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

FORM 10-Q



|[X] |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE
ACT OF 1934
|--- |  | ---------------------------------------------------------------------------------------

For the quarterly period ended March 31, 2002

OR



|[   ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
|----- |  | ----------------------------------------------------------------------------------------

For the transition period from ____________________________ to
_________________________

Commission File No. 000-23467

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

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|Washington                               |  | 91-1513032                          
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|(State of Incorporation)                 |  | (I.R.S. Employer Identification No.)
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|2981 Route 22, Patterson, NY             |  | 12563-2335                          
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|(Address of principal executive offices) |  | (Zip Code)                          

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|-----------------------------------------------------
|(845) 878-3414                                       
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|(Registrants telephone number, including area code.)

Indicate by a 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 the past 90 days.

Yes X No

Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of May 13, 2002.

|                              |  |            
|----------------------------- |  | -----------
|Class                         |  | Outstanding
|                              |  |            
|Common stock, par value $.001 |  | 15,465,852 

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TABLE OF CONTENTS



|                                                                                              |                                                      |  |  |  |  |  |  | 
|--------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION                                                               
|ITEM 1. FINANCIAL STATEMENTS                                                                 
|                                                                                              | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                                                                                              | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                                                                                              | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                                                                                              | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|PART II  OTHER INFORMATION                                                                  
|ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURE                                                                                    
|EXHIBIT INDEX                                                                                
|EX-10.1 ROYALTY AGREEMENT DATED SEPTEMBER 25, 1992                                           
|EX-10.2 CONFIDENTIALITY, CONSULTING AND NONCOMP...                                           
|EX-99 PAGES 23-30 OF COMPANY'S ANNUAL REPORT                                                 



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##### Table of Contents



PENWEST PHARMACEUTICALS CO.

TABLE OF CONTENTS

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|------------- | ------ | --------------------- | ------------------------------------------------------------------------------------- | ---------------------------------------------------- | -- | ---- | - | 
|              |        |                       |                                                                                       |                                                      |    | PAGE
|              |        |                       |                                                                                       |                                                      |    |     
|Part I        |        | Financial Information |                                                                                      
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|              | Item 1 |                       | Financial Statements (Unaudited)                                                     
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|              |        |                       |                                                                                       | Condensed Consolidated Balance Sheets                |    |      | 3
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|              |        |                       |                                                                                       | Condensed Consolidated Statements of Operations      |    |      | 4
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|              |        |                       |                                                                                       | Condensed Consolidated Statements of Cash Flows      |    |      | 5
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|              |        |                       |                                                                                       | Notes to Condensed Consolidated Financial Statements |    |      | 6
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|              | Item 2 |                       | Management's Discussion and Analysis of Financial Condition and Results of Operations |                                                      |    | 8   
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|              | Item 3 |                       | Quantitative and Qualitative Disclosures About Market Risk                            |                                                      |    | 11  
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|Part II       |        | Other Information     |                                                                                      
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|              | Item 6 |                       | Exhibits and Reports on Form 8-K                                                      |                                                      |    | 12  
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|Signature     |        |                       |                                                                                       |                                                      | 13
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|Exhibit Index |        |                       |                                                                                       |                                                      | 14

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##### Table of Contents






PART I  FINANCIAL INFORMATION




ITEM 1. FINANCIAL STATEMENTS




PENWEST PHARMACEUTICALS CO.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

|                                     |                                                                                                                                                                    |                         |                                            |         |             |        |              |         |       |        | 
|------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------- | ------------------------------------------ | ------- | ----------- | ------ | ------------ | ------- | ----- | ------ | 
|                                     |                                                                                                                                                                    |                         |                                            |         | March 31,   |        | December 31,
|                                     |                                                                                                                                                                    |                         |                                            |         | 2002        |        | 2001        
|                                     |                                                                                                                                                                    |                         |                                            |         |             |        |             
|                                     |                                                                                                                                                                    |                         |                                            |         | (Unaudited) |        | (Note 2)    
|ASSETS                              
|                                    
|                                    
|                                    
|                                    
|Current assets:                     
|                                    
|                                    
|                                    
|                                    
|                                     | Cash and cash equivalents                                                                                                                                          |                         | $                                          | 15,266  |             |        | $            | 12,903  |      
|                                    
|                                    
|                                    
|                                    
|                                     | Marketable securities                                                                                                                                              |                         |                                            | 7,268   |             |        |              | 9,609   |      
|                                    
|                                    
|                                    
|                                    
|                                     | Trade accounts receivable, net of allowance for
doubtful accounts of $226 and $220                                                                                 |                         |                                            | 6,992   |             |        |              | 6,228   |      
|                                    
|                                    
|                                    
|                                    
|                                     | Inventories:                                                                                                                                                      
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                                                                                    | Raw materials and other |                                            |         | 1,495       |        |              |         | 1,558 |       
|                                    
|                                    
|                                    
|                                    
|                                     |                                                                                                                                                                    | Finished goods          |                                            |         | 6,160       |        |              |         | 6,299 |       
|                                     |                                                                                                                                                                    |                         |                                            |         |             |        |              |        
|                                     |                                                                                                                                                                    |                         | 7,655                                      |         |             |        | 7,857        |        
|                                    
|                                    
|                                    
|                                    
|                                     | Prepaid expenses and other current assets                                                                                                                          |                         |                                            | 616     |             |        |              | 1,166   |      
|                                     |                                                                                                                                                                    |                         |                                            |         |             |        |              |        
|                                     |                                                                                                                                                                    |                         | Total current assets                       |         |             | 37,797 |              |         |       | 37,763 | 
|                                    
|                                    
|                                    
|                                    
|Fixed assets, net                    |                                                                                                                                                                    |                         | 14,985                                     |         |             |        | 15,567       |        
|                                    
|                                    
|                                    
|                                    
|Patents, net                         |                                                                                                                                                                    |                         | 3,854                                      |         |             |        | 3,545        |        
|                                    
|                                    
|                                    
|                                    
|Other assets                         |                                                                                                                                                                    |                         | 2,779                                      |         |             |        | 2,738        |        
|                                     |                                                                                                                                                                    |                         |                                            |         |             |        |              |        
|                                     |                                                                                                                                                                    |                         | Total assets                               |         | $           | 59,415 |              |         | $     | 59,613 | 
|                                     |                                                                                                                                                                    |                         |                                            |         |             |        |             
|LIABILITIES AND SHAREHOLDERS EQUITY
|                                    
|                                    
|                                    
|                                    
|Current liabilities:                
|                                    
|                                    
|                                    
|                                    
|                                     | Accounts payable                                                                                                                                                   |                         | $                                          | 3,293   |             |        | $            | 2,174   |      
|                                    
|                                    
|                                    
|                                    
|                                     | Accrued expenses                                                                                                                                                   |                         |                                            | 2,076   |             |        |              | 2,275   |      
|                                    
|                                    
|                                    
|                                    
|                                     | Accrued development costs                                                                                                                                          |                         |                                            | 4,838   |             |        |              | 3,139   |      
|                                    
|                                    
|                                    
|                                    
|                                     | Taxes payable                                                                                                                                                      |                         |                                            | 510     |             |        |              | 448     |      
|                                    
|                                    
|                                    
|                                    
|                                     | Loan payable                                                                                                                                                       |                         |                                            | 2,799   |             |        |              | 2,668   |      
|                                     |                                                                                                                                                                    |                         |                                            |         |             |        |              |        
|                                     |                                                                                                                                                                    |                         | Total current liabilities                  |         |             | 13,516 |              |         |       | 10,704 | 
|                                    
|                                    
|                                    
|                                    
|Deferred income taxes                |                                                                                                                                                                    |                         | 199                                        |         |             |        | 205          |        
|                                    
|                                    
|                                    
|                                    
|Deferred revenue                     |                                                                                                                                                                    |                         | 341                                        |         |             |        | 369          |        
|                                    
|                                    
|                                    
|                                    
|Deferred compensation                |                                                                                                                                                                    |                         | 2,753                                      |         |             |        | 2,711        |        
|                                     |                                                                                                                                                                    |                         |                                            |         |             |        |              |        
|                                     |                                                                                                                                                                    |                         | Total liabilities                          |         |             | 16,809 |              |         |       | 13,989 | 
|                                    
|                                    
|                                    
|                                    
|Shareholders equity:               
|                                    
|                                    
|                                    
|                                    
|                                     | Preferred stock, par value $.001, authorized
1,000,000 shares, none outstanding                                                                                    |                         |                                            |        |             |        |              |        |      
|                                    
|                                    
|                                    
|                                    
|                                     | Common stock, par value $.001, authorized
39,000,000 shares, issued and outstanding
15,450,852 shares at March 31, 2002 and 15,276,630
shares at December 31, 2001 |                         |                                            | 15      |             |        |              | 15      |      
|                                    
|                                    
|                                    
|                                    
|                                     | Additional paid in capital                                                                                                                                         |                         |                                            | 109,485 |             |        |              | 108,054 |      
|                                    
|                                    
|                                    
|                                    
|                                     | Accumulated deficit                                                                                                                                                |                         |                                            | (65,244 | )           |        |              | (60,926 | )    
|                                    
|                                    
|                                    
|                                    
|                                     | Accumulated other comprehensive loss                                                                                                                               |                         |                                            | (1,650  | )           |        |              | (1,519  | )    
|                                     |                                                                                                                                                                    |                         |                                            |         |             |        |              |        
|                                     |                                                                                                                                                                    |                         | Total shareholders equity                 |         |             | 42,606 |              |         |       | 45,624 | 
|                                     |                                                                                                                                                                    |                         |                                            |         |             |        |              |        
|                                     |                                                                                                                                                                    |                         | Total liabilities and shareholders equity |         | $           | 59,415 |              |         | $     | 59,613 | 
|                                     |                                                                                                                                                                    |                         |                                            |         |             |        |              |        

See accompanying notes to condensed consolidated financial statements.

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PENWEST PHARMACEUTICALS CO.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

|                                                    |                                     |                          |        |                 |        |      |        |       |        | 
|--------------------------------------------------- | ----------------------------------- | ------------------------ | ------ | --------------- | ------ | ---- | ------ | ----- | ------ | 
|                                                    |                                     |                          |        | Three Months   
|                                                    |                                     |                          |        | Ended March 31,
|                                                    |                                     |                          |        |                
|                                                    |                                     |                          |        | 2002            |        | 2001
|                                                    |                                     |                          |        |                 |        |     
|                                                    |                                     |                          |        | (Unaudited)    
|Revenues                                           
|                                                    | Product sales                       |                          | $      | 9,175           |        |      | $      | 9,236 |       
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Royalties and licensing fees        |                          |        | 1,138           |        |      |        | 1,703 |       
|                                                    |                                     |                          |        |                 |        |      |        |      
|                                                    |                                     | Total revenues           |        |                 | 10,313 |      |        |       | 10,939 | 
|                                                   
|                                                   
|                                                   
|                                                   
|Cost of product sales                               |                                     |                          | 6,594  |                 |        |      | 6,563  |      
|                                                    |                                     |                          |        |                 |        |      |        |      
|                                                    |                                     | Gross profit             |        |                 | 3,719  |      |        |       | 4,376  | 
|                                                   
|                                                   
|                                                   
|                                                   
|Operating expenses                                 
|                                                    | Selling, general and administrative |                          |        | 3,373           |        |      |        | 2,995 |       
|                                                   
|                                                   
|                                                   
|                                                   
|                                                    | Research and product development    |                          |        | 4,589           |        |      |        | 3,323 |       
|                                                    |                                     |                          |        |                 |        |      |        |      
|                                                    |                                     | Total operating expenses |        |                 | 7,962  |      |        |       | 6,318  | 
|                                                    |                                     |                          |        |                 |        |      |        |      
|Loss from operations                                |                                     |                          | (4,243 | )               |        |      | (1,942 | )    
|                                                   
|                                                   
|                                                   
|                                                   
|Investment income                                   |                                     |                          | 130    |                 |        |      | 40     |      
|                                                   
|                                                   
|                                                   
|                                                   
|Interest expense                                    |                                     |                          | 58     |                 |        |      | 74     |      
|                                                    |                                     |                          |        |                 |        |      |        |      
|Loss before income taxes                            |                                     |                          | (4,171 | )               |        |      | (1,976 | )    
|                                                   
|                                                   
|                                                   
|                                                   
|Income tax expense                                  |                                     |                          | 147    |                 |        |      | 147    |      
|                                                    |                                     |                          |        |                 |        |      |        |      
|Net loss                                            |                                     | $                        | (4,318 | )               |        | $    | (2,123 | )    
|                                                    |                                     |                          |        |                 |        |      |        |      
|                                                   
|Basic and diluted net loss per share                |                                     | $                        | (0.28  | )               |        | $    | (0.17  | )    
|                                                    |                                     |                          |        |                 |        |      |        |      
|                                                   
|Weighted average shares of common stock outstanding |                                     |                          | 15,398 |                 |        |      | 12,678 |      
|                                                    |                                     |                          |        |                 |        |      |        |      

See accompanying notes to condensed consolidated financial statements.

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PENWEST PHARMACEUTICALS CO.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

|                                                             |                                                   |   |                 |        |      |   |       |        |  
|------------------------------------------------------------ | ------------------------------------------------- | - | --------------- | ------ | ---- | - | ----- | ------ | -
|                                                             |                                                   |   | Three Months   
|                                                             |                                                   |   | Ended March 31,
|                                                             |                                                   |   |                
|                                                             |                                                   |   | 2002            |        | 2001
|                                                             |                                                   |   |                 |        |     
|                                                             |                                                   |   | (Unaudited)    
|Net cash (used in) provided by operating activities          |                                                   | $ | (902            | )      |      | $ | 352   |       
|                                                            
|Investing activities:                                       
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Acquisitions of fixed assets, net                 |   |                 | (146   | )    |   |       | (93    | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Intangible asset costs                            |   |                 | (370   | )    |   |       | (95    | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Proceeds from maturities of marketable securities |   |                 | 2,250  |      |   |       |       |  
|                                                             |                                                   |   |                 |        |      |   |       |       
|Net cash provided by (used in) investing activities          |                                                   |   | 1,734           |        |      |   | (188  | )     
|                                                            
|Financing activities:                                       
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Borrowings from credit facility                   |   |                 | 6,055  |      |   |       | 9,730  |  
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Repayments of credit facility                     |   |                 | (5,925 | )    |   |       | (7,147 | )
|                                                            
|                                                            
|                                                            
|                                                            
|                                                             | Issuance of common stock, net                     |   |                 | 1,431  |      |   |       | 139    |  
|                                                             |                                                   |   |                 |        |      |   |       |       
|Net cash provided by financing activities                    |                                                   |   | 1,561           |        |      |   | 2,722 |       
|                                                            
|Effect of exchange rate changes on cash and cash
equivalents |                                                   |   | (30             | )      |      |   | (55   | )     
|                                                             |                                                   |   |                 |        |      |   |       |       
|Net increase in cash and cash equivalents                    |                                                   |   | 2,363           |        |      |   | 2,831 |       
|                                                            
|                                                            
|                                                            
|                                                            
|Cash and cash equivalents at beginning of period             |                                                   |   | 12,903          |        |      |   | 2,204 |       
|                                                             |                                                   |   |                 |        |      |   |       |       
|Cash and cash equivalents at end of period                   |                                                   | $ | 15,266          |        |      | $ | 5,035 |       
|                                                             |                                                   |   |                 |        |      |   |       |       

See accompanying notes to condensed consolidated financial statements.

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PENWEST PHARMACEUTICALS CO.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. BUSINESS

Penwest Pharmaceuticals Co. (Penwest or the Company) is engaged in the
development of pharmaceutical products based on novel oral drug delivery
technologies. The Company is also a leader in the development, manufacture, and
distribution of branded pharmaceutical excipients which are the inactive
ingredients in tablets and capsules. Based on its fundamental expertise in
tabletting ingredients, the Company has developed its proprietary
TIMERx® controlled release drug delivery technology, which is
applicable to a broad range of orally administered drugs, and
ProSolv®, a high functionality excipient based on co-processing
technology, which, among other things, improves the performance characteristics
of tablets. The Company has manufacturing facilities in Iowa and Finland and
has customers primarily throughout North America and Europe.

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

2. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. In the opinion of management, all adjustments considered necessary
for a fair presentation for the interim periods presented have been included.
All such adjustments are of a normal recurring nature. Operating results for
the three-month period ended March 31, 2002 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2002. For
further information, refer to the consolidated financial statements and
footnotes thereto included in the Companys Annual Report on Form 10-K for the
year ended December 31, 2001.

The balance sheet at December 31, 2001 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by accounting principles generally accepted in the
United States for complete financial statements.

Certain prior year amounts have been reclassified to conform with the
current years presentation. These reclassifications had no effect on
previously reported results of operations.

3. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 141, Business
Combinations and SFAS No. 142, Goodwill and Other Intangible Assets
effective for fiscal years beginning after December 15, 2001. Under the new
rules, goodwill will no longer be amortized but will be subject to annual
impairment tests. Other intangible assets will continue to be amortized over
their estimated useful lives, if they have a finite useful life. The Company
adopted the new rules on accounting for goodwill and other intangible assets in
the first quarter of 2002. The adoption of the new standards did not affect the
results of operations, financial position, or cash flows of the Company.

In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of. The primary objectives of SFAS No. 144 are to
develop one accounting model based on the framework established in SFAS No. 121

6



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##### Table of Contents



for long-lived assets to be disposed of by sale, and to address significant
implementation issues. The Companys adoption of SFAS No. 144 in the first
quarter of 2002 did not affect the results of operations, financial position,
or cash flows of the Company.

4. CREDIT FACILITY

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

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

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

The interest rate on the Revolver at March 31, 2002 was 5.75%.

5. INCOME TAXES

The effective tax rates for the quarters ended March 31, 2002 and 2001,
were expenses of 4% and 7%, respectively. The effective tax rates are higher
than the federal statutory rate of a 34% benefit, due primarily to valuation
allowances recorded to offset deferred tax assets relating to the Companys net
operating losses, and state and foreign income taxes.

6. COMPREHENSIVE LOSS

The components of comprehensive loss for the three-month periods ended
March 31, 2002 and 2001 are as follows:

|                                                        |  |                 |        |      |  |   |        |  
|------------------------------------------------------- |  | --------------- | ------ | ---- |  | - | ------ | -
|                                                        |  | Three Months   
|                                                        |  | Ended March 31,
|                                                        |  |                
|                                                        |  | 2002            |        | 2001
|                                                        |  |                 |        |     
|                                                        |  | (in thousands) 
|Net loss                                                |  | $               | (4,318 | )    |  | $ | (2,123 | )
|                                                       
|                                                       
|                                                       
|                                                       
|Foreign currency translation adjustments                |  |                 | (114   | )    |  |   | (306   | )
|                                                       
|                                                       
|                                                       
|                                                       
|Change in unrealized net gains on
marketable securities |  |                 | (17    | )    |  |   |       |  
|                                                        |  |                 |        |      |  |   |        |  
|Comprehensive loss                                      |  | $               | (4,449 | )    |  | $ | (2,429 | )
|                                                        |  |                 |        |      |  |   |        |  

Accumulated other comprehensive loss equals the cumulative translation
adjustment and unrealized net gains on marketable securities which are the only
components of other comprehensive loss included in the Companys financial
statements.

7. ISSUANCE OF COMMON STOCK

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

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ITEM 2. 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 described below under Certain Factors That
May Affect Future Results.

OVERVIEW

Penwest is engaged in the development of pharmaceutical products based on
novel oral drug delivery technologies. The Company is also a leader in the
development, manufacture, and distribution of branded pharmaceutical excipients
which are the inactive ingredients in tablets and capsules. Based on its
fundamental expertise in tabletting ingredients, the Company has developed its
proprietary TIMERx® controlled release drug delivery technology,
which is applicable to a broad range of orally administered drugs, and
ProSolv®, a high functionality excipient based on co-processing
technology, which, among other things, improves the performance characteristics
of tablets.

The Company has incurred net losses since 1994. As of March 31, 2002, the
Companys accumulated deficit was approximately $65.2 million. The Company
expects operating losses and negative cash flows during the remainder of 2002
and into 2003. 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, including
in particular oxymorphone ER, a narcotic analgesic for the treatment of
moderate to severe pain, being developed with Endo Pharmaceuticals Inc.; royalties from Mylan Pharmaceuticals, Inc.s sales of
Pfizer, Inc.s 30 mg generic version of Procardia XL; sales growth of the
Companys pharmaceutical excipients products; as well as the level of the
Companys investment in research and development activities. The Companys
strategy includes a significant commitment to spending on research and
development targeted at identifying and developing extended release products
which will be formulated using the Companys drug delivery technologies. The
Company also expects to expend significant resources on the development of new
drug delivery technologies, both internally and through in-licenses or
acquisition. The Companys spending in this area, however, is discretionary and
is dependent on identifying appropriate opportunities as well as the
availability of funds from the Companys operations, cash resources,
collaborative research and development arrangements, and external financing.
There can be no assurance when or if the Company will achieve profitability or
if it will be able to sustain profitability on a quarterly basis, if at all.

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

The Companys business is conducted internationally and may be affected by
fluctuations in currency exchange rates, as well as by governmental controls
and other risks associated with international sales (such as export licenses,
collectibility of accounts receivable, trade restrictions, and changes in
tariffs). The Companys international subsidiaries 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.

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, royalties on Mylans sales of Pfizers 30 mg generic version of
Procardia XL, 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, and currency exchange
rate fluctuations.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The

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preparation of these financial statements
requires the Company to make estimates and assumptions that affect the reported
amounts of assets and liabilities as of the date of the financial statements
and the reported amounts of revenues and expenses during the reporting periods.
Areas where significant judgments are made include, but are not limited to,
revenue recognition, allowance for doubtful accounts, inventory, deferred taxes
 valuation allowance, and impairment of intangible assets. Actual results
could differ materially from these estimates. For a more detailed explanation
of the judgments made in these areas, refer to our Annual Report on Form 10-K
for the year ended December 31, 2001.

RESULTS OF OPERATIONS

Quarters Ended March 31, 2002 and 2001

Total revenues decreased by $0.6 million or 5.7% for the first quarter
ended March 31, 2002 to $10.3 million, from $10.9 million for the comparable
quarter ended March 31, 2001. Product sales remained constant
at approximately $9.2 million for each of the quarters ended March 31, 2002 and
2001. Royalties and licensing fees decreased by $0.6 million for the first
quarter of 2002 as compared to the first quarter of 2001, primarily due to
lower royalties from Mylan as a result of increased competition for generic
Procardia XL. Product sales were impacted by a decline in the first quarter of
2002 as compared to the first quarter of 2001, in sales of bulk TIMERx
resulting from the timing of certain customer orders. This decrease was
largely offset by increased excipient product sales, reflecting greater sales
of the Companys ProSolv® products primarily attributable to
additional filings and approvals of customers' products containing
ProSolv® in the ethical pharmaceutical market, and
growth in its European excipients business.

Gross profit decreased to $3.7 million, or 36.1% of total revenues, for
the first quarter of 2002 from $4.4 million, or 40.0% of total revenues, for
the first quarter of 2001. The Companys gross profit declined primarily due
to the lower royalties from Mylan noted above. Gross profit
percentage on
product sales decreased to 28.1% for the first quarter of 2002 from 28.9% for
the first quarter of 2001. This decrease was primarily due to the lower sales
in the first quarter of 2002 of bulk TIMERx, which has higher overall margins.

Selling, general and administrative expenses increased by $0.4 million or
12.6% for the first quarter of 2002 to $3.4 million, from $3.0 million for the
first quarter of 2001. This increase was primarily attributable to higher
selling costs in Europe, including those associated with the opening of a sales
office in France, increased compensation expense related to marketing and
information technology, as well as higher business insurance costs.

Research and product development expenses increased by $1.3 million or
38.1% for the first quarter of 2002 to $4.6 million, from $3.3 million for the
first quarter of 2001. In addition to the significant costs of Phase III
clinical trials for oxymorphone ER being developed with Endo,
the Company increased its investment in developing new products utilizing
TIMERx technology for its drug development pipeline, and in the research of new
drug delivery technologies.

As of March 31, 2002, the Company had ten product candidates utilizing
TIMERx technology in various stages of clinical trials. Completion of clinical
trials and commercialization of these product candidates may take several years
and the length of time can vary substantially according to the type,
complexity, and novelty of a product candidate.

The Companys most advanced product candidate, oxymorphone ER, is
currently in Phase III clinical trials. Endo is conducting these clinical
trials, which are scheduled to be completed in the second quarter of 2002.
Assuming the results of the clinical trials are consistent with the results of
previous trials, the Company expects that Endo will submit the NDA for this
product in the second half of 2002. The Company anticipates spending an
additional $7.0 million on this development and marketing program during the
remainder of 2002.

There can be no assurance that any of the Companys products will be
successfully developed, will receive regulatory approval, or will be
successfully commercialized.

The effective tax rates for the quarters ended March 31, 2002 and 2001,
were expenses of 4% and 7%, respectively. The effective tax rates are higher
than the federal statutory rate of a 34% benefit, due primarily to valuation
allowances recorded to offset deferred tax assets relating to the Companys net
operating losses, and state and foreign income taxes.

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LIQUIDITY AND CAPITAL RESOURCES

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

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

As of March 31, 2002, the Company had cash, cash equivalents, and
short-term investments of $22.5 million. The Company had no committed sources
of capital at March 31, 2002 other than the Companys revolving line of credit
(Revolver) with CIT Group/Business Credit, Inc. Under the Revolver, generally
85% of the Companys U.S. and Canadian receivables, as well as generally 60% of
the Companys U.S. saleable inventories, are included in the borrowing base.
Amounts outstanding under the Revolver are collateralized by the Companys U.S.
and Canadian accounts receivable, and its inventory and general intangibles.
The Revolver has an initial term of three years, and provides for annual
renewals thereafter. The Revolver bears interest at a specified banks prime
rate plus 1% per annum, on the greater of $3.0 million or on the average
outstanding balance. The Revolver also requires that fees be paid of 0.5% per
annum on unused portions of the Line of Credit. It also provides for early
termination fees of up to 0.75% in the event the Company terminates the Revolver
prior to the end of the initial term. The Revolver contains covenants,
including the requirement that the Company maintain at all times, certain
minimum levels of tangible net worth as defined, at varying specified amounts
during the initial term of the agreement, and restrictions on the incurrence of
additional indebtedness and the payment of dividends. The Revolver includes a
lockbox requirement under the control of the lender, whereby collections of
certain trade receivables are used to immediately reduce the balance of the
Revolver. Under the terms of the Revolver, the Company may borrow up to $10.0
million (Line of Credit) as determined by a formula based on the Companys
Eligible Accounts Receivable and Eligible Saleable Inventory, as defined in the
agreement. As of May 9, 2002, there was approximately $3.0 million
outstanding under the Revolver.

As of March 31, 2002, the Company did not have any material commitments
for capital expenditures. As of March 31, 2002, the Companys trade receivables
were $7.0 million, an increase of $0.8 million from the December 31, 2001
balance of $6.2 million. In connection with its strategic alliance agreement
with Endo, the Company expects to expend approximately an additional $7.0
million in 2002 on the development and pre-marketing costs of oxymorphone ER.

The Company had negative cash flow from operations in the quarter ended
March 31, 2002 of $0.9 million, primarily due to the net loss in the period,
partially offset by an increase of $2.6 million in accounts payable and accrued
expenses. This increase in accounts payable and accrued expenses is primarily
attributable to the timing of a payment due to Endo which was not paid until
April 2002. Funds expended during the first quarter of 2002 for the acquisition of fixed assets were
primarily related to additions at the Companys manufacturing
facility in
Iowa, and information technology associated with the Company strengthening its
technology infrastructure to prepare for increasing drug development
activities. Funds expended for intangible assets include costs to secure
patents on technology developed by the Company and to secure trademarks.

The Company intends to utilize available cash and short-term investments,
cash from operations, and funds available under the Revolver. The Companys
requirements for additional capital are 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, including the costs of
funding research and development and clinical trials as part of cost-sharing
arrangements with collaborators such as Endo; (iii) the progress of the
Companys collaborative and independent development projects; (iv) revenues
from the Companys sales of excipients; (v) the costs to the Company of
bioequivalence studies for the Companys products and other development
activities; (vi) the prosecution, defense and enforcement of patent claims and
other intellectual property rights; and (vii) the costs and timing of adding
drug development capabilities.

The Company anticipates that its existing capital resources, including
funds available under the Revolver as well as anticipated internally generated
funds from the sale of excipients and formulated bulk TIMERx, royalties from
Mylan and other payments from collaborators, will enable the Company to
maintain currently planned operations through the first quarter of 2003. The
Company may need to raise additional funds to maintain its operations beyond
such date. The Company may seek to obtain additional funds through transactions
relating to its business lines and/or debt or equity financings. The additional
financing may not be available to the Company on acceptable terms, if at all.
If adequate funds are not available, Penwest may be required to (i)
significantly curtail its

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

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

This Quarterly Report on Form 10-Q contains or incorporates
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of
1934, as amended. All statements, other than statements of historical facts,
included or incorporated in this report regarding our strategy, future
operations, financial position, future revenues, projected costs, prospects,
plans and objectives of management are forward-looking statements. The words
believes, anticipates, estimates, plans, expects, intends, may,
projects, will and would and similar expressions are intended to identify
forward-looking statements, although not all forward-looking statements contain
these identifying words. We cannot guarantee that we actually will achieve the
plans, intentions or expectations disclosed in our forward-looking statements
and you should not place undue reliance on our forward-looking statements.
There are a number of important factors that could cause actual results or
events to differ materially from the plans, intentions and expectations
disclosed in the forward-looking statements we make. These important factors
include the factors discussed in the Overview to Managements Discussion and
Analysis of Financial Condition and Results of Operations in this Quarterly
Report and the factors set forth under Item 7. Managements Discussion and
Analysis of Financial Condition and Results of Operations  Risk Factors in
the Companys Annual Report on Form 10-K for the year ended December 31, 2001,
which factors are filed with this report as Exhibit 99 and incorporated herein
by reference. In addition, any forward-looking statements represent Penwests
estimates only as of the date this Quarterly Report is first filed with the
Securities and Exchange Commission and should not be relied upon as
representing Penwests estimates as of any subsequent date. We do not assume
any obligation to update any forward-looking statements.




ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

MARKET RISK AND RISK MANAGEMENT POLICIES

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

The primary objectives for the Companys investment portfolio are
liquidity and safety of principal. Investments are made to achieve the highest
rate of return to the Company, consistent with these two objectives. The
Companys investment policy limits investments to certain types of instruments
issued by institutions with investment grade credit ratings and places
restrictions on maturities and concentration by issuer. Marketable securities
consist of corporate debt and approximated $7.3 million at March 31, 2002.
These securities have contractual maturity dates of up to two years. Due to the
relatively short-term maturities of these securities, management believes there
is no significant market risk. At March 31, 2002, market values approximated
carrying values. At March 31, 2002, the Company had approximately $22.5 million
in cash, cash equivalents and investments in marketable securities, and
accordingly, a sustained decrease in the rate of interest earned of 1% would
cause a decrease in the annual amount of interest earned of up to approximately
$225,000.

The Company has a revolving line of credit with a financial institution
which bears interest at a specified banks prime rate plus 1% per annum (5.75%
at March 31, 2002) on the greater of $3.0 million or on the average outstanding
balance. At March 31, 2002, there was approximately $2.8 million outstanding
under the line and, accordingly, a sustained increase in the interest rate of
1% would cause increased annual interest expense of approximately $30,000.

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. Where practical, the Company seeks to manage
expected local currency revenues in relation to local currency costs, and
manage local currency assets in relation to local currency liabilities. The
Company does not believe that the potential exposure is significant
in light of
the size of the Company and its business. The effect of an immediate 10% change
in exchange rates would not have a material effect on the Companys results of
operations, financial position or cash flows.

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PART II  OTHER INFORMATION




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



|a. |  | Exhibits.
|-- |  | ---------



| |  |                                                                                                                                                                 
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | See exhibit index below for a list of the exhibits filed as part of
this Quarterly Report on Form 10-Q, which exhibit
index is incorporated herein by reference.



|b. |  | Reports on Form 8-K.
|-- |  | --------------------



| |  |                                                                                                                                 
| |  | --------------------------------------------------------------------------------------------------------------------------------
| |  | On March 12, 2002, the Company filed a report on Form 8-K announcing
its results for the fourth quarter ended December 31, 2001.

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SIGNATURE

Pursuant to the requirements 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.

|      |  |              |  |                                                                                                         
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|      |  |              |  | PENWEST PHARMACEUTICALS CO                                                                              
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|Date: |  | May 13, 2002 |  | -s- Jennifer L. Good                                                                                    
|      |  |              |  |                                                                                                         
|      |  |              |  | Jennifer L. GoodSenior Vice President, Finance and
Chief Financial Officer
(Principal Financial Officer)

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EXHIBIT INDEX

|               |  |                                                                                                                                                                                                                                                                                                  
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                                                                                                                      
|               |  |                                                                                                                                                                                                                                                                                                  
|10.1           |  | Royalty Agreement dated September 25, 1992 between the
Company and John N. Staniforth                                                                                                                                                                                                            
|              
|10.2           |  | Confidentiality, Consulting and Noncompetition Agreement
dated September 25, 1992 between the Company and John N.
Staniforth                                                                                                                                                                     
|              
|99             |  | Pages 23 through 30 of the Companys Annual Report on Form
10-K for the year ended December 31, 2001, as filed with
the Securities and Exchange Commission on April 1, 2002
(which is not deemed filed except to the extent that
portions thereof are expressly incorporated by reference
herein)

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