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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
    September 30, 2002                                           
|  
|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.)
|                                                         
|2981 Route 22, Patterson, NY                              |  | 12563-2335                          
|(Address of principal executive
    offices)              |  | (Zip Code)                          
|(845) 878-3414                                           
|(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 the number of shares outstanding of each
of the issuers classes of common stock, as of
November 11, 2002.

|                              |  |            
|----------------------------- |  | -----------
|Class                         |  | Outstanding
|                              |  |            
|Common stock, par value $.001 |  | 15,495,045 



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TABLE OF CONTENTS



|                                                     |                                                                                               |  |  |  |  |  |  | 
|---------------------------------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I -- FINANCIAL INFORMATION                     
|                                                     | Item 1. Financial Statements                                                                 
|                                                     | CONDENSED CONSOLIDATED BALANCE SHEETS                                                        
|                                                     | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                                              
|CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                                                     | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                                     | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                                                     | Item 4. Controls and Procedures                                                              
|PART II -- Other Information                        
|                                                     | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURE                                           
|CERTIFICATIONS                                      
|EXHIBIT INDEX                                       
|EX-99.1 Certification of Chief Executive Officer    



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PENWEST PHARMACEUTICALS CO.

TABLE OF CONTENTS

|                                  |  |                                                                                           |    |      |    | 
|--------------------------------- |  | ----------------------------------------------------------------------------------------- | -- | ---- | -- | 
|                                  |  |                                                                                           |    | Page
|                                  |  |                                                                                           |    |     
|Part I  Financial
    Information |  |                                                                                           |    |     
|Item 1                            |  | Condensed Consolidated Financial Statements
    (Unaudited)                               |    |      |    | 
|                                  |  | Condensed Consolidated Balance Sheets                                                     |    |      | 3  | 
|                                  |  | Condensed Consolidated Statements of Operations                                           |    |      | 4  | 
|                                  |  | 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 |    |      | 8  | 
|Item 3                            |  | Quantitative and Qualitative Disclosures About
    Market Risk                            |    |      | 22 | 
|Item 4                            |  | Controls and Procedures                                                                   |    |      | 23 | 
|Part II  Other Information        |  |                                                                                           |    |     
|Item 6                            |  | Exhibits and Reports on Form 8-K                                                          |    |      | 23 | 
|Signature                         |  |                                                                                           | 24 |     
|Certifications                    |  |                                                                                           | 25 |     
|Exhibit Index                     |  |                                                                                           | 27 |     

2



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##### Table of Contents






PART I  FINANCIAL INFORMATION






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

PENWEST PHARMACEUTICALS CO.






CONDENSED CONSOLIDATED BALANCE
SHEETS


|                                         |                                                                                                                                                                                    |                                            |        |              |        |  |        |         |        | 
|---------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ------------ | ------ |  | ------ | ------- | ------ | 
|                                         |                                                                                                                                                                                    | September 30,                              |        | December 31,
|                                         |                                                                                                                                                                                    | 2002                                       |        | 2001        
|                                         |                                                                                                                                                                                    |                                            |        |             
|                                         |                                                                                                                                                                                    | (Unaudited)                                |        | (Note 2)    
|                                         |                                                                                                                                                                                    |                                           
|                                         |                                                                                                                                                                                    | (in thousands, except                     
|                                         |                                                                                                                                                                                    | share amounts)                            
|ASSETS                                  
|Current assets:                          |                                                                                                                                                                                    |                                            |        |              |        |  |        |        
|                                         | Cash and cash equivalents                                                                                                                                                          |                                            | $      | 5,986        |        |  | $      | 12,903  |       
|                                         | Marketable securities                                                                                                                                                              |                                            |        | 4,180        |        |  |        | 9,609   |       
|                                         | Trade accounts receivable, net of allowance for
    doubtful accounts of $216 at September 30, 2002, and $220
    at December 31, 2001                                             |                                            |        | 7,187        |        |  |        | 6,228   |       
|                                         | Inventories:                                                                                                                                                                       |                                            |        |              |        |  |        |         |       
|                                         |                                                                                                                                                                                    | Raw materials and other                    |        |              | 1,501  |  |        |         | 1,558  | 
|                                         |                                                                                                                                                                                    | Finished goods                             |        |              | 6,551  |  |        |         | 6,299  | 
|                                         |                                                                                                                                                                                    |                                            |        |              |        |  |        |        
|                                         |                                                                                                                                                                                    |                                            | 8,052  |              |        |  | 7,857  |        
|                                         | Prepaid expenses and other current assets                                                                                                                                          |                                            |        | 2,983        |        |  |        | 1,166   |       
|                                         |                                                                                                                                                                                    |                                            |        |              |        |  |        |        
|                                         |                                                                                                                                                                                    | Total current assets                       |        |              | 28,388 |  |        |         | 37,763 | 
|Fixed assets, net                        |                                                                                                                                                                                    |                                            | 14,422 |              |        |  | 15,567 |        
|Patents, net                             |                                                                                                                                                                                    |                                            | 4,151  |              |        |  | 3,545  |        
|Other assets                             |                                                                                                                                                                                    |                                            | 2,808  |              |        |  | 2,738  |        
|                                         |                                                                                                                                                                                    |                                            |        |              |        |  |        |        
|                                         |                                                                                                                                                                                    | Total assets                               |        | $            | 49,769 |  |        | $       | 59,613 | 
|                                         |                                                                                                                                                                                    |                                            |        |              |        |  |        |        
|LIABILITIES AND SHAREHOLDERS
    EQUITY
|Current liabilities:                     |                                                                                                                                                                                    |                                            |        |              |        |  |        |        
|                                         | Accounts payable                                                                                                                                                                   |                                            | $      | 2,885        |        |  | $      | 2,174   |       
|                                         | Accrued expenses                                                                                                                                                                   |                                            |        | 2,858        |        |  |        | 2,275   |       
|                                         | Accrued development costs                                                                                                                                                          |                                            |        | 2,611        |        |  |        | 3,139   |       
|                                         | Taxes payable                                                                                                                                                                      |                                            |        | 308          |        |  |        | 448     |       
|                                         | Loans payable                                                                                                                                                                      |                                            |        | 3,782        |        |  |        | 2,668   |       
|                                         |                                                                                                                                                                                    |                                            |        |              |        |  |        |        
|                                         |                                                                                                                                                                                    | Total current liabilities                  |        |              | 12,444 |  |        |         | 10,704 | 
|Deferred income taxes                    |                                                                                                                                                                                    |                                            | 199    |              |        |  | 205    |        
|Deferred revenue                         |                                                                                                                                                                                    |                                            | 306    |              |        |  | 369    |        
|Deferred compensation                    |                                                                                                                                                                                    |                                            | 2,844  |              |        |  | 2,711  |        
|                                         |                                                                                                                                                                                    |                                            |        |              |        |  |        |        
|                                         |                                                                                                                                                                                    | Total liabilities                          |        |              | 15,793 |  |        |         | 13,989 | 
|Shareholders equity:                    |                                                                                                                                                                                    |                                            |        |              |        |  |        |        
|                                         | Preferred stock, par value $.001, authorized
    1,000,000 shares, none outstanding                                                                                                |                                            |        |             |        |  |        |        |       
|                                         | Common stock, par value $.001, authorized
    39,000,000 shares, issued and outstanding 15,495,045 shares
    at September 30, 2002 and 15,276,630 shares at
    December 31, 2001 |                                            |        | 16           |        |  |        | 15      |       
|                                         | Additional paid in capital                                                                                                                                                         |                                            |        | 109,902      |        |  |        | 108,054 |       
|                                         | Accumulated deficit                                                                                                                                                                |                                            |        | (75,038      | )      |  |        | (60,926 | )     
|                                         | Accumulated other comprehensive loss                                                                                                                                               |                                            |        | (904         | )      |  |        | (1,519  | )     
|                                         |                                                                                                                                                                                    |                                            |        |              |        |  |        |        
|                                         |                                                                                                                                                                                    | Total shareholders equity                 |        |              | 33,976 |  |        |         | 45,624 | 
|                                         |                                                                                                                                                                                    |                                            |        |              |        |  |        |        
|                                         |                                                                                                                                                                                    | Total liabilities and shareholders equity |        | $            | 49,769 |  |        | $       | 59,613 | 
|                                         |                                                                                                                                                                                    |                                            |        |              |        |  |        |        

See accompanying notes to condensed consolidated
financial statements.

3



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##### Table of Contents



PENWEST PHARMACEUTICALS CO.






CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS


|                                                        |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |        |        | 
|------------------------------------------------------- | ----------------------------------- | ------------------------------------- | ------ | ----------------- | ------ | ---- | ------ | ----- | ----- | - | ------- | ------ | ------ | - | ------ | ------ | ------ | 
|                                                        |                                     |                                       |        |                  
|                                                        |                                     | Three Months Ended                    |        | Nine Months Ended
|                                                        |                                     | September 30,                         |        | September 30,    
|                                                        |                                     |                                       |        |                  
|                                                        |                                     | 2002                                  |        | 2001              |        | 2002 |        | 2001 
|                                                        |                                     |                                       |        |                   |        |      |        |      
|                                                        |                                     |                                      
|                                                        |                                     | (Unaudited)                          
|                                                        |                                     |                                      
|                                                        |                                     | (In thousands, except per share data)
|Revenues                                                |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |       
|                                                        | Product sales                       |                                       | $      | 9,431             |        |      | $      | 8,574 |       |   | $       | 27,549 |        |   | $      | 26,188 |       
|                                                        | Royalties and licensing fees        |                                       |        | 1,618             |        |      |        | 1,227 |       |   |         | 4,074  |        |   |        | 4,067  |       
|                                                        |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |       
|                                                        |                                     | Total revenues                        |        |                   | 11,049 |      |        |       | 9,801 |   |         |        | 31,623 |   |        |        | 30,255 | 
|Cost of product sales                                   |                                     |                                       | 6,445  |                   |        |      | 6,168  |       |       |   | 19,269  |        |        |   | 18,548 |       
|                                                        |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |       
|                                                        |                                     | Gross profit                          |        |                   | 4,604  |      |        |       | 3,633 |   |         |        | 12,354 |   |        |        | 11,707 | 
|Operating expenses                                      |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |       
|                                                        | Selling, general and administrative |                                       |        | 4,483             |        |      |        | 3,312 |       |   |         | 11,632 |        |   |        | 10,049 |       
|                                                        | Research and product development    |                                       |        | 4,489             |        |      |        | 4,518 |       |   |         | 14,618 |        |   |        | 10,801 |       
|                                                        |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |       
|                                                        |                                     | Total operating expenses              |        |                   | 8,972  |      |        |       | 7,830 |   |         |        | 26,250 |   |        |        | 20,850 | 
|                                                        |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |       
|Loss from operations                                    |                                     |                                       | (4,368 | )                 |        |      | (4,197 | )     |       |   | (13,896 | )      |        |   | (9,143 | )     
|Investment income                                       |                                     |                                       | 72     |                   |        |      | 230    |       |       |   | 314     |        |        |   | 290    |       
|Interest expense                                        |                                     |                                       | 61     |                   |        |      | 72     |       |       |   | 181     |        |        |   | 224    |       
|                                                        |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |       
|Loss before income taxes                                |                                     |                                       | (4,357 | )                 |        |      | (4,039 | )     |       |   | (13,763 | )      |        |   | (9,077 | )     
|Income tax expense                                      |                                     |                                       | 119    |                   |        |      | 86     |       |       |   | 349     |        |        |   | 337    |       
|                                                        |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |       
|Net loss                                                |                                     | $                                     | (4,476 | )                 |        | $    | (4,125 | )     |       | $ | (14,112 | )      |        | $ | (9,414 | )     
|                                                        |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |       
|Basic and diluted net loss per share                    |                                     | $                                     | (0.29  | )                 |        | $    | (0.28  | )     |       | $ | (0.91   | )      |        | $ | (0.70  | )     
|                                                        |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |       
|Weighted average shares of common stock
    outstanding |                                     |                                       | 15,488 |                   |        |      | 14,949 |       |       |   | 15,451  |        |        |   | 13,451 |       
|                                                        |                                     |                                       |        |                   |        |      |        |       |       |   |         |        |        |   |        |       

See accompanying notes to condensed consolidated
financial statements.

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PENWEST PHARMACEUTICALS CO.






CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS


|                                                                 |                                                   |                   |         |         |   |   |         |         |  
|---------------------------------------------------------------- | ------------------------------------------------- | ----------------- | ------- | ------- | - | - | ------- | ------- | -
|                                                                 |                                                   |                  
|                                                                 |                                                   | Nine Months Ended
|                                                                 |                                                   | September 30,    
|                                                                 |                                                   |                  
|                                                                 |                                                   | 2002              |         | 2001   
|                                                                 |                                                   |                   |         |        
|                                                                 |                                                   |                  
|                                                                 |                                                   | (Unaudited)      
|                                                                 |                                                   |                  
|                                                                 |                                                   | (in thousands)   
|Net cash used in operating activities                            |                                                   | $                 | (13,502 | )       |   | $ | (6,520  | )      
|Investing activities:                                            |                                                   |                   |         |         |   |   |         |        
|                                                                 | Acquisitions of fixed assets, net                 |                   |         | (1,012  | ) |   |         | (447    | )
|                                                                 | Intangible asset costs                            |                   |         | (797    | ) |   |         | (792    | )
|                                                                 | Proceeds from maturities of marketable securities |                   |         | 5,250   |   |   |         |        |  
|                                                                 | Purchases of marketable securities                |                   |         |        |   |   |         | (9,279  | )
|                                                                 |                                                   |                   |         |         |   |   |         |        
|Net cash provided by (used in) investing
    activities          |                                                   |                   | 3,441   |         |   |   | (10,518 | )      
|Financing activities:                                            |                                                   |                   |         |         |   |   |         |        
|                                                                 | Proceeds from loans                               |                   |         | 20,134  |   |   |         | 23,499  |  
|                                                                 | Repayments of loans                               |                   |         | (19,021 | ) |   |         | (20,739 | )
|                                                                 | Issuance of common stock, net                     |                   |         | 1,849   |   |   |         | 30,518  |  
|                                                                 |                                                   |                   |         |         |   |   |         |        
|Net cash provided by financing activities                        |                                                   |                   | 2,962   |         |   |   | 33,278  |        
|Effect of exchange rate changes on cash and cash
    equivalents |                                                   |                   | 182     |         |   |   | (15     | )      
|                                                                 |                                                   |                   |         |         |   |   |         |        
|Net (decrease) increase in cash and cash
    equivalents         |                                                   |                   | (6,917  | )       |   |   | 16,225  |        
|Cash and cash equivalents at beginning of period                 |                                                   |                   | 12,903  |         |   |   | 2,204   |        
|                                                                 |                                                   |                   |         |         |   |   |         |        
|Cash and cash equivalents at end of period                       |                                                   | $                 | 5,986   |         |   | $ | 18,429  |        
|                                                                 |                                                   |                   |         |         |   |   |         |        

See accompanying notes to condensed consolidated
financial statements.

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PENWEST PHARMACEUTICALS CO.






NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS


(Unaudited)




|   |         
|-- | --------
|1. | Business

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

On November 1, 2002, Penwest entered into an
agreement with Josef Rettenmaier Holding GmbH &
Co. KG (Rettenmaier) to sell substantially all
of the assets that comprise its excipient business for
$41.75 million in cash ($39.5 million to be received
at closing, $1.0 million on April 25, 2003 and
$1.25 million on May 25, 2004), subject to adjustment
based on the net working capital of the excipient business on
the closing date, and the assumption of specified liabilities
(the Asset Sale). The closing of the Asset Sale is
subject to shareholder approval and other customary conditions.
The Company anticipates that the closing of the Asset Sale will
occur in the first quarter of 2003. If the Asset Sale is
completed, the Company will use the net proceeds from the sale
to expand its drug delivery technologies and product development
pipeline.

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



|   |                      
|-- | ---------------------
|2. | Basis of Presentation

The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with
accounting principles generally accepted in the United States
for interim financial information and with the instructions to
Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the
opinion of management, all adjustments considered necessary for
a fair presentation for the interim periods presented have been
included. All such adjustments are of a normal recurring nature.
Operating results for the three-month and nine-month periods
ended September 30, 2002 are not necessarily indicative of
the results that may be expected for the year ending
December 31, 2002. For further information, refer to the
consolidated financial statements and footnotes thereto included
in the Companys Annual Report on Form 10-K for the
year ended December 31, 2001.

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

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

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|   |                                 
|-- | --------------------------------
|3. | Recent Accounting Pronouncements

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

In October 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. SFAS No. 144 supersedes SFAS
No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of. The
primary objectives of SFAS No. 144 are to develop one
accounting model based on the framework established in SFAS
No. 121 for long-lived assets to be disposed of by sale,
and to address significant implementation issues. The
Companys adoption of SFAS No. 144 in the first
quarter of 2002 did not affect the results of operations,
financial position, or cash flows of the Company.

In July 2002, the FASB issued SFAS No. 146,
Accounting for Costs Associated With Exit or Disposal
Activities. SFAS No. 146 addresses accounting and
reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force, or EITF, Issue
No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring).
SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when
the liability is incurred. Under EITF Issue No. 94-3, a
liability for an exit cost was recognized at the date an entity
committed to an exit plan. The provisions of SFAS No. 146
are effective for exit or disposal activities that are initiated
after December 31, 2002, with early adoption encouraged.



|   |              
|-- | -------------
|4. | Loans Payable

On January 17, 2001, the Company completed
arrangements for a revolving line of credit
(Revolver) with a financial institution. Under the
terms of the Revolver, the Company may borrow up to
$10.0 million (Line of Credit) as determined by
a formula based on the Companys Eligible Accounts
Receivable and Eligible Saleable Inventory, as defined in the
agreement. Under the formula, generally 85% of the
Companys U.S. and Canadian receivables, as well as
generally 60% of the Companys U.S. saleable inventories,
are included in the borrowing base. Amounts outstanding under
the Revolver are collateralized by the Companys U.S. and
Canadian accounts receivable, the Companys inventory and
general intangibles. The Revolver has an initial term of three
years, ending in January 2004, and provides for annual renewals
thereafter. If the Company completes the Asset Sale, it expects
to pay off all amounts outstanding under the Line of Credit and
terminate the Revolver at the time of closing of the Asset Sale.

The Revolver bears interest at a specified
banks prime rate plus 1% per annum, on the greater of
$3.0 million or on the average outstanding balance. The
Revolver also requires that fees be paid of 0.5% per annum on
unused portions of the Line of Credit and provides for early
termination fees of up to 0.75% in the event the Company
terminates the Revolver prior to the end of the initial term.
The interest rate on the Revolver at September 30, 2002 was
5.75%.

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

On September 24, 2002, the Company entered
into a Premium Finance Agreement (a Finance
Agreement) through which it financed approximately
$1.1 million of premiums payable in connection with

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the annual renewal of its general business
insurance. Under the Finance Agreement, Penwest is required to
repay the amount financed in equal monthly installments through
June 2003, plus interest at a rate of 3.11% per annum. In
addition, the Company assigned, as a security interest, any and
all unearned premiums or other amounts which may become payable
to the Company under the insurance policies.




|   |             
|-- | ------------
|5. | Income Taxes

The effective tax rates for the quarters ended
September 30, 2002 and 2001 were expenses of 3% and 2%,
respectively. The effective tax rates for the nine months ended
September 30, 2002 and 2001 were expenses of 3% and 4%,
respectively. The effective tax rates are higher than the
federal statutory rate of a 34% benefit due primarily to
valuation allowances recorded to offset deferred tax assets
relating to the Companys net operating losses, and state
and foreign income taxes.



|   |                   
|-- | ------------------
|6. | Comprehensive Loss

The components of comprehensive loss for the
three-month and nine-month periods ended September 30, 2002
and 2001 are as follows (in thousands):

|                                                            |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |        |  
|----------------------------------------------------------- |  | ------------------ | ------ | ----------------- |  | ---- | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                            |  |                    |        |                  
|                                                            |  | Three Months Ended |        | Nine Months Ended
|                                                            |  | September 30,      |        | September 30,    
|                                                            |  |                    |        |                  
|                                                            |  | 2002               |        | 2001              |  | 2002 |        | 2001
|                                                            |  |                    |        |                   |  |      |        |     
|                                                            |  |                    |        |                  
|                                                            |  | (unaudited)        |        | (unaudited)      
|Net loss                                                    |  | $                  | (4,476 | )                 |  | $    | (4,125 | )    |  | $ | (14,112 | ) |  | $ | (9,414 | )
|Foreign currency translation adjustments                    |  |                    | 7      |                   |  |      | 314    |      |  |   | 615     |   |  |   | (103   | )
|Change in unrealized net gains on marketable
    securities |  |                    | (9     | )                 |  |      | 47     |      |  |   |        |   |  |   | 47     |  
|                                                            |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |        |  
|Comprehensive loss                                          |  | $                  | (4,478 | )                 |  | $    | (3,764 | )    |  | $ | (13,497 | ) |  | $ | (9,470 | )
|                                                            |  |                    |        |                   |  |      |        |      |  |   |         |   |  |   |        |  

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



|   |                  
|-- | -----------------
|7. | Subsequent Events

On October 25, 2002, Penwest entered into an
agreement with AstraZeneca AB for the purchase of assets
relating to Pruv®, one of the excipient products that
Penwest distributes, for a purchase price of $3.0 million,
including cash of $750,000 and a promissory note of
$2.25 million. In accordance with the terms of the Pruv
agreement, the Company will be required to pay the promissory
note in full upon the closing of the Asset Sale.

On November 1, 2002, Penwest entered into an
agreement with Rettenmaier to sell substantially all of the
assets that comprise its excipient business for
$41.75 million in cash ($39.5 million to be received
at closing, $1.0 million on April 25, 2003 and
$1.25 million on May 25, 2004), subject to adjustment
based on the net working capital of the excipient business on
the closing date, and the assumption of specified liabilities.
The closing of the Asset Sale is subject to shareholder approval
and other customary conditions. The Company anticipates that the
closing of the Asset Sale will occur in the first quarter of
2003. If the Asset Sale is completed, the Company will use the
net proceeds from the sale to expand its drug delivery
technologies and product development pipeline.






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|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.

8



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##### Table of Contents



Overview

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

On November 1, 2002, Penwest entered into an
agreement with Josef Rettenmaier Holding GmbH &
Co. KG (Rettenmaier) to sell substantially all
of the assets that comprise its excipient business for
$41.75 million in cash ($39.5 million to be received
at closing, $1.0 million on April 25, 2003 and
$1.25 million on May 25, 2004), subject to adjustment
based on the net working capital of the excipient business on
the closing date, and the assumption of specified liabilities
(the Asset Sale). The closing of the Asset Sale is
subject to shareholder approval and other customary conditions.
The Company anticipates that the closing of the Asset Sale will
occur in the first quarter of 2003. If the Asset Sale is
completed, the Company will use the net proceeds from the sale
to expand its drug delivery technologies and product development
pipeline.

The Company has incurred net losses since
1994. As of September 30, 2002, the Companys
accumulated deficit was approximately $75.0 million. The
Company expects operating losses and negative cash flows to
continue until substantial sales of products commercialized
utilizing TIMERx technology occur whether or not the Asset Sale
is completed. A substantial portion of the Companys
revenues to date have been generated from sales of the
Companys pharmaceutical excipient product line. The
Companys future profitability will depend on several
factors, including the successful commercialization of TIMERx
controlled release products, including in particular oxymorphone
ER, a narcotic analgesic for the treatment of moderate to severe
pain, being developed with Endo Pharmaceuticals Inc.; royalties
from Mylan Pharmaceuticals, Inc.s sales of Pfizer,
Inc.s 30 mg generic version of Procardia XL; and
the level of the Companys investment in research and
development activities; and if the Asset Sale is not completed,
sales growth of the Companys pharmaceutical excipient
products and royalties received on third parties sales of
products containing ProSolv.

The Companys strategy includes a
significant commitment to spending on research and development
targeted at identifying and developing extended 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, external
financing, and if the Asset Sale takes place, the net proceeds
of the Asset Sale. 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 excipient products are sold
internationally and its results of operations may be affected by
fluctuations in currency exchange rates, as well as by
governmental controls and other risks associated with
international sales (such as export licenses, collectibility of
accounts receivable, trade restrictions, and changes in
tariffs). The Companys international subsidiaries transact
a substantial portion of their sales and purchases in European
currencies other than their functional currency, which can
result in the Company having gains or

9



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##### Table of Contents



losses from currency exchange rate fluctuations.
The Company does not use derivatives to hedge the impact of
fluctuations in foreign currencies. As part of the Asset Sale,
the Company is selling the stock of its foreign subsidiaries.
The Company expects that after the Asset Sale, its results of
operations will be less likely to be affected by currency
fluctuations.


The Companys results of operations may
fluctuate from quarter to quarter depending on the volume and
timing of orders of formulated bulk TIMERx, royalties on
Mylans sales of Pfizers 30 mg generic version
of Procardia XL, variations in payments under the Companys
collaborative agreements, including payments upon the
achievement of specified milestones and if the Asset Sale is not
completed, the volume and timing of orders of the Companys
pharmaceutical excipient products and royalties received on
third parties sales of products containing ProSolv. The
Companys quarterly operating results may also fluctuate
depending on other factors, including variations in gross
margins of the Companys products, the mix of products
sold, competition, regulatory actions and currency exchange rate
fluctuations.

Critical Accounting Policies and
Estimates

Our discussion and analysis of our financial
condition and results of operations are based upon our condensed
consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements
requires the Company to make estimates and assumptions that
affect the reported amounts of assets and liabilities as of the
date of the financial statements and the reported amounts of
revenues and expenses during the reporting periods. Areas where
significant judgments are made include, but are not limited to,
revenue recognition, allowance for doubtful accounts, inventory,
deferred taxes-valuation allowance and impairment of intangible
assets. Actual results could differ materially from these
estimates. For a more detailed explanation of the judgments made
in these areas, refer to our Annual Report on Form 10-K for
the year ended December 31, 2001.

Results of Operations

Quarters
Ended September 30, 2002 and 2001

Total revenues increased by $1.2 million or
12.7% for the third quarter ended September 30, 2002 to
$11.0 million, from $9.8 million for the quarter ended
September 30, 2001. Product sales increased by 10.0% to
$9.4 million for the quarter ended September 30, 2002
from $8.6 million for the quarter ended September 30,
2001. The increase in product sales was primarily due to
increased sales of the Companys ProSolv® products
primarily attributable to the launch of customers products
containing ProSolv® in the ethical pharmaceutical market,
and growth in the Companys European excipient business as
a whole, due in part to the Company beginning to sell direct in
certain countries in Europe. Royalties and licensing fees
increased by $391,000 for the third quarter of 2002 to
$1.6 million from $1.2 million in the third quarter of
2001, primarily due to higher royalties from Mylan attributable
to Mylans increased sales of Pfizers 30 mg generic
version of Procardia XL. During the third quarter of 2002,
the Company was notified by a major customer that a contract for
purchasing microcrystalline cellulose will not be renewed
beginning January 1, 2003. Sales approximated
$1.6 million to this customer of the excipient business for
the nine months ended September 30, 2002 (see Asset Sale).

Gross profit increased to $4.6 million, or
41.7% of total revenues, for the third quarter of 2002 from
$3.6 million, or 37.1% of total revenues, for the third
quarter of 2001. The Companys gross profit increased
primarily due to increased excipient sales, particularly of
those excipients with higher margins, and higher royalties from
Mylan, as noted above. Gross profit percentage on product sales
increased to 31.7% for the third quarter of 2002 from 28.1% for
the third quarter of 2001. This increase was primarily
attributable to a change in product mix with increased sales of
higher margin excipient products such as ProSolv and Pruv. The
Company expects that the sale of its excipient business will
result in a substantial decrease in gross profit in future
periods, at least initially.

Selling, general and administrative expenses
increased by $1.2 million to $4.5 million for the
third quarter of 2002 as compared to $3.3 million in the
third quarter of 2001. The increase in selling, general and

10



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administrative expenses was primarily due to
marketing costs incurred in preparation for the launch of
oxymorphone ER being developed with Endo, an increase in
premiums for business insurance, higher market research costs,
an increase in legal and professional fees, and an increase in
compensation expense primarily due to additional hiring to
support the drug delivery business.


Research and product development expenses were
approximately $4.5 million for the third quarters of 2002
and 2001. A significant portion of these costs was for Phase III
clinical trials for oxymorphone ER being developed with Endo, as
well as formulation work on several new product candidates in
the Companys development pipeline.

As of September 30, 2002, the Company had
several product candidates utilizing TIMERx technology in
various stages of clinical trials. Completion of clinical trials
and commercialization of these product candidates may take
several years, and the length of time can vary substantially
according to the type, complexity and novelty of a product
candidate.

The most advanced of these 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
pivotal Phase III clinical trial of the product in
July 2002 and has advised the Company that, assuming that
all Food and Drug Administration (FDA) requirements
for filing are met, Endo expects to submit the New Drug
Application (NDA) for the product to the FDA in late
2002. The Company anticipates spending an additional
$2.5 million on the development and pre-marketing costs of
the oxymorphone program during the fourth quarter of 2002, and
then anticipates that the Companys research and
development expenses with respect to this product will decrease
in 2003.

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

The effective tax rates for the quarters ended
September 30, 2002 and 2001 were expenses of 3% and 2%,
respectively. The effective tax rates are higher than the
federal statutory rate of a 34% benefit due primarily to
valuation allowances recorded to offset deferred tax assets
relating to the Companys net operating losses, and state
and foreign income taxes.

Nine Months
Ended September 30, 2002 and 2001

Total revenues increased 4.5% for the nine months
ended September 30, 2002 to $31.6 million from
$30.3 million for the nine months ended September 30,
2001. Product sales increased by 5.2% to $27.5 million for
the nine months ended September 30, 2002 compared to
$26.2 million for the nine months ended September 30,
2001. The increase in product sales was due to increased sales
of excipient products, primarily in Europe and due in part to
the Company beginning to sell direct in certain countries in
Europe, and was partially offset by lower revenues on sales of
formulated bulk TIMERx primarily due to the timing of customer
orders. Royalties and licensing revenues were comparable for the
first nine months of 2002 and 2001 at $4.1 million.

Gross profit increased to $12.4 million, or
39.1% of total revenues, for the first nine months of 2002 from
$11.7 million, or 38.7% of total revenues, for the first
nine months of 2001. The increase in the gross profit percentage
was primarily due to changes in the product mix of excipient
products sold in 2002, primarily increased ProSolv sales, as
compared to 2001. The Company expects that the sale of its
excipient business will result in a substantial decrease in
gross profit in future periods, at least initially.

Selling, general and administrative expenses
increased by 15.8% for the first nine months of 2002, to
$11.6 million as compared with $10.0 million for the
first nine months of 2001. The increase was primarily due to
marketing costs incurred by Endo on the joint development of
oxymorphone ER, increased compensation expense primarily due to
hiring additional drug delivery personnel, increased costs for
the Companys annual report and increased business
insurance costs.

Research and product development expenses
increased by 35.3% for the first nine months of 2002 to
$14.6 million from $10.8 million for the first nine
months of 2001. This increase was primarily due to the

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Companys share of the increased costs of
clinical trials for oxymorphone ER being developed with Endo and
the Companys increased investment in the development of
new products utilizing TIMERx technology and in research
involving new drug delivery technologies.


The effective tax rates for the first nine months
of 2002 and 2001 were expenses of 3% and 4%, respectively. The
effective tax rates are higher than the federal statutory rate
of a 34% benefit due primarily to valuation allowances recorded
to offset deferred tax assets relating to the Companys net
operating losses, and state and foreign income taxes.

Liquidity and Capital Resources

Subsequent to August 31, 1998, the date the
Company became an independent, publicly-owned company, the
Company has funded its operations and capital expenditures with
revenues from the sale of excipients, sale of formulated bulk
TIMERx, royalties and milestone payments from Mylan and other
collaborators, advances under credit facilities and proceeds
from the sale and issuance of shares of common stock. The
Company expects to continue to rely on these sources of funding
unless the Asset Sale is completed, in which case the Company
will have net proceeds from the Asset Sale (approximately
$41.75 million, $39.5 million payable in cash at closing
and subject to a working capital adjustment and a $2.25 million
note payable in installments through May 2004, less estimated
taxes of approximately $400,000 and expenses of the transaction)
available, but will no longer derive cash flow from the sale of
excipients (estimated to be approximately $6.0 million for 2002).

As of September 30, 2002, the Company had
cash, cash equivalents, and short-term investments of
$10.2 million. The Company has no committed sources of
capital other than a revolving line of credit
(Revolver) with a financial institution. Under the
Revolver, generally 85% of the Companys U.S. and Canadian
receivables, as well as generally 60% of the Companys U.S.
saleable inventories, are included in the borrowing base.
Amounts outstanding under the Revolver are collateralized by the
Companys U.S. and Canadian accounts receivable, and its
inventory and general intangibles. The Revolver has an initial
term of three years ending January 2004, and provides for annual
renewals thereafter. The Revolver bears interest at a specific
banks prime rate plus 1% per annum, on the greater of
$3.0 million or on the average outstanding balance. The
Revolver also requires that fees be paid of 0.5% per annum on
unused portions of the Line of Credit and also provides for
early termination fees of up to 0.75% in the event the Company
terminates the Revolver prior to the end of the initial term.
The interest rate on the Revolver at September 30, 2002 was
5.75%. The Revolver contains covenants, including the
requirement that the Company maintain at all times certain
minimum levels of tangible net worth as defined, at varying
specified amounts during the initial term of the agreement, and
restrictions on the incurrence of additional indebtedness and
the payment of dividends. The Revolver includes a lockbox
requirement under the control of the lender, whereby collection
of certain trade receivables are used to immediately reduce the
balance of the Revolver. Under the terms of the Revolver, the
Company may borrow up to $10.0 million (Line of
Credit) as determined by a formula based on the
Companys Eligible Accounts Receivable and Eligible
Saleable Inventory, as defined in the agreement. As of
September 30, 2002, there were approximately
$2.6 million of outstanding borrowings under the Revolver.
If the Asset Sale is completed, the Company will use a portion
of the net proceeds to pay all outstanding borrowings under the
Line of Credit and then will terminate the Revolver.

As of September 30, 2002, the Company did
not have any material commitments for capital expenditures. As
of September 30, 2002, the Companys trade receivables
were $7.2 million, an increase of $1.0 million from
the $6.2 million of trade receivables at December 31,
2001. In connection with its strategic alliance agreement with
Endo, the Company expects to expend an additional
$2.5 million during the fourth quarter of 2002 on the
development and pre-marketing costs of oxymorphone ER to fund
its cash needs and then anticipates the Companys R&D
expenses with respect to this product will decrease in 2003.

The Company had negative cash flow from
operations for the nine months ended September 30, 2002 of
$13.5 million, primarily due to the net loss in the period.
The Company had negative cash flow from operations for the nine
months ended September 30, 2001 of $6.5 million, primarily
due to the net loss in the period, partially offset by net
reductions of accounts receivable. Funds expended in 2002 for
the acquisition of fixed

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assets were primarily related to additions at the
Companys manufacturing facilities in Iowa and Finland,
laborotory equipment for drug development activities, and
information technology associated with the Company strengthening
its technology infrastructure to prepare for increasing drug
development activities. Funds expended in 2001 for the
acquisition of fixed assets were primarily related to additions
at the Companys manufacturing facilities in Iowa and
Finland, and information technology as described above. Funds
expended for intangible assets included costs to secure patents
on technology developed by the Company and to secure trademarks.
If the Asset Sale is completed, the Companys cash flow may
differ greatly from its current cash flow because it will no
longer derive revenues from sales of its excipient products nor
will it incur expenses in connection with its excipient business.


The Company intends to utilize available cash and
short-term investments, cash from operations, and if the Asset
Sale is not completed, funds available under the Revolver to
fund future operations. If the Asset Sale is completed, the
Company will also use the net proceeds of the Asset Sale to fund
future operations. The Companys requirements for capital
in its business are substantial and will depend on many factors,
including:



| |        |                                                                                                                                               
| | ------ | ----------------------------------------------------------------------------------------------------------------------------------------------
| | (i)    | the completion of the Asset Sale;                                                                                                             
|
| | (ii)   | the structure of any future collaborative or
    development agreements;                                                                      
|
| | (iii)  | the progress of the Companys collaborative
    and independent development projects and funding obligations
    with respect to the projects;
|
| | (iv)   | revenues from sales of the Companys
    excipients products if the Asset Sale is not completed;                                              
|
| | (v)    | the costs to the Company of clinical studies for
    its products;                                                                            
|
| | (vi)   | the costs and timing of adding drug development
    capabilities;                                                                             
|
| | (vii)  | royalties received from Mylan;                                                                                                                
|
| | (viii) | royalties from sales of TIMERx products;                                                                                                      
|
| | (ix)   | the timing and amount of payments received under
    existing and possible future collaborative agreements; and                               
|
| | (x)    | the prosecution, defense and enforcement of
    potential patent claims and other intellectual property rights.                               

If the Asset Sale is not completed, the Company
anticipates that its existing capital resources, including funds
available under the Revolver, and anticipated internally
generated funds from the sale of excipient products and
formulated bulk TIMERx, royalties from Mylan and other payments
from collaborators will enable the Company to fund its currently
planned operations through mid 2003. If the Asset Sale is
completed, we anticipate that the net proceeds received by the
Company from the Asset Sale, our existing capital resources and
anticipates internally generated funds from the sale of
formulated bulk TIMERx, royalties from Mylan and other payments
from collaborators, will enable the Company to fund its
currently planned operations for at least the next two years.

The Company will need to raise additional funds
to maintain its operations beyond such date. The Company may
seek to obtain additional funds through transactions relating to
its business lines and/or debt or equity financings. The
additional financing may not be available to the Company on
acceptable terms, it at all. If adequate funds are not
available, Penwest may be required to (1) significantly
curtail its product commercialization efforts, including
terminating existing collaborative agreements; (2) obtain
funds through arrangement with collaborators or others on
adverse terms to Penwest that may require Penwest to relinquish
rights to certain of its technologies, product candidates, or
products which Penwest would otherwise pursue on its own or that
would significantly dilute the Companys stockholders;
(3) significantly scale back or terminate operations and/or
(4) seek relief under the applicable bankruptcy laws.

At September 30, 2002, the Company had
federal net operating loss (NOL) carryforwards of
approximately $56.4 million for income tax purposes, of
which approximately $6.2 million, $8.4 million,
$9.1 million, $17.8 million and $14.9 million
expire in 2018, 2019, 2020, 2021 and 2022, respectively. In

13



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addition, the Company had research and
development tax credit carryforwards of approximately $1.4
million of which $298,000, $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 September 30, 2002, a valuation allowance
of approximately $20.3 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. If the Asset Sale is completed,
the Company expects that approximately $17.0 million of
NOLs will be used to offset the Companys taxable capital
gains and ordinary income from the Asset Sale.


Forward-Looking Statements

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

Risk Factors

WE HAVE NOT BEEN PROFITABLE

We have incurred net losses since 1994, including
net losses of approximately $14.1 million for the first
nine months of 2002 and of $15.9 million,
$8.8 million, and $7.7 million, during 2001, 2000, and
1999, respectively. As of September 30, 2002, our
accumulated deficit was approximately $75.0 million. The
Company expects net losses to continue until substantial sales
of products commercialized utilizing TIMERx technology occur. A
substantial portion of our revenues have been generated from the
sales of our pharmaceutical excipients. If the Asset Sale is
completed, we will no longer generate any revenues from the
sales of our excipient products and our business will depend
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 Pharmaceuticals Inc.;
|
| |  | royalties from Mylans sales of
    Pfizers 30mg generic version of Procardia XL; and                                                                                                                                                        
|
| |  | the level of investment in research and
    development activities.                                                                                                                                                                           

If we do not complete the Asset Sale and retain
our excipient business, our future profitability will also
depend on:



| |   |                                                                                   
| | - | ----------------------------------------------------------------------------------
| |  | royalties received on third parties sales
    of products containing ProSolv; and
|
| |  | sales growth of our pharmaceutical excipient
    products.                        

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

Many of our TIMERx controlled release products
have been or are being developed and commercialized in
collaboration with pharmaceutical companies. Under these
collaborations, depending on the structure of the collaboration,
we are dependent on our collaborators to fund some portion of
development, to conduct full-scale bioequivalence studies and
clinical trials, obtain regulatory approvals for, and
manufacture, market and sell products utilizing our TIMERx
controlled release technology. We are also dependent on Mylan
with respect to the marketing and sale of the 30 mg strength of
Pfizers generic version of Procardia XL. Our collaborators
may not devote the resources necessary or may otherwise be
unable to complete development and commercialization of these
potential products. Our existing collaborations are subject to
termination without cause on short notice under certain
circumstances.

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

Our existing collaborations and any future
collaborations with third parties may not be scientifically or
commercially successful. Factors that may affect the success of
our collaborations include the following:



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

WE REQUIRE ADDITIONAL FUNDING

We have no committed sources of capital except
for the Revolver. On November 1, 2002, Penwest entered into an
agreement with Josef Rettenmaier Holding GmbH & Co. KG
(Rettenmaier) to sell substantially all of the
assets that comprise its excipient business for
$41.75 million in cash ($39.5 million at closing,
$1.0 million on April 25, 2003 and $1.25 million
on May 25, 2004), subject to adjustment based on the net
working capital of the excipient business on the closing date,
and the assumption of specified liabilities (Asset
Sale). This transaction is subject to shareholder approval
and other customary conditions. We anticipated the closing of
this sale in the first quarter of 2003. If the Asset Sale takes
place, we will use the net proceeds from the sale to expand our
drug delivery technologies and product development pipeline.

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



| |   |                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------
| |  | the completion of the Asset Sale                                                                                                    
|
| |  | the structure of any future collaborative or
    development agreements;                                                            
|
| |  | the progress of our collaborative and independent
    development projects and funding obligations with respect to the
    projects;

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| |   |                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------
| |  | if the Asset Sale is not completed revenues from
    our excipient products;                                   
|
| |  | the costs to us of clinical studies for our
    products;                                                      
|
| |  | the costs and timing of adding drug development
    capabilities;                                              
|
| |  | royalties received from Mylan;                                                                                 
|
| |  | royalties from sales of TIMERx products;                                                                       
|
| |  | the timing and amount of payments received under
    existing and possible future collaborative agreements; and
|
| |  | the prosecution, defense and enforcement of
    potential patent claims and other intellectual property rights.

If the Asset Sale is not completed, we anticipate
that our existing capital resources, including funds available
under the Revolver, and anticipated internally generated funds
from the sale of our excipient products and formulated bulk
TIMERx, royalties from Mylan and other payments from
collaborators will enable us to fund our currently planned
operations through mid 2003. If the Asset Sale is completed, we
anticipate that the net proceeds received from us from the Asset
Sale, our existing capital resources and anticipated internally
generated funds from the sale of formulated bulk TIMERx,
royalties from Mylan and other payments from collaborators, will
enable us to fund our currently planned operations for at least
the next two years.

Additional financing may not be available to us
on acceptable terms, if at all. If adequate funds are not
available, we may be required to (i) significantly curtail
our product commercialization efforts, including terminating
existing collaborative agreements; (ii) obtain funds
through arrangements with collaborators or others on adverse
terms to us that may require us to relinquish rights to certain
of our technologies, product candidates, or products which we
would otherwise pursue on its own or that would significantly
dilute our stockholders; (iii) significantly scale back or
terminate operations and/or; (iv) seek relief under
applicable bankruptcy laws.

WE FACE SIGNIFICANT COMPETITION, WHICH MAY RESULT
IN OTHERS DISCOVERING, DEVELOPING OR COMMERCIALIZING PRODUCTS
BEFORE OR MORE SUCCESSFULLY THAN WE DO

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

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

In addition to competition from other drug
delivery technologies, our TIMERx products will also face
competition from products with the same indication as our
products. For instance, we expect extended release oxymorphone
ER will face competition from Purdue Pharmas
OxyContin®.

We concentrated a significant portion of our
initial development efforts on generic versions of branded
controlled release products. The success of generic versions of
branded controlled release products based on our TIMERx
technology depends, in large part, on the intensity of
competition from the branded controlled release product, other
generic versions of the branded controlled release product and
other drugs and technologies that compete with the branded
controlled release product, as well as the timing of product

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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.


In our excipient business, we compete with a
number of large manufacturers and other distributors of
excipient products, many of which have substantially greater
financial, marketing and other resources than us. Our principal
competitors are FMC Corporation, which markets its own line of
microcrystalline cellulose (MCC) excipient products, and
Rettenmaier.

IF OUR CLINICAL TRIALS ARE NOT SUCCESSFUL OR TAKE
LONGER TO COMPLETE THAN WE EXPECT, WE MAY NOT BE ABLE TO DEVELOP
AND COMMERCIALIZE CERTAIN OF OUR PRODUCTS

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

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

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

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

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



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

WE MAY NOT OBTAIN REGULATORY APPROVAL; THE
APPROVAL PROCESS CAN BE TIME-CONSUMING AND EXPENSIVE

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

We may encounter delays or rejections during any
stage of the regulatory approval process based upon the failure
of clinical data to demonstrate compliance with, or upon the
failure of the product to meet, the FDAs requirements for
safety, efficacy and quality; and those requirements may become
more stringent due to changes in regulatory agency policy or the
adoption of new regulations. After submission of a marketing
application, in the form of an NDA or an ANDA, the FDA may deny
the application, may require additional testing or data and/or
may require 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 (NDA or ANDA).

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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.

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.

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OUR CONTROLLED RELEASE PRODUCTS THAT ARE GENERIC
VERSIONS OF BRANDED CONTROLLED RELEASE PRODUCTS THAT ARE COVERED
BY ONE OR MORE PATENTS MAY BE SUBJECT TO LITIGATION

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

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

The commercial success of products incorporating
our controlled release technology that are approved for
marketing by the FDA and other regulatory authorities will
depend upon their acceptance by the medical community and third
party payors as clinically useful, cost-effective and safe. No
product based on our TIMERx or other controlled 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 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.

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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 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. We have not yet qualified a second source of
supply. In the event that our current manufacturer is unable to
manufacture the TIMERx material in the required quantities, on a
timely basis or at all, we may be unable to obtain alternative
contract manufacturing, or obtain such manufacturing on
commercially reasonable terms.

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



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

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

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

WE ARE DEPENDENT UPON A LIMITED NUMBER OF
SUPPLIERS FOR THE GUMS USED IN OUR TIMERx MATERIAL AND UPON A
LIMITED NUMBER OF SUPPLIERS FOR THE WOOD PULP USED IN THE
MANUFACTURE OF OUR EXCIPIENTS

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

IF OUR COLLABORATORS FAIL TO OBTAIN AN ADEQUATE
LEVEL OF REIMBURSEMENT BY THIRD PARTY PAYORS FOR OUR CONTROLLED
RELEASE PRODUCTS, THEY MAY NOT BE ABLE TO SUCCESSFULLY
COMMERCIALIZE CONTROLLED RELEASE PRODUCTS IN CERTAIN MARKETS

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

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

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

If we or our collaborators obtain marketing
approvals for our products, we expect to experience pricing
pressure due to the trend toward managed health care, the
increasing influence of health maintenance

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organizations and additional legislative
proposals. We may not be able to sell our products profitably if
reimbursement is unavailable or limited in scope or amount.


WE WILL BE EXPOSED TO PRODUCT LIABILITY CLAIMS
AND MAY NOT BE ABLE TO OBTAIN ADEQUATE PRODUCT LIABILITY
INSURANCE

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

We are currently covered by primary product
liability insurance in the amount of $1 million per
occurrence and $2 million annually in the aggregate on a
claims-made basis and by umbrella liability insurance in excess
of $25 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.

CERTAIN PROVISIONS OF OUR CERTIFICATE OF
INCORPORATION AND BYLAWS AND OF WASHINGTON LAW, AS WELL AS THE
RIGHTS AGREEMENT TO WHICH WE ARE A PARTY, MAKE A TAKEOVER OF
PENWEST MORE DIFFICULT

Provisions of our Certificate of Incorporation,
our Bylaws and Washington law, as well as the Rights Agreement
to which we are a party, may have the effect of deterring
hostile takeovers or delaying or preventing changes in control
or management of our company, including transactions in which
our stockholders might otherwise receive a premium for their
shares over then current market prices. In addition, these
provisions may limit the ability of stockholders to approve
transactions that they may deem to be in their best interest.




Item
3.     Quantitative and Qualitative
Disclosures About Market Risk

Market Risk and Risk Management
Policies

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

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The primary objectives for the Companys
investment portfolio are liquidity and safety of principal.
Investments are made to achieve the highest rate of return to
the Company, consistent with these two objectives. The
Companys investment policy limits investments to certain
types of instruments issued by institutions with investment
grade credit ratings and places restrictions on maturities and
concentration by issuer. Marketable securities consist of
corporate debt and approximated $4.2 million at
September 30, 2002. These securities have contractual
maturity dates of up to eleven months. Due to the relatively
short-term maturities of these securities, management believes
there is no significant market risk. At September 30, 2002,
market values approximated carrying values. At
September 30, 2002, the Company had approximately
$10.2 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 $102,000.

The Company has a revolving line of credit with a
financial institution which bears interest at a specified
banks prime rate plus 1% per annum (5.75% at
September 30, 2002) on the greater of $3.0 million or
on the average outstanding balance. At September 30, 2002,
there was $2.6 million outstanding under the line and,
accordingly, a sustained increase in the interest rate of 1%
would cause increased annual interest expense of approximately
$30,000.

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




Item
4.     Controls and
Procedures

a)Evaluation of disclosure controls and
procedures. Based on their evaluation of the Companys
disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities Exchange
Act of 1934) as of a date within 90 days of the filing date
of this Quarterly Report on Form 10-Q, the Companys
principal executive officer and principal financial officer have
concluded that the Companys disclosure controls and
procedures are designed to ensure 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 and are operating in an effective
manner.

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




PART II  Other
Information




Item
6.     Exhibits and Reports on
Form 8-K

a.     Exhibits.



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

b.     Reports on
Form 8-K.



| |                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------
| | On August 13, 2002, the Company filed a
    report on Form 8-K announcing its results for the second
    quarter ended June 30, 2002.

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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: November 13, 2002

24



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##### Table of Contents






CERTIFICATIONS

I, Tod R. Hamachek, certify that:

1) I have reviewed this quarterly report on
Form 10-Q of Penwest Pharmaceuticals Co.;

2) Based on my knowledge, this quarterly
report does not contain any untrue statement of a material fact
or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period
covered by this quarterly report;

3) Based on my knowledge, the financial
statements, and other financial information included in this
quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;

4) The registrants other certifying
officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:



| |                                                                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this quarterly report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this
    quarterly report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this quarterly report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date                                                                                                                                 

5) The registrants other certifying
officer and I have disclosed, based on our most recent
evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6) The registrants other certifying
officer and I have indicated in this quarterly report whether or
not there were significant changes in internal controls or in
other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |                          
| | -------------------------
| | /s/ TOD R. HAMACHEK      
| |                          
| | Tod R. Hamachek          
| | Chairman of the Board and
| | Chief Executive Officer  

Date: November 13, 2002

25



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##### Table of Contents



I, Jennifer L. Good, certify that:

1) I have reviewed this quarterly report on
Form 10-Q of Penwest Pharmaceuticals Co.;

2) Based on my knowledge, this quarterly
report does not contain any untrue statement of a material fact
or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period
covered by this quarterly report;

3) Based on my knowledge, the financial
statements, and other financial information included in this
quarterly report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;

4) The registrants other certifying
officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:



| |                                                                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this quarterly report is being prepared;
|
| | b) evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this
    quarterly report (the Evaluation Date); and                                                                                                      
|
| | c) presented in this quarterly report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date                                                                                                                                 

5) The registrants other certifying
officer and I have disclosed, based on our most recent
evaluation, to the registrants auditors and the audit
committee of registrants board of directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6) The registrants other certifying
officer and I have indicated in this quarterly report whether or
not there were significant changes in internal controls or in
other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |                                
| | -------------------------------
| | /s/ JENNIFER L. GOOD           
| |                                
| | Jennifer L. Good               
| | Sr. Vice President, Finance and
| | Chief Financial Officer        

Date: November 13, 2002

26



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EXHIBIT INDEX

|        |      |             |  |                                                                                                                                
|------- | ---- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |            
|Number  |      | Description
|        |      |            
|        | 99.1 |             |  | Certifications pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    The Sarbanes-Oxley Act of 2002

27