##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-Q

|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | QUARTERLY REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|  
|   |  | For the quarterly period ended June 30,
    2003                                            
|  
|or
|  
|o  |  | 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)


|                                                                                                      |  |                                     
|----------------------------------------------------------------------------------------------------- |  | ------------------------------------
|Washington                                                                                            |  | 91-1513032                          
|(State of Incorporation)                                                                              |  | (I.R.S. Employer Identification No.)
|                                                                                                     
|39 Old Ridgebury Road, Suite 11,
    Danbury, Connecticut(Address of principal executive
    offices) |  | 06810-5120(Zip Code)                

(877) 736-9378

(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 þ          No o

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

Indicate the number of shares outstanding of each
of the issuers classes of common stock, as of
August 7, 2003.

|                              |  |            
|----------------------------- |  | -----------
|Class                         |  | Outstanding
|                              |  |            
|Common stock, par value $.001 |  | 18,167,311 



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TABLE OF CONTENTS



|                                                                            |                                                                                               |  |  |  |  |  |  | 
|--------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I -- FINANCIAL INFORMATION                                            
|                                                                            | Item 1. Financial Statements                                                                 
|CONDENSED CONSOLIDATED BALANCE SHEETS                                      
|CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                            
|PENWEST PHARMACEUTICALS CO. 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                           
|                                                                            | Item 4. Controls and Procedures                                                              
|PART II -- OTHER INFORMATION                                               
|                                                                            | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                                                                            | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURE                                                                  
|EXHIBIT INDEX                                                              
|EX-31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER                           
|EX-31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER                           
|EX-32.1 CERTIFICATION TO SECT. 906 (CEO)                                   
|EX-32.2 CERTIFICATION TO SECT. 906 (CFO)                                   



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##### Table of Contents



PENWEST PHARMACEUTICALS CO.

TABLE OF CONTENTS

|                                   |  |                                                                                           |    |      |    | 
|---------------------------------- |  | ----------------------------------------------------------------------------------------- | -- | ---- | -- | 
|                                   |  |                                                                                           |    | Page
|                                   |  |                                                                                           |    |     
|PART I  FINANCIAL
    INFORMATION
|Item 1.                            |  | Condensed Consolidated Financial Statements
    (Unaudited)                               |    |      | 2  | 
|                                   |  | Condensed Consolidated Balance Sheets                                                     |    |      | 2  | 
|                                   |  | Condensed Consolidated Statements of Operations                                           |    |      | 3  | 
|                                   |  | Condensed Consolidated Statements of Cash Flows                                           |    |      | 5  | 
|                                   |  | Notes to Condensed Consolidated Financial
    Statements                                  |    |      | 6  | 
|Item 2.                            |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations |    |      | 12 | 
|Item 3.                            |  | Quantitative and Qualitative Disclosures About
    Market Risk                            |    |      | 27 | 
|Item 4.                            |  | Controls and Procedures                                                                   |    |      | 27 | 
|PART II  OTHER
    INFORMATION   
|Item 4.                            |  | Submission of Matters to a Vote of Security
    Holders                                   |    |      | 28 | 
|Item 6.                            |  | Exhibits and Reports on Form 8-K                                                          |    |      | 28 | 
|Signature                          |  |                                                                                           | 29 |     
|Exhibit Index                      |  |                                                                                           | 30 |     

1



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##### Table of Contents






PART I  FINANCIAL
INFORMATION






|        |                     
|------- | --------------------
|Item 1. | Financial Statements

PENWEST PHARMACEUTICALS CO.






CONDENSED CONSOLIDATED BALANCE
SHEETS


|                       |                                                                                                                                                                               |                                            |       |              |        |  |       |         |        | 
|---------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | ------------ | ------ |  | ----- | ------- | ------ | 
|                       |                                                                                                                                                                               | June 30,                                   |       | December 31,
|                       |                                                                                                                                                                               | 2003                                       |       | 2002        
|                       |                                                                                                                                                                               |                                            |       |             
|                       |                                                                                                                                                                               | (Unaudited)                                |       | (Note 2)    
|                       |                                                                                                                                                                               |                                           
|                       |                                                                                                                                                                               | (In thousands,                            
|                       |                                                                                                                                                                               | except share amounts)                     
|ASSETS                
|Current assets:        |                                                                                                                                                                               |                                            |       |              |        |  |       |        
|                       | Cash and cash equivalents                                                                                                                                                     |                                            | $     | 15,639       |        |  | $     | 1,629   |       
|                       | Marketable securities                                                                                                                                                         |                                            |       | 10,193       |        |  |       | 2,057   |       
|                       | Trade accounts receivable                                                                                                                                                     |                                            |       | 1,250        |        |  |       | 1,078   |       
|                       | Inventories:                                                                                                                                                                  |                                            |       |              |        |  |       |         |       
|                       |                                                                                                                                                                               | Raw materials and other                    |       |              | 372    |  |       |         | 149    | 
|                       |                                                                                                                                                                               | Finished goods                             |       |              | 370    |  |       |         | 312    | 
|                       |                                                                                                                                                                               |                                            |       |              |        |  |       |        
|                       |                                                                                                                                                                               |                                            | 742   |              |        |  | 461   |        
|                       | Prepaid expenses and other current assets                                                                                                                                     |                                            |       | 756          |        |  |       | 1,902   |       
|                       | Deferred transaction costs                                                                                                                                                    |                                            |       |             |        |  |       | 1,741   |       
|                       | Note receivable                                                                                                                                                               |                                            |       | 1,250        |        |  |       |        |       
|                       | Assets held for sale                                                                                                                                                          |                                            |       |             |        |  |       | 33,143  |       
|                       |                                                                                                                                                                               |                                            |       |              |        |  |       |        
|                       |                                                                                                                                                                               | Total current assets                       |       |              | 29,830 |  |       |         | 42,011 | 
|Fixed assets, net      |                                                                                                                                                                               |                                            | 2,759 |              |        |  | 2,406 |        
|Intangible assets, net |                                                                                                                                                                               |                                            | 3,230 |              |        |  | 2,947 |        
|Other assets           |                                                                                                                                                                               |                                            | 2,938 |              |        |  | 2,856 |        
|                       |                                                                                                                                                                               |                                            |       |              |        |  |       |        
|                       |                                                                                                                                                                               | Total assets                               |       | $            | 38,757 |  |       | $       | 50,220 | 
|                       |                                                                                                                                                                               |                                            |       |              |        |  |       |        
|Current liabilities:   |                                                                                                                                                                               |                                            |       |              |        |  |       |        
|                       | Accounts payable                                                                                                                                                              |                                            | $     | 726          |        |  | $     | 880     |       
|                       | Accrued expenses                                                                                                                                                              |                                            |       | 1,806        |        |  |       | 2,886   |       
|                       | Accrued development costs                                                                                                                                                     |                                            |       | 2,817        |        |  |       | 2,785   |       
|                       | Taxes payable                                                                                                                                                                 |                                            |       | 349          |        |  |       | 258     |       
|                       | Loans and notes payable                                                                                                                                                       |                                            |       |             |        |  |       | 5,693   |       
|                       | Deferred revenue                                                                                                                                                              |                                            |       |             |        |  |       | 150     |       
|                       | Liabilities held for sale                                                                                                                                                     |                                            |       |             |        |  |       | 3,004   |       
|                       |                                                                                                                                                                               |                                            |       |              |        |  |       |        
|                       |                                                                                                                                                                               | Total current liabilities                  |       |              | 5,698  |  |       |         | 15,656 | 
|Deferred income taxes  |                                                                                                                                                                               |                                            | 118   |              |        |  | 118   |        
|Deferred revenue       |                                                                                                                                                                               |                                            | 121   |              |        |  | 134   |        
|Deferred compensation  |                                                                                                                                                                               |                                            | 2,938 |              |        |  | 2,889 |        
|                       |                                                                                                                                                                               |                                            |       |              |        |  |       |        
|                       |                                                                                                                                                                               | Total liabilities                          |       |              | 8,875  |  |       |         | 18,797 | 
|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 15,632,809 shares at
    June 30, 2003 and 15,506,259 shares at December 31,
    2002 |                                            |       | 16           |        |  |       | 16      |       
|                       | Additional paid in capital                                                                                                                                                    |                                            |       | 110,991      |        |  |       | 110,000 |       
|                       | Accumulated deficit                                                                                                                                                           |                                            |       | (81,134      | )      |  |       | (78,025 | )     
|                       | Accumulated other comprehensive income (loss)                                                                                                                                 |                                            |       | 9            |        |  |       | (568    | )     
|                       |                                                                                                                                                                               |                                            |       |              |        |  |       |        
|                       |                                                                                                                                                                               | Total shareholders equity                 |       |              | 29,882 |  |       |         | 31,423 | 
|                       |                                                                                                                                                                               |                                            |       |              |        |  |       |        
|                       |                                                                                                                                                                               | Total liabilities and shareholders equity |       | $            | 38,757 |  |       | $       | 50,220 | 
|                       |                                                                                                                                                                               |                                            |       |              |        |  |       |        

See accompanying notes to condensed consolidated
financial statements.

2



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PENWEST PHARMACEUTICALS CO.






CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS


|                                                                                             |                                     |                          |              |       |       |       |        |       |       |       | 
|-------------------------------------------------------------------------------------------- | ----------------------------------- | ------------------------ | ------------ | ----- | ----- | ----- | ------ | ----- | ----- | ----- | 
|                                                                                             |                                     |                         
|                                                                                             |                                     | Three Months Ended      
|                                                                                             |                                     | June 30,                
|                                                                                             |                                     |                         
|                                                                                             |                                     | 2003                     |              | 2002 
|                                                                                             |                                     |                          |              |      
|                                                                                             |                                     |                         
|                                                                                             |                                     | (Unaudited)             
|                                                                                             |                                     | (In thousands,          
|                                                                                             |                                     | except per share data)  
|Revenues                                                                                     |                                     |                          |              |       |       |       |        |      
|                                                                                             | Product sales                       |                          | $            | 230   |       |       | $      | 75    |      
|                                                                                             | Royalties and licensing fees        |                          |              | 1,019 |       |       |        | 1,193 |      
|                                                                                             |                                     |                          |              |       |       |       |        |      
|                                                                                             |                                     | Total revenues           |              |       | 1,249 |       |        |       | 1,268 |      
|Cost of revenues                                                                             |                                     |                          | 63           |       |       |       | 35     |      
|                                                                                             |                                     |                          |              |       |       |       |        |      
|                                                                                             |                                     |                          | Gross profit |       |       | 1,186 |        |       |       | 1,233 | 
|Operating expenses                                                                           |                                     |                          |              |       |       |       |        |      
|                                                                                             | Selling, general and administrative |                          |              | 3,226 |       |       |        | 1,954 |      
|                                                                                             | Research and product development    |                          |              | 5,559 |       |       |        | 5,353 |      
|                                                                                             |                                     |                          |              |       |       |       |        |      
|                                                                                             |                                     | Total operating expenses |              |       | 8,785 |       |        |       | 7,307 |      
|                                                                                             |                                     |                          |              |       |       |       |        |      
|Operating loss from continuing operations                                                    |                                     |                          | (7,599       | )     |       |       | (6,074 | )    
|Investment income                                                                            |                                     |                          | 79           |       |       |       | 112    |      
|Interest expense                                                                             |                                     |                          | 2            |       |       |       | 62     |      
|                                                                                             |                                     |                          |              |       |       |       |        |      
|Loss from continuing operations before income
    taxes                                      |                                     |                          | (7,522       | )     |       |       | (6,024 | )    
|Income tax expense                                                                           |                                     |                          |             |       |       |       |       |      
|                                                                                             |                                     |                          |              |       |       |       |        |      
|Loss from continuing operations                                                              |                                     |                          | (7,522       | )     |       |       | (6,024 | )    
|Earnings from discontinued operations, net of tax
    expense of $80                         |                                     |                          |             |       |       |       | 706    |      
|Working capital adjustment on sale of
    discontinued operations, net of tax benefit of $11 |                                     |                          | (83          | )     |       |       |       |      
|                                                                                             |                                     |                          |              |       |       |       |        |      
|Net loss                                                                                     |                                     | $                        | (7,605       | )     |       | $     | (5,318 | )    
|                                                                                             |                                     |                          |              |       |       |       |        |      
|Basic and diluted (loss) earnings per common
    share:                                      |                                     |                          |              |       |       |       |        |      
|                                                                                             | Continuing operations               |                          | $            | (0.48 | )     |       | $      | (0.39 | )    
|                                                                                             | Discontinued operations             |                          |              | (0.01 | )     |       |        | 0.05  |      
|                                                                                             |                                     |                          |              |       |       |       |        |      
|Net loss per common share                                                                    |                                     | $                        | (0.49        | )     |       | $     | (0.34  | )    
|                                                                                             |                                     |                          |              |       |       |       |        |      
|Weighted average shares of common stock
    outstanding                                      |                                     |                          | 15,572       |       |       |       | 15,466 |      
|                                                                                             |                                     |                          |              |       |       |       |        |      

See accompanying notes to condensed consolidated
financial statements.

3



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PENWEST PHARMACEUTICALS CO.

CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                                              |                                     |                          |              |       |        |       |         |       |        |       | 
|----------------------------------------------------------------------------- | ----------------------------------- | ------------------------ | ------------ | ----- | ------ | ----- | ------- | ----- | ------ | ----- | 
|                                                                              |                                     |                         
|                                                                              |                                     | Six Months Ended        
|                                                                              |                                     | June 30,                
|                                                                              |                                     |                         
|                                                                              |                                     | 2003                     |              | 2002 
|                                                                              |                                     |                          |              |      
|                                                                              |                                     |                         
|                                                                              |                                     | (Unaudited)             
|                                                                              |                                     | (In thousands,          
|                                                                              |                                     | except per share data)  
|Revenues                                                                      |                                     |                          |              |       |        |       |         |      
|                                                                              | Product sales                       |                          | $            | 455   |        |       | $       | 150   |       
|                                                                              | Royalties and licensing fees        |                          |              | 1,966 |        |       |         | 2,233 |       
|                                                                              |                                     |                          |              |       |        |       |         |      
|                                                                              |                                     | Total revenues           |              |       | 2,421  |       |         |       | 2,383  |      
|Cost of revenues                                                              |                                     |                          | 144          |       |        |       | 61      |      
|                                                                              |                                     |                          |              |       |        |       |         |      
|                                                                              |                                     |                          | Gross profit |       |        | 2,277 |         |       |        | 2,322 | 
|Operating expenses                                                            |                                     |                          |              |       |        |       |         |      
|                                                                              | Selling, general and administrative |                          |              | 5,530 |        |       |         | 3,483 |       
|                                                                              | Research and product development    |                          |              | 9,142 |        |       |         | 9,804 |       
|                                                                              |                                     |                          |              |       |        |       |         |      
|                                                                              |                                     | Total operating expenses |              |       | 14,672 |       |         |       | 13,287 |      
|                                                                              |                                     |                          |              |       |        |       |         |      
|Operating loss from continuing operations                                     |                                     |                          | (12,395      | )     |        |       | (10,965 | )    
|Investment income                                                             |                                     |                          | 120          |       |        |       | 242     |      
|Interest expense                                                              |                                     |                          | 34           |       |        |       | 120     |      
|                                                                              |                                     |                          |              |       |        |       |         |      
|Loss from continuing operations before income
    taxes                       |                                     |                          | (12,309      | )     |        |       | (10,843 | )    
|Income tax expense                                                            |                                     |                          |             |       |        |       |        |      
|                                                                              |                                     |                          |              |       |        |       |         |      
|Loss from continuing operations                                               |                                     |                          | (12,309      | )     |        |       | (10,843 | )    
|Earnings from discontinued operations, net of tax
    expense of $26 and $221 |                                     |                          | 177          |       |        |       | 1,207   |      
|Gain on sale of discontinued operations, net of
    tax expense of $51        |                                     |                          | 9,497        |       |        |       |        |      
|                                                                              |                                     |                          |              |       |        |       |         |      
|Net loss                                                                      |                                     | $                        | (2,635       | )     |        | $     | (9,636  | )    
|                                                                              |                                     |                          |              |       |        |       |         |      
|Basic and diluted (loss) earnings per common
    share:                       |                                     |                          |              |       |        |       |         |      
|                                                                              | Continuing operations               |                          | $            | (0.79 | )      |       | $       | (0.70 | )     
|                                                                              | Discontinued operations             |                          |              | 0.62  |        |       |         | 0.08  |       
|                                                                              |                                     |                          |              |       |        |       |         |      
|Net loss per common share                                                     |                                     | $                        | (0.17        | )     |        | $     | (0.62   | )    
|                                                                              |                                     |                          |              |       |        |       |         |      
|Weighted average shares of common stock
    outstanding                       |                                     |                          | 15,540       |       |        |       | 15,432  |      
|                                                                              |                                     |                          |              |       |        |       |         |      

See accompanying notes to condensed consolidated
financial statements.

4



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PENWEST PHARMACEUTICALS CO.

CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                                            |                                                                                                                                 |                  |         |        |   |   |         |         |  
|------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------- | ---------------- | ------- | ------ | - | - | ------- | ------- | -
|                                                                                            |                                                                                                                                 |                 
|                                                                                            |                                                                                                                                 | Six Months Ended
|                                                                                            |                                                                                                                                 | June 30,        
|                                                                                            |                                                                                                                                 |                 
|                                                                                            |                                                                                                                                 | 2003             |         | 2002  
|                                                                                            |                                                                                                                                 |                  |         |       
|                                                                                            |                                                                                                                                 |                 
|                                                                                            |                                                                                                                                 | (Unaudited)     
|                                                                                            |                                                                                                                                 |                 
|                                                                                            |                                                                                                                                 | (In thousands)  
|Net cash used in operating activities:                                                      |                                                                                                                                 |                  |         |        |   |   |         |        
|Net loss                                                                                    |                                                                                                                                 | $                | (2,635  | )      |   | $ | (9,636  | )      
|Less earnings from discontinued operations, net
    of tax                                  |                                                                                                                                 |                  | (177    | )      |   |   | (1,207  | )      
|Less gain on sale of discontinued operations, net
    of tax                                |                                                                                                                                 |                  | (9,497  | )      |   |   |        |        
|                                                                                            |                                                                                                                                 |                  |         |        |   |   |         |        
|Loss from continuing operations                                                             |                                                                                                                                 |                  | (12,309 | )      |   |   | (10,843 | )      
|                                                                                            | Adjustments to reconcile loss from continuing
    operations to net cash used in continuing operations operating
    activities |                  |         | 225    |   |   |         | 1,421   |  
|                                                                                            |                                                                                                                                 |                  |         |        |   |   |         |        
|Net cash used in continuing operations operating
    activities                             |                                                                                                                                 |                  | (12,084 | )      |   |   | (9,422  | )      
|Net cash provided by discontinued operations
    operating activities                       |                                                                                                                                 |                  | 874     |        |   |   | 225     |        
|                                                                                            |                                                                                                                                 |                  |         |        |   |   |         |        
|Net cash used in operating activities                                                       |                                                                                                                                 |                  | (11,210 | )      |   |   | (9,197  | )      
|Investing activities:                                                                       |                                                                                                                                 |                  |         |        |   |   |         |        
|                                                                                            | Proceeds from sale of discontinued operations,
    net of transaction costs paid of $1,351.                                     |                  |         | 36,900 |   |   |         |        |  
|                                                                                            | Acquisitions of fixed assets, net                                                                                               |                  |         | (635   | ) |   |         | (103    | )
|                                                                                            | Intangible asset costs                                                                                                          |                  |         | (386   | ) |   |         | (357    | )
|                                                                                            | Proceeds from maturities of marketable securities                                                                               |                  |         | 1,000  |   |   |         | 3,250   |  
|                                                                                            | Purchases of marketable securities                                                                                              |                  |         | (9,035 | ) |   |         |        |  
|                                                                                            |                                                                                                                                 |                  |         |        |   |   |         |        
|Net cash provided by continuing operations
    investing activities                         |                                                                                                                                 |                  | 27,844  |        |   |   | 2,790   |        
|Net cash used in discontinued operations
    investing activities                           |                                                                                                                                 |                  | (97     | )      |   |   | (308    | )      
|                                                                                            |                                                                                                                                 |                  |         |        |   |   |         |        
|Net cash provided by investing activities                                                   |                                                                                                                                 |                  | 27,747  |        |   |   | 2,482   |        
|Financing activities:                                                                       |                                                                                                                                 |                  |         |        |   |   |         |        
|                                                                                            | Proceeds from loans                                                                                                             |                  |         | 1,354  |   |   |         | 12,284  |  
|                                                                                            | Repayments of loans                                                                                                             |                  |         | (7,047 | ) |   |         | (12,115 | )
|                                                                                            | Issuance of common stock, net                                                                                                   |                  |         | 885    |   |   |         | 1,715   |  
|                                                                                            | Net cash provided by discontinued operations                                                                                    |                  |         | 2,249  |   |   |         |        |  
|                                                                                            |                                                                                                                                 |                  |         |        |   |   |         |        
|Net cash (used in) provided by financing
    activities                                     |                                                                                                                                 |                  | (2,559  | )      |   |   | 1,884   |        
|Effect of exchange rate changes on cash and cash
    equivalents of discontinued operations |                                                                                                                                 |                  | 32      |        |   |   | (30     | )      
|                                                                                            |                                                                                                                                 |                  |         |        |   |   |         |        
|Net increase (decrease) in cash and cash
    equivalents                                    |                                                                                                                                 |                  | 14,010  |        |   |   | (4,861  | )      
|Cash and cash equivalents at beginning of period                                            |                                                                                                                                 |                  | 1,629   |        |   |   | 11,530  |        
|                                                                                            |                                                                                                                                 |                  |         |        |   |   |         |        
|Cash and cash equivalents at end of period                                                  |                                                                                                                                 | $                | 15,639  |        |   | $ | 6,669   |        
|                                                                                            |                                                                                                                                 |                  |         |        |   |   |         |        

See accompanying notes to condensed consolidated
financial statements.

5



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PENWEST PHARMACEUTICALS CO.






NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS


(Unaudited)


1.     Business

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

Prior to February 27, 2003, Penwest also
developed, manufactured and distributed branded pharmaceutical
excipients, which are the inactive ingredients in tablets and
capsules, primarily consisting of binders, disintegrants and
lubricants. On February 27, 2003, Penwest sold
substantially all of the assets used in the Companys
excipient business (the Asset Sale) to subsidiaries
and affiliates of Josef Rettenmaier Holding GmbH & Co.
KG. The Company received $39.5 million in cash and a
promissory note for $2.25 million in consideration for the
excipient business. The Company used approximately $5.5 million
of proceeds of the sale of its excipient business to repay debt
(see Note 5) and intends to use the balance of the proceeds to
expand its drug delivery business. Commencing in the first
quarter of 2003, the Company has reported the operating results
of the excipient business as a discontinued operation (see
Note 8).

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, competition from current and potential competitors,
some with greater resources than the Company and a requirement
for additional funding.

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 and six month periods ended
June 30, 2003 are not necessarily indicative of the results
that may be expected for the year ending December 31, 2003.
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, 2002.

During the quarter ended March 31, 2003, the
Company recorded an impairment loss of approximately $214,000,
net of accumulated depreciation, relating to equipment of its
excipient business. The impaired equipment primarily related to
a pulp shredding transfer system which did not function as
planned, resulting in the eventual abandonment of the related
project and full write-down of its carrying value. This
impairment loss is included in earnings from discontinued
operations in the six months ended June 30, 2003 condensed
consolidated statements of operations.

As a result of the Asset Sale, the operating
results of the excipient business have been presented as
discontinued operations in the condensed consolidated statements
of operations for the three and six month periods ended
June 30, 2003 and 2002 (see Note 8). In order to
conform to the current period presentation, certain
reclassifications have been made in the prior period financial
statements.

The balance sheet at December 31, 2002,
presented with reclassifications made for the Asset Sale, has
been derived from the audited financial statements at that date
but does not include all of the information and

6



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PENWEST PHARMACEUTICALS CO.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

footnotes required by accounting principles
generally accepted in the United States for complete financial
statements.

3.     Summary of
Significant Accounting Policies



| |                    
| | -------------------
| | Revenue Recognition

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



| |              
| | -------------
| | Stock Options

The Company adopted the disclosure provisions of
Statement of Financial Accounting Standards (SFAS)
No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, which
amends SFAS No. 123, Accounting for Stock-Based
Compensation, in 2002. SFAS No. 148 provides
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation, which was originally provided under SFAS
No. 123. The Statement also improves the timeliness of
disclosures by requiring the information to be included in
interim as well as annual financial statements. The adoption of
these disclosure provisions had no impact on the Companys
2003 consolidated results of operations, financial position or
cash flows.

At June 30, 2003, the Company maintained two
stock-based employee compensation plans. The Company accounts
for these employee stock compensation plans in accordance with
the intrinsic value-based method prescribed by Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees. During the quarter ended
June 30, 2003, the Company recorded $106,000 in
compensation expense (no related tax effect) in connection with
the acceleration of the vesting date of certain stock options.
No other stock-based employee compensation expense is reflected
in net loss as all options granted under these plans had an
exercise price equal to the fair market value of the underlying
common stock on the date of grant.

Consistent with the method described in SFAS
No. 123, if compensation expense for the Companys
plans had been determined based on the fair value at the grant
dates for awards under its plans, net loss and

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PENWEST PHARMACEUTICALS CO.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

loss per share would have been increased to the
pro forma amounts indicated below (in thousands, except per
share data):

|                                                        |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |         |  
|------------------------------------------------------- |  | ------------------ | ------ | ---------------- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                        |  |                    |        |                 
|                                                        |  | Three Months Ended |        | Six Months Ended
|                                                        |  | June 30,           |        | June 30,        
|                                                        |  |                    |        |                 
|                                                        |  | 2003               |        | 2002             |  | 2003 |        | 2002
|                                                        |  |                    |        |                  |  |      |        |     
|                                                        |  |                    |        |                 
|                                                        |  | (Unaudited)        |        | (Unaudited)     
|Net loss  as reported                                  |  | $                  | (7,605 | )                |  | $    | (5,318 | )    |  | $ | (2,635 | ) |  | $ | (9,636  | )
|Net loss  pro forma                                    |  | $                  | (7,636 | )                |  | $    | (5,464 | )    |  | $ | (4,003 | ) |  | $ | (10,842 | )
|Net loss per share, basic and diluted 
    as reported |  | $                  | (0.49  | )                |  | $    | (0.34  | )    |  | $ | (0.17  | ) |  | $ | (0.62   | )
|Net loss per share, basic and diluted 
    pro forma   |  | $                  | (0.49  | )                |  | $    | (0.35  | )    |  | $ | (0.26  | ) |  | $ | (0.70   | )

4.     Recent
Accounting Pronouncements

In November 2002, the Emerging Issues Task Force
(EITF) finalized its tentative consensus on EITF
Issue 00-21, Revenue Arrangements with Multiple
Deliverables, which provides guidance on the timing and
method of revenue recognition for arrangements that include the
delivery of more than one product or service. EITF 00-21 is
effective prospectively for arrangements entered into in fiscal
periods beginning after June 15, 2003. The adoption of
EITF 00-21 is not expected to have a material effect on the
Companys financial position or results of operations.

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

5.     Loans and
Notes Payable



| |                  
| | -----------------
| | Credit Facilities

On January 17, 2001, the Company completed
arrangements for a revolving line of credit
(Revolver) with a financial institution. Under the
terms of the Revolver, the Company could 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, were included in the borrowing base. Amounts
outstanding under the Revolver were collateralized by the
Companys U.S. and Canadian accounts receivable, and its
inventory and general intangibles. The Revolver had an initial
term of three years, and provided for annual renewals
thereafter. On February 27, 2003, the Company paid off the
outstanding balance of $3.3 million and terminated the
Revolver in connection with the Asset Sale (see Note 8).



| |                                   
| | ----------------------------------
| | Note Payable to AstraZeneca
    AB

On October 25, 2002, the Company entered
into an agreement with AstraZeneca AB to acquire from
AstraZeneca AB assets related to the excipient product, Pruv,
including trademarks and other intellectual property, for a
total purchase price of $3 million. Pursuant to this
agreement, the Company issued a note to AstraZeneca AB in the
principal amount of $2.25 million. Under the agreement, the
note required the Company to pay all indebtedness outstanding
under the note upon the closing of the Asset Sale. As a result,
the note was paid in full in February 2003 in connection with
the Asset Sale (see Note 8).



| |                                         
| | ----------------------------------------
| | Business Insurance Premium
    Financing

On September 24, 2002, the Company entered
into a Premium Finance Agreement (the Finance
Agreement) through which it financed approximated
$1.1 million of premiums payable in connection with the
annual renewal of its general business insurance. Under the
Finance Agreement, Penwest was required to

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PENWEST PHARMACEUTICALS CO.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

repay the amount financed in equal monthly
installments through June 2003, plus interest at a rate of 3.11%
per annum. In addition, the Company assigned, as a security
interest, any and all unearned premiums or other amounts which
may become payable to the Company under the insurance policies.
The amount financed under the Finance Agreement was paid in full
in May 2003.

6.     Income
Taxes

For continuing operations, the effective tax
rates for the quarters and six months ended June 30, 2003
and 2002, were zero. The effective tax rates are higher than the
federal statutory rate of a 34% benefit due to valuation
allowances recorded to offset deferred tax assets relating to
the Companys net operating losses.

In the quarter ended June 30, 2003, the
Company recorded a working capital adjustment to the gain on
sale of discontinued operations of $83,000 (expense), which is
net of a tax benefit of $11,000. The gain on sale of
discontinued operations of approximately $9.5 million,
recorded in the six months ended June 30, 2003, is net of
tax expense of $51,000, or less than 1% of the pretax gain. The
tax expense is lower than the federal statutory rate of 34%
primarily due to net operating losses which offset the gain. In
addition, earnings from discontinued operations of $177,000 and
$1,207,000, respectively, for the six months ended June 30,
2003 and June 30, 2002, are net of tax expenses of $26,000
and $221,000, respectively, or 13% and 15% of pretax earnings,
respectively. These tax expenses, which include foreign taxes,
are lower than the federal statutory rate of 34% primarily due
to overall U.S. net operating losses which offset the
U.S. earnings of the discontinued operation (see
Note 8).

7.     Comprehensive
Loss

The components of comprehensive loss for the
three and six months ended June 30, 2003 and 2002 are as
follows (in thousands):

|                                                            |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  
|----------------------------------------------------------- |  | ------------------ | ------ | ---------------- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                            |  |                    |        |                 
|                                                            |  | Three Months Ended |        | Six Months Ended
|                                                            |  | June 30,           |        | June 30,        
|                                                            |  |                    |        |                 
|                                                            |  | 2003               |        | 2002             |  | 2003 |        | 2002
|                                                            |  |                    |        |                  |  |      |        |     
|                                                            |  |                    |        |                 
|                                                            |  | (Unaudited)        |        | (Unaudited)     
|Net loss                                                    |  | $                  | (7,605 | )                |  | $    | (5,318 | )    |  | $ | (2,635 | ) |  | $ | (9,636 | )
|Foreign currency translation adjustments                    |  |                    |       |                  |  |      | 722    |      |  |   | 109    |   |  |   | 608    |  
|Change in unrealized net gains on marketable
    securities |  |                    | (6     | )                |  |      | 26     |      |  |   | (6     | ) |  |   | 9      |  
|                                                            |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  
|Comprehensive loss                                          |  | $                  | (7,611 | )                |  | $    | (4,570 | )    |  | $ | (2,532 | ) |  | $ | (9,019 | )
|                                                            |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  

Accumulated other comprehensive income
(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. Effective on the date of
the Asset Sale, accumulated other comprehensive income
(loss) is comprised solely of unrealized net gains and
losses on marketable securities.

8.     Discontinued
Operations

On February 27, 2003, Penwest sold
substantially all of the assets (the Assets) used in
the Companys excipient business to subsidiaries and
affiliates of Josef Rettenmaier Holding GmbH & Co. KG
(Rettenmaier) for $41.75 million, plus the
assumption of specified liabilities, subject to a working
capital adjustment. The Assets of the excipient business were
sold to Rettenmaier, either directly or through the sale of the
outstanding capital stock of the three subsidiaries of Penwest
that did business in the UK, Germany and Finland. The purchase
price included $39.5 million in cash and a non-interest
bearing promissory note of $2.25 million, with
$1.0 million paid in April 2003 and $1.25 million due
May 25, 2004.

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PENWEST PHARMACEUTICALS CO.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In the first quarter of 2003, the Company
recorded a gain on the Asset Sale of approximately
$9.6 million, net of taxes of $62,000, and has reported the
operating results of the excipient business as a discontinued
operation in accordance with SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. In
the second quarter of 2003, the Company recorded an expense of
$83,000 for the working capital adjustment, net of a tax benefit
of $11,000, for a total gain of $9.5 million, net of tax
expense of $51,000 for the six months ended June 30, 2003.
The net carrying amount of the assets and liabilities on the
date of the Asset Sale was approximately $29.5 million. The
approximate carrying values of the major classes were: property,
plant and equipment of $11.4 million; inventory of
$8.3 million; receivables of $6.0 million; and intangible
assets of $4.3 million offset by other net liabilities. The
Company has presented its December 31, 2002 balance sheet
in the consolidated financial statements to reflect the assets
and liabilities of the excipient business separately as assets
held for sale and liabilities held for sale. The gain on the
Asset Sale is net of transaction related costs totaling
$3.1 million, primarily consisting of professional and
advisory fees. As of December 31, 2002, these costs
approximated $1.7 million and were reflected as deferred
transaction costs on the condensed consolidated balance sheet.
Revenues and pretax profits for the excipient business
approximated $6.1 million and $203,000, respectively, for
the period January 1, 2003 through the Asset Sale date of
February 27, 2003, and approximated $9.0 million and
$786,000, respectively, and $18.2 million and $1.4 million,
respectively, for the quarter and six months ended June 30, 2002.

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

9.     Licensing
Agreements

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

In September 1997, the Company entered into a
strategic alliance agreement with Endo Pharmaceuticals, Inc.
with respect to the development of an extended release
formulation of oxymorphone a narcotic analgesic for the
treatment of moderate to severe pain based on the Companys
TIMERx technology. This agreement was amended and restated in
April 2002. Endo is a fully integrated specialty pharmaceutical
company with a market leadership in pain management. Endo has a
broad product line including 20 branded products that include
the established brands such as Percodan®, Percocet®,
and Lidoderm®. Endo is registered with the U.S. Drug
Enforcement Administration as a developer, manufacturer and
marketer of controlled narcotic substances.

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

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PENWEST PHARMACEUTICALS CO.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

agreed to manufacture and market oxymorphone ER
in the United States. The manufacture and marketing outside of
the United States may be conducted by the Company, Endo or a
third party, as determined by the Alliance Committee.

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

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

10.     Subsequent
Events

On August 5 and August 6, 2003, the
Company completed the sale of a total of 2,507,762 shares
of common stock through a private placement to selected
institutional investors, resulting in gross proceeds to the
Company of $52.7 million, less fees and expenses estimated
to be approximately $3.3 million. In addition, the Company
has granted the institutional investors additional rights to
purchase up to an additional 501,552 shares of common stock
at $26.00 per share. These additional investment rights will
become exercisable 90 days after the closing date or, if
earlier, upon the effectiveness of a registration statement for
the resale of the common stock issued to the investors, and will
expire 60 trading days after the effectiveness of such
registration statement. The Company intends to use the net
proceeds to fund the research, development, marketing and
commercialization of its products and technologies, and for
general corporate purposes.

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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 Risk Factors.

Overview

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

Penwests product portfolio includes four
products utilizing its proprietary controlled release drug
delivery technology that were developed with collaborators and
have been approved in various countries. In addition, the
Company has a number of product candidates in its drug
development pipeline. The most advanced of these is oxymorphone
ER, an extended release formulation of oxymorphone incorporating
TIMERx technology. The Company is developing oxymorphone ER with
Endo. The FDA accepted for filing a new drug application, or
NDA, submitted by Endo for oxymorphone ER in February 2003, and
the FDA is currently reviewing the application. On
March 17, 2003, the Company exercised its right under the
oxymorphone ER agreement and gave Endo notice that it was
discontinuing its participation in the funding of the
development and marketing of oxymorphone ER, effective
April 17, 2003.

Prior to February 27, 2003, Penwest also
developed, manufactured and distributed branded pharmaceutical
excipients, which are the inactive ingredients in tablets and
capsules, primarily consisting of binders, disintegrants and
lubricants. On February 27, 2003, Penwest sold
substantially all of the assets used in the Companys
excipient business to subsidiaries and affiliates of Josef
Rettenmaier Holding GmbH & Co. KG (the Asset
Sale). The Company received $39.5 million in cash and
a promissory note for $2.25 million in consideration for
the excipient business. The Company received $1.0 million
of the $2.25 million promissory note in April 2003 with the
balance due in May 2004. The Company intends to use the proceeds
of the sale of its excipient business to expand its drug
delivery business. Commencing in the first quarter of 2003, the
Company reported the operating results of the excipients
business as a discontinued operation.

On August 5 and August 6, 2003, the Company
completed the sale of a total of 2,507,762 shares of common
stock through a private placement to selected institutional
investors (the Private Placement), resulting in
gross proceeds to the Company of $52.7 million, less fees and
expenses estimated to be approximately $3.3 million. In
addition, the Company has granted the institutional investors
additional rights to purchase up to an additional 501,552 shares
of common stock at $26.00 per share. These additional investment
rights will become exercisable 90 days after the closing
date or, if earlier, upon the effectiveness of a registration
statement for the resale of the common stock issued to the
investors, and will expire 60 trading days after the
effectiveness of such registration statement. The Company
intends to use the net proceeds to fund the research,
development, marketing and commercialization of its products and
technologies, and for general corporate purposes.

The Company has incurred net losses since 1994.
As of June 30, 2003, the Companys accumulated deficit
was approximately $81.1 million. The Company expects
operating losses and negative cash flows to continue until
substantial sales of products commercialized utilizing TIMERx
technology occur. A substantial portion of the Companys
revenues through February 27, 2003 were generated from
sales of the Companys pharmaceutical excipient product
line. The Company expects that the balance of its revenues for
2003 will be generated primarily from Mylan royalties and
shipments of bulk TIMERx. The Companys future
profitability will depend on several factors, including the
successful commercialization of TIMERx controlled release

12



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##### Table of Contents



products, including in particular oxymorphone ER;
the Companys ability to use net proceeds from the Asset
Sale and the Private Placement to expand its drug development
product pipeline; royalties from Mylans sales of
Pfizers 30 mg generic version of Procardia XL; and the
level of the Companys investment in research and
development activities.


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

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

The Companys results of operations may
fluctuate from quarter to quarter depending on the amount and
timing of royalties on Mylans sales of Pfizers 30 mg
generic version of Procardia XL, volume and timing of orders of
formulated bulk TIMERx, 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 product sales and royalty
revenues, competition and regulatory actions.

Critical Accounting Policies and
Estimates

The Companys discussion and analysis of its
financial condition and results of operations are based upon its
condensed consolidated financial statements, which have been
prepared in accordance with accounting principles generally
accepted in the United States. The Companys significant
accounting policies are more fully described in the notes to the
consolidated financial statements in the Companys Annual
Report on Form 10-K for the year ended December 31,
2002. These policies are important to the portrayal of the
Companys financial condition and results of operations.
The preparation of these financial statements requires the
Company to make estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date of the
financial statements 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, deferred taxes-valuation allowance and impairment
of long-lived assets. Actual results could differ materially
from these estimates. For a more detailed explanation of the
judgments made in these areas, refer to Managements
Discussion and Analysis of Financial Condition and Results of
Operations in our Annual Report on Form 10-K for the year
ended December 31, 2002.

Results of Operations  Continuing
Operations

Quarters
Ended June 30, 2003 and 2002

Total revenues for both the second quarter of
2003 and the second quarter of 2002 were $1.2 million.
Sales of formulated bulk TIMERx increased to $230,000 for the
quarter ended June 30, 2003 from $75,000 for the quarter
ended June 30, 2002. The increase in these product sales
was primarily due to the timing of shipments of formulated bulk
TIMERx to customers. Royalties and licensing fees decreased by
$174,000 for

13



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the second quarter of 2003 to $1.0 million
from $1.2 million in the second quarter of 2002, primarily due
to lower royalties from Mylan attributable to Mylans
decreased sales of Pfizers 30 mg generic version of
Procardia XL, due to increased generic competition.


Selling, general and administrative expenses
increased by $1.2 million to $3.2 million for the
second quarter of 2003 from $2.0 million in the second
quarter of 2002. The increase in selling, general and
administrative expenses was primarily due to the Companys
marketing costs for oxymorphone ER which increased in
preparation for product launch, an increase in premiums for
business insurance, increased professional fees associated with
business development and accounting services, and increased
personnel costs primarily associated with the expansion of the
business development and marketing teams. The increase also
reflects certain selling, general and administrative overhead
expenses being fully absorbed in continuing operations during
the quarter ended June 30, 2003, that were previously
allocated between continuing operations and discontinuing
operations for the quarter ended June 30, 2002. The second
quarter of 2003 only includes expenses for oxymorphone ER
through April 17, 2003. No selling, general and
administrative expenses related to oxymorphone are expected to
be incurred during the remainder of 2003, unless the Company
resumes its participation in the funding of the development and
marketing of oxymorphone ER.

Research and product development expenses
increased by $206,000 to $5.6 million for the second quarter of
2003 as compared to $5.4 million in the second quarter of
2002. The Company incurred costs of approximately $635,000 on
the development of oxymorphone ER in the second quarter of 2003.
This was a decrease of approximately $2.3 million from the
second quarter of 2002 due to lower development costs on
oxymorphone ER as clinical activity declined in the second
quarter of 2003 as a result of the submission of the NDA for
oxymorphone ER in December 2002, as well as the fact that the
Company only funded these research and development expenses
through April 17, 2003. Notwithstanding this decrease
relating to oxymorphone ER, total research and development
expenses increased during the period as the Company conducted
clinical trials of several product candidates utilizing TIMERx
technology. The majority of the increase in spending was due to
the scale-up and preparation for clinical trials for the
Companys hypertension product, PW2101 which began dosing
in July 2003. The Company believes these trials will be the
final clinical trials for PW2101 before submission to the FDA
for approval. 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 most advanced of the Companys product
candidates is oxymorphone ER, which the Company is developing
with Endo. Endo, which is responsible for conducting the
clinical trials and seeking regulatory approval of the product,
completed the clinical trials for this product in 2002 and the
FDA accepted for filing the NDA for oxymorphone ER in February
2003. No research and development expenses are expected to be
incurred with respect to oxymorphone ER after April 17,
2003, unless the Company resumes its participation in the
funding of the development and marketing of oxymorphone ER.

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.

For continuing operations, the effective tax
rates for the quarters ended June 30, 2003 and 2002 were
zero. The effective tax rates are higher than the federal
statutory rate of a 34% benefit due to valuation allowances
recorded to offset deferred tax assets relating to the
Companys net operating losses.

Six Months
Ended June 30, 2003 and 2002

Total revenues for the six months ended
June 30, 2003 and June 30, 2002 were
$2.4 million. Product sales increased by $305,000 to
$455,000 for the six months ended June 30, 2003 compared to
$150,000 for the six months ended June 30, 2002. The increase in
product sales was primarily due to the timing of shipments of
formulated bulk TIMERx to customers. Royalties and licensing
revenues decreased by $267,000 to approximately
$2.0 million for the first six months of 2003 as compared
to approximately $2.2 million in the comparable period in
2002, primarily due to lower royalties from Mylan, attributable
to Mylans decreased sales of Pfizers 30 mg generic
version of Procardia XL, due to increased generic competition.

14



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Selling, general and administrative expenses
increased $2.0 million to approximately $5.5 million
for the six months ended June 30, 2003, from $3.5 million
for the six months ended June 30, 2002. This increase is
primarily attributable to an increase in the Companys
share of marketing expenses on oxymorphone ER, and increases in
the cost of business insurance, increased professional fees
associated with business development and accounting services,
and increased personnel costs primarily associated with the
expansion of the business development and marketing teams. The
increase also reflects certain selling, general and
administrative overhead expenses that were incurred subsequent
to February 27, 2003, the date of the Asset Sale, being
fully absorbed in continuing operations for the six months ended
June 30, 2003, that were previously allocated between
continuing operations and discontinuing operations for the six
months ended June 30, 2002. The six months ended
June 30, 2003 only include expenses for oxymorphone ER
through April 17, 2003. No selling, general and
administrative expenses related to oxymorphone are expected to
be incurred during the remainder of 2003, unless the Company
resumes its participation in the funding of the development and
marketing of oxymorphone ER.

Research and development expenses during the six
months ended June 30, 2003 were $9.1 million, compared
to $9.8 million for the comparable period of 2002. This
lower spending is primarily related to a decrease in the
development costs of oxymorphone ER in 2003 compared to the
comparable period of 2002, when several clinical trials were
underway and the Company was participating in the development
costs for the full six months. This decrease was partially
offset by increased development costs on other products in the
Companys development pipeline, primarily on the
Companys hypertension product, PW2101.

For continuing operations, the effective tax
rates for the six months ended June 30, 2003 and 2002 were
zero. The effective tax rates are higher than the federal
statutory rate of a 34% benefit, due to valuation allowances
recorded to offset deferred tax assets relating to the
Companys net operating losses.

The gain on sale of discontinued operations of
approximately $9.5 million, recorded in the six months
ended June 30, 2003, is net of tax expense of $51,000, or
less than 1% of the pretax gain. The tax expense is lower than
the federal statutory rate of 34% primarily due to net operating
losses which offset the gain. In addition, earnings from
discontinued operations of $177,000 and $1,207,000,
respectively, for the six months ended June 30, 2003 and
June 30, 2002, are net of tax expenses of $26,000 and $221,000,
respectively, or 13% and 15% of pretax earnings, respectively.
These tax expenses, which include foreign taxes, are lower than
the federal statutory rate of 34% primarily due to overall U.S.
net operating losses which offset the U.S. earnings of the
discontinued operation.

Liquidity and Capital Resources

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

The Company is a party to an agreement with Endo
with respect to the development of oxymorphone ER. On
April 17, 2003, the Company discontinued its participation
in the funding of the development and marketing of oxymorphone
ER. Accordingly, the Company anticipates its research and
development and selling, and general and administrative expenses
with respect to oxymorphone ER will decrease significantly in
2003 after the first quarter, unless the Company resumes its
participation in the funding of the development and marketing of
oxymorphone ER. The Company anticipates using the funds that
otherwise would have been expended on oxymorphone ER to increase
its investment in the development of additional products
utilizing TIMERx technologies and in research and development
involving new drug delivery technologies.

On February 27, 2003, the Company completed
the sale of its excipient business to Rettenmaier. As a result
of the Asset Sale, the Company had approximately
$35 million of net cash proceeds available after the
closing, which the Company plans to use to fund development of
products in its pipeline as well as the rest of

15



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the Companys operations. However, as a
result of the Asset Sale, the Company no longer derives cash
flow from the sale of excipients. A portion of the proceeds from
the sale of the excipient business was used to pay the
$3.3 million of outstanding borrowings under the
Companys line of credit, which was terminated on
February 27, 2003. In addition, the Company used the
proceeds from the Asset Sale to repay in full a
$2.25 million note payable to AstraZeneca AB, incurred in
connection with the Companys acquisition of certain
intellectual property related to the excipient business.


On August 5 and August 6, 2003, the Company
sold 2,507,762 shares of common stock through the Private
Placement to selected institutional investors, resulting in
gross proceeds to the Company of $52.7 million, less fees
and expenses estimated to be approximately $3.3 million. In
addition, the Company has granted the institutional investors
additional rights to purchase up to an additional 501,552 shares
of common stock at $26.00 per share. These additional investment
rights will become exercisable 90 days after the closing
date or, if earlier, upon the effectiveness of a registration
statement for the resale of the common stock issued to these
investors, and will expire 60 trading days after the
effectiveness of such registration statement.

As of June 30, 2003, the Company had cash,
cash equivalents, and short-term investments of
$25.8 million, which excludes net cash proceeds of
$49.4 million from the Private Placement. The Company has
no committed sources of capital other than Rettenmaiers
commitment to repay the Company pursuant to promissory notes, of
which $1.0 million was received in April 2003 and $1.25
million is due in May 2004, in connection with the sale of the
excipient business.

The Company had negative cash flow from
operations for the six months ended June 30, 2003 of
$11.2 million, primarily due to a loss from continuing
operations of $12.3 million in the period. The Company had
negative cash flow from operations for the six months ended
June 30, 2002 of $9.2 million, primarily due to the loss
from continuing operations of $10.8 million in the period.
Investing activities provided $27.7 million in cash for the
six months ended June 30, 2003, primarily reflecting the
Companys receipt of cash proceeds from the Asset Sale of
$36.9 million, net of transaction costs paid of
$1.4 million. The Company used $2.6 million of cash for
financing activities, primarily with respect to the repayment of
approximately $5.5 million in loans in connection with the
Asset Sale, offset by net cash provided by discontinued
operations of approximately $2.2 million. The Company
expects that its cash flow in 2003 will differ from its cash
flow during 2002 and 2001 because the Company will no longer
derive revenues from sales of its excipient products nor will it
incur expenses in connection with its excipient business, except
for the related revenues and expenses during the period ended
February 26, 2003.

The Company anticipates that its existing capital
resources, including the proceeds from the Private Placement,
and anticipated internally generated funds from the sale of
formulated bulk TIMERx, royalties from Mylan and other payments
from collaborators, will be sufficient to fund our operations
for the foreseeable future if oxymorphone ER is approved by the
FDA during 2004.

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



| |   |                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the ongoing costs under the Companys other
    collaboration agreements;                                                                                                                                                       
|
| |  | whether oxymorphone ER is approved on a timely
    basis or at all;                                                                                                                                                             
|
| |  | whether the Company resumes its participation in
    the funding of the development and marketing of oxymorphone ER;                                                                                                            
|
| |  | the structure of any future collaborative or
    development agreements;                                                                                                                                                        
|
| |  | the progress of the Companys collaborative
    and independent development projects and funding obligations
    with respect to the projects and the related the costs to the
    Company of clinical studies for its products;
|
| |  | the costs and timing of adding drug development
    capabilities;                                                                                                                                                               
|
| |  | royalties received from Mylan;                                                                                                                                                                                                  

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| |   |                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the timing and amount of payments received under
    existing and possible future collaborative agreements, in
    particular oxymorphone ER; and
|
| |  | the prosecution, defense and enforcement of
    potential patent claims and other intellectual property rights.                                  

In addition, if the Companys existing
resources are insufficient to satisfy its need for capital due
to a delay in the approval for oxymorphone ER, lower than
expected revenues from oxymorphone ER or otherwise, or if the
Company acquires additional product candidates or technologies,
the Company may need to sell additional equity or debt
securities or seek additional financing through other
arrangements. Any sale of additional equity or debt securities
may result in additional dilution to the Companys
shareholders, and the Company cannot be certain that additional
public or private financing will be available in amounts or on
terms acceptable to the Company, if at all. If the Company is
unable to obtain this additional financing, the Company may be
required to delay, reduce the scope of, or eliminate one or more
of its planned research, development and commercialization
activities, which could harm its financial condition and
operating results.

Contractual Obligations

The Companys major outstanding contractual
cash obligations relate to its operating leases, primarily for
facilities, and a consulting agreement for an implementation
project relating to its information system. Below is a table
summarizing the Companys contractual obligations and
non-cancelable commercial commitments, including operating
leases having initial lease terms of more than one year, as of
June 30, 2003 (in thousands):

|                 |  |       |       |           |  |       |     |       |  |         |     |  |  |   |   |  |  |   |   | 
|---------------- |  | ----- | ----- | --------- |  | ----- | --- | ----- |  | ------- | --- |  |  | - | - |  |  | - | - | 
|                 |  |       |       | Less than |  | 1-3   |     | 4-5   |  | After 5
|                 |  | Total |       | One Year  |  | Years |     | Years |  | Years  
|                 |  |       |       |           |  |       |     |       |  |        
|Operating Leases |  | $     | 700   |           |  | $     | 283 |       |  | $       | 417 |  |  | $ |  |  |  | $ |  | 
|Other            |  |       | 580   |           |  |       | 580 |       |  |         |    |  |  |   |  |  |  |   |  | 
|                 |  |       |       |           |  |       |     |       |  |         |     |  |  |   |   |  |  |   |   | 
|Total            |  | $     | 1,280 |           |  | $     | 863 |       |  | $       | 417 |  |  | $ |  |  |  | $ |  | 
|                 |  |       |       |           |  |       |     |       |  |         |     |  |  |   |   |  |  |   |   | 

Net Operating Loss Carryforwards

At June 30, 2003, the Company had federal
net operating loss (NOL) carryforwards of
approximately $60.6 million for income tax purposes, of
which approximately $6.2 million, $8.4 million,
$9.1 million, $17.8 million and $19.1 million expire
in 2018, 2019, 2020, 2021 and 2022, respectively. In addition,
the Company had research and development tax credit
carryforwards of approximately $1.4 million of which
$299,000; $306,000 and $777,000 expire in 2019, 2020, and 2021,
respectively. The use of the NOLs and research and development
tax credit carryforwards are limited to future taxable earnings
of the Company. Due to the degree of uncertainty related to the
ultimate realization of such carryforwards, at June 30,
2003, a valuation allowance of approximately $23.3 million
has been recognized to offset net deferred tax assets, primarily
attributable to the NOL carryforward. Utilization of the
operating losses may be subject to a limitation due to the
ownership change provisions of the Internal Revenue Code. The
Company expects to use approximately $1.4 million of NOL
carryforwards (in addition to current year losses) to offset the
Companys taxable capital gains and ordinary income from
the sale of the excipient business.

Forward Looking Statements

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

17



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statements represent our estimates only as of the
date this annual report is filed with the SEC and should not be
relied upon as representing our estimates as of any subsequent
date. We do not assume any obligation to update any
forward-looking statements.


Risk Factors

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



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

We have incurred net losses since 1994, including
net losses of $17.1 million, $16.0 million and
$8.8 million, during 2002, 2001, and 2000, respectively.
For the six months ended June 30, 2003, we had a loss from
continuing operations of $12.3 million, which was partially
offset by income from discontinued operations of $177,000 and a
gain on the sale of the excipient business of $9.5 million.
This resulted in an overall net loss for the six months ended
June 30, 2003 of $2.6 million. As of June 30,
2003, our accumulated deficit was approximately
$81.1 million.

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

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

Our future profitability will depend on several
factors, including:



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

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



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

Many of our TIMERx controlled release products
have been or are being developed and commercialized in
collaboration with pharmaceutical companies. Under these
collaborations, depending on the structure of the collaboration,
we are dependent on our collaborators to fund some portion of
development, to conduct clinical trials, obtain regulatory
approvals for, and manufacture, market and sell products
utilizing our TIMERx controlled release technology. For
instance, we are dependent on Endo to obtain the regulatory
approvals required to market oxymorphone ER and will be
dependent on Endo to manufacture and market oxymorphone ER in
the United States. We are also dependent on Sanofi and Leiras to
manufacture and market

18



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Slofedipine XL and Cystrin CR, respectively. In
addition, we are dependent on Mylan with respect to the
marketing and sale of the 30 mg strength of Pfizers
generic version of Procardia XL.


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

If we cannot maintain our existing collaborations
or establish new collaborations, we would be required to
terminate the commercialization of products or undertake
commercialization activities at our own expense. Moreover, we
have limited experience in conducting full-scale clinical
trials, preparing and submitting regulatory applications and
manufacturing, marketing and selling the pharmaceutical
products. We may not be successful in performing these
activities.

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

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



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



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

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

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

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

In addition to developing controlled release
versions of immediate release products, we also selectively
develop 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

19



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release product and other drugs and technologies
that compete with the branded controlled release product, as
well as the timing of product approval.


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



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

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

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

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

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

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



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



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

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

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



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

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

20



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

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

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

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

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

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

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

21



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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.

We
may require additional funding, which may be difficult to
obtain

As of June 30, 2003, the Company had cash,
cash equivalents, and short-term investments of
$25.8 million, which includes the net cash proceeds from
the sale of the Companys excipient business. In addition,
in August 2003, the Company received $52.7 million less
fees and expenses estimated to be approximately
$3.3 million, from the Private Placement. The Company has
no committed sources of capital other than Rettenmaiers
commitment to repay the Company pursuant to promissory notes, of
which $1.0 million was received in April 2003 and
$1.25 million is due in May 2004, in connection with the
sale of the excipient business.

We anticipate that our existing capital
resources, including the proceeds from the Private Placement,
anticipated internally generated funds from the sale of
formulated bulk TIMERx, royalties from Mylan and other payments
from collaborators, and an anticipated launch of oxymorphone ER
in 2004 will enable us to fund our currently planned operations,
including the planned increase in our drug development and
commercialization efforts, without having to raise additional
capital for the foreseeable future.

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

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

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



| |   |                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the ongoing costs under the Companys other
    collaboration agreements;                                                                                                                                                       
|
| |  | whether oxymorphone ER is approved on a timely
    basis, or at all;                                                                                                                                                            
|
| |  | whether the Company resumes its participation in
    the funding of the development and marketing of oxymorphone ER;                                                                                                            
|
| |  | the structure of any future collaborative or
    development agreements;                                                                                                                                                        
|
| |  | the progress of the Companys collaborative
    and independent development projects and funding obligations
    with respect to the projects and the related the costs to the
    Company of clinical studies for its products;
|
| |  | the costs and timing of adding drug development
    capabilities;                                                                                                                                                               
|
| |  | royalties received from Mylan;                                                                                                                                                                                                  
|
| |  | the timing and amount of payments received under
    existing and possible future collaborative agreements, in
    particular oxymorphone ER; and                                                                               
|
| |  | the prosecution, defense and enforcement of
    potential patent claims and other intellectual property rights.                                                                                                                 

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

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

22



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Any sale of additional equity or debt securities
may result in additional dilution to the Companys
shareholders, and the Company cannot be certain that additional
public or private financing will be available in amounts or on
terms acceptable to the Company, if at all. If the Company is
unable to obtain this additional financing, the Company may be
required to delay, reduce the scope of, or eliminate one or more
of its planned research, development and commercialization
activities, which could harm its financial condition and
operating results.



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



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

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

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



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



| |                                                                          
| | -------------------------------------------------------------------------
| | Our success depends on our protecting our
    patents and patented rights

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

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

23



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may not be able to obtain an adequate, or
perhaps, any remedy to such a breach. In addition, our trade
secrets may otherwise become known or be independently developed
by our competitors.




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

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



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

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

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

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

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

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

24



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If our third party manufacturers fail to perform
their 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 is subject
to regulation by the FDA and comparable agencies in foreign
countries. Any delay in complying or failure to comply with such
manufacturing requirements could materially adversely affect the
marketing of our products and our business, financial condition
and results of operations.



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

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



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

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

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

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

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

25



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

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

We are currently covered by primary product
liability insurance in the amount of $1 million per
occurrence and $2.0 million annually in the aggregate on a
claims-made basis and by umbrella liability insurance in excess
of $25.0 million which can also be used for product liability
insurance. This coverage may not be adequate to cover any
product liability claims. Product liability coverage is
expensive. In the future, we may not be able to maintain or
obtain such product liability insurance at a reasonable cost or
in sufficient amounts to protect us against losses due to
liability claims. Any claims that are not covered by product
liability insurance could have a material adverse effect on our
business, financial condition and results of operations.



| |                                                         
| | --------------------------------------------------------
| | The market price of our common stock may be
    volatile

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

26



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##### Table of Contents








|        |                                                               
|------- | --------------------------------------------------------------
|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,
primarily changes in interest rates. The Companys interest
rate risk primarily relates to its investments in marketable
securities.

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 primarily consist
of corporate debt, certificates of deposit and
U.S. Government Agency-backed notes, and approximated
$10.1 million at June 30, 2003. These securities have
contractual maturity dates of up to twenty months. Due to the
relatively short-term maturities of these securities, management
believes there is no significant market risk. At June 30,
2003, market values approximated carrying values. At
June 30, 2003, the Company had approximately
$25.8 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 $258,000.






|        |                        
|------- | -----------------------
|Item 4. | Controls and Procedures

The Companys management, with the
participation of the Companys chief executive officer and
chief financial officer, evaluated the effectiveness of the
Companys disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of
June 30, 2003. Based on this evaluation, the Companys
chief executive officer and chief financial officer concluded
that, as of June 30, 2003, the Companys disclosure
controls and procedures were (1) designed to ensure that
material information relating to the Company, including its
consolidated subsidiaries, is made known to the Companys
chief executive officer and chief financial officer by others
within those entities, particularly during the period in which
this report was being prepared and (2) effective, in that
they provide reasonable assurance that information required to
be disclosed by the Company in the reports that it files or
submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the
SECs rules and forms.

No change in the Companys internal control
over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) occurred during the fiscal
quarter ended June 30, 2003 that has materially affected,
or is reasonably likely to materially affect, the Companys
internal control over financial reporting.

27



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##### Table of Contents






PART II  OTHER
INFORMATION






|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

At the Companys Annual Meeting of
Shareholders held on June 4, 2003, the following proposals
were adopted by the vote specified below:

a.     Election of
Class III directors for a term of three years:

|                       |  |     |            |          |  |  |           | 
|---------------------- |  | --- | ---------- | -------- |  |  | --------- | 
|                       |  | For |            | Withhold
|                       |  |     |            |         
|Tod R. Hamachek        |  |     | 12,432,439 |          |  |  | 1,317,043 | 
|Robert J. Hennessey    |  |     | 13,732,197 |          |  |  | 17,285    | 
|Dr. John N. Staniforth |  |     | 12,561,883 |          |  |  | 1,187,599 | 



| |  |                                                                                                                                                                                                 
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The following directors did not stand for
    reelection as their terms in office continued after the Annual
    Meeting: Paul E. Freiman, Jere E. Goyan, Rolf H. Henel and Anne
    M. VanLent.



| |    |                                                                                                                        
| | -- | -----------------------------------------------------------------------------------------------------------------------
| | b. | Ratification of the selection of Ernst &
    Young LLP as independent auditors of the Company for the current
    year:

|    |            |         |  |         |        |                  |  |  |        |  |  |  |      | 
|--- | ---------- | ------- |  | ------- | ------ | ---------------- |  |  | ------ |  |  |  | ---- | 
|For |            | Against |  | Abstain |        | Broker Non-Votes
|    |            |         |  |         |        |                 
|    | 13,710,366 |         |  |         | 21,336 |                  |  |  | 17,780 |  |  |  | NONE | 






|        |                                     
|------- | ------------------------------------
|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 May 12, 2003, the Company filed a report
on Form 8-K announcing its results for the first quarter
ended March 31, 2003.

28



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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.



| |                                                                                             
| | --------------------------------------------------------------------------------------------
| | PENWEST PHARMACEUTICALS CO.                                                                 
|
| | /s/ JENNIFER L. GOOD                                                                        
| |                                                                                             
| | Jennifer L. Good                                                                            
| | Senior Vice President, Finance and Chief
    Financial Officer (Principal Financial Officer)

Date: August 12, 2003

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EXHIBIT INDEX

|        |      |             |  |                                                                                                                                                                                                                                          
|------- | ---- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |            
|Number  |      | Description
|        |      |            
|        | 31.1 |             |  | Certification of Chief Executive Officer pursuant
    to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange
    Act of 1934, as adopted pursuant to Section 302 of The
    Sarbanes-Oxley Act of 2002                           
|        | 31.2 |             |  | Certification of Chief Financial Officer pursuant
    to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange
    Act of 1934, as adopted pursuant to Section 302 of The
    Sarbanes-Oxley Act of 2002                           
|        | 32.1 |             |  | Certification of Chief Executive Officer pursuant
    to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange
    Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant
    to Section 906 of The Sarbanes-Oxley Act of 2002
|        | 32.2 |             |  | Certification of Chief Financial Officer pursuant
    to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange
    Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant
    to Section 906 of The Sarbanes-Oxley Act of 2002