennessey

Director

Date: March 13, 2007/s/  David
    P. MeekerDavid
    P. Meeker, M.D.

Director

Date: March 13, 2007/s/  John
    N. StaniforthJohn
    N. Staniforth, Ph.D.

Director

Date: March 13, 2007/s/  Anne
    M. VanLentAnne
    M. VanLent

Director

Date: March 13, 2007  42




---



##### 



APPENDIX A
  PENWEST
    PHARMACEUTICALS CO.
  INDEX TO
    FINANCIAL STATEMENTS AND
 FINANCIAL
    STATEMENT SCHEDULE
  
  PageFinancial StatementsReport of
    Independent Registered Public Accounting Firm


F-2Balance
    Sheets


F-3Statements of
    Operations


F-4Statements of
    Shareholders Equity


F-5Statements of Cash
    Flows


F-6Notes to Financial
    Statements


F-7Schedule II 
    Valuation and Qualifying Accounts


S-1   F-1




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##### Table of Contents



Report of
    Independent Registered Public Accounting Firm               
    F-2




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO.



BALANCE
    SHEETS  December 31,2006


2005(In thousands,except share amounts)ASSETSCurrent assets:Cash and cash equivalents

$
16,182


$
15,917Marketable securities


24,408



39,377Trade accounts receivable


683



942Inventories


201



140Prepaid expenses and other current
    assets


1,595



1,112Total current assets


43,069



57,488Fixed assets, net


3,787



2,990Patents, net


3,184



3,383Other assets


2,702



3,160Total assets

$
52,742


$
67,021LIABILITIES AND
    SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable

$
1,324


$
1,064Accrued expenses


2,096



1,722Accrued development costs


1,105



499Deferred compensation 
    current portion


290



291Total current liabilities


4,815



3,576Deferred revenue


43



57Deferred compensation


2,763



2,977Total liabilities


7,621



6,610Shareholders equity:Preferred stock, par value $.001,
    authorized 1,000,000 shares, none outstanding






Common stock, par value $.001,
    authorized 60,000,000 shares, issued and outstanding
    23,132,815 shares at December 31, 2006 and
    21,889,940 shares at December 31, 2005


23



22Additional paid in capital


217,427



201,659Accumulated deficit


(172,428
)


(141,116
)Accumulated other comprehensive
    income (loss)


99



(154
)Total shareholders equity


45,121



60,411Total liabilities and
    shareholders equity

$
52,742


$
67,021    F-3




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##### Table of Contents



PENWEST
    PHARMACEUTICALS CO.



STATEMENTS
    OF OPERATIONS  Year Ended December 31,2006


2005


2004(In thousands, except per share data)Revenues:Royalties and licensing fees

$
3,118


$
6,213


$
4,882Product sales


381







226Total revenues


3,499



6,213



5,108Cost of revenues


231



39



104Gross profit


3,268



6,174



5,004Operating expenses:Selling, general and administrative


14,075



13,247



9,485Research and product development


22,857



17,797



20,205Total operating expenses


36,932



31,044



29,690Loss from operations


(33,664
)


(24,870
)


(24,686
)Investment income


2,352



1,974



906Loss before income tax expense


(31,312
)


(22,896
)


(23,780
)Income tax expense






2



5Net loss

$
(31,312
)

$
(22,898
)

$
(23,785
)Basic and diluted net loss per
    common share

$
(1.38
)

$
(1.05
)

$
(1.28
)Weighted average shares of common
    stock outstanding


22,751



21,711



18,627    F-4




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##### Table of Contents



PENWEST
    PHARMACEUTICALS CO.



STATEMENTS
    OF SHAREHOLDERS EQUITY  AccumulatedAdditional





OtherCommon Stock


Paid-In


Accumulated


ComprehensiveShares


Amount


Capital


Deficit


(Loss) Income


Total(In thousands)Balances, December 31, 2003


18,423


$
18


$
162,068


$
(94,433
)

$
43


$
67,696Net loss














(23,785
)






(23,785
)Changes in unrealized gain/loss on
    marketable securities


















(143
)


(143
)Comprehensive loss






















(23,928
)Issuance of common stock pursuant
    to an equity financing, net


3,125



4



32,795











32,799Issuance of common stock pursuant
    to stock compensation plans


130







2,081











2,081Issuance of common stock pursuant
    to Stock Purchase Plan


15







153











153Balances, December 31, 2004


21,693



22



197,097



(118,218
)


(100
)


78,801Net loss














(22,898
)






(22,898
)Changes in unrealized loss on
    marketable securities


















(54
)


(54
)Comprehensive loss






















(22,952
)Issuance of common stock pursuant
    to stock compensation plans


183







2,027











2,027Stock compensation charge in
    connection with modification of stock options










2,398











2,398Issuance of common stock pursuant
    to Stock Purchase Plan


14







137











137Balances, December 31, 2005


21,890



22



201,659



(141,116
)


(154
)


60,411Net loss














(31,312
)






(31,312
)Changes in unrealized loss on
    marketable securities


















143



143Comprehensive loss






















(31,169
)Transition adjustment for funded
    status of post retirement plan


















110



110Issuance of common stock pursuant
    to stock compensation plans


1,233



1



11,511











11,512Stock compensation charges in
    connection with stock options and Stock Purchase Plan










4,098











4,098Issuance of common stock pursuant
    to Stock Purchase Plan


10







159











159Balances, December 31, 2006


23,133


$
23


$
217,427


$
(172,428
)

$
99


$
45,121    F-5




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO.



STATEMENTS
    OF CASH FLOWS  Year Ended December 31,2006


2005


2004(In thousands)Operating activities:Net loss

$
(31,312
)

$
(22,898
)

$
(23,785
)Adjustments to reconcile net loss
    to net cash used in operating activities:Depreciation


1,001



987



1,042Amortization of patents


565



464



410Inventory reserves






497



75Patent impairment losses


254



137



417Deferred revenue


(14
)


(14
)


(14
)Deferred compensation


190



194



211Stock compensation


4,978



3,083



297Changes in operating assets and
    liabilities:Trade accounts receivable


259



184



27Inventories


(61
)


5



(62
)Accounts payable, accrued expenses
    and other


497



(2,700
)


(1,505
)Net cash used in operating
    activities


(23,643
)


(20,061
)


(22,887
)Investing activities:Proceeds from sale of discontinued
    operations










1,250Acquisitions of fixed assets, net


(1,818
)


(276
)


(1,226
)Patent costs


(619
)


(479
)


(643
)Purchases of marketable securities


(27,739
)


(51,499
)


(57,681
)Proceeds from maturities of
    marketable securities


41,248



47,054



17,795Proceeds from sales of marketable
    securities


1,600



25,450



35,150Proceeds from cash surrender value
    of life insurance policy withdrawal


446







Net cash provided by (used in)
    investing activities


13,118



20,250



(5,355
)Financing activities:Issuance of common stock, net


10,790



1,479



34,250Net cash provided by financing
    activities


10,790



1,479



34,250Net increase in cash and cash
    equivalents


265



1,668



6,008Cash and cash equivalents at
    beginning of year


15,917



14,249



8,241Cash and cash equivalents at end
    of year

$
16,182


$
15,917


$
14,249    F-6




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO



NOTES TO
    FINANCIAL STATEMENTS  1.
    BUSINESS  ® twice-a-day around-the-clock
      2.
    SUMMARY
    OF SIGNIFICANT ACCOUNTING POLICIES  Basis
    of Presentation
    Cash
    and Cash Equivalents
    Marketable
    Securities
  available-for-sale
 F-7




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
    Credit
    Risk and Fair Value of Financial Instruments
        Inventories
  (first-in,
  Long-Lived
    Assets
    Machinery and equipment


5-10 yearsOffice furniture, equipment and
    software


3-10 yearsLeasehold improvements


1-3 years    F-8




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
    Foreign
    Currencies
    Accumulated
    Other Comprehensive Income (Loss)
    Income
    Taxes
    Revenue
    Recognition
  Royalties and licensing fees scale-up, proof-of-principle
  Product sales
 F-9




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   Research
    and Development Expenses
    Per
    Share Data
    December 31,2006


2005


2004(In thousands of shares)Stock options outstanding


2,267



3,016



2,647Restricted stock outstanding
    (unvested)


52



68



502,319



3,084



2,697   Share-Based
    Compensation
      
    the stock option exercise price;
    the expected term of the option;
    the grant date price of the Companys common stock, which
    is issuable upon exercise of the option;
    the expected volatility of the Companys common stock; F-10




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   
    expected dividends on the Companys common stock (the
    Company does not anticipate paying dividends for the foreseeable
    future); and
    the risk free interest rate for the expected option term.        3.
    RECENT
    ACCOUNTING PRONOUNCEMENTS     F-11




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##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
        ,
   F-12




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
      4.
    MARKETABLE
    SECURITIES    Gross


Gross


EstimatedAmortized


Unrealized


Unrealized


FairCost


Gains


Losses


Value(In thousands)December 31, 2006:Corporate debt securities

$
21,381


$
3


$
10


$
21,374U.S. government agency-backed
    discounted notes


3,038







4



3,034Total marketable securities

$
24,419


$
3


$
14


$
24,408December 31, 2005:Corporate debt securities

$
32,472


$



$
113


$
32,359U.S. government agency-backed
    discounted notes


7,059







41



7,018Total marketable securities

$
39,531


$



$
154


$
39,377     Contractual maturity 
    maturing in one year or less

$
24,408       5.
    INVENTORIES    December 31,2006


2005(In thousands)Raw materials

$
64


$
44Finished products


137



96Total inventories

$
201


$
140    F-13




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
        6.
    FIXED
    ASSETS    December 31,2006


2005(In thousands)Equipment and leasehold
    improvements

$
6,382


$
5,092Software


1,998



1,834Projects in progress


308



768,688



7,002Less: accumulated depreciation and
    amortization


4,901



4,012$
3,787


$
2,990     7.
    PATENTS  December 31,2006


2005(In thousands)Patents, net of accumulated
    amortization of $2,101 and $1,625:

$
3,184


$
3,383  F-14




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##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
      Year

Amount2007

$
3792008


3762009


3632010


3302011


284Thereafter


1,452Total

$
3,184     8.
    SHAREHOLDERS
    EQUITY  Form S-3
    Share-Based
    Compensation
   F-15




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
      Year Ended December 312005


2004(In thousands,except per share data)Net loss  as reported

$
(22,898
)

$
(23,785
)Stock-based compensation expense
    included in reported net loss


2,939



296Stock-based compensation under
    fair value method


(3,652
)


(3,575
)Net loss  pro forma
    after stock-based compensation under fair value method

$
(23,611
)

$
(27,064
)Net loss per share, basic and
    diluted  as reported

$
(1.05
)

$
(1.28
)Net loss per share, basic and
    diluted  pro forma after stock-based compensation
    under fair value method

$
(1.09
)

$
(1.45
)   Penwest
    Stock Option Plans
     F-16




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
          Weighted-AverageWeighted


Remaining


AggregateAverage


Contractual Terms


IntrinsicShares


Exercise Price


in Years


ValueBalance at December 31, 2005


3,015,563


$
10.88Options Exercisable


2,120,947


$
9.99Granted


622,250


$
20.03Exercised


(1,202,792
)

$
8.84Forfeited


(167,286
)

$
14.10Expired


(1,075
)

$
15.93Balance at December 31, 2006


2,266,660


$
14.23



6.5


$
7,809,424Options Exercisable


1,274,381


$
11.98



4.7


$
6,219,428    F-17




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
     2006


2005


2004Expected dividend yield


None



None



NoneRisk free interest rate


4.7
%


4.1
%


3.7
%Expected volatility


58
%


48
%


46
%Expected life of options


5.6 years



7.5 years



7.5 years     Weighted-Average


AggregateGrant-Date


IntrinsicShares


Fair Value


ValueRestricted stock outstanding at
    December 31, 2005


68,000


$
11.37


$
1,308,660Granted


24,000


$
19.41Vested


(40,500
)

$
11.17Restricted stock outstanding at
    December 31, 2006


51,500


$
15.24


$
853,355     Employee
    Stock Purchase Plan
    Rights
    Agreement
     F-18




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   9.
    COMMITMENTS  Leases
          OperatingLeases(In thousands)2007

$
7652008


322009


2010


2011


Thereafter


Total minimum lease payments

$
797   10.
    INCOME
    TAXES   F-19




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
     2006


2005


2004Statutory tax rate


(34
)%


(34
)%


(34
)%Valuation allowance


34



34



34
%



%



%     2006


2005(In thousands)Inventory allowance and basis
    differences

$
(13
)

$
(163
)Deferred compensation and SERP
    liability


(1,266
)


(1,307
)Deferred revenue


(17
)


(23
)Stock-based compensation


(1,830
)


Tax credit carryforwards


(5,363
)


(4,497
)Net operating loss carryforwards


(56,156
)


(44,413
)Total deferred tax assets


(64,645
)


(50,403
)Depreciation and amortization


1,608



1,708Other


337



284Total deferred tax liabilities


1,945



1,992Net deferred tax asset before
    valuation allowance


(62,700
)


(48,411
)Valuation allowance


62,700



48,411Net deferred tax liability

$



$
        F-20




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
    11.
    COMPENSATION
    CHARGE    12.
    RETIREMENT
    PLANS AND OTHER EMPLOYEE BENEFITS  Savings
    Plan
      Supplemental
    Executive Retirement Plan
     F-21




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
        December 31, 2006Prior to Adopting


Effect of Adopting


As Reported atSFAS No. 158


SFAS No. 158


December 31, 2006Intangible asset (retirement plan)

$



$



$
Liability for plan benefits

$
2,297


$
(110
)

$
2,187Accumulated other comprehensive
    income

$



$
110


$
110       2006


2005(In thousands)Benefit obligation at beginning of
    period

$
2,168


$
2,168Interest cost


120



122Actuarial (gain) loss


50



(21
)Benefits paid


(151
)


(101
)Benefit obligation at
    December 31,

$
2,187


$
2,168Change in plan assets:   2006


2005(In thousands)Fair value of plan assets at
    beginning of year

$



$
Employer contributions


151



101Benefit payments


(151
)


(101
)Fair value of plan assets at end
    of year

$



$
  F-22




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
    2006(In thousands)Current liabilities

$
(147
)Noncurrent liabilities


(2,040
)Net amount recognized at
    December 31, (included in deferred compensation)

$
(2,187
)     2006(In thousands)Net gain

$
(122
)Prior service cost


12Total

$
(110
)     2006


2005(In thousands)Projected benefit obligation

$
2,187


$
2,168Accumulated benefit obligation

$
2,187


$
2,168Plan assets at fair value

$



$
     2006


2005(In thousands)Interest cost

$
120


$
123Amortization of prior service cost


2



2Amortization of gains






(1
)Net periodic benefit cost

$
122


$
124       2006


2005Discount rate


5.60
%


5.75
%Rate of compensation increase


N/A



N/A     2006


2005Discount rate


5.75
%


6.00
%Rate of compensation increase


N/A



N/A    F-23




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
    2007

$
1512008


1512009


1512010


1512011


151Years
    2012-2016


752   Deferred
    Compensation Plan
    2007

$
1432008


1432009


1432010


1432011


143Years
    2012-2014


429     Health
    Care and Life Insurance Benefits
   F-24




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   13.
    DISCONTINUED
    OPERATIONS    14.
    LICENSING
    AGREEMENTS    Endo
    Pharmaceuticals Inc.
  ® ® ® ® ® tm .
        
    Endo will pay the Company royalties on U.S. sales of Opana
    ER calculated based on a royalty rate starting at 22% of annual
    net sales of the product up to $150 million of annual net
    sales, with the royalty rate increasing, based on
    agreed-upon
    levels of annual net sales achieved, from 25% up to a maximum of
    30%.
    No royalty payments will be due to the Company for the first
    $41 million of royalties that would otherwise have been
    payable beginning from the time of the product launch in July
    2006.
    Endo will pay the Company a percentage of any sublicense income
    it receives and milestone payments of up to $90 million
    based upon the achievement of
    agreed-upon
    annual sales thresholds. F-25




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
   
    The Companys share of the development costs for Opana ER
    that it opted out of funding in April 2003 will be fixed at
    $28 million and will be recouped by Endo through a
    temporary 50% reduction in royalties. This temporary reduction
    in royalties will not apply until the threshold for the
    $41 million royalty holiday referred to above has been met.  Mylan
    Pharmaceuticals Inc.
    Prism
    Pharmaceuticals, Inc.
  and/or
    15.
    CONTINGENCIES    16.
    RELATED
    PARTY TRANSACTIONS   F-26




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
  ® ®
  ® ®
    17.
    SUBSEQUENT
    EVENTS  Royalty
    Termination Agreements
        Credit
    Facility
   F-27




---



##### Table of Contents



PENWEST
    PHARMACEUTICALS CO
  NOTES TO
    FINANCIAL STATEMENTS  (Continued)
      18.
    QUARTERLY
    FINANCIAL DATA (UNAUDITED)    Quarter EndedMar. 31, 2006


June 30, 2006


Sept. 30, 2006


Dec. 31, 2006(Unaudited)


(Unaudited)


(Unaudited)


(Unaudited)Total revenues

$
965


$
1,075


$
720


$
739Gross profit


943



1,042



671



612Net loss

$
6,303


$
(7,416
)

$
(8,741
)

$
(8,852
)Net loss per share

$
(0.28
)

$
(0.33
)

$
(0.38
)

$
(0.38
)   Quarter EndedMar. 31, 2005


June 30, 2005


Sept. 30, 2005


Dec. 31, 2005(a)


(b)


(c)(Unaudited)


(Unaudited)


(Unaudited)


(Unaudited)(In thousands, except per share data)Total revenues

$
982


$
1,296


$
3,004


$
931Gross profit


974



1,282



2,996



922Net loss

$
(8,947
)

$
(5,686
)

$
(2,986
)

$
(5,279
)Net loss per share

$
(0.41
)

$
(0.26
)

$
(0.14
)

$
(0.24
)     (a)
    
    During the first quarter of 2005, the Company recorded a
    $3.0 million compensation charge in connection with a
    Severance and Settlement Agreement and Release it entered into
    with Tod Hamachek, Penwests former Chairman and Chief
    Executive Officer, upon his resignation in February 2005. Such
    charge is reflected in selling, general and administrative
    expense.(b)
    
    During the second quarter of 2005, the Company recorded a
    write-off of inventory of approximately $395,000 relating
    primarily to a change in specifications for TIMERx. The Company
    also recognized impairment losses of $118,000 related to patents
    covering PW2101, a beta blocker intended for the treatment of
    hypertension and angina, which the Company determined no longer
    had value. Such charges are reflected in research and product
    development expense.(c)
    
    During the third quarter of 2005, the Company recognized
    $2.25 million of licensing revenue under its agreement with
    Prism, which was terminated in July 2005. Such revenue is
    reflected in royalties and licensing fees. F-28




---



##### Table of Contents



SCHEDULE II  VALUATION
    AND QUALIFYING ACCOUNTS
  PENWEST
    PHARMACEUTICALS CO.
    DECEMBER 31, 2006
  AdditionsCharged toBalance at


Charged to


Other





Balance atBeginning


Costs and


Accounts-


Deductions-


End ofof Period


Expenses


Describe


Describe


Period(In thousands)Year ended December 31, 2006Inventory Allowances

$
208


$



$



$
208
(a)

$
Year ended December 31, 2005Inventory Allowances

$
85


$
497


$



$
374
(a)

$
208Year ended December 31, 2004Inventory Allowances

$
82


$
75


$



$
72
(a)

$
85     (a)
    
    Disposals of unrecoverable inventory costs. S-1




---



##### Table of Contents



Exhibit Index
 Filed withExhibit
    
    
    
    this Form
    
    Form or
    
    Filing Date
    
    SEC FileNumber
    
    Description
    
    10-K
    
    Schedule
    
    with SEC
    
    Number2.1
    
    Purchase Agreement by and between Penwest
Pharmaceuticals Co. and Josef Rettenmaier Holding
GmBh & Co. KG, dated November 1, 2002.
    
    
    
    Schedule 14A
    
    1/31/2003
    
    000-234672.2
    
    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.
    
    
    
    
    8-K
    
    
    2/28/2003
    
    000-234673.1
    
    Amended and Restated Articles of Incorporation
    
    
    
    
    10-Q
    
    
    8/3/2004
    
    000-234673.2
    
    Amended and Restated Bylaws of the Company.
    
    
    
    
    S-1
    
    
    10/21/1997
    
    333-383893.3
    
    Designation of Rights and Preference of Series A
Junior Participating Preferred Stock of the
Company filed on July 17, 1998.
    
    
    
    
    10/A
    
    
    7/17/1998
    
    000-234674.1
    
    Specimen certificate representing the Common Stock.
    
    
    
    
    S-1/A
    
    
    12/17/1997
    
    333-383894.2
    
    Form of Rights Agreement dated as of July 27, 1998
between the Company and the Rights Agent.
    
    
    
    
    10/A
    
    
    7/17/1998
    
    000-2346710.1
    
    Product Development and Supply Agreement dated
August 17, 1994 by and between the Registrant and
Mylan Pharmaceuticals Inc.
    
    
    
    
    S-1
    
    
    10/21/1997
    
    333-3838910.2
    
    Sales and Distribution Agreement dated January 3,
1997 by and between the Registrant and Mylan
Pharmaceuticals Inc.
    
    
    
    
    S-1
    
    
    10/21/1997
    
    333-3838910.3
    
    Letter Agreement dated February 25, 2000 by and
between the Registrant Mylan Pharmaceuticals Inc.
    
    
    
    
    10-Q
    
    
    8/14/2000
    
    000-2346710.4
    
    Amended and Restated Strategic Alliance Agreement,
dated as of April 2, 2002, by and between Endo
Pharmaceuticals Holdings Inc. and the Company
    
    
    
    
    10-Q
    
    
    8/14/2002
    
    000-2346710.5
    
    1997 Equity Incentive Plan.
    
    
    
    
    S-1
    
    
    10/21/1997
    
    333-3838910.6
    
    1997 Employee Stock Purchase Plan.
    
    
    
    
    S-1
    
    
    10/21/1997
    
    333-3838910.7
    
    1998 Spinoff Option Plan.
    
    
    
    
    10/A
    
    
    7/7/1998
    
    000-2346710.8
    
    Form of Tax Allocation Agreement entered into
between the Registrant and Penford Corporation.
    
    
    
    
    10
    
    
    6/22/1998
    
    000-2346710.9
    
    Recognition and Incentive Agreement dated as of
May 14, 1990 between the Registrant and Anand
Baichwal, as amended.
    
    
    
    
    S-1/A
    
    
    11/10/1997
    
    333-38389




---



##### Table of Contents



Filed withExhibit
    
    
    
    this Form
    
    Form or
    
    Filing Date
    
    SEC FileNumber
    
    Description
    
    10-K
    
    Schedule
    
    with SEC
    
    Number10.10
    
    Royalty Agreement dated September 25, 1992 between
the Company and John N. Staniforth.
    
    
    
    
    10-Q
    
    
    5/15/2002
    
    000-2346710.11
    
    Confidentiality, Consulting and Noncompetition
Agreement dated September 25, 1992 between the
Company and John N. Staniforth.
    
    
    
    
    10-Q
    
    
    5/15/2002
    
    000-2346710.12
    
    Lease Agreement dated as of February 3, 2003 by
and between Union Carbide Corporation and the
Registrant.
    
    
    
    
    10-Q
    
    
    5/15/2003
    
    000-2346710.13
    
    Lease Amendment and Attornment Agreement, dated
March 15, 2004, by and between Union Carbide
Corporation and the Registrant.
    
    
    
    
    10-Q
    
    
    8/3/2004
    
    000-2346710.14
    
    Form of Option Agreement for 1997 Incentive Plan
    
    
    
    
    10-K
    
    
    3/16/05
    
    000-2346710.15
    
    Nonstatutory Stock Option Agreement dated June 21,
2004 by and between the Registrant and Alan F.
Joslyn, Ph.D.
    
    
    
    
    S-8
    
    
    7/26/2005
    
    333-12689710.16
    
    Severance and Settlement Agreement and Release
dated February 14, 2005 by and between the
Registrant and Tod R. Hamachek
    
    
    
    
    10-Q
    
    
    5/9/2005
    
    000-2346710.17
    
    Offer Letter dated February 15, 2005 by and
between the Registrant and Robert J. Hennessey
    
    
    
    
    10-Q
    
    
    5/9/2005
    
    000-2346710.18
    
    2005 Stock Incentive Plan
    
    
    
    
    8-K
    
    
    6/7/2005
    
    000-2346710.19
    
    Amendment No. 1 to 2005 Stock Incentive Plan
    
    
    
    
    10-Q
    
    
    11/9/06
    
    000-2346710.20
    
    Form of Incentive Stock Option Agreement for
grants under 2005 Stock Incentive Plan
    
    
    
    
    8-K
    
    
    6/7/2005
    
    000-2346710.21
    
    Form of Employee Nonstatutory Stock Option
Agreement for grants under 2005 Stock Incentive
Plan
    
    
    
    
    8-K
    
    
    6/7/2005
    
    000-2346710.22
    
    Form of Nonstatutory Stock Option Agreement
(Consultants and Directors) for grants under 2005
Stock Incentive Plan
    
    
    
    
    8-K
    
    
    6/7/2005
    
    000-2346710.23
    
    Form of Director Restricted Stock Agreement for
grants under 2005 Stock Incentive Plan
    
    
    
    
    8-K
    
    
    6/7/2005
    
    000-2346710.24
    
    Form of Executive Retention Agreement entered into
by the Registrant and each of the Executive
Officers
    
    
    
    
    10-K
    
    
    3/16/2006
    
    000-2346710.25
    
    Summary of Executive Officer Bonus Program
    
    X10.26
    
    Summary of the Director Compensation Program
    
    X10.27
    
    Offer Letter between the Company and Benjamin L.
Palleiko, effective June 19, 2006
    
    
    
    
    10-Q
    
    
    8/9/06
    
    00-23467




---



##### Table of Contents



Filed withExhibit
    
    
    
    this Form
    
    Form or
    
    Filing Date
    
    SEC FileNumber
    
    Description
    
    10-K
    
    Schedule
    
    with SEC
    
    Number10.28
    
    Manufacture and Supply Agreement dated November 6,
2006 between the Company and Draxis Specialty
Pharmaceuticals Inc.
    
    X23
    
    Consent of Ernst & Young LLP
    
    X31.1
    
    Certification of Principal Executive Officer
pursuant to Exchange Act Rules 13a-14 or 15d-14,
as adopted pursuant to Section 302 of
Sarbanes-Oxley Act of 2002.
    
    X31.2
    
    Certification of Principal Financial Officer
pursuant to Exchange Act Rules 13a-14 or 15d-14,
as adopted pursuant to Section 302 of
Sarbanes-Oxley Act of 2002.
    
    X32.1
    
    Certification of Principal Executive Officer
pursuant to Exchange Act Rules 13a-14(b) or
15d-14(b) and 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of Sarbanes-Oxley Act of
2002
    
    X32.2
    
    Certification of Principal Financial Officer
pursuant to Exchange Act Rules 13a-14(b) or
15d-14(b) and 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of Sarbanes-Oxley Act of
2002
    
    X
 
 
    
    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 the Annual Report on Form
10-K.
    
    Confidential treatment requested as to certain portions,
which portions are omitted and filed separately with the Commission.