<PAGE>   1

                                  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, 1999

                                       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                                       91-1513032
    (State or other jurisdiction of                     (I.R.S. Employer
    incorporation or organization)                    Identification No.)

                 2981 Route 22
         Patterson, New York                                  12563-9970
    (Address of principal Executive Offices)                  (Zip Code)

    Registrant's telephone number, including area code:

                                 (914) 878-3414

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

    Title of each class               Name of each exchange of which registered
    None                                            None
    ----                                            ----

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

                          Common Stock, $.001 par value
                          Common 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. [x]

<PAGE>   2

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                    FORM 10-K


                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934


(continued)

The aggregate market value of the Registrant's Common Stock held by
non-affiliates as of March 7, 2000 was approximately $224 million based on the
closing price of $18.50 per share. The number of shares of the Registrant's
Common Stock (the Registrant's only outstanding class of stock) outstanding as
of March 7, 2000 was 12,552,950.


                       DOCUMENTS INCORPORATED BY REFERENCE

The Registrant's definitive Proxy Statement relating to the 2000 Annual Meeting
of Shareholders is incorporated by reference into Part III of this Form 10-K.


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<PAGE>   3

PART I

ITEM 1:  BUSINESS

GENERAL

    Penwest Pharmaceuticals Co. ("Penwest" or "the Company") is engaged in the
research, development and commercialization of novel drug delivery technologies
and has extensive expertise in developing and manufacturing excipient
ingredients for the pharmaceutical industry. Based on this fundamental expertise
in tabletting ingredients, the Company has developed its proprietary TIMERx (R)
controlled release drug delivery technology, which is applicable to a broad
range of orally administered drugs, and ProSolv(R) a co-processing drug delivery
technology platform. The Company had revenues, primarily from the sale of
excipients, in 1999, 1998 and 1997 of $37.2 million, $29.0 million and $26.9
million, respectively.

TIMERX CONTROLLED RELEASE TECHNOLOGY

     The Company has developed the TIMERx delivery system, a novel drug delivery
technology, to address the limitations of currently available oral controlled
release delivery systems. The Company believes that the TIMERx system is a major
advancement in oral drug delivery that represents the first easily-manufactured
oral controlled release drug delivery system that is applicable to a wide
variety of drug classes, including soluble drugs, insoluble drugs and drugs with
a narrow therapeutic index. The Company is utilizing the TIMERx system to
formulate generic versions of branded controlled release drugs, controlled
release formulations of currently-marketed immediate release drugs and New
Chemical Entities ("NCE's").

     The TIMERx drug delivery system is a hydrophilic matrix combining primarily
a heterodispersed mixture, usually polysaccharides xanthan and locust bean gums,
in the presence of dextrose. 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 third component, 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.

    Each of the TIMERx formulations developed by the Company to date has been
developed under a collaborative arrangement with a pharmaceutical company. The
Company's collaborator, Leiras OY, a Finnish subsidiary of Schering AG
("Leiras"), received marketing approval in Finland for Cystrin CR(R) , a
controlled release version of oxybutynin utilizing Penwest's TIMERx technology
for the treatment of urge urinary incontinence and began marketing the product
in Finland in January 1998. The Company's collaborator, Sanofi Winthrop
International S.A. ("Sanofi"), received marketing approval in the United Kingdom
and began marketing the product in November, 1998 for Slofedipine XL, a
controlled release version of nifedipine utilizing Penwest's TIMERx technology
for the treatment of angina. The Company's collaborator, Mylan Pharmaceuticals
Inc. ("Mylan"), received final marketing approval in December 1999 of an
Abbreviated New Drug Application ("ANDA")


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<PAGE>   4

from the U.S. Food and Drug Administration (the "FDA") for the first generic
version of the 30 mg dosage strength of Procardia(R) XL (nifedipine), a leading
cardiovascular drug for angina and hypertension.

    On March 2, 2000 Mylan announced that it had 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. As a result of
the agreement, Pfizer agreed to dismiss all pending litigation against Mylan. In
connection with that agreement, Mylan has agreed to pay Penwest a royalty on net
sales of Pfizer's 30 mg generic version of Procardia XL. The royalty percentage
will be 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. Mylan has also agreed to purchase from the Company
formulated bulk TimerX manufactured for Nifedipine XL.

     The Company also has a strategic alliance with Endo Pharmaceuticals, Inc.
("Endo") to jointly develop a controlled release version of Numorphan(R). The
Company and Endo have agreed to share the costs involved in the development and
commercialization of this product, and share in the net profits from the sale of
this product once it is marketed.

     The Company believes that the TIMERx controlled release system has several
advantages over other oral controlled release systems.

        -   Broad Applicability as a Drug Delivery System. The TIMERx system is
            adaptable to a wide range of drugs with different physical and
            chemical properties. For instance, the TIMERx system can be used to
            deliver both low dose (less than 5 mg) and high dose (greater than
            700 mg) drugs as well as water soluble and insoluble drugs. Because
            of the high affinity of xanthan and locust bean gums, the TIMERx
            system permits a formulation with a high drug-to-gum ratio, which
            permits tablets to include a higher dosage of the active drug
            substance.

        -   Flexible Pharmacokinetic Profile. The Company formulates the TIMERx
            material to optimize the desired kinetic profile of the active drug
            substance. In this manner, the TIMERx system can be designed to
            enhance the therapeutic effect of the active drug substance.
            Depending on the desired release profile, the Company can formulate
            the drug to be released in the body (i) at a constant amount or
            linear rate over time, (ii) at a decreasing amount over time where
            the rate is dependent on drug concentration, or (iii) at a varied
            release rate.

        -   Ease of Manufacture. Drugs formulated using the TIMERx system are
            designed for production on standard pharmaceutical processing
            equipment. The TIMERx technology is easily and reproducibly
            scaled-up in a commercial manufacturing environment often utilizing
            the cost-effective direct compression tabletting process.

        -   Cost-Effective System. The TIMERx system is a cost-effective drug
            delivery system. It involves fewer and less complex ingredients than
            other systems and does not require the manufacturer to purchase
            specialized equipment. The Company believes that drug formulations
            using the TIMERx system can be developed more rapidly than drugs
            formulated with alternative controlled delivery systems and that the
            time to scale up to commercial quantities is minimized.


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<PAGE>   5

         PROSOLV(R)

      Prosolv, which is silicified microcrystalline cellulose, is a patented
combination of microcrystalline cellulose and colloidal silicon dioxide. These
two ingredients work together synergistically for optimal tabletting
performance. The Company has developed two products from this technology
platform: ProSolv SMCC(R) and ProSolv HD(R). ProSolv SMCC can be used by
manufacturers to produce harder tablets and can enable manufacturers to reduce
the amount of binders used in the tablet, thereby reducing the size and cost of
the tablet. Additionally, it can be used to manufacture tablets with difficult
active ingredients which otherwise may not have been manufactured. ProSolv HD
improves flow and compaction, and can increase throughput by increasing
production speeds.

PENWEST STRATEGY

     The Company's strategy is to become the premier oral drug delivery company
for the pharmaceutical industry. The Company's strategy consists of the
following principal elements:

Leverage the TIMERx technology through the following:

-   Create Innovative Branded Controlled Release Versions of Immediate Release
    Pharmaceuticals. The Company is increasingly focused on the application of
    its TIMERx technology to the development of controlled release formulations
    of immediate release drugs, which will be marketed as brand name
    pharmaceuticals. In developing these controlled release formulations, the
    Company intends to seek collaborations with developers of the immediate
    release drugs or with pharmaceutical companies having a market presence in
    the applicable therapeutic area. The development of these controlled release
    drugs is subject to the New Drug Application ("NDA") approval process,
    although the Company and its collaborators may be permitted to rely on
    existing safety and efficacy data with respect to the immediate release drug
    in submitting the NDA.

-   Apply TIMERx Technology to Generic Versions of Branded Controlled Release
    Pharmaceuticals. The Company is also focused on the application of its
    TIMERx technology to the development of generic versions of branded
    controlled release drugs. In selecting generic controlled release
    pharmaceutical candidates to develop, the Company targets high sales volume,
    technically-complex controlled release pharmaceuticals. The Company believes
    these drug candidates may be difficult to replicate and, as a result, TIMERx
    versions may have limited competition from other formulations.

-   Apply TIMERx Technology to the Development of New Chemical Entities. The
    Company believes that its TIMERx technology may be applicable to the
    development of products containing NCEs by pharmaceutical companies. The
    development of such NCE's is subject to the full NDA approval process,
    including conducting preclinical studies, filing an Investigational New Drug
    ("IND") application, conducting clinical trials and submitting an NDA.


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<PAGE>   6

Establish Collaborations for Development, Manufacture and Marketing

The Company's principal collaborative agreements are with Mylan, Endo, Leiras
and Sanofi. The Company is seeking to enter into additional collaborative
agreements for both TIMERx and Prosolv. The Company's existing and potential
future collaborations enable the Company to secure additional financial support
for its research and development activities, to obtain access to the clinical,
manufacturing and regulatory resources and expertise of its collaborators and to
rely on them for the sales and marketing, distribution and promotion.

Continue Research in ProSolv Technology to Add Additional Products to the
Company's Portfolio and to Fully Commercialize ProSolv

The Company continues its research to develop additional ProSolv products from
its ProSolv co-processing technology platform. The Company intends to develop
additional ProSolv products which it believes addresses formulation issues or
needs in tabletting.

     The achievement of the Company's strategy is subject to various risks and
uncertainties. In particular, there can be no assurance that the Company's
capital resources will be sufficient to fully implement its strategy. The costs
of implementing the Company's strategy are difficult to predict and will depend
on numerous factors. If the Company's capital resources are insufficient to
fully implement its strategy, the Company may be required to modify its
strategy.

TIMERX PRODUCT DEVELOPMENT

     The following table provides information by therapeutic area, development
status and collaborator for each of the principal products being marketed or
under development utilizing the Company's TIMERx technology. The Company is also
conducting development activities with respect to various additional controlled
release formulations.


<TABLE>
<CAPTION>
BRAND NAME                           THERAPEUTIC              DEVELOPMENT
 (COMPOUND)                              AREA                   STATUS                              COLLABORATOR(1)

<S>                                 <C>                     <C>                                     <C>
BRANDED CONTROLLED RELEASE(2)

Cystrin CR                          Urge Urinary               Approved                                  Leiras
  (oxybutynin)                       Incontinence            and Marketed (3)

Numorphan                           Pain Relief               Clinical Trials                             Endo
  (oxymorphone)

GENERIC CONTROLLED RELEASE(4)

Procardia XL (30 mg)                Hypertension,               Approved (5)                              Mylan
  (nifedipine)                         Angina

Slofedipine XL                      Hypertension,               Approved                                  Sanofi
  (nifedipine)                         Angina                 and Marketed (6)

Glucotrol XL                          Diabetes               Bioequivalence Studies                        Mylan
  (glipizide)
</TABLE>


                                       6
<PAGE>   7

 (1) The Company's collaborators typically provide research and development
     support and are responsible for conducting full scale bioequivalence
     studies or clinical trials, obtaining regulatory approvals and
     manufacturing, marketing and selling the product. There can be no assurance
     that the results obtained in bioequivalence studies or preclinical studies
     will be obtained in full scale bioequivalence studies and other late stage
     clinical studies or that the Company or its collaborators will receive
     regulatory approvals to continue clinical studies of such products or to
     market any such products.

(2)  Controlled release formulations of immediate release products are subject
     to the NDA regulatory process. To the extent that the controlled release
     product is an extension of an FDA-approved immediate release version of the
     same chemical entity, the Company's collaborators may be permitted to rely
     on existing clinical data as to the safety and efficacy of the chemical
     entity in filing NDAs.

(3)  Leiras received marketing approval for Cystrin CR in Finland in October
     1997 and began marketing the product in January 1998.

(4)  Generic versions of controlled release products are developed in three
     basic stages:

        FORMULATION. Involves the utilization or adaptation of drug delivery
        technologies to the product candidate and evaluation in in-vitro
        dissolution studies.

        BIOEQUIVALENCE STUDIES. (a) Pilot bioequivalence studies involve testing
        in 10 to 15 human subjects to determine if the formulation yields a
        blood level comparable to the existing controlled release drug; (b) Full
        scale bioequivalence studies involve the manufacture of at least 10% of
        the intended commercial lot size and the analysis of plasma
        concentrations of the drug in 24 or more human subjects under fasting
        conditions and multiple dose conditions and 18 or more human subjects
        under fed conditions to determine whether the rate and extent of the
        absorption of the drug are substantially equivalent to that of the
        existing drug.

        ANDA FILING. An ANDA is submitted to the FDA with results of
        bioequivalence studies and other data such as in-vitro specifications
        for the formulation, stability data, analytical data, methods validation
        and manufacturing procedures and controls.

(5)  Mylan received marketing approval for Nifedipine XL on December 17, 1999.
     On March 2, 2000, the Company announced Mylan had 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 has agreed to pay Penwest a royalty
     on all future net sales of Pfizer's 30 mg generic version of Procardia XL.
     The royalty percentage will be comparable to those called for in Penwest's
     original agreement with Mylan for Nifedipine XL.

(6)  Sanofi received marketing approval for and began marketing Slofedipine XL
     in the United Kingdom in November 1998.

Branded Controlled Release Pharmaceuticals

     The Company is increasingly applying its TIMERx technology to the
development of controlled release formulations of immediate release
pharmaceuticals. The Company's principal branded controlled release
pharmaceuticals being marketed or in development are as follows:

     CYSTRIN CR. The Company and Leiras have developed a controlled release
formulation of Cystrin(R) incorporating TIMERx technology, which is being
marketed in Finland by Leiras under the tradename Cystrin CR. Leiras received
marketing approval in Finland for Cystrin CR in October 1997 and began marketing
the product in Finland in January 1998. Cystrin is a two to three times-a-


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<PAGE>   8

day immediate release version of the anticholinergic drug oxybutynin indicated
for the treatment of urge urinary incontinence. Oxybutynin is marketed in
Finland by Leiras under the trademark Cystrin.

      NUMORPHAN. The Company and Endo are currently developing a controlled
release formulation of Numorphan(R) incorporating TIMERx technology. Numorphan
is oxymorphone, a narcotic analgesic for the treatment of moderate to severe
pain which is currently given in the parenteral and suppository dosage form.
Numorphan is marketed by Endo and had sales in the United States in 1999 of
approximately $1 million. Numorphan, if successfully developed, would represent
the first oral controlled release version of Numorphan and would compete in the
severe analgesic market with products such as MS Contin and Oxycontin, which had
aggregate sales in the United States in 1999 of approximately $650 million. The
product is currently in Phase II clinical studies.

Generic Controlled Release Pharmaceuticals

     Generic controlled release pharmaceuticals are therapeutic equivalents of
brand name drugs for which patents or marketing exclusivity rights have expired.
Generic controlled release pharmaceuticals are typically difficult to replicate
because of: (i) formulation complexity; (ii) analytical complexity; and/or (iii)
manufacturing complexity. The Company believes that such generic controlled
release pharmaceuticals are less likely to suffer the same price erosion as
other generic pharmaceuticals because of the difficulty in replicating
controlled release pharmaceuticals and the resulting limits on competition.

     When developing generic pharmaceuticals, the drug developer is required to
demonstrate that the generic product candidate will exhibit in vivo release and
absorption characteristics equivalent to those of the branded pharmaceutical
without infringing on any unexpired patents. During the formulation of generic
pharmaceuticals, drug developers create their own version of the branded drug by
using or adapting drug delivery technologies to the product candidate.

     The Company's principal generic controlled release pharmaceuticals are as
follows:

NIFEDIPINE XL. The Company and Mylan developed the first generic equivalent to
the 30 mg strength of Procardia XL incorporating TIMERx technology. Procardia XL
is a once-a-day controlled release formulation of nifedipine, a calcium channel
blocking agent indicated for hypertension, vasospastic angina and chronic stable
angina, which uses the OROS delivery system. Procardia XL is marketed in three
dosage strengths (30 mg, 60 mg and 90 mg) by the Pratt Pharmaceuticals division
of Pfizer and had sales in the United States in 1999 of approximately $514
million. The sales of the 30 mg dosage strength in 1999 were $181 million.

     In December 1999, Mylan's ANDA for Nifedipine XL (30 mg) was approved by
the FDA. Mylan's ANDA was the first ANDA for a generic version of Procardia XL
filed with the FDA for the 30 mg strength. On March 2, 2000 Mylan announced that
it had 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. As a result of the agreement, Pfizer agreed to dismiss all pending
litigation against Mylan. In connection with that agreement, Mylan has agreed to
pay Penwest a royalty on all future net sales of Pfizer's 30 mg generic version
of Procardia XL. The royalty percentage will be 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. Mylan has also
agreed to purchase from the Company formulated bulk TIMERx manufactured for
Nifedipine XL.


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<PAGE>   9

SLOFEDIPINE XL. The Company and Sanofi received approval for and began marketing
in the United Kingdom in November 1998 Slofedipine XL, a generic version of
Adalat LA(R) (a drug marketed in Europe) incorporating TIMERx technology. Adalat
LA is a once-a-day controlled release formulation of nifedipine, a calcium
channel blocking agent indicated for hypertension, vasospastic angina and
chronic stable angina, which uses the OROS delivery system. Adalat LA is
marketed in two dosage strengths (30 mg and 60 mg) by Bayer in Europe and had
sales in the UK in 1999 of approximately $60 million. In December 1999, Sanofi
also received country approval in Italy for this product.

GLIPIZIDE XL. The Company and Mylan are currently developing Glipizide XL, a
generic version of Glucotrol XL(R) incorporating TIMERx technology. Glucotrol XL
is a once-a-day controlled release formulation of glipizide, a blood-glucose
lowering agent indicated as an adjunct to diet for the control of hyperglycemia
in diabetes patients, which uses the OROS delivery system. Glucotrol XL is
marketed in a 2.5 mg, 5 mg and 10 mg dosage strengths by the Pratt
Pharmaceuticals division of Pfizer and had sales in the United States in 1999 of
approximately $206 million. Mylan is conducting full scale bioequivalence
studies of the 5 mg and 10 mg dosage strengths of Glipizide XL. The Company is
aware that other companies are developing generic formulations of Glucotrol XL.

PHARMACEUTICAL EXCIPIENTS

     The Company sells 29 excipient products which are used in the manufacture
of tablets by pharmaceutical and nutritional companies worldwide. The Company's
product line is broadly classified into three distinct categories: binders,
disintegrants and lubricants. Binders, working in conjunction with other
products, are the primary tablet-forming component of excipients. Disintegrants
function helps a tablet fall apart when consumed by drawing water into the
dosage form, a necessary precursor to dissolution and ultimately absorption of
the drug. Lubricants help facilitate the ease of manufacture of drugs so that
they emerge from a tabletting machine with the desired physical characteristics.

     The Company's excipients are sold to the prescription, over-the-counter and
nutritional markets. In 1999, the Company sold bulk excipients to more than 300
customers, including some of the leading pharmaceutical companies in the world,
in more than 40 countries.

     The following is a list of excipient products currently being marketed in
bulk by the Company:

    PROSOLV SMCC(R) was introduced in late 1996 and the Company sells it both in
bulk and through licensing arrangements when exclusivity is offered. The Company
believes that Prosolv SMCC offers numerous advantages over traditional
microcrystalline cellulose such as enhanced drug loading capability, production
of elegant, robust tablets, and has excellent disintegration properties.

    PROSOLV HD(TM) was introduced in late 1999, and is the newest ProSolv
technology that provides superior flow in the manufacturing process. The
addition of ProSolv HD in some formulations can increase throughput and capacity
in a production line.

    EMCOCEL(R), or microcrystalline cellulose ("MCC"), the Company's largest
selling product, is a tabletting binder used in pharmaceutical formulations
worldwide. EMCOCEL is utilized in a number of products including ethical and
over-the-counter brands.


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<PAGE>   10

     EMCOMPRESS(R), or dicalcium phosphate, is a binder marketed by the Company
under an exclusive worldwide distribution agreement with the manufacturer
Albright and Wilson Americas Inc. The distribution agreement expires on December
31, 2000, subject to automatic extension on an annual basis unless either party
gives the other party 12 months notice of its desire to terminate the agreement.
EMCOMPRESS is frequently used in vitamin formulations as it serves as an
additional source of dietary calcium.

     EMDEX(R), or dextrates, is a binder that is used as a directly compressible
excipient in both chewable and non-chewable tablets. EMDEX is odorless with a
sweet taste caused by its sugar composition. EMDEX is used in, among other
things, chewable antacid tablets and vitamins.

     EXPLOTAB(R), or sodium starch glycolate, is the principal disintegrant
marketed by the Company. EXPLOTAB is distributed by the Company under an
exclusive worldwide distribution agreement with the manufacturer, Roquette
America, Inc. The distribution agreement is automatically renewable on an annual
basis unless either party gives the other party 12 months notice of its desire
to terminate the agreement. EXPLOTAB is used in a number of products and is an
essential component of the Tylenol family of products.

     PRUV(R), or sodium stearyl fumarate, is the principal lubricant marketed by
the Company. PRUV is marketed under an exclusive worldwide distribution
agreement with Astra-Zeneca. PRUV is used in several prescription
pharmaceuticals. The Company has reached an agreement in principle with
Astra-Zeneca to purchase the trademark and manufacturing know-how associated
with this product.

    The Company had revenues from the sale of pharmaceutical excipients in 1999,
1998 and 1997 of $36.7 million, $28.7 million and $26.0 million, respectively.

COLLABORATIVE ARRANGEMENTS

     The Company enters into collaborative arrangements with pharmaceutical
companies to facilitate and expedite the commercialization of its TIMERx drug
delivery technology.

     Under most of its collaborative arrangements, the Company has received
upfront fees and milestone payments and is entitled to receive additional
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. There can be no assurance that future
milestone payments will be received. The Company's principal collaborative
arrangements are described below.

MYLAN PHARMACEUTICALS, INC.

     In August 1994 and March 1996, the Company entered into product development
and supply agreements with Mylan with respect to the development of generic
versions of Procardia XL (nifedipine) and Glucotrol XL (glipizide), based on the
Company's TIMERx technologies (the "Mylan Products"). Mylan is one of the
leading generic pharmaceutical companies in the United States.


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<PAGE>   11

     Under these product development and supply agreements, the Company is
responsible for the formulation, manufacture and supply of TIMERx material for
use in the Mylan Products, and Mylan is responsible for conducting all
bioequivalence studies, preparing all regulatory applications and submissions
and manufacturing and marketing the Mylan Products in the United States, Canada
and Mexico. Each product development and supply agreement is terminable by
either party upon 90 days prior written notice at any time (i) prior to the
submission of the ANDA for the product covered by such agreement if such party
reasonably determines that no further development efforts are likely to lead to
the successful development of such product and (ii) prior to approval by the FDA
of such ANDA if such party reasonably determines that such ANDA is not likely to
be approved. Following approval of the ANDA, the product development and supply
agreement will extend for a term of 20 years from the date on which the ANDA is
approved, subject to earlier termination by either party upon specified
circumstances, including termination by the Company if Mylan fails to meet
minimum sales volume requirements and termination by either party upon a
material breach by the other party of the agreement. If the Company does not
satisfy its obligations under any of these agreements, the Company will be in
breach of such agreement and Mylan will be entitled to terminate such agreement.

     The Company has received milestone payments under each of the product
development and supply agreements and is entitled to additional milestone
payments under the Glucotrol XL product development agreement. The Company is
also entitled to royalties on the sale of each Mylan Product. In addition, Mylan
has agreed that during the term of the product development and supply agreements
it will purchase formulated TIMERx material for use in the Mylan Products
exclusively from the Company at specified prices.

    On March 2, 2000 Mylan announced that it had 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. As a result of
the agreement, Pfizer agreed to dismiss all pending litigation against Mylan. In
connection with that agreement, Mylan has agreed to pay Penwest a royalty on net
sales of Pfizer's 30 mg generic version of Procardia XL. The royalty percentage
will be comparable to those called for in Penwest's original agreement with
Mylan for Nifedipine XL. As part of Mylan's new agreement with Penwest, Mylan
has agreed to purchase from the Company formulated bulk TIMERx manufactured for
Nifedipine XL. Although Mylan has retained the marketing rights to the 30 mg
strength of Nifedipine XL, the Company does not anticipate that Mylan will be
purchasing formulated bulk TIMERx from the Company prospectively as Mylan will
not be manufacturing the finished product.

     The Company and Mylan also entered into a sales and distribution agreement
in January 1997 (the "Mylan Distribution Agreement") with respect to Nifedipine
XL pursuant to which Mylan agreed to manufacture and supply Nifedipine XL to the
Company for distribution by the Company and one or more distributors (as to
which the Company and Mylan must mutually agree) in certain specified European
and Latin American countries. This agreement expires in January 2007, subject to
automatic extension on an annual basis. Under this agreement, the Company has
agreed to purchase Nifedipine XL exclusively from Mylan at specified prices or
to pay Mylan 50% of any royalties received by the Company from its distributors
if Mylan licenses its manufacturing technology to the Company for use by the
Company's distributors instead of manufacturing the product for distribution.
Under this agreement, Mylan is entitled to 50% of any royalties or milestone
payments received by the Company under the Company's product development and
supply agreement with Sanofi described below.


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<PAGE>   12

SANOFI WINTHROP INTERNATIONAL 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 based on the Company's TIMERx technology (the "Sanofi Product"), a
drug that utilizes the same controlled release technology as Procardia XL.
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 is
responsible for conducting pilot bioequivalence studies of the Sanofi Product
and for manufacturing and supplying TIMERx material to Sanofi, and Sanofi is
responsible for conducting all full scale bioequivalence and clinical studies,
preparing all regulatory applications and submissions and manufacturing and
marketing the Sanofi Product in specified countries in Europe and in South
Korea. This drug was approved and Sanofi began marketing the drug in the U.K. in
November 1998.

     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 is entitled to milestone payments under the product development
and supply agreement upon the continued development of the Sanofi Product. The
Company is also entitled to royalties upon the sale of the Sanofi Product. One
half of such payments will be paid to Mylan in accordance with the Mylan
Distribution Agreement. In addition, Sanofi has agreed that, during the term of
the product development and supply agreement, it will purchase 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. Leiras is a Finnish subsidiary of
Schering AG. Leiras is developing products focused in the areas of reproductive
health care, urology, oncology and inhalation technology.

     Under the agreements, the Company is responsible for the development and
formulation of Cystrin CR and for manufacturing and supplying TIMERx material to
Leiras for use in the manufacture of Cystrin CR, and Leiras is responsible for
preparing all regulatory applications and submissions and manufacturing and
marketing Cystrin CR on a worldwide basis. 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.


                                       12
<PAGE>   13

     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.

ENDO PHARMACEUTICALS INC.

     In September 1997, the Company entered into a strategic alliance agreement
with Endo with respect to the development of controlled release formulations of
oxymorphone based on the Company's TIMERx technology (the "Endo Products"). Endo
is a fully integrated specialty pharmaceutical company with a market leadership
in pain management. Endo has a broad product line including 14 branded products
that include the established brands such as Percodan(R) and Percocet(R). 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 any Endo Product will be determined by a committee
comprised of an equal number of members from each of the Company and Endo (the
"Alliance Committee"). However, the Company expects that it will formulate each
drug candidate and that Endo will conduct all clinical studies and prepare and
file all regulatory applications and submissions. In addition, under the
agreement, the Company has agreed to manufacture and supply TIMERx material to
Endo, and Endo has agreed to manufacture and market the Endo Products in the
United States. The manufacture and marketing of Endo Products outside of the
United States may be conducted by the Company, Endo or a third party, as
determined by the Alliance Committee.

     The strategic alliance agreement is terminable with respect to an Endo
Product by either party upon 30 days prior written notice at any time (i) prior
to the completion of development activities with respect to such Endo Product if
such party determines that further development efforts are not likely to lead to
the successful development of such Endo Product and (ii) prior to obtaining
approval by the FDA (or equivalent regulatory authority) of an NDA (or
equivalent regulatory filing) with respect to such Endo Product if such party
determines that further efforts are not likely to lead to such approval,
although the non-terminating party would have the right to continue the
agreement with respect to such Endo Product for a specified period and the
royalties that might otherwise have been payable to the terminating party would
be reduced. Following regulatory approval of the marketing and sale of such Endo
Product, the term of the strategic alliance agreement will extend for up to 20
years from the date of such regulatory approval, subject to earlier termination
under specified circumstances, including failure to launch full-scale marketing
of such Endo Product when required or material breach of the agreement by a
party.

     The Company and Endo have agreed to share the costs involved in the
development and commercialization of the Endo Products and that the party
marketing the Endo Products (which the Company expects will be Endo) will pay
the other party royalties equal to 50% of net marketing revenues after
fully-burdened costs (although this percentage will decrease as the total U.S.
marketing revenues from an Endo Product increase), subject to each party's right
to terminate its participation with respect to any Endo Product described above.
If the Company does not satisfy its funding and other obligations under the
agreement, the Company will be in breach of the agreement and Endo will


                                       13
<PAGE>   14

be entitled to terminate the agreement. Endo will purchase formulated TIMERx
material for use in the Endo Products exclusively from the Company at specified
prices. Such prices will be reflected in the determination of fully-burdened
costs.

RESEARCH AND DEVELOPMENT

    The Company conducts research and development activities with respect to
additional applications of TIMERx technology, advances in the TIMERx technology
and additional novel excipients such as Prosolv. The Company's research and
development expenses in 1999, 1998 and 1997 were $7.4 million, $6.1 million and
$3.7 million, respectively. 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 currently has a laboratory and pilot manufacturing facility
covering approximately 55,000 square feet contiguous to its executive offices in
Patterson, New York. However, the Company does not have commercial-scale
facilities to manufacture its TIMERx material in accordance with cGMP
requirements prescribed by the FDA. As a result, the Company has contracted with
a large third-party pharmaceutical company, Draxis Pharmaceuticals, Inc.
("Draxis"), for the bulk manufacture of its TIMERx material for delivery to its
collaborators under an agreement that expires in September 2004.

     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 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 TIMERx drug delivery system is a hydrophilic matrix combining
primarily a heterodispersed mixture, usually 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.

     The Company currently has two cGMP-approved manufacturing facilities for
its MCC products, including EMCOCEL and ProSolv. These facilities are located in
Cedar Rapids, Iowa and Nastola, Finland and cover approximately 35,000 square
feet and 15,000 square feet, respectively. The Company's MCC products are
primarily made from a specialty grade of wood pulp. Although the Company obtains
wood pulp primarily from two suppliers, wood pulp is widely available from a
number of suppliers.


                                       14
<PAGE>   15

     All manufacturing operations of the Company are subject to federal, state
and local laws and regulations governing the use, manufacture, storage, handling
and disposal of certain materials and waste products.

MARKETING AND DISTRIBUTION

     Pursuant to the Company's collaborative agreements, the Company's
collaborators have responsibility for the marketing and distribution of any
controlled release pharmaceuticals developed based on the Company's TIMERx
technology. Because the Company does not plan on developing any of such
pharmaceuticals without a collaborator, the Company has not developed and does
not intend to develop 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.

     The Company has an in-house sales force of ten employees who market the
Company's excipient products in the United States and in Europe. This sales
force focuses primarily on pharmaceutical and nutritional companies. The Company
also markets its products worldwide through the use of distributors located in
over 40 countries. The Company typically sells its excipients to its largest
customers under multi-year supply agreements.

PATENTS AND PROPRIETARY RIGHTS

     The Company believes that patent and trade secret protection, particularly
of its drug delivery technology, is important to its business and that its
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.

     The Company has been issued 21 U.S. and 48 foreign patents, principally
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,
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 method of treatment and methods of preparation. All these patents
will expire between 2008 and 2015. The Company also has been issued an
additional nine U.S. patents covering its ProSolv technology. These patents will
expire between 2017 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 (i) any of the Company's future processes or products
will be patentable; (ii) any pending or additional patents will be issued in any
or all appropriate jurisdictions; (iii) the Company's processes or products will
not infringe upon the patents of third parties; or (iv) 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.


                                       15
<PAGE>   16

     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. Most 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. To date, one such action has been commenced
against one of the Company's collaborators and it is anticipated that additional
actions will be filed as the Company's collaborators file additional ANDAs. 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, as well as the expense of such 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.

     In 1994, Boots Company PLC ("Boots") filed in the European Patent Office,
or the EPO, an opposition to a patent granted by the EPO to the Company relating
to its TIMERx technology. In June 1996, the EPO dismissed Boots' opposition,
leaving intact all claims included in the patent. Boots has appealed this
decision to the EPO Board of Appeals, but no decision has been rendered.
We can provide no assurance we will prevail in this matter.

    TIMERx, Emcocel, Explotab, Emdex, Emcompress and Candex are registered
trademarks of the Company. Other tradenames and trademarks appearing in this
Annual Report on Form 10-K are the property of their respective owners.

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,


                                       16
<PAGE>   17

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 IND 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


                                       17
<PAGE>   18

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 ANDAs 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 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.


                                       18
<PAGE>   19

     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 ("GATT"), 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.

    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.

FDA REGULATION OF EXCIPIENTS

     Products sold for use as excipients in finished drug products are subject
to regulation by the FDA with regard to labeling, product integrity and
manufacturing. The FDA will not approve a drug for marketing without adequate
assurances that the excipients are safe for use in the product. The FDA presumes
certain excipients that are present in approved drug products currently marketed
for human use to be safe. These excipients are listed by the FDA in a document
known as the Inactive Ingredient


                                       19
<PAGE>   20

Guide, or "IIG." All of the Company's pharmaceutical excipients other than
ProSolv are listed in the IIG. While the FDA does not ordinarily require
applicants for NDAs or ANDAs to submit data demonstrating the safety of
excipients listed in the IIG, it may require evidence of safety in certain
circumstances, such as when evidence is required to demonstrate that such
excipients interact safely with other components of a drug product. For
excipients not listed in the IIG, the FDA will generally require data, which may
include clinical data, demonstrating the safety of the excipient for use in the
product at issue. In the case of generic drug products approved based on
bioequivalence to a reference drug, the FDA may in some cases (e.g., products
for parenteral, ophthalmic, otic or topical use) require excipients that are
identical to the excipients in the reference drug. There can be no assurance
that the FDA will not require new clinical safety data to approve an application
for a product with a Penwest excipient or that the FDA will approve such an
application even if such clinical data are submitted.

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


                                       20
<PAGE>   21

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.

     The Company's European excipients manufacturing operations are subject to a
variety of laws and regulations, including environmental and good manufacturing
practices regulations.

OTHER REGULATIONS

     The Company is governed by federal, state and local laws of general
applicability, such as laws regulating working conditions and environmental
protection. Certain 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 ad 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. The
Company's TIMERx business faces competition from numerous public and private
companies and their controlled release technologies, including Alza
Corporation's ("Alza") Oros technology, multiparticulate systems marketed by
Elan Corporation PLC ("Elan") and Biovail, traditional matrix systems marketed
by SkyePharma, plc and other controlled release technologies marketed or under
development by Andrx Corporation, among others.

    The Company's entry strategy in drug delivery was to concentrate development
efforts on 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, analytical and
manufacturing complexity of the generic versions may be difficult for other
companies to replicate, which could limit competition. Competition may also
arise


                                       21
<PAGE>   22

from therapeutic products that are functionally equivalent but produced by other
methods. In addition, under several of the Company's collaborative arrangements,
the payments due to the Company with respect to the controlled release products
covered by such collaborative arrangements will be reduced in the event that
there are competing generic controlled release versions of such products. The
Company is now focusing its business development efforts and new research and
development projects on controlled release versions of existing immediate
release drugs. These drugs will be filed as NDAs.

    In its excipients business, the Company competes with a number of large
manufacturers and other distributors of excipient products, many of which have
substantially greater financial, marketing and other resources than the Company.
The Company's principal competitor in this market is FMC Corporation, which
markets its own line of MCC excipient products.

MYLAN LITIGATION

    In May 1997, our collaborator, Mylan, filed an ANDA with the FDA for the 30
mg dosage strength of Nifedipine XL, a generic version of Procardia XL, a
controlled release formulation of nifedipine. Bayer AG and Alza own patents
listed for Procardia XL, and Pfizer is the sponsor of the NDA and markets the
product.

   In connection with the ANDA filing, Mylan certified in May 1997 to the FDA
that Nifedipine XL does not infringe these Bayer or Alza patents and notified
Bayer, Alza and Pfizer of such certification. Bayer and Pfizer sued Mylan in the
United States District Court for the Western District of Pennsylvania, alleging
that Nifedipine XL infringes Bayer's patent. In March 1999, following receipt of
tentative approval of the ANDA by the FDA, Mylan filed an amended answer to the
action and made certain antitrust counterclaims. On March 29, 1999, Mylan filed
a motion for summary judgment based on, among other things, an adverse decision
against Bayer in Bayer's litigation against Elan which involved the same Bayer
patent as in this action. In July 1999, Pfizer and Bayer filed a motion for
summary judgment to dismiss Mylan's patent defenses and counterclaims. No
determination has been made with respect to either motion. On March 2, 2000
Mylan announced that it had signed a supply and distribution agreement with
Pfizer, Inc. to market Pfizer's generic version of all three strengths (30 mg,
60 mg, 90 mg) of Procardia XL. As a result of the agreement, Pfizer agreed to
dismiss all pending litigation against Mylan. Bayer and Mylan have not yet
settled, however, Mylan will be entitled to market the products supplied by
Pfizer, irrespective of the fate of its litigation with Bayer. Mylan has agreed
to pay Penwest a royalty on net sales of the 30 mg generic version of Procardia
XL. The royalty percentage will be comparable to those called for in Penwest's
original agreement with Mylan for Nifedipine XL. Mylan has also agreed to
purchase from the Company formulated bulk TimerX manufactured for Nifedipine XL.
Although Mylan has retained the marketing rights to the 30 mg strength of
Nifedipine XL, the Company does not anticipate that Mylan will be purchasing
formulated bulk TIMERx from the Company prospectively as Mylan will not be
manufacturing the finished product.

EMPLOYEES

    As of December 31, 1999, the Company employed 131 persons, of which 75 were
involved in research and development, administration and sales and marketing
activities in Patterson, New York, 20 were involved in manufacturing operations
at the Company's facility in Nastola, Finland, 30 were involved in manufacturing
operations at the Company's facility in Cedar Rapids, Iowa and six were involved
in sales activities in the Company's European sales offices.

    None of the Company's employees are covered by collective bargaining
agreements other than the Company's employees in Finland who are covered by a
national collective bargaining agreement. The Company considers its employee
relations to be good.


                                       22
<PAGE>   23

ITEM 2:  PROPERTIES

    The Company's executive, administrative, research, small-scale production
and warehouse facilities, comprising approximately 55,000 square feet, currently
are located in a single facility on a 15 acre site owned by the Company in
Patterson, New York.

    The Company owns a facility in Cedar Rapids, Iowa where it manufactures and
packages pharmaceutical excipients. The facility is a 35,000 square foot
building containing manufacturing and administrative space. The Company also
manufactures pharmaceutical excipients in a 15,000 square foot facility leased
by the Company in Nastola, Finland, which lease renews annually with a two year
notification of termination period for either party.

    The Company believes that all its present facilities are well maintained and
in good operating condition.

ITEM 3:  LEGAL PROCEEDINGS

    None.


                                       23
<PAGE>   24

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 1999.

ITEM 4a:  EXECUTIVE OFFICERS OF THE REGISTRANT

<TABLE>
<CAPTION>
              NAME                  AGE                           TITLE
              ----                  ---                           -----
<S>                                 <C>     <C>
Tod R. Hamachek                      54     Chairman of the Board and Chief Executive Officer       1997 - current

                                            President and Chief Executive Officer - Penford
                                            Corp.                                                   1985 - 1997

Anand R. Baichwal, Ph.D.             45     Senior Vice President, Research & Development           1997 - current

                                            Vice President, Technology                              1994 - 1997

Stephen J. Berte, Jr.                44     Vice President, Marketing & Sales                       1995 - current

                                            Sr. Director, New Product Development - Sanofi          1992 - 1995

Jennifer L. Good                     35     Vice President, Finance and Chief Financial
                                            Officer                                                 1997 - current

                                            Corporate Director of Finance & Secretary -
                                            Penford Corp.                                           1996 - 1997

                                            Corporate Controller - Penford Corp.                    1993 - 1996
</TABLE>


                                       24
<PAGE>   25

PART II

ITEM 5:  MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
         MATTERS

    Penwest's common stock, $.001 par value, is listed with and trades on the
Nasdaq National Market under the symbol "PPCO." On August 31, 1998, the
Company's former parent, Penford Corporation ("Penford"), distributed to the
shareholders of record of Penford common stock on August 10, 1998 all of the
shares of the Company's common stock (the "Distribution"). In connection with
the Distribution, the Company's common stock was listed and began trading on the
Nasdaq National Market on August 10, 1998. The high and low closing prices of
the Company's common stock during 1999 and the last two quarters of 1998 are set
forth below. The quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not necessarily represent actual transactions.

<TABLE>
<CAPTION>
PERIOD 1999                                                   HIGH           LOW
-----------                                                   ----           ---
<S>                                                           <C>            <C>
    Quarter Ended March 31                                    $11.75         $6.25
    Quarter Ended June 30                                     $10.38         $6.63
    Quarter Ended September 30                                $ 8.88         $5.13
    Quarter Ended December 31                                 $16.25         $5.56

PERIOD 1998                                                   HIGH           LOW
-----------                                                   ----           ---
    Quarter Ended September 30 (commencing August 10)         $7.50          $3.50
    Quarter Ended December 31                                 $9.44          $3.75
</TABLE>

    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 the Credit Facility as required by its terms. The Credit Facility is no
longer available to the Company.

On March 7, 2000 there were 1,017 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. The Company is prohibited from paying dividends on its
common stock under its credit facility.

ITEM 6:  SELECTED FINANCIAL DATA

The following selected financial data are derived from the consolidated
financial statements of Penwest Pharmaceuticals Co. The data set forth below
should be read in conjunction with the consolidated financial statements and
notes thereto and other financial information included elsewhere in this Form
10-K.

<TABLE>
<CAPTION>
                                                                 YEAR ENDED DECEMBER 31,
                                                                 -----------------------
                                                1999           1998           1997           1996           1995
                                                ----           ----           ----           ----           ----
STATEMENT OF OPERATIONS DATA:                           (IN THOUSANDS EXCEPT FOR PER SHARE DATA)
<S>                                        <C>            <C>            <C>            <C>            <C>
Revenues ............................       $ 37,207       $ 29,011       $ 26,941       $ 26,089       $ 25,089
Cost of product sales ...............         25,789         21,045         20,357         19,062         17,267
Gross profit ........................         11,418          7,966          6,584          7,027          7,822
Selling, general and administrative..         11,425         11,354          8,708          6,776          7,676
Research and product development ....          7,371          6,054          3,681          3,351          2,719
Asset write-off (a) .................           --            1,341           --             --             --
IPO transaction costs (b) ...........           --             --            1,367           --             --
Net loss ............................       $ (7,681)      $ (8,829)      $ (7,316)      $ (3,864)      $ (3,252)
                                            ========       ========       ========       ========       ========
Basic and diluted net
    loss per share ..................       $  (0.69)      $  (0.80)      $  (0.66)      $  (0.35)      $  (0.29)
                                            ========       ========       ========       ========       ========
Weighted average shares of
   common stock outstanding .........         11,103         11,037         11,037         11,037         11,037
                                            ========       ========       ========       ========       ========
</TABLE>


                                       25
<PAGE>   26

<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                      --------------------------------------------------------------------
                                          1999       1998 (C)           1997           1996           1995
                                          ----       --------           ----           ----           ----
BALANCE SHEET DATA:                                                    (IN THOUSANDS)
<S>                                   <C>            <C>            <C>            <C>            <C>
Cash and cash equivalents .......      $    739       $  1,476       $    938       $    695       $    290
Working capital .................         8,010          7,648        (33,049)       (23,362)       (19,461)
Total assets ....................        38,417         41,082         37,820         35,083         31,671
Long-term debt (d) ..............         6,700           --             --             --             --
Accumulated deficit .............       (36,159)       (28,478)       (19,649)       (12,333)        (8,469)
Shareholders' equity (deficit) ..        22,509         30,032        (12,297)        (4,412)          (477)
</TABLE>


(a) 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.

(b) Represents a write-off of transaction costs associated with an abandoned
    initial public offering.

(c) In conjunction with the August 31, 1998 Distribution, Penford contributed to
    the Company's capital, all existing intercompany indebtedness.

(d) In connection with the repayment of loans payable with proceeds from the
    Company's private placement of common stock in March 2000, loans payable
    have been classified as non-current at December 31, 1999.

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

    The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements which involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth below under "Risk Factors."

OVERVIEW

    Penwest Pharmaceuticals Co. ("Penwest" or the "Company"), is engaged in the
research, development and commercialization of novel drug delivery technologies.
The Company has extensive experience in developing and manufacturing tabletting
ingredients for the pharmaceutical industry. The Company's product portfolio
ranges from excipients that are sold in bulk, to more technically advanced and
patented excipients that are licensed to customers. On August 31, 1998 (the
"Distribution Date"), Penwest became an independent, publicly owned company when
Penford Corporation ("Penford"), the Company's former parent, distributed (the
"Distribution") to the shareholders of record of Penford common stock on August
10, 1998 all of the shares of the Company's common stock. Pursuant to the
Distribution, each Penford shareholder of record received three shares of the
Company's Common Stock for every two shares of Penford common stock held by
them.

    The Company has incurred net losses since 1994. As of December 31, 1999, the
Company's accumulated deficit was approximately $36.2 million. The Company
expects net losses to continue at least into mid 2000. A substantial portion of
the Company's revenues to date have been generated from the sales of the
Company's pharmaceutical excipients. The Company's future profitability will
depend on several factors, including the successful commercialization of TIMERx
controlled release products, and, to a lesser extent, an increase in sales of
its pharmaceutical excipients products. There can be no assurance that the
Company will achieve profitability or that it will be able to sustain
profitability on a quarterly basis, if at all.


                                       26
<PAGE>   27

    Under most of the Company's collaborative agreements, 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. Substantially all the TIMERx revenues generated to
date have been milestone fees received for products under development as well as
sales of formulated TIMERx. 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.

    The Company's results of operations may fluctuate from quarter to quarter
depending on the volume and timing of orders of the Company's pharmaceutical
excipients and on variations in payments under the Company's collaborative
agreements including payments upon the achievement of specified milestones. The
Company's quarterly operating results may also fluctuate depending on other
factors, including variations in gross margins of the Company's products, the
mix of products sold, competition, regulatory actions, litigation and currency
exchange rate fluctuations.

RESULTS OF OPERATIONS

    YEARS ENDED DECEMBER 31, 1999 AND 1998

Total revenues increased by 28.3% in 1999 to $37.2 million from $29.0 million in
1998. Product sales increased to $36.7 million in 1999 from $28.7 million in
1998 representing an increase of 27.7%. The increase in product sales was
primarily due to increased sales volumes of Emcocel, as well as increased sales
volumes of formulated bulk TIMERx in anticipation of Mylan's launch of
Nifedipine XL. As a result of the Company's new agreement with Mylan, Mylan has
agreed to purchase from the Company formulated bulk TimerX for manufactured
Nifedipine XL in 2000. Although Mylan has retained the marketing rights to the
30 mg strength of Nifedipine XL, the Company does not anticipate that Mylan will
be purchasing formulated bulk TIMERx from the Company prospectively as Mylan
will not be manufacturing the finished product. The Company added two new
Emcocel customers in December 1998, which contributed to most of the volume
increase in 1999. Royalties and licensing fees relating to the TIMERx drug
delivery system increased to $539,000 for the year ended December 31, 1999 from
$302,000 for the year ended December 31, 1998 due to the timing of when
development milestones were earned.

    Gross profit increased to $11.4 million or 30.7% of total revenues in 1999
from $8.0 million or 27.5% of total revenues in 1998. Gross profit percentage on
product sales increased to 29.7% in 1999 from 26.7% in 1998. The increase in
gross profit percentage was partly due to increasing margins on Emcocel products
due to volume-based manufacturing efficiencies, increased sales of ProSolv and
formulated TIMERx, which have higher margins, as well as increased development
revenues under collaborative agreements utilizing the TIMERx technology.

    Selling, general and administrative expenses were comparable from
year-to-year at $11.4 million. The 1998 expenses included a one-time charge of
$1.3 million relating to the write-off of costs associated with the decision to
outsource certain manufacturing as opposed to constructing a new manufacturing
facility.

    Research and development expenses increased by 21.8% in 1999 to $7.4 million
from $6.1 million in 1998. The increased spending in 1999 relates primarily to
increased funding of clinical development programs under the Company's
collaborative agreement with Endo.


                                       27
<PAGE>   28

    For 1999 the Company recorded an income tax benefit of 1% principally as a
result of valuation allowances recorded for deferred tax assets primarily
attributable to the net operating loss for the year. For 1998 the Company
recorded an income tax benefit of 19% principally as a result of operating
losses generated by the Company in the period prior to August 31, 1998 that were
utilized by Penford.

    YEARS ENDED DECEMBER 31, 1998 AND 1997

    Total revenues increased by 7.7% in 1998 to $29.0 million from $26.9 million
in 1997. Product sales increased to $28.7 million in 1998 from $26.0 million in
1997 representing an increase of 10.3%. The increase in product sales was
primarily due to increased sales volumes of Emcocel. The Company added one
significant Emcocel customer early in 1998 and two additional large
pharmaceutical companies in December 1998 which resulted in additional shipments
of Emcocel late in December 1998. Royalties and licensing fees relating to the
TIMERx drug delivery system decreased to $302,000 for the year ended December
31, 1998 from $911,000 for the year ended December 31, 1997 due to the timing of
when development milestones were earned.

    Gross profit increased to $8.0 million or 27.5% of total revenues in 1998
from $6.6 million or 24.4% of total revenues in 1997. The increase in gross
profit percentage was primarily due to improved product mix within product
sales. This increase, however, was partially offset by a decrease in royalties
and licensing fees for the year. Gross profit percentage on product sales
increased to 26.7% in 1998 from 21.8% in 1997. This improvement in gross profit
percentage on product sales was due to increasing sales of formulated TIMERx and
Prosolv, which have higher margins than traditional excipients, as well as
increasing margins on Emcocel products due to volume manufacturing efficiencies.

    Selling, general and administrative expenses increased by 30.4% in 1998 to
$11.4 million. The 1998 asset write-off expenses included a one-time charge of
$1.3 million relating to the write-off of costs associated with the decision to
outsource certain manufacturing as opposed to constructing a new manufacturing
facility.

    Research and development expenses increased by 64.5% in 1998 to $6.1 million
from $3.7 million in 1997. The increased spending in 1998 relates primarily to
additional biostudy activity related to the development of TIMERx controlled
release products as well as increased funding under the Company's collaborative
agreement with Endo.

    For 1998 the Company recorded an income tax benefit of 19% principally as a
result of operating losses generated by the Company in the period prior to the
August 31, 1998 that were utilized by Penford. For 1997 the Company recorded
income tax expense of 2% primarily because net operating losses for the year
were utilized by Penford and the Company was not compensated for these losses.

LIQUIDITY AND CAPITAL RESOURCES

    Prior to the Distribution, the Company received intercompany advances from
Penford to fund the Company's operations, capital expenditures and the original
acquisition of the Company's predecessor, which aggregated $50.9 million. Upon
the Distribution, Penford contributed the outstanding intercompany indebtedness
and certain other assets and liabilities to the capital of the Company. Since
the Distribution, the Company has funded its operations and capital expenditures
from cash from operations and advances under a Credit Facility. The Company had
an available


                                       28
<PAGE>   29

credit facility which was a revolving loan facility of $15.0 million of
unsecured financing (the "Credit Facility"). Penford guaranteed the Company's
indebtedness under the Credit Facility.

    On March 6, 2000, the Company completed a private placement of equity in
which it sold 1.4 million shares of newly issued common stock to selected
institutional and other accredited investors for $18.2 million. The Company
received approximately $17 million, after fees. Approximately $7.7 million was
used to repay the existing outstanding balance under the Credit Facility as
required by the terms of the Credit Facility and the Credit Facility is no
longer available to the Company.

    As of December 31, 1999, the Company had cash and cash equivalents of
$739,000 and $6.7 million of outstanding borrowings under the Credit Facility.
With the termination of the Credit facility, the Company has no committed
sources of capital and no indebtedness to any third or related parties. As of
December 31, 1999, the Company did not have any material commitments for capital
expenditures. The Company has entered into a strategic alliance agreement with
Endo and the Company expects to expend an additional $7 million, primarily in
2000 and 2001 on the development of a drug. The Company expects to rely on cash
generated from operations as well as proceeds from its equity financing to fund
expenditures. However, the Company may be required to raise additional funds to
continue its development activities under the Endo agreement. However, either
the Company or Endo may terminate the agreement upon 30 days' prior written
notice, at which time the Company's funding obligations would cease.

    The Company had negative cash flow from operations in each of the periods
presented primarily due to net losses for the periods as well as higher trade
receivables over December 31, 1998. Funds expended for the acquisition of fixed
assets were primarily related to efforts at the Company's manufacturing facility
in Iowa to increase capacity. Funds expended for intangible assets include costs
to secure and defend patents on technology developed by the Company and secure
trademarks.

    Following the March 2000 financing, the Company anticipates that its
existing capital resources, as well as cash generated from operations, will
enable it to maintain currently planned operations through at least mid 2001.
However, this expectation is based on the Company's current operating plan,
which could change as a result of many factors and the Company could require
additional funding sooner than anticipated. The Company's requirements for
additional capital could be substantial and will depend on many factors,
including (i) the timing and amount of payments received under existing and
possible future collaborative agreements; (ii) the structure of any future
collaborative or development agreements; (iii) the progress of the Company's
collaborative and independent development projects; (iv) revenues from the
Company's traditional excipients; (v) the costs to the Company of bioequivalence
studies for the Company's products; (vi) the prosecution, defense and
enforcement of patent claims and other intellectual property rights; and (vii)
the development of manufacturing, marketing and sales capabilities.

MARKET RISK AND RISK MANAGEMENT POLICIES

    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 consists of cash flow risk associated with
borrowing under its variable rate Credit Facility. The Company's international
subsidiaries transact 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 or interest rates. The Company does not believe that the potential


                                       29
<PAGE>   30

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 impact on the Company's future operating results or cash flows.

RECENT ACCOUNTING DEVELOPMENTS

     In December 1999, the staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in
Financial Statements. SAB 101 requires that license and other upfront fees
received from research collaborators be recognized over the term of the
agreement unless the fee is in exchange for products delivered or services
performed that represent the culmination of a separate earnings process. SAB 101
requires a company to follow its guidance no later than the first quarter of its
fiscal year beginning after December 15, 1999 through a cumulative effect of a
change in accounting principle. The Company has not yet determined the impact of
its implementation of SAB 101 on the Company's financial statements.

YEAR 2000

    Many computer programs and applications define the applicable year using two
digits rather than four in order to save memory and enhance the speed of
repeated data based calculations. The Year 2000 problem refers to the inability
of these computer programs on or after January 1, 2000 to recognize that "00"
refers to "2000" rather than "1900". The term "Year 2000-compliant" means a
computer or a computer system, which has been designed or modified to recognize
dates on or after January 1, 2000. The Company established programs to
coordinate its year 2000 ("Y2K") compliance efforts across all business
functions and geographic areas. The Company used the following four phases in
executing its Y2K compliance program: assessment, remediation, testing and
contingency planning. These phases were completed during 1999. The Company has
not experienced any material Y2K problems since the date change on January 1,
2000. However, there can be no assurance that problems will not arise for the
Company, its suppliers, its customers or others with whom the Company does
business later in 2000, with systems that have not yet been fully tested. The
Company intends to continue to monitor its compliance, as well as the compliance
of others whose operations are material to the Company's business.

EURO CONVERSION

    On January 1, 1999, certain member countries of the European Union adopted
the Euro as their common legal currency. Between January 1, 1999 and January 1,
2002, transactions may be conducted in either the Euro or the participating
countries national currency. However, by July 1, 2002, the participating
countries will withdraw their national currency as legal tender and complete the
conversion to the Euro.

    The Company conducts business in Europe and does not expect the conversion
to the Euro to have an adverse effect on its competitive position or
consolidated financial position. The Company's existing systems allow the
company to conduct business transactions in both the Euro as well as other
foreign currencies.


                                       30
<PAGE>   31

    This Annual Report on Form 10-K 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. For this purpose, any statements
contained herein that are not statements of historical fact may be deemed to be
forward-looking statements. Without limiting the foregoing, the words
"believes", "anticipates", "plans", "expects", "intends", "may", and other
similar expressions are intended to identify forward-looking statements. There
are a number of important factors that could cause the Company's actual results
to differ materially from those indicated by forward-looking statements
contained in this report and presented elsewhere by management from time to
time. These factors include the risk factors listed below.

RISK FACTORS

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 Nifedipine XL. 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.

WE ARE DEPENDENT ON MYLAN AND OTHER CORPORATE COLLABORATORS TO CONDUCT
FULL-SCALE BIOEQUIVALENCE STUDIES AND CLINICAL TRIALS, OBTAIN REGULATORY
APPROVALS FOR, AND MANUFACTURE, MARKET, AND SELL OUR TIMERx CONTROLLED RELEASE
PRODUCTS

    We develop and commercialize our TIMERx controlled release products in
collaboration with pharmaceutical companies. We are parties to collaborative
agreements with third parties relating to certain of our principal products. We
are relying on Mylan to conduct full-scale bioequivalence studies and clinical
trials, obtain regulatory approvals for, and manufacture, market and sell one of
our TIMERx controlled release products, and Endo to develop and commercialize a
controlled release version of Numorphan. We are also 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 without cause on short notice under certain
circumstances.

    If we cannot maintain our existing collaborations or establish new
collaborations, we would be required to terminate the development and
commercialization of our potential products or undertake product development and
commercialization activities at our own expense. Moreover, we have limited or no
experience in conducting full-scale bioequivalence studies and clinical trials,
preparing and submitting regulatory applications and manufacturing, marketing
and selling our TIMERx controlled release products. We may not be successful in
performing these activities.


                                       31
<PAGE>   32

    Our existing collaborations and any future collaborations with third parties
may not be scientifically or commercially successful. 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 will 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 HAVE NOT BEEN PROFITABLE

         We have incurred net losses since our inception, including net losses
of approximately $7.7 million, $8.8 million and $7.3 million during 1999, 1998
and 1997, respectively. As of December 31, 1999, our accumulated deficit was
approximately $36.2 million. A substantial portion of our revenues have been
generated from the sales of our pharmaceutical excipients. Our future
profitability will depend on several factors, including:

        -    the timing of the commercial launch by Mylan of Pfizer's generic
             version of the 30 mg strength of its Procardia XL in the
             United States;

        -    the successful commercialization of our controlled release products
             for which regulatory approval currently is pending;

        -    the completion of the development of other pharmaceuticals using
             our TIMERx controlled release technology;

        -    an increase in sales of our pharmaceutical excipient products; and

        -    our funding obligations under certain of our collaborations.

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.


                                       32
<PAGE>   33

    Our TIMERx business faces competition from numerous public and private
companies and their controlled release technologies, including ALZA's oral
osmotic pump (OROS(R)) 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.

    In addition to developing controlled release versions of immediate release
products, we have 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. Competition from other generic versions of branded controlled release
products will also reduce the royalty rate to be paid to us under several of our
collaborations.

    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.

    In our excipients business, we compete with a number of large manufacturers
and other distributors of excipient products, many of which have substantially
greater financial, marketing and other resources than the Company. Our principal
competitor in this market is FMC Corporation, which markets its own line of MCC
excipient products.

WE MAY REQUIRE ADDITIONAL FUNDING

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

    -   the timing and amount of payments received under existing and possible
        future collaborative agreements;

    -   the structure of any future collaborative or development agreements; o
        the progress of our collaborative and independent development projects;

    -   revenues from our excipients business;

    -   the costs to us of clinical studies for our products;

    -   the prosecution, defense and enforcement of patent claims and other
        intellectual property rights; and

    -   the development of manufacturing, marketing and sales capabilities.

    After the March 6, 2000 financing (see Part II, Item 5), we have no
committed sources of capital. We may seek additional funds through collaborative
arrangements and public or private financing. 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


                                       33
<PAGE>   34

stockholders. If we are unable to obtain funding on a timely basis, we may be
required to significantly curtail one or more of our research or development
programs. We also could be required to seek funds through arrangements with
collaborators or others that may require us to relinquish rights to certain of
our technologies, product candidates or products which we otherwise pursue on
our own.

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 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 ARE INVOLVED IN AND MAY BECOME INVOLVED IN ADDITIONAL 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. In addition to the recently dismissed
litigation involving Mylan, Pfizer and the still pending litigation involving
Mylan and Bayer, we may become parties to, or our products (or products based on
our TIMERx controlled release technology) may become the subject of, additional
patent litigation and other proceedings in the future. 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.


                                       34
<PAGE>   35

    -   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 (unless such claim relates to
TIMERx in which case such costs are our responsibility) are generally the
contractual responsibility of our collaborators, 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.

    In 1994, the Boots Company PLC filed in the European Patent Office, or the
EPO, an opposition to a patent granted by the EPO to us relating to our TIMERx
technology. In June 1996, the EPO dismissed Boots' opposition, leaving intact
all claims included in the patent. Boots has appealed this decision to the EPO
Board of Appeals, but no judgment has been rendered. We can provide no assurance
that we will prevail in this matter.

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 certain
of our potential products, including controlled release versions of immediate
release drugs and new chemical entities, our collaborators will be required to
complete clinical trials in humans to demonstrate the safety and efficacy of the
products. Our collaborators may not be able to obtain authority from the FDA or
other regulatory agencies to commence or complete these clinical trails.

    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, one of our collaborators, or the FDA may suspend clinical
trails at any time if the subjects or patients participating in such trails are
being exposed to unacceptable health risks, or for other reasons.


                                       35

<PAGE>   36
         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:

         -        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

         The development, clinical testing, manufacture, marketing and sale of
pharmaceutical products are subject to extensive federal, state and local
regulation in the United States and other countries. This regulatory approval
process can be time-consuming and expensive.

         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 ANDA, the FDA may deny the application, may require additional
testing or data and/or may require postmarketing 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 (NDA
or ANDA). 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.

         Many 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.


                                       36
<PAGE>   37
         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.

         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
violative products, to seize allegedly violative products, to obtain injunctions
to close manufacturing plants allegedly not operating in conformity with current
Good Manufacturing Practices (GMP) and to stop shipments of allegedly violative
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.

THE MARKET MAY NOT BE RECEPTIVE TO PRODUCTS INCORPORATING OUR TIMERx CONTROLLED
RELEASE TECHNOLOGY

         The commercial success of products incorporating our controlled 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.

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


                                       37
<PAGE>   38
         -        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.

WE HAVE ONLY LIMITED MANUFACTURING CAPABILITIES AND WILL BE DEPENDENT ON THIRD
PARTY MANUFACTURERS.

         We lack commercial scale facilities to manufacture our TIMERx material
in accordance with current GMP requirements prescribed by the FDA. We currently
rely on a third party pharmaceutical company for the bulk manufacture of our
TIMERx material for delivery to our collaborators.

         There are a limited number of manufacturers that operate under GMP
regulations capable of manufacturing our TIMERx material. We have not yet
qualified a second source of supply. In the event that our current manufacturer
is unable to manufacture the TIMERx material in the required quantities or at
all, we may be unable to obtain alternative contract manufacturing, or obtain
such manufacturing on commercially reasonable terms.

         If our third party manufacturer fails to perform its obligations, we
may be adversely affected in a number of ways, including:

         -        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 (both TIMERx material and
excipients) 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 SOLE SOURCE SUPPLIER FOR THE GUMS USED IN OUR TIMERx
MATERIAL AND UPON A LIMITED NUMBER OF SUPPLIERS FOR THE WOOD PULP USED IN THE
MANUFACTURE OF OUR EXCIPIENTS

         Our TIMERx drug delivery system is a hydrophilic matrix combining
primarily two polysaccharides, xanthan and locust bean gums, in the presence of
dextrose. We purchase these gums from a sole source supplier. Emcocel and
Prosolv, our two largest selling excipients, are manufactured from a specialty
grade of wood pulp. We have qualified alternate suppliers with


                                       38
<PAGE>   39
respect to these 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 or to manufacture these excipients.

IF 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 or 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 $1.0 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 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.


                                       39
<PAGE>   40
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 CERTIFICATE OF INCORPORATION AND BYLAWS AND OF
WASHINGTON LAW, AS WELL AS THE RIGHTS AGREEMENT TO WHICH WE ARE A PARTY, MAKE A
TAKEOVER OF PENWEST MORE DIFFICULT

         Provisions of our Certificate of Incorporation, our Bylaws and
Washington law, as well as the Rights Agreement to which we are a party, may
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.

RESIDUAL YEAR 2000 ISSUES MAY ADVERSELY AFFECT OUR BUSINESS, FINANCIAL POSITION,
RESULTS OF OPERATIONS AND RELATIONSHIPS WITH CUSTOMERS AND SUPPLIERS

         Prior to January 1, 2000, there was a great deal of concern regarding
the ability of computer programs and hardware and other equipment to adequately
recognize 21st century dates from 20th century dates due to the two-digit date
fields used by many systems. For example, computer programs that have
time-sensitive components may recognize a date represented as "00" as the year
1900 rather than the year 2000. In addition, programs may have failed to
recognize February 29, 2000 as a leap year date as a result of an exception to
the calculation of leap years that did occur in the year 2000 and otherwise
occurs only once every 400 years. As of March 7, 2000, our computer programs and
hardware and other equipment are functioning normally and the compliance and
remediation work performed by us appears to be effective to prevent any
problems. However, computer experts have warned that there may still be residual
consequences of the change in centuries. If residual Year 2000 issues cause the
failure of any of the computer programs and hardware and other equipment
necessary to operate our business, our business, financial position and results
of operations, as well as our relationships with customers and suppliers, may be
adversely affected. Furthermore, if third parties of business importance to us
do not successfully and timely anticipate and address their own residual Year
2000 issues, any residual Year 2000 issues that arise could have a material
adverse effect on our business, financial position and results of operations.


                                       40
<PAGE>   41
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 14 (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" in the Company's
definitive Proxy Statement for the 2000 Annual Meeting of Shareholders is
incorporated herein by reference.

Information regarding executive officers of the Company is set forth in Part I
above and incorporated herein by reference.

ITEM 11: EXECUTIVE COMPENSATION

The information set forth under "Executive Compensation" in the Company's
definitive Proxy Statement for the 2000 Annual Meeting of Shareholders is
incorporated herein by reference.

ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information set forth under "Security Ownership of Certain Beneficial Owners
and Management" in the Company's definitive Proxy Statement for the 2000 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 2000 Annual Meeting of
Shareholders is incorporated herein by reference.


                                       41
<PAGE>   42
PART IV

ITEM 14: 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, 1999 and
                  1998 and the related statements of operations, cash flows and
                  shareholders' equity for each of the three years in the period
                  ended December 31, 1999.

                  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.

(b)               Reports on Form 8-K.

                  The Company did not file any reports on Form 8-K during the
                  three months ended December 31, 1999.


                                       42
<PAGE>   43
                                   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 17, 2000              /s/ Tod R. Hamachek
                                  ----------------------------------------------
                                  Tod 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 17, 2000              /s/ Tod R. Hamachek
                                  ----------------------------------------------
                                  Tod R. Hamachek, Chairman of the Board
                                   and Chief Executive Officer
                                  (Principal Executive Officer)



Date: March 17, 2000              /s/ Jennifer L. Good
                                  ----------------------------------------------
                                  Jennifer L. Good, Vice President, Finance and
                                  Chief Financial Officer  (Principal Financial
                                  Officer)

Directors

Paul E. Freiman*
Jere E. Goyan, Ph.D.*
Tod R. Hamachek*                  By /s/ Jennifer L. Good
Rolf H. Henel*                    ----------------------------------------------
Robert J. Hennessey*
N. Stewart Rogers*                Attorney-in-Fact*
John N. Staniforth, Ph.D.*        Power of Attorney Dated
Anne M. VanLent*
                                  Date  March 17, 2000


                                       43
<PAGE>   44
                                   APPENDIX A


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


<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
<S>                                                                         <C>
Financial Statements
  Report of Independent Auditors                                            F-2
  Consolidated Balance Sheets                                               F-3
  Consolidated Statements of Operations                                     F-4
  Consolidated Statements of Shareholders' Equity (Deficit)                 F-5
  Consolidated Statements of Cash Flows                                     F-6
  Notes to Consolidated Financial Statements                                F-7
Schedule II - Valuation and Qualifying Accounts                             F-25
</TABLE>


                                      F-1
<PAGE>   45
                         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, 1999 and 1998, and the related
consolidated statements of operations, shareholders' equity (deficit) and cash
flows for each of the three years in the period ended December 31, 1999. Our
audits also included the financial statement schedule listed in the Index at
Item 14(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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Penwest
Pharmaceuticals Co. at December 31, 1999 and 1998, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1999, 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.

                                  /s/ ERNST & YOUNG LLP

Stamford, Connecticut
March 15, 2000


                                      F-2
<PAGE>   46
                           PENWEST PHARMACEUTICALS CO.

                           CONSOLIDATED BALANCE SHEETS
                      (in thousands, except share amounts)

<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                          ---------------------
                                                            1999         1998
                                                          --------     --------
<S>                                                       <C>          <C>
ASSETS
Current assets:
  Cash and cash equivalents ..........................    $    739     $  1,476
  Trade accounts receivable, net of allowance for
     doubtful accounts of  $245 and $227 .............       5,043        4,381
  Inventories ........................................       7,649        8,804
  Prepaid expenses and other current assets ..........         629          572
  Deferred income taxes ..............................         297          356
                                                          --------     --------
     Total current assets ............................      14,357       15,589
  Fixed assets, net ..................................      18,942       20,822
  Other assets .......................................       5,118        4,671
                                                          --------     --------
     Total assets ....................................    $ 38,417     $ 41,082
                                                          ========     ========

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable ...................................    $  3,296     $  2,757
  Accrued expenses ...................................       2,707        2,648
  Taxes payable ......................................         344          336
  Loans payable ......................................          --        2,200
                                                          --------     --------
       Total current liabilities .....................       6,347        7,941

  Loans payable refinanced in March 2000 .............       6,700           --
  Deferred income taxes ..............................         520          932
  Other long-term liabilities ........................       2,341        2,177
                                                          --------     --------
       Total liabilities .............................      15,908       11,050
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
     11,148,718 shares in 1999 and 11,043,331
      shares in 1998 .................................          11           11
  Additional paid in capital .........................      59,718       59,025
  Accumulated deficit ................................     (36,159)     (28,478)
  Accumulated other comprehensive loss ...............      (1,061)        (526)
                                                          --------     --------
       Total shareholders' equity ....................      22,509       30,032
                                                          --------     --------
       Total liabilities and shareholders' equity ....    $ 38,417     $ 41,082
                                                          ========     ========
</TABLE>


                             See accompanying notes.


                                      F-3
<PAGE>   47
                           PENWEST PHARMACEUTICALS CO.

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


<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31,
                                               --------------------------------
                                                 1999        1998        1997
                                               --------    --------    --------
<S>                                            <C>         <C>         <C>
Revenues
  Product sales ............................   $ 36,668    $ 28,709    $ 26,030
  Royalties and licensing fees .............        539         302         911
                                               --------    --------    --------
     Total revenues ........................     37,207      29,011      26,941
Cost of product sales ......................     25,789      21,045      20,357
                                               --------    --------    --------
       Gross profit ........................     11,418       7,966       6,584
Operating expenses
  Selling, general and administrative ......     11,425      11,354       8,708
  Research and product development .........      7,371       6,054       3,681
  IPO transaction costs ....................         --          --       1,367
  Asset write-off ..........................         --       1,341          --
                                               --------    --------    --------
     Total operating expenses ..............     18,796      18,749      13,756
                                               --------    --------    --------
Loss from operations .......................     (7,378)    (10,783)     (7,172)
Interest expense ...........................        371          72          --
                                               --------    --------    --------
Loss before income taxes ...................     (7,749)    (10,855)     (7,172)
Income tax (benefit) expense ...............        (68)     (2,026)        144
                                               --------    --------    --------
Net loss ...................................   $ (7,681)   $ (8,829)   $ (7,316)
                                               ========    ========    ========

Basic and diluted net loss per share .......   $  (0.69)   $  (0.80)   $  (0.66)
                                               ========    ========    ========
Weighted average shares of common
   stock outstanding .......................     11,103      11,037      11,037
                                               ========    ========    ========
</TABLE>


                             See accompanying notes.


                                      F-4
<PAGE>   48
                           PENWEST PHARMACEUTICALS CO.

            CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                                               ACCUMULATED
                                                                                                  OTHER
                                                 COMMON STOCK      ADDITIONAL                 COMPREHENSIVE
                                                                     PAID-IN    ACCUMULATED       INCOME
                                              SHARES     AMOUNT      CAPITAL      DEFICIT         (LOSS)        TOTAL
                                             -------    --------   ----------   -----------   -------------   --------
<S>                                           <C>       <C>        <C>           <C>          <C>             <C>
Balances, January 1, 1997 ................    11,037    $     11     $ 8,079     $(12,333)      $  (169)      $ (4,412)

  Net loss ...............................                                         (7,316)                      (7,316)
  Other comprehensive loss - translation
     adjustment ..........................                                                         (569)          (569)
                                                                                                              --------
        Comprehensive loss ...............                                                                      (7,885)
                                             -------    --------     -------     --------       -------       --------
Balances, December 31, 1997 ..............    11,037          11       8,079      (19,649)         (738)       (12,297)

  Net loss ...............................                                         (8,829)                      (8,829)
  Other comprehensive income --
        translation adjustment ...........                                                          212            212
                                                                                                              --------
           Comprehensive loss ............                                                                      (8,617)
Capital contribution from Penford ........                            50,914                                    50,914
Issuance of common stock pursuant to Stock
   Purchase Plan .........................         6          --          32                                        32
                                             -------    --------     -------     --------       -------       --------
Balances, December 31, 1998 ..............    11,043          11      59,025      (28,478)         (526)        30,032

  Net loss ...............................                                         (7,681)                      (7,681)
  Other comprehensive loss - translation
      adjustment .........................                                                         (535)          (535)
                                                                                                              --------
           Comprehensive loss ............                                                                      (8,216)
Issuance of common stock pursuant to stock
    compensation plans ...................        80          --         539                                       539
Issuance of common stock pursuant to Stock
   Purchase Plan .........................        26          --         154                                       154
                                             -------    --------     -------     --------       -------       --------
Balances, December 31, 1999 ..............    11,149    $     11     $59,718     $(36,159)      $(1,061)      $ 22,509
                                             =======    ========     =======     ========       =======       ========
</TABLE>


                             See accompanying notes.


                                      F-5
<PAGE>   49
                           PENWEST PHARMACEUTICALS CO.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (in thousands)

<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31,
                                                -------------------------------
                                                  1999        1998       1997
                                                --------    -------    --------
<S>                                             <C>         <C>        <C>
Operating activities:
Net loss ....................................   $ (7,681)   $(8,829)   $ (7,316)
Adjustments to reconcile net loss to
  net cash used in operating activities:
    Depreciation ............................      2,881      2,611       2,047
    Amortization ............................        189        162         157
    Asset write-off .........................         --      1,341          --
    Deferred income taxes ...................       (353)    (2,126)       (104)
    Stock compensation ......................        142         --          --
Changes in operating assets and liabilities:
    Trade accounts receivable ...............       (662)    (1,376)      1,805
    Inventories .............................      1,155       (113)     (1,135)
    Accounts payable, accrued expenses and
      other .................................        260      1,733        (345)
                                                --------    -------    --------
Net cash used in operating activities .......     (4,069)    (6,597)     (4,891)

Investing activities:
    Acquisitions of fixed assets, net .......     (1,116)    (2,003)     (4,023)
    Other ...................................       (490)      (181)       (833)
                                                --------    -------    --------
Net cash used in investing activities .......     (1,606)    (2,184)     (4,856)

Financing activities:
    Borrowings from Credit Facility .........     11,600      3,300          --
    Repayments of Credit Facility ...........     (7,100)    (1,100)         --
    Issuance of common stock ................        551         32          --
    Proceeds from Penford ...................         --      7,030      10,120
                                                --------    -------    --------
Net cash provided by financing activities ...      5,051      9,262      10,120

Effect of exchange rate changes on
  cash and cash equivalents .................       (113)        57        (130)
                                                --------    -------    --------
Net (decrease) increase in cash and
  cash equivalents ..........................       (737)       538         243
Cash and cash equivalents at beginning
  of year ...................................      1,476        938         695
                                                --------    -------    --------
Cash and cash equivalents at end of
  year ......................................   $    739    $ 1,476    $    938
                                                ========    =======    ========
</TABLE>


                             See accompanying notes.


                                      F-6
<PAGE>   50
                           PENWEST PHARMACEUTICALS CO.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. BUSINESS

    Penwest Pharmaceuticals Co. ("Penwest" or the "Company"), is engaged in the
research, development and commercialization of novel drug delivery technologies.
Based on its extensive expertise in developing and manufacturing tabletting
ingredients for the pharmaceutical industry, the Company has developed TIMERx, a
proprietary controlled release drug delivery technology and ProSolv SMCC(R)
("ProSolv"), another drug delivery technology which improves the performance
characteristics of tablets. The Company's product portfolio ranges from
excipients that are sold in bulk, to more technically advanced and patented
excipients that are licensed to customers. The Company has manufacturing
facilities in Iowa and Finland and has customers primarily throughout North
America and Europe. The Company was a wholly-owned subsidiary of Penford
Corporation ("Penford") prior to August 31, 1998 ("Distribution Date"). On
August 31, 1998, Penford distributed to the stockholders of record of Penford's
common stock on August 10, 1998, all of the shares of the Company's common stock
(see Note 7).

      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,
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 generally accepted accounting principles 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. In addition, the consolidated financial statements include various
costs allocated by Penford prior to the Distribution Date. Management believes
the amounts allocated are reasonable and approximate the cost of obtaining the
service from an unrelated third party.

    Certain amounts in the financial statements for prior years have been
reclassified to conform with the current year presentation. These
reclassifications had no effect on previously reported results of operations or
financial position.

   Cash and Cash Equivalents

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


                                      F-7
<PAGE>   51
   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. No customers of the Company accounted for 10% or more of total revenues
in 1999 or 1997. One customer accounted for approximately 11% of total revenues
in 1998.

    The carrying value of financial instruments, which includes cash,
receivables, obligations under the Company's credit facility (see Note 6) and
payables, approximates market value due to their short term nature and the fact
that all borrowings are at floating interest rates.

   Long Lived Assets

    Property and equipment 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:

<TABLE>
<S>                                                     <C>
             Buildings ..............................   20-25 years
             Machinery and equipment ................   10-12 years
             Office furniture, equipment and software    5-10 years
</TABLE>

    In accordance with Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of," the Company recognizes impairment losses on
long-lived assets used in operations when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the assets' carrying amounts.

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
equals the cumulative translation adjustment, which is the only component of
other comprehensive 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, 1999.

Income Taxes

    The Company's results of operations were included in the tax returns of
Penford through the Distribution Date. Effective September 1, 1998, the Company
files its income taxes on a stand-alone basis. Deferred income tax benefits and
related income tax assets and liabilities are reflected as if the Company were
an independent entity for all periods presented, in accordance with SFAS No.
109, "Accounting for Income Taxes", except that the Company was not compensated
for tax losses utilized by Penford (see Note 11).


                                      F-8
<PAGE>   52
Revenue Recognition

     Revenues from product sales are recognized when title transfers. Royalties
and licensing fees include milestone fees related to licensing agreements for
TIMERx with various collaborators and royalties when earned. To date there have
been minimal royalties recognized from the TIMERx technology. Milestone payments
are derived from reaching development milestones with collaborators and are
recognized as achieved in accordance with the contract terms. These milestone
payments are not subject to forfeiture. The Company receives certain
nonrefundable payments upon the signing of collaborative agreements. Up-front
payments that obligate the Company to perform specific functions or services
over the licensing term are recognized over the term of the agreement. Up-front
payments related solely to the signing of agreements where additional services
are not required are recognized upon signing.

Recently Issued Accounting Pronouncements

     In December 1999, the staff of the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in
Financial Statements. SAB 101 requires that license and other upfront fees
received from research collaborators be recognized over the term of the
agreement unless the fee is in exchange for products delivered or services
performed that represent the culmination of a separate earnings process. SAB 101
requires a company to follow its guidance no later than the first quarter of its
fiscal year beginning after December 15, 1999 through a cumulative effect of a
change in accounting principle. The Company has not yet determined the impact of
its implementation of SAB 101 on the Company's financial statements.

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.

Per Share Data

    Loss per common share is computed based on the weighted average number of
common shares outstanding during the period after giving effect to the
0.76-for-1 reverse stock split and the 2,907.66-for-1 stock split of the common
stock of the Company (see Note 9).


                                      F-9
<PAGE>   53
Stock Based Compensation

     The Company accounts for stock option grants in accordance with Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees," and, accordingly, recognizes no compensation expense for stock
options granted for which the exercise price of the options was the same as the
market price of the Company's common stock on the date of grant. The Company has
elected to continue to account for its employee stock compensation plans under
APB No. 25. As prescribed under SFAS No. 123, "Accounting for Stock Based
Compensation," the Company has disclosed in Note 9, the pro forma effects on net
loss and loss per share of recording compensation expense for the fair value of
the options granted.

3. INVENTORIES

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

    Inventories are summarized as follows:

<TABLE>
<CAPTION>
                                               DECEMBER 31,
                                             ---------------
                                              1999     1998
                                             ------   ------
                                              (IN THOUSANDS)
<S>                                          <C>      <C>
                    Raw materials ........   $1,513   $1,365
                    Finished products ....    6,136    7,439
                                             ------   ------
                         Total inventories   $7,649   $8,804
                                             ======   ======
</TABLE>

    Included in inventories are approximately $2,882,000 and $3,262,000 of
TIMERx raw materials and bulk TIMERx as of December 31, 1999 and 1998,
respectively. The ability to continue to sell TIMERx related inventory is
dependent, in part, upon the commercialization of products by third parties
utilizing bulk TIMERx and the continued use by the Company and third parties of
the TIMERx related inventory in existing and new research efforts. Although
third parties have products in various stages of development and the first
commercial product was launched for sale in Finland in January 1998, marketing
approval for a second product was received in the United Kingdom and launched in
November 1998, and final approval for a product was received in the United
States in December 1999, the period required to achieve the successful
commercialization of these and other products is uncertain if achieved at all.
On March 2, 2000, Mylan Pharmaceuticals ("Mylan") announced that it had signed a
supply and distribution agreement with Pfizer, Inc. ("Pfizer") to market a
generic version of Pfizer's Procardia XL. As a result of this agreement, Penwest
will be paid a royalty on Mylan's net sales of Pfizer's 30 mg generic version of
Procardia XL. Mylan has also agreed to purchase from the Company formulated bulk
TIMERx manufactured for Nifedipine XL.

    The Company periodically reviews and quality tests its inventory to identify
obsolete, slow moving or otherwise unsaleable inventories. Inventories at
December 31, 1999 and 1998, are net of reserves of $277,000 and $132,000,
respectively.


                                      F-10
<PAGE>   54
    To date, the Company has primarily relied on a large third-party
pharmaceutical company for the manufacture of its TIMERx products under an
agreement that expired in June 1998. In September 1999, the Company entered into
a five year contract (plus automatic renewals of one year each) and is in the
final stages of qualifying, another third-party manufacturer to manufacture
TIMERx material. 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.

4. FIXED ASSETS

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

<TABLE>
<CAPTION>
                                                    DECEMBER 31,
                                                 -----------------
                                                   1999      1998
                                                 -------   -------
                                                   (IN THOUSANDS)
<S>                                              <C>       <C>
             Buildings, equipment and software   $32,865   $32,740
             Land ............................       696       696
             Construction in progress ........       616        34
                                                 -------   -------
                                                  34,177    33,470
             Less: accumulated depreciation ..    15,235    12,648
                                                 -------   -------
                                                 $18,942   $20,822
                                                 =======   =======
</TABLE>

    During the fourth quarter of 1998, the Company decided to outsource the
manufacturing of TIMERx as opposed to constructing a new manufacturing facility.
As a result of this decision, $1,341,000 of construction in progress related to
the new manufacturing facility was written off in 1998.


                                      F-11
<PAGE>   55
5. OTHER ASSETS

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

<TABLE>
<CAPTION>
                                                          DECEMBER 31,
                                                        ---------------
                                                         1999     1998
                                                        ------   ------
                                                         (IN THOUSANDS)
<S>                                                     <C>      <C>
         Patents, net of accumulated amortization of
           $485 and $354 ............................   $2,478   $2,120
         Goodwill, net of accumulated amortization of
           $410 and $352 ............................      130      187
         Cash surrender value of officer's life
           insurance policies .......................    2,510    2,364
                                                        ------   ------
                                                        $5,118   $4,671
                                                        ======   ======
</TABLE>

    Patents include costs to secure and defend patents on technology developed
by the Company and secure trademarks. Patents are amortized over their useful
lives of 17 to 20 years. Amortization expense of $131,000, $105,000 and $87,000
was recorded in the years ended December 31, 1999, 1998 and 1997, respectively.

    Goodwill is being amortized over ten years and was recorded upon the
acquisition of the Company by Penford. Amortization expense approximated $58,000
for each of the years ended December 31, 1999, 1998 and 1997.

    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.

    Cash surrender value of officer's life insurance policies approximating
$2,364,000 was contributed to the Company by Penford on the Distribution Date.
(See Note 7).

6. CREDIT FACILITY

  On July 2, 1998 the Company obtained a $15 million unsecured revolving credit
  facility (the "Credit Facility") which was guaranteed by Penford. Proceeds
  from the Credit Facility were used to fund working capital and for general
  corporate purposes, including capital expenditures. On August 31, 2000, all
  outstanding amounts under the Credit Facility were to become automatically due
  and payable. Penford agreed that, for a period ending August 31, 2000, it
  would guarantee the Company's indebtedness under the Credit Facility. LIBOR
  Advances (available in multiples of $1,000,000 for 1, 2 or 3 month LIBOR
  periods) under the Credit Facility bore interest at a rate equal to LIBOR,
  plus 1.25%. Base Rate Advances (available in minimum amounts of $100,000) bore
  interest at the Bank's Alternate Base Rate. The Credit Facility also required
  commitment fees to be paid of .325% on unused portions of the commitment
  amount. The Credit Facility contained a number of financial covenants that
  related to Penford (and not Penwest), including requirements that Penford
  maintain certain levels of financial performance and capital structure. The
  Credit Facility also contained certain covenants applicable to both Penford
  and Penwest including restrictions on the incurrence of additional debt and
  the payment of dividends. Based upon the terms of the Credit Facility, Penwest
  could not make dividend payments. Accordingly, the Company was substantially
  dependent on Penford's compliance with such covenants in order to access and
  maintain the Credit Facility.


                                      F-12
<PAGE>   56
     In March 2000, in connection with its private placement of common stock
  (see Note 16), the Company repaid its outstanding obligations under the Credit
  Facility and, accordingly, the amount outstanding at December 31, 1999 of $6.7
  million, was excluded from current liabilities. Pursuant to the terms of the
  Credit Facility, amounts available to the Company are reduced by any net
  proceeds from financings conducted by the Company, thereby terminating the
  Credit Facility.

  Amounts outstanding under the Credit Facility are as follows:

<TABLE>
<CAPTION>
                                                          DECEMBER 31,
                                                         1999     1998
                                                        ------   ------
                                                         (IN THOUSANDS)
<S>                                                     <C>      <C>
         LIBOR Advances - 7.4% and 6.5% at
            December 31, 1999 and 1998, respectively,
            Maturities from January 24, 2000 through
            February 22, 2000 .......................   $6,000   $2,000
         Base Rate Advances, 8.5% and 7.8% at
            December 31, 1999 and 1998,
            respectively ............................      700      200
                                                        ------   ------
                                                        $6,700   $2,200
                                                        ======   ======
</TABLE>

Approximately $303,000 and $52,000 of interest was paid in 1999 and 1998,
respectively.

7. DISTRIBUTION AND CAPITAL CONTRIBUTION

     On August 31, 1998, Penford distributed to the shareholders of record of
Penford common stock on August 10, 1998, all of the shares of the Company's
Common Stock (the "Distribution"). Pursuant to the Distribution, each Penford
shareholder of record received three shares of the Company's Common Stock for
every two shares of Penford common stock held by them. In connection with the
Distribution (i) the Company's Common Stock was registered under the Securities
Exchange Act of 1934, as amended, pursuant to the registration statement on Form
10 which was declared effective on July 31, 1998, (ii) the Company's Common
Stock was listed with and began trading on the National Market on August 10,
1998 and (iii) Penford obtained a private letter ruling from the Internal
Revenue Service to the effect that, among other things, the Distribution
qualified as tax-free under Sections 355 and 368 of the Internal Revenue Code of
1986, as amended, and that the receipt of shares of the Company's Common Stock
in the Distribution would not result in the recognition of income, gain or loss
to Penford's shareholders for federal income tax purposes.

     In connection with the Distribution, the Company and Penford have entered
into agreements that govern various interim and ongoing relationships. These
agreements include (i) a Separation and Distribution Agreement setting forth the
agreement of the parties with respect to the principal corporate transactions
which were required to effect the separation of Penford's pharmaceutical
business from its specialty carbohydrate-based chemical business and the
Distribution, including without limitation Penford's agreement to guarantee the
Company's indebtedness under its credit facility (see Note 6); (ii) a Services
Agreement pursuant to which Penford continued on an interim basis to provide
specified services to the Company until June 30, 1999 or until Penwest no longer
needed the services, of which costs were charged to the Company on an actual or
allocated basis, plus a specified profit percentage (as of August 31, 1998,
significant services were no longer provided to the Company by Penford).; (iii)
a Tax Allocation Agreement relating to, among other things, the allocation of
tax liability between the Company and Penford in connection with the
Distribution, all pre-distribution liabilities are the responsibility of Penford
and all post distribution liabilities are those


                                      F-13
<PAGE>   57
of the respective entities; (iv) an Excipient Supply Agreement pursuant to which
Penford will manufacture and supply exclusively to the Company, and the Company
will purchase exclusively from Penford, subject to certain exceptions, all the
Company's requirements for two excipients marketed by the Company under quantity
and pricing terms that the Company believes approximate fair market value; and
(v) an Employee Benefits Agreement setting forth the parties' agreements as to
the continuation of certain Penford benefit arrangements for the employees of
the Company. Subsequent to the Distribution, no terminating liabilities were
incurred by Penwest related to the Penford defined benefit plan.

    On August 31, 1998, in connection with the separation of its pharmaceutical
business, Penford contributed to the capital of the Company all existing
intercompany indebtedness of the Company (the "Contribution") which approximated
$50.9 million.

    Prior to deciding to distribute 100% of the Company's common stock to
Penford's shareholders, in October 1997, Penford's Board of Directors approved
the sale of approximately 20% of the Company's common stock in an initial public
offering ("IPO"). The IPO was initially intended to be completed during December
1997. Due to market conditions, the IPO was initially postponed and during May
1998, after further evaluation of the market opportunities, Penford's Board of
Directors decided to distribute 100% of the Company's common stock to Penford's
shareholders and forego the IPO at such time. Based on this decision, the
Company wrote-off approximately $1.4 million of transaction costs, principally
legal, accounting and printing associated with the IPO, during the year ended
December 31, 1997.

8. TRANSACTIONS WITH PENFORD

    The intercompany indebtedness to Penford that was contributed upon the
Distribution consisted solely of advances. These advances were generated
primarily from the initial acquisition of the Company, the addition of a
microcrystalline cellulose plant and the funding of operations. The intercompany
indebtedness to Penford was a non-interest-bearing obligation. Average balances
for the 1998 period prior to the Distribution were $46,784,000. The Company also
participated in pension and other employee benefit plans sponsored by Penford
and purchases inventory from a wholly-owned subsidiary of Penford. The inventory
purchases amounted to approximately $469,000, $438,000 and $367,000 for the
years ended December 31, 1999, 1998 and 1997, respectively. The Company believes
the terms of its employee benefit and inventory purchase transactions
approximate those that would have been reached with a third party in an arms
length transaction and represent the approximate costs the Company would have
incurred on a stand-alone basis. Penford allocated executive office salaries,
bonuses and legal fees to the Company in the form of a management fee prior to
the Distribution Date. The costs making up the management fee were allocated to
the Company based upon its pro rata portion of Penford's consolidated revenue.
The Company believes the management fees approximate the actual costs of
services provided and represent the approximate costs the Company would have
incurred on a stand-alone-basis. Included in selling, general and administrative
expenses is a management fee of $219,000 and $601,000 for the years ended
December 31, 1998 and 1997 respectively.

9. EQUITY

Penford Stock Option Plan

    Certain of the Company's employees participated in Penford's 1994 Stock
Option Plan (the "1994 Plan") for which 1,000,000 shares of common stock had
been authorized for grants of options by


                                      F-14
<PAGE>   58
Penford. The 1994 Plan provided for the granting of stock options at the fair
market value of the common stock on the date of grant. Either incentive stock
options or non-qualified stock options were granted under the 1994 Plan. The
incentive stock options generally vest over five years at the rate of 20% each
year and expire 10 years from the date of grant. The non-qualified stock options
generally vest over four years at the rate of 25% each year and expire 10 years
and 10 days from the date of grant. Changes in Penford stock options granted to
employees of Penwest for the years ended December 31, 1997 and 1998 (through the
Distribution) are as follows:

<TABLE>
<CAPTION>
                                                   OPTION PRICE     WTD. AVERAGE
                                       SHARES         RANGE        EXERCISE PRICE
                                     ---------    --------------   --------------
<S>                                  <C>          <C>              <C>
1997
Balance December 31, 1996 .........    165,500    $17.00 - 24.50       $19.61
Granted ...........................      1,000        $18.25           $18.25
Exercised .........................       (600)       $18.25           $18.25
Cancelled .........................     (1,800)       $18.25           $18.25
                                      --------
Balance, December 31, 1997 ........    164,100    $17.00 - 24.50       $19.62
                                      ========

1998
Granted ...........................         --                --           --
Exercised .........................     (4,800)   $17.00 - 18.25       $17.83
Transferred to Spin-Off Option Plan   (159,300)   $17.00 - 24.50       $20.15
                                      --------
Balance, December 31, 1998 ........         --
                                      ========
</TABLE>

   Penwest Stock Option Plans

    As of December 31, 1999 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. During 1998, 52,500 restricted shares were granted. There were no
such shares granted in either 1999 or 1997.

    The Company's 1998 Spin-off Option Plan was adopted by the Company 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 cease 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


                                      F-15
<PAGE>   59
option will cease to be available for grant under the Spin-off Plan.

<TABLE>
<CAPTION>
                                                   OPTION PRICE    WTD. AVERAGE
                                         SHARES       RANGE       EXERCISE PRICE
                                       ---------   ------------   --------------
<S>                                    <C>         <C>            <C>
1998
Balance, December 31, 1997 .......            --             --           --
Spin-off Option Plan .............     1,000,722   $4.06 - 8.67        $5.78
Granted ..........................     1,032,455   $3.70 - 8.06        $6.74
Exercised ........................            --             --           --
Cancelled ........................      (319,739)  $5.72 - 6.75        $6.59
                                       ---------
Balance, December 31, 1998 .......     1,713,438   $3.70 - 8.67        $6.21
                                       =========

1999
Granted ..........................       332,307   $4.78 - 9.21        $7.33
Exercised ........................       (85,160)  $5.26 - 7.03        $6.19
Cancelled ........................       (35,092)  $5.26 - 6.75        $6.35
                                       ---------
Balance, December 31, 1999 .......     1,925,493   $3.70 - 9.21        $6.41
                                       =========

Options Exercisable ..............       722,818   $3.70 - 9.21        $6.00
                                       =========
</TABLE>

Stock Compensation

    Statement of Financial Accounting Standard No. 123 "Accounting for Stock
Based Compensation" requires the Company to disclose the pro forma impact on net
loss and loss per basic and diluted share as if compensation expense associated
with employee stock options granted to employees of Penwest had been calculated
under the fair value method of Statement No.
123 as follows:

<TABLE>
<CAPTION>
                                                         YEARS ENDED DECEMBER 31,
                                                        1999       1998       1997
                                                        ----       ----       ----
                                                           (IN THOUSANDS, EXCEPT
                                                               PER SHARE DATA)
<S>                                                   <C>        <C>        <C>
Net loss - as reported                                $(7,681)   $(8,829)   $(7,316)
Net loss - pro forma                                  $(9,286)   $(9,712)   $(7,766)
Net loss per share, basic and diluted - as reported   $ (0.69)   $ (0.80)   $ (0.66)
Net loss per share, basic and diluted - pro forma     $ (0.84)   $ (0.88)   $ (0.70)
</TABLE>

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

<TABLE>
<CAPTION>
                                           1999           1998           1997
                                           ----           ----           ----
<S>                                     <C>            <C>            <C>
Expected dividend yield                      None           None           None
Risk free interest rate                     5.80%          5.50%          5.90%
Expected volatility                           75%           119%            49%
Expected life of options                7.5 years      7.5 years      4.8 years
</TABLE>



                                      F-16
<PAGE>   60
    The weighted average fair value of options granted during the years ended
December 31, 1999, 1998 and 1997 was $5.73, $6.17, and $2.99, respectively. The
weighted average remaining contractual life of options outstanding at December
31, 1999 is 8.0 years. The weighted effect of applying Statement No. 123 for
providing pro forma disclosures for the years ended December 31, 1999, 1998 and
1997 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.

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 25,930 shares and
6,509 shares issued under the Plan during 1999 and 1998, respectively. There
were no shares issued prior to 1998.

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.

Stock Splits

    On October 20, 1997, the Company effected a 2,907.66-for-1 stock split
transforming the Company's capital structure from 50,000 shares, $1.00 par value
per share, of common stock authorized and 5,000 shares of common stock
outstanding to 39,000,000 shares, $.001 par value per share, of common stock
authorized and 14,538,282 shares of Common Stock outstanding and 1,000,000
shares of preferred stock, $.001 par value per share, authorized, that may be
issued by the Board in one or more series. On June 19, 1998, the Company
effected a 0.76-for-1 reverse stock split, reducing the outstanding shares to
11,036,822 shares of common stock. Accordingly, all share and per share data
have been retroactively adjusted to give effect to the stock split and reverse
stock split.


                                      F-17
<PAGE>   61
10. COMMITMENTS

   Leases

    The Company's manufacturing facility in Finland is leased under a two-year
operating lease which includes renewal options with annual rental expense of
$182,000 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
$343,000, $316,000 and $283,000 for the years ended December 31, 1999, 1998, and
1997, respectively. Future minimum lease payments as of December 31, 1999 for
noncancellable operating leases having initial lease terms of more than one year
are as follows:

<TABLE>
<CAPTION>
                                                   OPERATING
                                                     LEASES
                                                     ------
                                                 (IN THOUSANDS)
<S>                                              <C>
                          2000                       $509
                          2001                        475
                          2002                         75
                          2003                         60
                          2004                         57
                       Thereafter                     122
                                                   ------
              Total minimum lease payments         $1,298
                                                   ======
</TABLE>

11. INCOME TAXES

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

<TABLE>
<CAPTION>
                                    YEARS ENDED DECEMBER 31,
                                    ------------------------
                                     1999      1998     1997
                                    -----    -------    ----
                                         (IN THOUSANDS)
<S>                                 <C>      <C>        <C>
                   Federal:
                     Deferred ...   $(218)   $(1,585)   $(81)
                   Foreign:
                     Current ....     283         88     247
                     Deferred ...     (87)      (100)     --
                   State:
                     Current ....       2         12       1
                     Deferred ...     (48)      (441)    (23)
                                    -----    -------    ----
                                    $ (68)   $(2,026)   $144
                                    =====    =======    ====
</TABLE>

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

<TABLE>
<CAPTION>
                                               YEARS ENDED DECEMBER 31,
                                               ------------------------
                                                 1999    1998    1997
                                                 ----    ----    ----
                                                    (IN THOUSANDS)
<S>                                              <C>     <C>     <C>
          Statutory tax rate ................    (34)%   (34)%   (34)%
          Valuation allowance ...............     35      --      --
          Tax benefit utilized by Penford ...     --      19      36
          Foreign taxes .....................     (1)     (1)     --
          State taxes, net of federal benefit     --      (3)     --
          Other .............................     (1)     --      --
                                                 ---     ---     ---
                                                 (1)%   (19)%     2 %
                                                 ===     ===     ===
</TABLE>


                                      F-18
<PAGE>   62
    The components of deferred income tax (assets) and liabilities at December
31 are as follows:

<TABLE>
<CAPTION>
                                                      1999       1998
                                                      ----       ----
                                                       (IN THOUSANDS)
<S>                                                 <C>        <C>
         Receivable allowance ...................   $   (95)   $   (91)
         Inventory reserves and basis differences      (282)      (265)
         Other ..................................        80         --
                                                    -------    -------
         Current deferred tax asset .............   $  (297)   $  (356)
                                                    =======    =======

         Depreciation and amortization ..........   $ 3,631    $ 3,743
         Deferred compensation and SERP liability      (904)      (872)
         Net operating loss carryforwards .......    (5,836)    (2,282)
         Valuation allowance ....................     3,629        343
                                                    -------    -------
         Non-current net deferred tax liability .   $   520    $   932
                                                    =======    =======
</TABLE>

    The Company's income tax payments, primarily comprised of foreign income
taxes, approximated $243,000, $151,000 and $181,000 for the years ended December
31, 1999, 1998 and 1997, respectively.

    Through August 31, 1998 the Company was included in the consolidated federal
and state tax returns of Penford. In accordance with the Company's tax sharing
agreement, the Company was not compensated for tax losses that were utilized by
Penford. As a result of Penford fully utilizing all of the Company's tax losses
through the Distribution Date, the Company does not possess net operating loss
carryforwards attributable to such periods. Through August 31, 1998, Penford has
utilized approximately $26,693,000 of federal net operating loss carryforwards
that the Company would have had outstanding were it a stand-alone entity through
such date, of which approximately $3,393,000, $4,503,000, $5,084,000, $7,643,000
and $6,070,000 would have expired in 2009, 2010, 2011, 2012 and 2013,
respectively. In addition, Penford is liable for any federal, state or foreign
tax adjustments assessed against the Company for periods through the
Distribution Date. The valuation allowance and the deferred tax assets at
December 31, 1998 related to deferred compensation and the SERP liability, were
recorded in conjunction with the Contribution (see Note 7).

    At December 31, 1999, the Company has federal net operating loss ("NOL")
carryforwards of $15,111,000 for income tax purposes, of which approximately
$6,187,000 and $8,924,000 expire in 2018 and 2019, respectively. The use of the
NOLs is limited to future taxable earnings of the Company. For financial
reporting purposes, a valuation allowance of $3.6 million has been recognized to
offset net deferred tax assets, primarily attributable to the NOL carryforward.

    The Company's policy is to permanently reinvest foreign earnings.
Accumulated foreign earnings, for which no deferred taxes have been provided,
amounted to $3,372,000 $2,580,000 and $2,230,000 as of December 31, 1999, 1998
and 1997, respectively. If such earnings were to be repatriated, the income tax
effect would not be significant.

    Included in the loss before income taxes is foreign income of $971,000,
$476,000 and $757,000 for the years ended December 31, 1999, 1998 and 1997,
respectively.


                                      F-19
<PAGE>   63
12. PENSION AND OTHER EMPLOYEE BENEFITS

   Savings and Stock Ownership Plans

    The Company's employees participated, prior to the Distribution, in
Penford's Savings and Stock Ownership Plan and costs were charged to the Company
based upon actual costs incurred for the Company's employees. Seventy-five
percent (75%) of employee's contributions were matched up to 6% of the
employee's pay, in the form of Penford common stock. A similar plan was adopted
by the Company upon the Distribution. The primary changes in the new plan
include the shortening of the vesting period from five years to four years and
the Company's match is now in the form of cash. The Company's expense under the
Plans was $212,000, $217,000 and $161,000 for 1999, 1998 and 1997, respectively.

    The Plans also include a discretionary annual profit-sharing component that
is awarded by Penford's Board of Directors prior to the spin-off and Penwest's
Board of Directors subsequent to the spin-off, generally based on achievement of
predetermined corporate goals. This feature is available to all employees who
meet the eligibility requirements of the Plans. The profit sharing expense
related to the Company's employees was $125,000 and $95,000 for 1998 and 1997,
respectively. There was no profit sharing expense in 1999.

   Supplemental Executive Retirement Plan

    Penford sponsored a Supplemental Executive Retirement Plan (SERP), a
nonqualified plan, which covers the Chairman and Chief Executive Officer of
Penwest. For 1999, 1998 and 1997, the net expense for the SERP incurred by
Penwest was $141,000, $56,000 and $22,000, respectively. The allocated costs
represent the costs attributable to the Company's employees. As part of the
Distribution, the SERP liability was assumed by the Company. The Company does
not fund this liability and no assets are held by the Plan. The following
disclosures represent information subsequent to the Distribution.

    Change in benefit obligation (in thousands):

<TABLE>
<CAPTION>
                                                         1999       1998
                                                         ----       ----
<S>                                                    <C>        <C>
      Benefit obligation at beginning of period ....   $ 1,388    $ 1,362
      Service cost .................................       (15)        (5)
      Interest cost ................................        96         32
      Actuarial gains ..............................      (151)        (1)
                                                       -------    -------
          Benefit obligation at December 31 ........   $ 1,318    $ 1,388
                                                       =======    =======
</TABLE>

    Funded status (in thousands):

<TABLE>
<CAPTION>
                                                         1999       1998
                                                         ----       ----
<S>                                                    <C>        <C>
      Funded status ................................   $(1,318)   $(1,388)
      Unrecognized net transition obligation .......       280        340
      Unrecognized prior service cost ..............       162        225
      Unrecognized net actuarial gain ..............      (796)      (708)
                                                       -------    -------
          Net amount recognized at December 31,
          (included in other long term liabilities)    $(1,672)   $(1,531)
                                                       =======    =======
</TABLE>


                                      F-20
<PAGE>   64
Components of net periodic benefit cost (in thousands):

<TABLE>
<CAPTION>
                                                       1999    1998
                                                       ----    ----
<S>                                                   <C>      <C>
            Service cost ..........................   $ (15)   $ (4)
            Interest cost .........................      96      32
            Amortization of unrecognized transition
              obligation ..........................      60      19
            Amortization of prior service cost ....      63      21
            Amortization of gains .................     (63)    (21)
                                                      -----    ----
                Net periodic benefit cost .........   $ 141    $ 47
                                                      =====    ====
</TABLE>

The plan's accumulated benefit obligation at December 31, 1999 and 1998 was
$1,066,000 and $1,088,000, respectively. The Company's benefit obligation was
measured using a weighted average discount rate of 7.5% in 1999 and 7% in 1998
and a compensation increase of 3% in 1999 and 1998. 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 $491,000, $496,000 and
$343,000 in 1999, 1998 and 1997, respectively.

   Pension Plan

    Prior to the Distribution, Penwest participated in a noncontributory defined
benefit pension plan (the Plan) that covered substantially all employees. The
Plan was sponsored by Penford and costs were allocated based upon actual costs
incurred for the Company's employees. In addition to the employees of the
Company, employees of Penford and its other subsidiaries participated in the
Plan. The Company has accounted for its involvement in the overall Plan as a
participant in a multi-employer pension plan. Under this method, the Company
recognized as net periodic pension costs its allocated contribution for the
period. The Company recognized a liability to Penford for any contributions due
and unpaid.

    Under the terms of the Employee Benefits Agreement between Penford and
Penwest, Penford froze all benefits to employees of Penwest under the Plan as of
the Distribution and distributed to each employee his or her fully vested
interest in the form of a lump sum payment or an annuity. Based upon the terms
of the agreement, there were no termination gains or losses as a result of the
freezing of Plan benefits, the termination of the right of employees of the
Company to participate in the Plan or the subsequent distribution.

    Benefits for employees are primarily related to years of credited service
and final average five-year earnings. Employees generally become eligible to
participate in the Plan after attaining age 21 and benefits become vested after
five years of credited service.

    Pension expense of $50,000 and $66,000 was recorded for the years ended
December 31, 1998 and 1997, respectively, for this Plan. There was no pension
expense for 1999.


                                      F-21
<PAGE>   65
13. LICENSING AGREEMENTS

    The Company enters into collaborative arrangements with pharmaceutical
companies to facilitate and expedite the commercialization of its TIMERx drug
delivery technology.

    In September 1997, the Company entered into a strategic alliance agreement
with Endo Pharmaceuticals Inc. ("Endo") with respect to the development of
controlled release formulations of oxymorphone based on the Company's TIMERx
technology (the "Endo Products"). Under the agreement, the Company has agreed to
manufacture and supply TIMERx material to Endo, and Endo has agreed to
manufacture and market the Endo Products in the United States. The manufacture
and marketing of Endo Products outside of the United States may be conducted by
the Company, Endo or a third party, as determined by a committee comprised of an
equal number of members from each of the Company and Endo. The Company and Endo
have agreed to share the costs involved in the development and commercialization
of the Endo Products and that the party marketing the Endo Products (which the
Company expects will be Endo) will pay the other party royalties equal to 50% of
their respective net marketing revenues after fully-burdened costs (although
this percentage will decrease as the total U.S. marketing revenues from an Endo
Product increase), subject to each party's right to terminate its participation
with respect to any Endo Product described above. Endo will purchase formulated
TIMERx material for use in the Endo Products exclusively from the Company at
specified prices. Such prices will be reflected in the determination of
fully-burdened costs. Under the Company's strategic alliance agreement with
Endo, the Company is contractually obligated to spend an additional $4.3
million, but intends to fund the full 50% of the development costs.

    Royalties and licensing fees revenue consist solely of payments received
under TIMERx collaborative agreements. Included in royalties and licensing
revenue are approximately $175,000, $80,000 and $50,000 for the years ended
December 31, 1999, 1998 and 1997, respectively, of payments received upon the
signing of collaborative agreements. These up-front payments relate principally
to the performance of pilot bioequivalence studies and have been recognized upon
the delivery of the results of such studies to the collaborators. In addition,
approximately $340,000, $190,000 and $861,000 of non-refundable milestone
payments were recognized as the milestones were achieved during the years ended
December 31, 1999, 1998 and 1997, respectively. Approximately $6,429,000,
$5,084,000 and $3,075,000 for the years ended December 31, 1999, 1998 and 1997,
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.

14. CONTINGENCIES

    In 1994, the Boots Company PLC ("Boots") filed an opposition to a patent
granted by the European Patent Office (the "EPO") to the Company relating
to its TIMERx technology. In June 1996, the EPO dismissed Boots' opposition,
leaving intact all claims included in the patent. Boots has appealed this
decision to the EPO Board of Appeals. There can be no assurance that the Company
will prevail in this matter. An unfavorable outcome could materially adversely
affect the Company's business, financial condition, cash flows and results of
operations.


                                      F-22
<PAGE>   66
    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.

15. SEGMENT INFORMATION

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

<TABLE>
<CAPTION>
                              NORTH
                             AMERICA   FINLAND     OTHER   ELIMINATIONS   TOTAL
                             -------   -------     -----   ------------   -----
                                              (IN THOUSANDS)
<S>                          <C>       <C>        <C>      <C>           <C>
DECEMBER 31, 1999
Total Revenues ..........    $35,190    $5,490    $4,038     $(7,511)    $37,207
Long-lived Assets .......    $23,377    $  650    $   34                 $24,061

DECEMBER 31, 1998
Total Revenues ..........    $27,716    $3,844    $3,411     $(5,960)    $29,011
Long-lived Assets .......    $24,572    $  855    $   66                 $25,493

DECEMBER 31, 1997
Total Revenues ..........    $24,818    $3,470    $2,993     $(4,340)    $26,941
Long-lived Assets .......    $23,411    $  899    $  134                 $24,444
</TABLE>

    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.


                                      F-23
<PAGE>   67
16. SUBSEQUENT EVENTS

     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 the Credit Facility as required by its terms. The Credit Facility is no
longer available to the Company (see Note 6).

    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. As a result of the
agreement, Pfizer agreed to dismiss all pending litigation against Mylan. In
connection with that agreement, Mylan has agreed to pay Penwest a royalty on all
future net sales of Pfizer's 30 mg generic version of Procardia XL. The
royalty percentage will be 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. Mylan has also agreed to purchase from
the Company formulated bulk TimerX manufactured for Nifedipine XL.


                                      F-24
<PAGE>   68
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

                           PENWEST PHARMACEUTICALS CO.
                                DECEMBER 31, 1999

                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                               Charged to
                                     Balance at   Charged to      Other                        Balance at
                                     Beginning     Costs and    Accounts    Deductions           End of
                                     of Period     Expenses     Describe     Describe            Period
                                     ---------     --------     --------     --------            ------
<S>                                  <C>          <C>          <C>          <C>          <C>   <C>
Year ended December 31, 1999
  Allowance for Doubtful Accounts      $227          $ 32          --          $ 14      (a)      $245
  Inventory Reserve                    $132          $243          --          $ 98      (b)      $277

Year ended December 31, 1998
  Allowance for Doubtful Accounts      $337          $ 74          --          $184      (a)      $227
  Inventory Reserve                    $ 80          $ 52          --            --                $132

Year ended December 31, 1997
  Allowance for Doubtful Accounts      $237          $100          --            --                $337
  Inventory Reserve                    $ 80            --          --            --                $ 80
</TABLE>

(a)  Uncollectible accounts written off, net of recoveries.

(b)  Disposals of unrecoverable inventory costs.


                                      F-25
<PAGE>   69
                                INDEX TO EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT

NO.        DESCRIPTION
---        -----------
<S>        <C>
3.1*       Amended and Restated Articles of Incorporation

3.2**      Articles of Amendment to the Amended and Restated Articles of
           Incorporation filed on June 19, 1998.

3.3*       Amended and Restated Bylaws of the Company.

3.4**      Designation of Rights and Preference of Series A Junior Participating
           Preferred Stock of the Company filed on July 17, 1998.

4.1*       Specimen certificate representing the Common Stock.

4.2**      Form of Rights Agreement dated as of July 27, 1998 between the
           Company and the Rights Agent.

+10.1*     Product Development and Supply Agreement dated August 17, 1994 by and
           between the Registrant and Mylan Pharmaceuticals Inc. ("Mylan").

+10.2*     Product Development and Supply Agreement dated August 3, 1995 by and
           between the Registrant and Mylan.

+10.3*     Product Development and Supply Agreement dated March 22, 1996 by and
           between the Registrant and Mylan.

+10.4*     Sales and Distribution Agreement dated January 3, 1997 by and between
           the Registrant and Mylan.

10.5**     Form of Separation and Distribution Agreement entered into between
           Registrant and Penford Corporation ("Penford").

10.6       Intentionally Omitted.

+10.7*     Product Development, License and Supply Agreement dated February 28,
           1997 by and between the Registrant and Sanofi Winthrop S.A., as
           amended.

+10.8*     Agreement dated May 26, 1995 by and between the Registrant and Leiras
           OY.

+10.9*     Agreement dated July 27, 1992 by and between the Registrant and
           Leiras, OY.

+10.10*    Strategic Alliance Agreement dated as of September 17, 1997 by and
           between the Registrant and Endo Pharmaceuticals Inc.

10.11*++   1997 Equity Incentive Plan.

10.12*++   1997 Employee Stock Purchase Plan.

10.13*++   1998 Spinoff Option Plan.

10.14*     Form of Excipient Supply Agreement to be entered into between the
           Registrant and Penford.

10.15**    Form of Services Agreement to be entered into between the Registrant
           and Penford.

10.16**    Form of Tax Allocation Agreement to be entered into between the
           Registrant and Penford.

10.17**    Form of Employee Benefits Agreement to be entered into between the
           Registrant and Penford.

10.18*     Recognition and Incentive Agreement dated as of May 14, 1990 between
           the Registrant and Anand Baichwal, as amended.

+10.19**   License Agreement dated December 17, 1997 between Synthelabo and the
           Registrant.

+10.20**   Supply Agreement dated December 17, 1997 between Synthelabo and the
           Registrant.

10.21**    Revolving Term Credit Facility dated July 2, 1998 by and between the
           Company and the Bank of Nova Scotia.

10.22+++   Manufacturing Agreement dated September 27, 1999 between the Company
           and Draxis Pharma, Inc.
</TABLE>


                                      F-26
<PAGE>   70
<TABLE>
<S>        <C>
21.1*      Subsidiaries.

23         Consent of Ernst & Young LLP.

24         Power of Attorney.

27.1       Financial Data Schedule (December 31, 1999)
</TABLE>

*Incorporated by reference to Exhibits to the Registrant's Registration
Statement on Form S-1 (File No. 333-38389).

**Incorporated by reference to Exhibits to the Company's Registration Statement
on Form 10 filed with the Commission on June 22, 1998 and July 31, 1998.

+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.

+++Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the Commission.


                                      F-27