<PAGE>   1


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


                                    FORM 10-Q

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

                  For the quarterly period ended JUNE 30, 1998

                                       OR

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

For the transition period from ___________________ to ______________________


                          Commission File No. 000-23467


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


       Washington                                               91-1513032
--------------------------------------------------------------------------------
(State of Incorporation)                                      (I.R.S. Employer
                                                             Identification No.)

     2981 Route 22, Patterson, NY                               12563-9970
--------------------------------------------------------------------------------
(Address of principal executive offices)                        (Zip Code)


                                  (914)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 [ ]   No [X]

         Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of August 31, 1998.

            Class                                            Outstanding
            -----                                            -----------

Common stock, par value $.001                                11,055,462




                                       1
<PAGE>   2

                        PART I -- FINANCIAL INFORMATION

1.  Financial Statements


                           PENWEST PHARMACEUTICALS CO.
                           CONSOLIDATED BALANCE SHEETS
                     (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)




<TABLE>
<CAPTION>
                                                             December 31,        June 30,
                                                                1997               1998
                                                             -----------       -----------
                                                                               (unaudited)
<S>                                                            <C>              <C>     

ASSETS
 Current assets:
   Cash and cash equivalents                                   $    938         $    900
   Trade accounts receivable, net                                 3,005            4,798
   Inventories:
      Raw materials and other                                     1,545            1,119
      Finished goods                                              7,146            7,215
                                                               --------         --------
                                                                  8,691            8,334
Prepaid expenses and other current assets                           358              172
                                                               --------         --------
         Total current assets                                    12,992           14,204

Fixed assets, net                                                22,311           22,709
Other assets                                                      2,133            2,270
                                                               --------         --------
         Total assets                                          $ 37,436         $ 39,183
                                                               ========         ========

LIABILITIES AND SHAREHOLDER'S DEFICIT
Current liabilities:
   Accounts payable and accrued expenses                       $  3,410         $  3,819
   Taxes payable                                                    361              756
   Payable to Penford                                            42,654           47,330
                                                               --------         --------
         Total current liabilities                               46,425           51,905
Deferred taxes                                                    2,967            3,201
Other long-term liabilities                                         341              319
                                                               --------         --------
         Total liabilities
                                                                 49,733           55,425
Shareholder's deficit
   Common stock, par value $.001, authorized 39,000,000
      shares, issued and outstanding 11,055,462 shares               11               11
   Additional paid-in capital                                     8,079            8,079
   Accumulated deficit                                          (19,649)         (23,665)
   Cumulative translation adjustment                               (738)            (667)
                                                               --------         --------
         Total shareholder's deficit                            (12,297)         (16,242)
                                                               --------         --------
         Total liabilities and shareholder's deficit           $ 37,436         $ 39,183
                                                               ========         ========


</TABLE>


See accompanying notes to condensed consolidated financial statements.




                                       2
<PAGE>   3


                           PENWEST PHARMACEUTICALS CO.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)


<TABLE>
<CAPTION>
                                                             Three Months
                                                             Ended June 30
                                                        -----------------------
                                                         1997            1998
                                                        -------         ------- 
                                                              (unaudited)
<S>                                                         <C>              <C>

Revenues
Product sales                                           $ 6,586         $ 7,488   
Royalties and licensing fees                                261              68 
                                                        -------         ------- 
     Total revenues                                       6,847           7,556 
Cost of product sales                                     4,878           5,268 
                                                        -------         ------- 
     Gross profit                                         1,969           2,288 
Operating expenses                                                              
  Selling, general and administrative                     1,659           2,670 
  Research and product development                        1,292           1,538 
                                                        -------         ------- 
     Total operating expenses                             2,951           4,208 
                                                        -------         ------- 
Loss before income taxes                                   (982)         (1,920)
Income tax expense                                           20              66 
                                                        -------         ------- 
Net loss                                                $(1,002)        $(1,986)
                                                        =======         ======= 
                                                                                
Basic and diluted net loss per share                    $ (0.09)        $ (0.18)
                                                        =======         ======= 

Weighted average shares of common                                               
   stock outstanding                                                            
                                                         11,055          11,055 
                                                        =======         =======
</TABLE>







See accompanying notes to condensed consolidated financial statements.




                                       3
<PAGE>   4
                          PENWEST PHARMACEUTICALS CO.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)


<TABLE>
<CAPTION>
                                                            Six Months
                                                          Ended June 30
                                                     -----------------------  
                                                      1997            1998
                                                     -------         ------- 
                                                           (unaudited)
<S>                                                  <C>             <C>
Revenues
   Product sales                                     $13,231         $15,249  
   Royalties and licensing fees                          586              93  
                                                     -------         -------  
         Total revenues                               13,817          15,342  
   Cost of product sales                               9,769          11,104  
                                                     -------         -------  
         Gross profit                                  4,048           4,238  
   Operating expenses                                                         
     Selling, general and administrative               3,703           5,027  
     Research and product development                  2,143           2,823  
                                                     -------         -------  
         Total operating expenses                      5,846           7,850  
   Loss before income taxes                           (1,798)         (3,612) 
   Income tax expense                                     36             404  
                                                     -------         -------  
   Net loss                                          $(1,834)        $(4,016) 
                                                     =======         =======  
                                                                              
   Basic and diluted net loss per share              $ (0.17)        $ (0.36) 
                                                     =======         =======  
                                                                              
   Weighted average shares of common                                          
     stock outstanding                                11,055          11,055  
                                                     =======         =======  
                                                          

</TABLE>






See accompanying notes to condensed consolidated financial statements.




                                       4
<PAGE>   5



                           PENWEST PHARMACEUTICALS CO.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                 Six Months
                                                                Ended June 30
                                                            -----------------------
                                                              1997            1998
                                                            -------         ------- 
<S>                                                         <C>             <C>     

Net cash used in operating activities                       $(1,853)        $(3,634)
Net cash used in investing activities:
      Acquisitions of fixed assets, net                         (60)           (951)
      Other                                                    (615)           (125)
                                                            -------         ------- 
Net cash used in investing activities                          (675)         (1,076)
Cash provided by financing activities:
   Increase in payable to Penford                             2,830           4,676
Effect of exchange rate changes on cash                        (103)             (4)
                                                            -------         ------- 
Net increase (decrease) in cash and cash equivalents            199             (38)
Cash and cash equivalents at beginning of period                695             938
                                                            -------         ------- 
Cash and cash equivalents at end of period                  $   894         $   900
                                                            =======         =======

</TABLE>





See accompanying notes to condensed consolidated financial statements.




                                       5
<PAGE>   6

                           PENWEST PHARMACEUTICALS CO.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1.       BASIS OF PRESENTATION

         The accompanying unaudited condensed consolidated financial statements
         have been prepared in accordance with generally accepted accounting
         principles 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 generally
         accepted accounting principles for complete financial statements. In
         the opinion of management, all adjustments (consisting of normal
         recurring accruals) considered necessary for a fair presentation for
         the interim periods presented have been included. Operating results for
         the three month period and six month period ended June 30, 1998 are not
         necessarily indicative of the results that may be expected for the year
         ending December 31, 1998. For further information, refer to the
         consolidated financial statements and footnotes thereto included in
         Penwest Pharmaceuticals Co.'s (or the "Company") Registration 
         Statement on Form 10 (declared effective on July 31, 1998).

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

2.       INCOME TAXES

         The effective tax rates for the quarter ended June 30, 1998 and the six
         month period ended June 30, 1998 were 3% and 11%, respectively. The
         effective rates are higher than the federal statutory rate of a 34%
         benefit due primarily to the effect of tax benefits utilized by Penford
         Corporation (the Company's former parent company) for which Penwest is
         not reimbursed, temporary differences resulting from accelerated
         depreciation reversing when losses are not expected to be available and
         foreign income taxes.

3.       EARNINGS PER COMMON SHARE

         During the first quarter of 1998, the Company adopted Statement of
         Financial Accounting Standards (SFAS) No. 128, "Earnings per Share."
         Statement No. 128 replaced the previous requirement to report primary
         and fully diluted earnings per share with basic and diluted earnings
         per share. Basic earnings per share reflects only the weighted average
         common shares outstanding. Diluted earnings per share reflects weighted
         average common shares outstanding and the effect, if any, of dilutive
         common stock equivalent shares. SFAS No. 128 does not impact the
         Company's net loss per share.

4.       COMPREHENSIVE LOSS

         As of January 1, 1998, the Company adopted Financial Accounting
         Standards Board Statement No. 130 "Reporting Comprehensive Income".
         Statement No. 130 establishes new rules for the reporting and display
         of comprehensive income (loss) and its components; however, the
         adoption of this Statement had no impact on the Company's net loss or
         shareholder's deficit.

         The components of comprehensive loss, for the three and six month
         periods ended June 30, 1997 and 1998 are as follows:


<TABLE>
<CAPTION>
                                             Three Months Ended June 30      Six Months Ended June 30
                                               1997              1998          1997             1998     
                                             -------           --------      --------          -------   
                                             (in thousands of dollars)       (in thousands of dollars)
       <S>                                   <C>               <C>           <C>               <C>

       Net loss                              $(1,002)          $(1,986)      $(1,834)          $(4,016)  
       Foreign currency translation             (380)              147          (648)               71   
                                             -------           -------       -------           -------   
       adjustments                                                                                       
       Comprehensive loss                    $(1,382)          $(1,839)      $(2,482)          $(3,945)  
                                             =======           =======       =======           =======   
</TABLE>


         Accumulated other comprehensive loss equals the amount included in
         shareholder's deficit for the cumulative translation adjustment which 
         is the only component of other comprehensive loss included in the
         Company's financial statements.

5.       CONTINGENCIES

         In May 1997, one of the Company's collaborators, Mylan,
         Pharmaceuticals, Inc. ("Mylan") filed an Abbreviated New Drug
         Application ("ANDA") with the U.S. Food and Drug Administration ("FDA")
         for the 30 mg dosage strength of Nifedipine XL, a generic version of
         Procardia XL, a controlled release formulation of nifedipine. Bayer AG
         ("Bayer") and ALZA Corporation ("ALZA") own patents listed for
         Procardia XL (the last of which expires in 2010), and Pfizer, Inc.
         ("Pfizer is the sponsor of the New Drug Application ("NDA") and markets
         the product. In connection with the ANDA filing, Mylan certified to the
         FDA that Nifedipine XL does not infringe these Bayer or ALZA patents
         and notified Bayer, ALZA and Pfizer of such certification. Bayer and
         Pfizer sued Mylan in the United States District Court for the Western
         District of Pennsylvania, alleging that Mylan's product infringes
         Bayer's patent. The Company has been informed by Mylan that ALZA does
         not believe that the notice given to it complied with the requirements
         of the Waxman-



                                       6
<PAGE>   7
         Hatch Act, and there can be no assurance that ALZA will not sue Mylan
         for patent infringement or take any other actions with respect to such
         notice. Mylan has advised the Company that it intends to contest
         vigorously the allegations made in the lawsuit. However, there can be
         no assurance that Mylan will prevail in this litigation or that it will
         continue to contest the lawsuit. If the litigation results in a
         determination that Nifedipine XL infringes Bayer's patent, Nifedipine
         XL could not be marketed in the United States until such patent
         expired. An unfavorable outcome or protracted litigation for Mylan
         would materially adversely affect the Company's business, financial
         condition, cash flows and results of operations. Delays in the
         commercialization of Nifedipine XL could also occur because the FDA
         will not grant final marketing approval of Nifedipine XL until a final
         judgment on the patent suit is rendered in favor of Mylan by the
         district court, or in the event of an appeal, by the court of appeals,
         or until 30 months (or such longer or shorter period as the court may
         determine) have elapsed from the date of Mylan's certification,
         whichever is sooner.

         In 1993, Pfizer filed a "citizen's petition" with the FDA, claiming
         that its Procardia XL formulation constituted a unique delivery system
         and that a drug with a different release mechanism such as the TIMERx
         controlled release system cannot be considered the same dosage form and
         approved in an ANDA as bioequivalent to Procardia XL. In August 1997,
         the FDA rejected Pfizer's citizen's petition. In July 1997, Pfizer also
         sued the FDA in the District Court of the District of Columbia,
         claiming that the FDA's acceptance of Mylan's ANDA filing for
         Nifedipine XL was contrary to law, based primarily on the arguments
         stated in its citizen's petition. Mylan and the Company intervened as
         defendants in this suit. In April 1998 the District Court of the
         District of Columbia rejected Pfizer's claim, and in May 1998, Pfizer
         appealed the District Court's decision. There can be no assurance that
         the FDA, Mylan and the Company will prevail in this litigation. An
         outcome in this litigation adverse to Mylan and the Company would
         result in Mylan being required to file a suitability petition in order
         to maintain the ANDA filing or to file an NDA with respect to
         Nifedipine XL, each of which would be expensive and time consuming. An
         adverse outcome also would result in Nifedipine XL becoming ineligible
         for an "AB" rating from the FDA. Failure to obtain an AB rating from
         the FDA would indicate that for certain purposes Nifedipine XL would
         not be deemed to be therapeutically equivalent to the referenced
         branded drug, would not be fully substitutable for the referenced
         branded drug and would not be relied upon by Medicaid and Medicare
         formularies for reimbursement. Any such failure would have a material
         adverse effect on the Company's business, financial condition, cash
         flows and results of operations. If any of such events occur, Mylan may
         terminate its efforts with respect to Nifedipine XL, which would have a
         material adverse effect on the Company's business, financial condition,
         cash flows and results of operations.

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

         Substantial patent litigation exist in the pharmaceutical industry.
         Patent litigation generally involves complex legal and factual
         questions, and the outcome frequently is difficult to predict. An
         unfavorable outcome in any patent litigation affecting the Company
         could cause the Company to pay substantial damages, alter its products
         or processes, obtain licenses and/or cease certain activities. Even if
         the outcome is favorable to the Company, the Company could incur
         substantial litigation costs. Although the legal costs of defending
         litigation relating to a patent infringement claim (unless such claim
         relates to TIMERx, in which case such costs are the responsibility of
         the Company) are generally the contractual responsibility of the
         Company's collaborators, the Company could nonetheless incur
         significant unreimbursed costs in participating and assisting in the
         litigation.

         Testing, manufacturing, marketing and selling pharmaceutical products
         entail a risk of product liability. The Company faces the risk of
         product liability claims in the event that the use of its products is
         alleged to have resulted in harm to a patient or subject. Such risks
         exist even with respect to those products that are manufactured in
         licensed and regulated facilities or that otherwise possess regulatory
         approval for commercial sale. Product liability insurance coverage is
         expensive, difficult to obtain and may not be available in the future
         on acceptable terms, if at all. Prior to August 31, 1998, the Company
         was covered by primary product liability insurance maintained by
         Penford in the amount of $1.0 million per occurrence and $2.0 million
         annually in the aggregate on a claims-made basis and by umbrella
         liability insurance in excess of $5.0 million which can also be used
         for product liability insurance. Coverages obtained subsequent to the
         Distribution remain substantially unchanged. There can be no assurance
         that this coverage is adequate to cover potential liability claims and
         may not be adequate as the Company develops additional products. As the
         Company receives regulatory approvals for products under development,
         there can be no assurance that additional liability insurance coverage
         for any such products will be available in the future on acceptable
         terms, if at all. The Company's business, financial condition, cash
         flows and results of operations could be materially adversely affected
         by the assertion of a product liability claim.

6.       RIGHTS AGREEMENT

         On June 25, 1998, the Board of Directors declared a dividend of one
         right for each outstanding share of the Common Stock (the "Right") to
         shareholders of record at the close of business on July 28, 1998. Each
         Right entitles the registered holder to purchase from the Company one
         one-thousandth of a share of the Series A Preferred Stock, at a
         purchase price of $60 in cash, subject to adjustment.

         The rights are not currently exercisable and will not be exercisable
         until the earlier of (I) 10 business days (or such later date as may be
         determined by the Board) following the later of (a) a public
         announcement that a person or group of affiliated or associated persons
         (a "Rights Acquiring Person") has acquired, or obtained the right to
         acquire, beneficial ownership of 15% or more of the outstanding shares
         of Common Stock or (b) the first date on which an executive officer of
         the Company has actual knowledge that a Rights Acquiring Person has
         become such, or (ii) 10 business days (or such later date as may be
         determined by the Board) following the commencement of a tender offer
         or exchange offer that would result in a person or group beneficially
         owning 15% or more of such outstanding shares of Common Stock. The
         Rights will expire upon the close of business on July 27, 2008 unless
         earlier redeemed or exchanged.

         In the event that any Person becomes a Rights Acquiring Person, unless
         the event causing the 15% threshold to be crossed is a





                                       7
<PAGE>   8
         permitted offer, as defined in the agreement, then, promptly following
         the first occurrence of such event, each holder of a Right (except as
         provided below and under certain circumstances) shall thereafter have
         the right to receive, upon exercise, that number of shares of Common
         Stock of the Company (or, in certain circumstances, cash, property or
         other securities of the Company) which equals the exercise price of the
         Right divided by 50% of the current market price per share of Common
         Stock at the date of the occurrence of such event. However, Rights are
         not exercisable following such event until such time as the Rights are
         no longer redeemable by the Company. Notwithstanding any of the
         foregoing, following the occurrence of such event, all Rights that are,
         or (under certain circumstances) were, beneficially owned by any Rights
         Acquiring Person will be null and void.

         In the event that, at any time after any Person becomes a Rights
         Acquiring Person, (i) the Company is consolidated with, or merger with
         and into, another entity and the Company is not the surviving entity of
         such consolidation or merger (other than a consolidation or merger
         which follows a Permitted Offer) or if the Company is the surviving
         entity, but shares of its outstanding Common Stock are changed or
         exchanged for stock or securities (of any other person) or cash or any
         other property, or (ii) 50% or more the Company's assets or earning
         power is sold or transferred, each holder of a Right (except Rights
         which previously have been voided as set forth above) shall thereafter
         have the right to receive, upon exercise, that number of shares of
         common stock of the acquiring company which equals the exercise price
         of the Right divided by 50% of the current market price of such common
         stock at the date of the occurrence of the event.


7.       REVERSE STOCK SPLIT

         On June 19, 1998, the Company effected a 0.76-for-1 reverse stock split
         of its Common Stock. Accordingly, all share and per share data have
         been retroactively adjusted to give effect to the reverse stock split.


8.       SUBSEQUENT EVENTS

         Distribution

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

         In connection with the Distribution, the Company and Penford have
         entered into agreements that govern various interim and ongoing
         relationships. These agreements include (i) a Separation and
         Distribution Agreement setting forth the agreement of the parties with
         respect to the principal corporate transactions required to effect the
         separation of Penford's pharmaceutical business from its specialty
         carbohydrate-based chemical business and the Distribution, including
         without limitation Penford's agreement to guarantee the Company's
         indebtedness under the Credit Facility referred to below; (ii) a
         Services Agreement pursuant to which Penford will continue on an
         interim basis to provide specified services to the Company until June
         30, 1999 or until Penwest does not need the services, of which costs
         will be charged to the Company on an actual or allocated basis, plus a
         specified profit percentage; (iii) a Tax Allocation Agreement relating
         to, among other things, the allocation of tax liability between the
         Company and Penford in connection with the Distribution, all
         pre-distribution liabilities are the responsibility of Penford and all
         post distribution liabilities are those of the respective entities;
         (iv) an Excipient Supply Agreement pursuant to which Penford will
         manufacture and supply exclusively to the Company, and the Company will
         purchase exclusively from Penford, subject to certain exceptions, all
         the Company's requirements for two excipients marketed by the Company
         under quantity and pricing terms that the Company believes approximate
         fair market value; and (v) an Employee Benefits Agreement setting forth
         the parties' agreements as to the continuation of certain Penford
         benefit arrangements for the employees of the Company. Subsequent to
         the Distribution, no terminating liabilities will be incurred by
         Penwest related to the Penford defined benefit plan.

         Credit Facility

         On July 2, 1998 the Company obtained a $15 million unsecured revolving
         credit facility (the "Credit Facility") which is guaranteed by Penford.
         The proceeds may be used to fund working capital and for general
         corporate purposes, including capital expenditures. On August 31, 2000,
         all outstanding amounts under the Credit Facility will become
         automatically due and payable. Penford has agreed that, for a period
         ending August 31, 2000, it will guarantee the Company's indebtedness
         under the Credit Facility. Borrowings under the Credit Facility bear
         interest at a rate equal to LIBOR, plus 1.25%. The Credit Facility
         provides that the maximum amount available to the Company under the
         Credit Facility will be reduced by the amount of any net proceeds from
         any financing conducted by the Company, and that the Company will be
         required to repay any outstanding amounts under the Credit Facility in
         excess of the new maximum amount. The Credit Facility contains a number
         of financial covenants that relate to Penford (and not Penwest),
         including requirements that Penford maintain certain levels of
         financial performance and capital structure. The Credit Facility also
         contains certain covenants applicable to both Penford and Penwest
         including restrictions on the incurrence of additional debt and the
         payment of dividends. Accordingly, the Company is substantially
         dependent on Penford's compliance with such covenants in order to
         access and maintain the Credit Facility. Any breach by Penford of these
         covenants would constitute a default by the Company under the Credit
         Facility, which would have a material adverse effect on the Company's
         business, financial condition and results of operation.

         Stock Options

         On September 4, 1998 there were 1,010,000 options to purchase common
         stock granted to management. These options were priced at market and
         will vest over a four-year period.
 



                                       8
<PAGE>   9


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

OVERVIEW

         Since 1991, Penwest has been engaged in the research, development and
commercialization of novel drug delivery technologies, including the development
of its TIMERx controlled release drug delivery technology. The Company also
develops, manufactures, distributes and sells excipients to the pharmaceutical
and nutritional industries. Penwest was incorporated under the name Edward
Mendell Co., Inc. in the State of Washington in 1991 following Penford's
acquisition of substantially all the assets of its predecessor company. On
August 31, 1998, Penford Corporation, the Company's former parent corporation
("Penford"), distributed (the "Distribution") to the shareholders of record of
Penford common stock on August 10, 1998 all of the shares of the Company's
Common Stock. Pursuant to the Distribution, each Penford shareholder of record
received three shares of the Company's Common Stock for every two shares of
Penford common stock held by them.

         The Company's principal development focus to date has been the
development of controlled release drugs based on the TIMERx technology. The
Company's collaborator, Leiras, received marketing approval in Finland for
Cystrin CR, a TIMERx formulation for the treatment of urge urinary incontinence
and in October 1997 began marketing the product in Finland in January 1998. In
May 1997, the Company's collaborator, Mylan, filed an ANDA with the FDA for the
30 mg dosage strength of Nifedipine XL, the first generic version of Procardia
XL. Subsequent to the filing of Mylan's ANDA, Bayer and Pfizer sued Mylan
alleging patent infringement and Pfizer sued the FDA claiming that the FDA's
acceptance of Mylan's ANDA filing was contrary to law. Pfizer's claim against
the FDA was rejected by a district court in April 1998 and in May 1998 Pfizer
appealed the district court's decision. There can be no assurance that Mylan or
the FDA will prevail in these matters or that they will continue to contest
these matters. An unfavorable outcome or protracted litigation with respect to
either of these matters would have a material adverse effect on the Company's
business, financial condition and results of operations.

         The Company is a party to collaborative agreements with Mylan, Leiras,
Kremers, Sanofi, Synthelabo and Endo with respect to the development and
commercialization of TIMERx controlled release products. Under these
collaborative agreements, the Company's collaborators are generally responsible
for conducting full scale bioequivalence studies and clinical trials, preparing
and submitting all regulatory applications and submissions and manufacturing,
marketing and selling the TIMERx controlled release products. There can be no
assurance that the Company's collaborations will be commercially successful. The
Company cannot control the amount and timing of resources which its
collaborators devote to the Company's programs or potential products. If any of
the Company's collaborators breach or terminate their agreements with the
Company or otherwise fail to conduct their collaborative activities in a timely
manner, the development and commercialization of product candidates would either
be terminated or delayed, or the Company would be required to undertake product
development and commercialization activities on its own and at its own expense,
which would increase the Company's capital requirements or require the Company
to limit the scope of its development and commercialization activities.

         Under most of these collaborative agreements, the Company has received
upfront fees and milestone payments. In connection with the receipt of certain
upfront fees, the Company was required to perform pilot bioequivalence studies
and only recognized such fees upon delivery of the results of such studies to
the collaborators. In addition, under most of these collaborative agreements,
the Company is entitled to receive additional milestone payments, royalties on
the sale of the products covered by such collaborative agreements and payments
for the purchase of formulated TIMERx material. Because the timing and the
amount of each of these payments are dependent on the continued development and
commercialization of the products covered by such agreements, as to which the
Company has limited control, there can be no assurance as to the timing of
receipt of some or all of these payments or as to the amount of payments to be
received by the Company.

         Except for Cystrin CR, which received marketing approval in Finland in
October 1997, and Ditropan CR, which received marketing approval in the
Netherlands, Austria and Ireland in June 1998, no product based on TIMERx
technology has ever received regulatory approval for commercial sale.
Substantially all the TIMERx revenues generated to date have been milestone fees
received for products under development. 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 has incurred net losses since 1994. As of June 30, 1998,
the Company's accumulated deficit was approximately $23.7 million. The Company
expects net losses to continue at least into late 1999. A substantial portion of
the Company's revenues to date have been generated from the sales of the
Company's pharmaceutical excipients. The Company's future profitability will
depend on several factors, including the successful commercialization of TIMERx
controlled release products, and, to a lesser extent, an increase in sales of
its pharmaceutical excipients products. There can be no assurance that the
Company will achieve profitability or that it will be able to sustain any
profitability on a quarterly basis, if at all.

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

         The Company's business is conducted internationally and may be affected
by fluctuations in currency exchange rates, as well as by governmental controls
and other risks associated with international sales (such as export licenses,
collectibility of accounts receivable, trade restrictions and changes in
tariffs). The Company's international subsidiaries transact a substantial
portion of their sales and purchases in European currencies other than their
functional currency, which can result in the Company having gains or losses from
currency exchange rate fluctuations. The Company does not use derivatives to
hedge the impact of fluctuations in foreign currencies.





                                       9
<PAGE>   10

RESULTS OF OPERATIONS

    Quarter Ended June 30, 1998 and 1997

         Total revenues increased 10.4% for the three months ended June 30, 1998
to $7.6 million from $6.8 million for the three months ended June 30, 1997.
Product sales increased to $7.5 million for the three months ended June 30, 1998
from $6.6 million for the three months ended June 30, 1997 representing an
increase of 13.7%. The increase in product sales was primarily due to increased
sales in North America of EMCOCEL, one of the Company's principal excipient
products. Royalties and licensing fees relating to the TIMERx drug delivery
system decreased to $68,000 for the three months ended June 30, 1998 from
$261,000 for the three months ended June 30, 1997 due to the timing of when
development milestones were earned.

         Gross profit increased to $2.3 million or 30.3% of total revenues for
the three months ended June 30, 1998 from $2.0 million or 28.8% of total
revenues for the three months ended June 30, 1997. The increase in gross profit
percentage was primarily due to improved margins on the Company's Emcocel
products due to volume efficiencies in the manufacturing facility partially
offset by a decrease in remedy milestone fees.

         Selling, general and administrative expenses increased by 60.9% for the
three months ended June 30, 1998 to $2.7 million from $1.7 million for the three
months ended June 30, 1997. This increase is primarily due to unusually low
general and administrative expenses in 1997 due to a property tax refund
recorded in the second quarter of 1997 on the Patterson facility. The increase
in 1998 is also due to relocation expenses associated with the hiring of
additional employees required for the Company to operate as a stand-alone
entity, depreciation on a new computer system and higher compensation expenses
related to the employment of additional employees in 1998.

         Research and development expenses increased by 19.0% for the three
months ended June 30, 1998 to $1.5 million from $1.3 million for the three
months ended June 30, 1997. This increase was due to increased spending under
the Company's collaborative agreement with Endo and increased spending related
to the development of TIMERx controlled release products.

         For the three months ended June 30, 1998 and 1997, the Company did not
record a benefit for federal or state taxes because net operating losses were
utilized by Penford in the year they were generated, and the Company was not
compensated by Penford for these losses. In addition, the Company's provision
for income taxes includes foreign taxes and federal and state deferred tax
liabilities that exceed deferred tax assets that will be available to the
Company as an independent taxpayer.

         Six Months Ended June 30, 1998 and 1997

         Total revenues increased 11.0% for the six months ended June 30, 1998
to $15.3 million from $13.8 million for the six months ended June 30, 1997.
Product sales increased to $15.2 million for the six months ended June 30, 1998
from $13.2 million for the six months ended June 30, 1997 representing an
increase of 15.3%. The increase in product sales was primarily due to increased
sales volumes of EMCOCEL. Royalties and licensing fees relating to the TIMERx
drug delivery system decreased to $93,000 for the six months ended June 30, 1998
from $586,000 for the six months ended June 30, 1997 due to the timing of when
development milestones were earned.

         Gross profit increased to $4.2 million or 27.6% of total revenues for
the six months ended June 30, 1998 from $4.0 million or 29.3% of total revenues
for the six months ended June 30, 1997. Overall gross profit increased due to
the increase in product sales. However, the gross profit percentage decreased
due to the reduction in TIMERx milestone fees earned. This decrease was
partially offset by improved margins on the product sales of EMCOCEL. 

         Selling, general and administrative expenses increased by 35.8% for the
six months ended June 30, 1998 to $5.0 million from $2.7 million for the six
months ended June 30, 1997. This increase from reflects unusually low general
and administrative expenses in 1997 from a property tax refund recorded in the
second quarter of 1997 on the Patterson facility. The increase in 1998 is also
due to relocation expenses associated with the hiring of additional employees
required for the Company to operate as a stand-alone entity, depreciation on a
new computer system and higher compensation expenses related to the employment
of additional employees in 1998.

         Research and development expenses increased by 31.7% for the six months
ended June 30, 1998 to $2.8 million from $2.1 million for the six months ended
June 30, 1997. This increase was due to increased spending under the Company's
collaborative agreement with Endo and increased spending related to the
development of TIMERx controlled release products.

         For the six months ended June 30, 1998 and 1997, the Company did not
record a benefit for federal or state taxes because net operating losses were
utilized by Penford in the year they were generated, and the Company was not
compensated by Penford for these losses. In addition, the Company's provision
for income taxes includes foreign taxes and federal and state deferred tax
liabilities that exceed deferred tax assets that will be available to the
Company as an independent taxpayer.


                                       10
<PAGE>   11

LIQUIDITY AND CAPITAL RESOURCES

         Since its incorporation, the Company has received intercompany advances
from Penford to fund the Company's operations, capital expenditures and the
original acquisition of the Company's predecessor, which equalled $47.3 million
as of June 30, 1998. Penford continued to provide advances to the Company until
the Distribution date of September 1, 1998 at which time Penford contributed
the outstanding intercompany indebtedness to the capital of the Company. In
addition, Penford has guaranteed the Company's indebtedness under the Credit
Facility. In no other respects will Penford provide financial support to the
Company after the Distribution.

         As of June 30, 1998, the Company had cash and cash equivalents of
$900,000. Following the Distribution Date, the Company had no committed sources
of capital other than the Credit Facility and no indebtedness to any third or
related parties other than under the Credit Facility. As of June 30, 1998, the
Company did not have any material commitments for capital expenditures.

         The Company had negative cash flow from operations in each of the
periods presented primarily due to net losses for the period as well as
increasing trade receivables. As of December 31, 1997 there was a temporary
decrease in accounts receivable due primarily to the timing of customer
purchases and improved collection efforts. However, accounts receivable as of
June 30, 




                                       11
<PAGE>   12

1998 increased by 60% from December 31, 1997 primarily due to the increase and
the timing of customer purchases.

         Funds expended for the acquisition of fixed assets were primarily
related to the expansion of the Company's manufacturing facilities and
laboratory space as well as the purchase of equipment used principally for
research and development efforts. The payable to Penford increased to fund the
operations and capital needs of the Company.

         The Company anticipates that its existing capital resources, together
with the funds available under the Credit Facility and internally generated
funds, will enable it to maintain currently planned operations through at least
1999. However, this expectation is based on the Company's current operating
plan, which could change as a result of many factors and the Company could
require additional funding sooner than anticipated. The Company's requirements
for additional capital could be substantial and will depend on many factors,
including the timing and amount of payments received under existing and possible
future collaborative agreements; the structure of any future collaborative or
development agreements; the progress of the Company's collaborative and
independent development projects; revenues from the Company's excipients
business, including from the introduction of ProSolv; the costs to the Company
of bioequivalence studies for the Company's products; the prosecution, defense
and enforcement of patent claims and other intellectual property rights; and the
development of manufacturing, marketing and sales capabilities. Upon the
Distribution Date, the Company will have no committed sources of capital other
than the Credit Facility. There can be no assurance that the Company will be
able to access the Credit Facility at such times as it desires or needs capital.





                                       12
<PAGE>   13
         To the extent capital resources are insufficient to meet future
requirements, the Company will have to raise additional funds to continue the
development of its technologies. There can be no assurance that such funds will
be available on favorable terms, if at all. The Credit Facility restricts the
incurrence of additional indebtedness by the Company and provides that the
maximum amount available to Penwest under the Credit Facility, $15.0 million,
will be reduced by the amount of any net proceeds from any financing conducted
by the Company and that the Company will repay any outstanding amounts under the
Credit Facility in excess of the new maximum amount. To the extent that
additional capital is raised through the sale of equity or convertible debt
securities, the issuance of such securities could result in dilution to the
Company's shareholders. If adequate funds are not available, the Company may
unable to comply with its obligations under its collaborative agreements, which
could result in the termination of such collaborative agreements. In addition,
the Company may be required to curtail operations significantly or obtain funds
through entering into collaborative agreements on unfavorable terms. The
Company's inability to raise capital would have a material adverse effect on the
Company's business, financial condition and results of operations.

         Under the Company's strategic alliance agreement with Endo, the Company
expects to expend approximately $12.0 million, primarily in 1999 and 2000. The
Company expects to rely on funds available under the Credit Facility and cash
from operations to fund expenditures. However, as noted above the Company may be
required to raise additional funds to continue its development activities,
including its activities under the Endo agreement. However, either the Company
or Endo may terminate the agreement upon 30 days' prior written notice, at which
time the Company's funding obligations would cease.

         The Credit Facility is a revolving Loan Facility with a maximum
principal amount of $15.0 million of unsecured financing. On August 31, 2000,
all outstanding amounts under the Credit Facility will become automatically due
and payable. Penford has agreed that, for a period ending August 31, 2000, it
will guarantee the Company's indebtedness under the Credit Facility. Borrowings
under the Credit Facility bare interest at a rate equal to LIBOR, plus 1.25%.
The Credit Facility contains a number of non-financial covenants that are
applicable to Penwest, including without limitation, restrictions on the
incurrence of additional debt and on the payment of dividends. Any breach of
these covenants by the Company would constitute a default by the Company under
the Credit Facility. In addition, the Credit Facility provides that a breach by
Penford of its guarantee of the Company's indebtedness under the Credit Facility
or the occurrence of a default under any credit agreement with Penford under
which the lender is either the sole or a participating lender, including without
limitation an event of default arising from the failure of Penford to satisfy
certain financial conditions requiring, among other things, the maintenance of a
minimum net worth and of certain financial ratios, would constitute a default by
the Company under the Credit Facility. Accordingly, the Company will be
substantially dependent on Penford in order to access and maintain the Credit
Facility. Any default under the Credit Facility would have a material adverse
effect on the Company's business, financial condition and result of operations.

YEAR 2000

         The Company has undergone a review of its domestic information systems,
including consideration of issues associated with the Year 2000. Due to the
recent addition of a new integrated computer system (at a cost of approximately
$3.9 million) that is Year 2000 compliant, other domestic Year 2000 expenditures
have not been and are not expected to be material. Also, the Company has
initiated a review of potential Year 2000 matters at its European manufacturing
facility and communications with its significant suppliers and customers (which
it expects to complete by the end of 1998) to determine the extent to which the
Company is vulnerable to those third parties failure to remediate their own Year
2000 issues. Although the actual costs of such review and any corrective actions
required are not expected to be significant, actual costs cannot be determined
until the review is completed. There can be no assurance that the systems of
other companies or the Company's European manufacturing facility will be
converted on a timely basis and will not have a corresponding adverse effect on
the Company's results of operations or cash flows.

COMMON EUROPEAN CURRENCY

         The Treaty on European Economic and Monetary Union (the "Maastricht
Treaty") provides for the introduction of a single European currency, the Euro
in substitution for the national currencies of the member states of the European
Union that adopt the Euro. In May 1998, the European Council determined (i) the
11 member states that met the requirement for the Monetary Union, and (ii) the
currency exchange rates among the currencies for the members states joining the
Monetary Union. The transitory period for the Monetary Union starts on January
1, 1999. According to Council Resolution of July 7, 1997, the introduction of
the Euro will be made in three steps: (i) a transitory period from January 1,
1999 to December 31, 2001, in which current accounts may be opened and financial
statements may be drawn in Euros, and local currencies and Euros will coexist;
(ii) from January 1, 2002 to June 30, 2002, in which local currencies will be
exchanged for Euros; and (iii) from July 1, 2002 in which local currencies will
disappear. Although there can be no assurance that a single European currency
will be adopted or, if adopted, on what time schedule and with what success
substantial transitional costs could result as the Company redesigns its
software systems to reflect the adoption of the new currency. In addition, there
can be no assurance as to the effect of the adoption of the Euro on the
Company's payment obligations under commercial agreements in such currencies.


                                       13
<PAGE>   14


                 CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS


     This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. For this purpose, any
statements contained herein that are not statements of historical fact may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes", "anticipates", "plans", "expects", "intends", "may", and
other similar expressions are intended to identify forward-looking statements.
There are a number of important factors that could cause the Company's actual
results to differ materially from those indicated by forward-looking statements
contained in this report and presented elsewhere by management from time to
time. These factors include the matters discussed in the Overview to this Item
7. Management's Discussion and Analysis of Results of Operations and Financial
Conditions and the matters set forth under the heading "Risk Factors" in the
Company's Registration Statement on Form 10 (declared effective on July 31,
1998), which matters are incorporated herein by reference.


Item 3.   Quantitative and Qualitative Disclosure about Market Risk

          Not applicable.

Part II.  OTHER INFORMATION

Item 2.   Changes in Securities and Use of Proceeds

     On June 19, 1998, the Company effected a 0.76-for-1 reverse stock split of
its Common Stock.

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

     In June 1998, Penford Corporation, the sole shareholder of the Company at
such time, approved by written consent the following proposals:

     a.   Election of Paul E. Freiman, Rolf H. Henel and N. Stewart Rogers as
          Class I directors. The following directors' terms in office continued
          after such election: Tod R. Hamachek, John V. Talley, Jr., Jere E.
          Goyan and Robert J. Hennessey.     

     b.   Ratification of the appointment of Ernst & Young LLP as the
          independent auditors of the Company for the fiscal year ending
          December 31, 1998.

     c.   Approval of Articles of Amendment to the Amended and Restated
          Articles of Incorporation of the Company.

     d.   Approval of the Company's 1998 Spinoff Option Plan.


Item 5.   Other Information

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



                                       14
<PAGE>   15

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.

          None.



                                   SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.


                                        PENWEST PHARMACEUTICALS CO.



Date: September 14, 1998                By: /s/ Tod R. Hamachek
                                           --------------------------
                                           Tod R. Hamachek
                                           Chairman of the Board and
                                           Chief Executive Officer





                                 EXHIBIT INDEX


     Exhibit Number                                  Description
     --------------                                  -----------
           27                                  Financial Data Schedule