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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form 10-Q

|     |  |                                                                                         
|---- |  | ----------------------------------------------------------------------------------------
|[X]  |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 
|     |  |                                                                                         
|     |  | For the quarterly period ended September 30, 2003                                       
|     |  |                                                                                         
|     |  | 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(State of Incorporation)39 Old Ridgebury Road, Suite 11,
Danbury, Connecticut(Address of principal executive offices) |  | 91-1513032(I.R.S. Employer Identification No.)06810-5120(Zip Code)

(877) 736-9378(Registrants telephone number, including area code.)

Indicate by a check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X]   No [  ]

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

Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of October 26, 2003.

|                              |  |             |            | 
|----------------------------- |  | ----------- | ---------- | 
|Class                         |  | Outstanding
|                              |  |            
|Common stock, par value $.001 |  |             | 18,296,367 | 



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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
|                                          | 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 2. Changes in Securities and Use of Proceeds                                            
|                                          | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURE                                
|EXHIBIT INDEX                            
|EX-31.1 SECT. 302 CERTIFICATION OF C.E.O.
|EX-31.2 SECT. 302 CERTIFICATION OF C.F.O.
|EX-32.1 SECT. 906 CERTIFICATION OF C.E.O.
|EX-32.2 SECT. 906 CERTIFICATION OF C.F.O.



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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                                       |  |  | 6  |     
|              |  | Notes to Condensed Consolidated Financial Statements                                  |  |  | 7  |     
|Item 2.       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  |  | 13 |     
|Item 3.       |  | Quantitative and Qualitative Disclosures About Market Risk                            |  |  | 26 |     
|Item 4.       |  | Controls and Procedures                                                               |  |  | 27 |     
|              |  | PART II  OTHER INFORMATION                                                           |  |  |    |     
|Item 2.       |  | Changes in Securities and Use of Proceeds                                             |  |  | 28 |     
|Item 6.       |  | Exhibits and Reports on Form 8-K                                                      |  |  | 28 |     
|Signature     |  |                                                                                       |  |  |    |      | 29 | 
|Exhibit Index |  |                                                                                       |  |  |    |      | 30 | 

TIMERx®
is a registered trademark of the Company. GeminexTM and
SyncroDoseTM are also trademarks of the Company. Other tradenames and
trademarks appearing in this quarterly report are the property of their
respective owners.

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PART I  FINANCIAL INFORMATION

Item 1.Financial Statements




PENWEST PHARMACEUTICALS CO.
CONDENSED CONSOLIDATED BALANCE SHEETS

|                       |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |              |        |  |  | 
|---------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------------------------------------ | ------- | ------ | --------------------- | ----- | ------------ | ------ |  |  | 
|                       |                                                                                                                                                                        |                                            |                                      |         |        | September 30,         |       | December 31,
|                       |                                                                                                                                                                        |                                            |                                      |         |        | 2003                  |       | 2002        
|                       |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |             
|                       |                                                                                                                                                                        |                                            |                                      |         |        | (Unaudited)           |       | (Note 2)    
|                       |                                                                                                                                                                        |                                            |                                      |         |        | (In thousands,       
|                       |                                                                                                                                                                        |                                            |                                      |         |        | except share amounts)
|ASSETS                 |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |             
|Current assets:        |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |             
|                       | Cash and cash equivalents                                                                                                                                              |                                            | $                                    | 40,706  |        |                       | $     | 1,629        |       
|                       | Marketable securities                                                                                                                                                  |                                            |                                      | 28,847  |        |                       |       | 2,057        |       
|                       | Trade accounts receivable                                                                                                                                              |                                            |                                      | 1,069   |        |                       |       | 1,078        |       
|                       | Inventories:                                                                                                                                                           |                                            |                                      |         |        |                       |       |              |       
|                       |                                                                                                                                                                        | Raw materials and other                    |                                      |         | 268    |                       |       |              | 149    | 
|                       |                                                                                                                                                                        | Finished goods                             |                                      |         | 502    |                       |       |              | 312    | 
|                       |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |              |       
|                       |                                                                                                                                                                        |                                            | 770                                  |         |        |                       | 461   |             
|                       | Prepaid expenses and other current assets                                                                                                                              |                                            |                                      | 1,399   |        |                       |       | 1,902        |       
|                       | Deferred transaction costs                                                                                                                                             |                                            |                                      |        |        |                       |       | 1,741        |       
|                       | Note receivable                                                                                                                                                        |                                            |                                      | 1,250   |        |                       |       |             |       
|                       | Assets held for sale                                                                                                                                                   |                                            |                                      |        |        |                       |       | 33,143       |       
|                       |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |              |       
|                       |                                                                                                                                                                        | Total current assets                       |                                      |         | 74,041 |                       |       |              | 42,011 | 
|Fixed assets, net      |                                                                                                                                                                        |                                            | 3,771                                |         |        |                       | 2,406 |             
|Intangible assets, net |                                                                                                                                                                        |                                            | 3,342                                |         |        |                       | 2,947 |             
|Other assets           |                                                                                                                                                                        |                                            | 2,924                                |         |        |                       | 2,856 |             
|                       |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |              |       
|                       |                                                                                                                                                                        | Total assets                               |                                      | $       | 84,078 |                       |       | $            | 50,220 | 
|                       |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |              |       
|                       |                                                                                                                                                                        |                                            | LIABILITIES AND SHAREHOLDERS EQUITY |         |        |                       |       |              |        |  | 
|Current liabilities:   |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |             
|                       | Accounts payable                                                                                                                                                       |                                            | $                                    | 1,115   |        |                       | $     | 880          |       
|                       | Accrued expenses                                                                                                                                                       |                                            |                                      | 1,933   |        |                       |       | 2,886        |       
|                       | Accrued development costs                                                                                                                                              |                                            |                                      | 2,523   |        |                       |       | 2,785        |       
|                       | Taxes payable                                                                                                                                                          |                                            |                                      | 459     |        |                       |       | 258          |       
|                       | Loans and notes payable                                                                                                                                                |                                            |                                      |        |        |                       |       | 5,693        |       
|                       | Deferred revenue                                                                                                                                                       |                                            |                                      |        |        |                       |       | 150          |       
|                       | Liabilities held for sale                                                                                                                                              |                                            |                                      |        |        |                       |       | 3,004        |       
|                       |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |              |       
|                       |                                                                                                                                                                        | Total current liabilities                  |                                      |         | 6,030  |                       |       |              | 15,656 | 
|Deferred income taxes  |                                                                                                                                                                        |                                            | 118                                  |         |        |                       | 118   |             
|Deferred revenue       |                                                                                                                                                                        |                                            | 114                                  |         |        |                       | 134   |             
|Deferred compensation  |                                                                                                                                                                        |                                            | 3,050                                |         |        |                       | 2,889 |             
|                       |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |              |       
|                       |                                                                                                                                                                        | Total liabilities                          |                                      |         | 9,312  |                       |       |              | 18,797 | 
|Shareholders equity:  |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |             
|                       | Preferred stock, par value $.001, authorized
1,000,000 shares, none outstanding                                                                                        |                                            |                                      |        |        |                       |       |             |       
|                       | Common stock, par value $.001, authorized
39,000,000 shares, issued and outstanding
18,291,367 shares at September 30, 2003 and
15,506,259 shares at December 31, 2002 |                                            |                                      | 18      |        |                       |       | 16           |       
|                       | Additional paid in capital                                                                                                                                             |                                            |                                      | 161,355 |        |                       |       | 110,000      |       
|                       | Accumulated deficit                                                                                                                                                    |                                            |                                      | (86,671 | )      |                       |       | (78,025      | )     
|                       | Accumulated other comprehensive income (loss)                                                                                                                          |                                            |                                      | 64      |        |                       |       | (568         | )     
|                       |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |              |       
|                       |                                                                                                                                                                        | Total shareholders equity                 |                                      |         | 74,766 |                       |       |              | 31,423 | 
|                       |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |              |       
|                       |                                                                                                                                                                        | Total liabilities and shareholders equity |                                      | $       | 84,078 |                       |       | $            | 50,220 | 
|                       |                                                                                                                                                                        |                                            |                                      |         |        |                       |       |              |       

See accompanying notes to condensed consolidated financial statements.

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PENWEST PHARMACEUTICALS CO.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                                  |                                     |                          |        |                        |       |      |        |       |       | 
|----------------------------------------------------------------- | ----------------------------------- | ------------------------ | ------ | ---------------------- | ----- | ---- | ------ | ----- | ----- | 
|                                                                  |                                     |                          |        | Three Months Ended    
|                                                                  |                                     |                          |        | September 30,         
|                                                                  |                                     |                          |        |                       
|                                                                  |                                     |                          |        | 2003                   |       | 2002
|                                                                  |                                     |                          |        |                        |       |     
|                                                                  |                                     |                          |        | (Unaudited)           
|                                                                  |                                     |                          |        | (In thousands,        
|                                                                  |                                     |                          |        | except per share data)
|Revenues                                                          |                                     |                          |        |                        |       |      |        |      
|                                                                  | Product sales                       |                          | $      |                       |       |      | $      | 201   |      
|                                                                  | Royalties and licensing fees        |                          |        | 1,016                  |       |      |        | 1,480 |      
|                                                                  |                                     |                          |        |                        |       |      |        |       |      
|                                                                  |                                     | Total revenues           |        |                        | 1,016 |      |        |       | 1,681 | 
|Cost of revenues                                                  |                                     |                          | 11     |                        |       |      | 59     |      
|                                                                  |                                     |                          |        |                        |       |      |        |       |      
|                                                                  | Gross profit                        |                          |        | 1,005                  |       |      |        | 1,622 |      
|Operating expenses                                                |                                     |                          |        |                        |       |      |        |      
|                                                                  | Selling, general and administrative |                          |        | 2,276                  |       |      |        | 2,221 |      
|                                                                  | Research and product development    |                          |        | 4,413                  |       |      |        | 4,355 |      
|                                                                  |                                     |                          |        |                        |       |      |        |       |      
|                                                                  |                                     | Total operating expenses |        |                        | 6,689 |      |        |       | 6,576 | 
|                                                                  |                                     |                          |        |                        |       |      |        |       |      
|Operating loss from continuing operations                         |                                     |                          | (5,684 | )                      |       |      | (4,954 | )    
|Investment income                                                 |                                     |                          | 147    |                        |       |      | 72     |      
|Interest expense                                                  |                                     |                          |       |                        |       |      | 61     |      
|                                                                  |                                     |                          |        |                        |       |      |        |       |      
|Loss from continuing operations before income taxes               |                                     |                          | (5,537 | )                      |       |      | (4,943 | )    
|Income tax expense                                                |                                     |                          |       |                        |       |      |       |      
|                                                                  |                                     |                          |        |                        |       |      |        |       |      
|Loss from continuing operations                                   |                                     |                          | (5,537 | )                      |       |      | (4,943 | )    
|Earnings from discontinued operations, net of tax
expense of $116 |                                     |                          |       |                        |       |      | 467    |      
|                                                                  |                                     |                          |        |                        |       |      |        |       |      
|Net loss                                                          |                                     | $                        | (5,537 | )                      |       | $    | (4,476 | )    
|                                                                  |                                     |                          |        |                        |       |      |        |       |      
|Basic and diluted (loss) earnings per common share:               |                                     |                          |        |                        |       |      |        |      
|                                                                  | Continuing operations               |                          | $      | (0.32                  | )     |      | $      | (0.32 | )    
|                                                                  | Discontinued operations             |                          |        |                       |       |      |        | 0.03  |      
|                                                                  |                                     |                          |        |                        |       |      |        |       |      
|Net loss per common share                                         |                                     | $                        | (0.32  | )                      |       | $    | (0.29  | )    
|                                                                  |                                     |                          |        |                        |       |      |        |       |      
|Weighted average shares of common stock outstanding               |                                     |                          | 17,254 |                        |       |      | 15,488 |      
|                                                                  |                                     |                          |        |                        |       |      |        |       |      

See accompanying notes to condensed consolidated financial statements.

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PENWEST PHARMACEUTICALS CO.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                                          |                                     |              |                          |        |                        |        |         |        |       |        | 
|------------------------------------------------------------------------- | ----------------------------------- | ------------ | ------------------------ | ------ | ---------------------- | ------ | ------- | ------ | ----- | ------ | 
|                                                                          |                                     |              |                          |        | Nine Months Ended     
|                                                                          |                                     |              |                          |        | September 30,         
|                                                                          |                                     |              |                          |        |                       
|                                                                          |                                     |              |                          |        | 2003                   |        | 2002   
|                                                                          |                                     |              |                          |        |                        |        |        
|                                                                          |                                     |              |                          |        | (Unaudited)           
|                                                                          |                                     |              |                          |        | (In thousands,        
|                                                                          |                                     |              |                          |        | except per share data)
|Revenues                                                                  |                                     |              |                          |        |                        |        |         |       
|                                                                          | Product sales                       |              | $                        | 455    |                        |        | $       | 351    |      
|                                                                          | Royalties and licensing fees        |              |                          | 2,982  |                        |        |         | 3,713  |      
|                                                                          |                                     |              |                          |        |                        |        |         |        |      
|                                                                          |                                     |              | Total revenues           |        |                        | 3,437  |         |        |       | 4,064  | 
|Cost of revenues                                                          |                                     |              | 155                      |        |                        |        | 120     |       
|                                                                          |                                     |              |                          |        |                        |        |         |        |      
|                                                                          |                                     | Gross profit |                          |        | 3,282                  |        |         |        | 3,944 |       
|Operating expenses                                                        |                                     |              |                          |        |                        |        |         |       
|                                                                          | Selling, general and administrative |              |                          | 7,806  |                        |        |         | 5,704  |      
|                                                                          | Research and product development    |              |                          | 13,555 |                        |        |         | 14,159 |      
|                                                                          |                                     |              |                          |        |                        |        |         |        |      
|                                                                          |                                     |              | Total operating expenses |        |                        | 21,361 |         |        |       | 19,863 | 
|                                                                          |                                     |              |                          |        |                        |        |         |        |      
|Operating loss from continuing operations                                 |                                     |              | (18,079                  | )      |                        |        | (15,919 | )     
|Investment income                                                         |                                     |              | 267                      |        |                        |        | 314     |       
|Interest expense                                                          |                                     |              | 34                       |        |                        |        | 181     |       
|                                                                          |                                     |              |                          |        |                        |        |         |        |      
|Loss from continuing operations before income taxes                       |                                     |              | (17,846                  | )      |                        |        | (15,786 | )     
|Income tax expense                                                        |                                     |              |                         |        |                        |        |        |       
|                                                                          |                                     |              |                          |        |                        |        |         |        |      
|Loss from continuing operations                                           |                                     |              | (17,846                  | )      |                        |        | (15,786 | )     
|Earnings from discontinued operations, net of tax expense of $26
and $337 |                                     |              | 177                      |        |                        |        | 1,674   |       
|Gain on sale of discontinued operations, net of tax expense of $51        |                                     |              | 9,497                    |        |                        |        |        |       
|                                                                          |                                     |              |                          |        |                        |        |         |        |      
|Net loss                                                                  |                                     | $            | (8,172                   | )      |                        | $      | (14,112 | )     
|                                                                          |                                     |              |                          |        |                        |        |         |        |      
|Basic and diluted (loss) earnings per common share:                       |                                     |              |                          |        |                        |        |         |       
|                                                                          | Continuing operations               |              | $                        | (1.11  | )                      |        | $       | (1.02  | )    
|                                                                          | Discontinued operations             |              |                          | 0.60   |                        |        |         | 0.11   |      
|                                                                          |                                     |              |                          |        |                        |        |         |        |      
|Net loss per common share                                                 |                                     | $            | (0.51                    | )      |                        | $      | (0.91   | )     
|                                                                          |                                     |              |                          |        |                        |        |         |        |      
|Weighted average shares of common stock outstanding                       |                                     |              | 16,118                   |        |                        |        | 15,451  |       
|                                                                          |                                     |              |                          |        |                        |        |         |        |      

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,    
|                                                                                        |                                                                                                                         |   |                  
|                                                                                        |                                                                                                                         |   | 2003              |         | 2002
|                                                                                        |                                                                                                                         |   |                   |         |     
|                                                                                        |                                                                                                                         |   | (Unaudited)      
|                                                                                        |                                                                                                                         |   | (In thousands)   
|Net cash used in operating activities:                                                  |                                                                                                                         |   |                   |         |      |   |         |        
|Net loss                                                                                |                                                                                                                         | $ | (8,172            | )       |      | $ | (14,112 | )      
|Less earnings from discontinued operations, net of tax                                  |                                                                                                                         |   | (177              | )       |      |   | (1,674  | )      
|Less gain on sale of discontinued operations, net of tax                                |                                                                                                                         |   | (9,497            | )       |      |   |        |        
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        
|Loss from continuing operations                                                         |                                                                                                                         |   | (17,846           | )       |      |   | (15,786 | )      
|                                                                                        | Adjustments to reconcile loss from continuing operations to net
cash used in continuing operations operating activities |   |                   | 606     |      |   |         | (523    | )
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        
|Net cash used in continuing operations operating activities                             |                                                                                                                         |   | (17,240           | )       |      |   | (16,309 | )      
|Net cash provided by discontinued operations operating activities                       |                                                                                                                         |   | 874               |         |      |   | 1,985   |        
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        
|Net cash used in operating activities                                                   |                                                                                                                         |   | (16,366           | )       |      |   | (14,324 | )      
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        
|Investing activities:                                                                   |                                                                                                                         |   |                   |         |      |   |         |        
|                                                                                        | Proceeds from sale of discontinued operations, net of
transaction costs paid of $1,351                                  |   |                   | 36,900  |      |   |         |        |  
|                                                                                        | Acquisitions of fixed assets, net                                                                                       |   |                   | (1,820  | )    |   |         | (1,106  | )
|                                                                                        | Intangible asset costs                                                                                                  |   |                   | (554    | )    |   |         | (596    | )
|                                                                                        | Proceeds from maturities of marketable securities                                                                       |   |                   | 3,994   |      |   |         | 5,250   |  
|                                                                                        | Purchases of marketable securities                                                                                      |   |                   | (30,816 | )    |   |         |        |  
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        
|Net cash provided by continuing operations investing activities                         |                                                                                                                         |   | 7,704             |         |      |   | 3,548   |        
|Net cash used in discontinued operations investing activities                           |                                                                                                                         |   | (97               | )       |      |   | (308    | )      
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        
|Net cash provided by investing activities                                               |                                                                                                                         |   | 7,607             |         |      |   | 3,240   |        
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        
|Financing activities:                                                                   |                                                                                                                         |   |                   |         |      |   |         |        
|                                                                                        | Proceeds from loans                                                                                                     |   |                   | 1,354   |      |   |         | 20,134  |  
|                                                                                        | Repayments of loans                                                                                                     |   |                   | (7,047  | )    |   |         | (19,021 | )
|                                                                                        | Issuance of common stock, net                                                                                           |   |                   | 51,248  |      |   |         | 1,849   |  
|                                                                                        | Net cash provided by discontinued operations                                                                            |   |                   | 2,249   |      |   |         |        |  
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        
|Net cash (used in) provided by financing activities                                     |                                                                                                                         |   | 47,804            |         |      |   | 2,962   |        
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        
|Effect of exchange rate changes on cash and cash equivalents of
discontinued operations |                                                                                                                         |   | 32                |         |      |   | 182     |        
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        
|Net increase (decrease) in cash and cash equivalents                                    |                                                                                                                         |   | 39,077            |         |      |   | (7,940  | )      
|Cash and cash equivalents at beginning of period                                        |                                                                                                                         |   | 1,629             |         |      |   | 11,530  |        
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        
|Cash and cash equivalents at end of period                                              |                                                                                                                         | $ | 40,706            |         |      | $ | 3,590   |        
|                                                                                        |                                                                                                                         |   |                   |         |      |   |         |        

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

Prior to February 27, 2003, Penwest also developed, manufactured and
distributed branded pharmaceutical excipients, which are the inactive
ingredients in tablets and capsules, primarily consisting of binders,
disintegrants and lubricants. On February 27, 2003, Penwest sold substantially
all of the assets used in the Companys excipient business to subsidiaries and
affiliates of Josef Rettenmaier Holding GmbH & Co. KG (the Asset Sale). The Company received $39.5 million in
cash and a promissory note for $2.25 million in consideration for the excipient
business. The Company received $1.0 million of the $2.25 million promissory
note in April 2003 with the balance due in May 2004. The Company used
approximately $5.5 million of proceeds of the sale of its excipient business to
repay debt (see Note 6) and intends to use the balance of the proceeds to
expand its drug delivery business. As a result of the Asset Sale, the
accompanying consolidated financial statements present Penwests excipient
business as a discontinued operation, for all periods presented.

The Company is subject to the risks and uncertainties associated with a
drug delivery company actively engaged in research and development. These risks
and uncertainties include, but are not limited to, a history of net losses,
technological changes, dependence on collaborators and key personnel, the
successful completion of development efforts and of obtaining regulatory
approvals, 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, and a requirement for additional funding.

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. In the opinion of management, all adjustments considered necessary
for a fair presentation for the interim periods presented have been included.
All such adjustments are of a normal recurring nature. Operating results for
the three and nine month periods ended September 30, 2003 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2003. For further information, refer to the full-year consolidated financial
statements and footnotes thereto included in the Companys Current Report on
Form 8-K filed on September 4, 2003.

As a result of the Asset Sale, the operating results of the excipient
business have been presented as discontinued operations in the condensed
consolidated statements of operations for the three and nine month periods
ended September 30, 2002 and the nine month period ended September 30, 2003
(see Note 9). In order to conform to the current period presentation, certain
reclassifications have been made in the prior period financial statements.

During the quarter ended September 30, 2003, the Company recorded an
adjustment to reduce the accruals for its share of the costs of oxymorphone ER
development and marketing by $266,000 and $72,000, respectively. The effect of
this adjustment for the quarter was to decrease the net loss by $338,000 (no
tax effect) or $0.02 per common share. In addition, the Company recorded an
adjustment of approximately $202,000 in the quarter ended September 30, 2003,
to reduce an accrual relating to 2003 compensation. The effect of this
adjustment for the quarter was to decrease the net loss by $202,000 (no tax
effect) or $0.01 per common share.

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

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

The balance sheet at December 31, 2002, 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.

3. Summary of Significant Accounting Policies

Revenue Recognition

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

Research and Development Expenses

Research
and development expenses consist of costs associated with products
being developed internally as well as products being developed under
collaboration agreements and include related salaries, benefits and other personnel
related expenses, clinical trial costs, and contract and other outside service
fees. Research and development costs are expensed as incurred.
Certain reimbursements of costs, generally related to drug formulation on
feasibility studies, are netted against research and development expense. A
significant portion of the Companys development activities are outsourced to
third parties including contract research organizations, and contract
manufacturers in connection with the production of clinical materials, or may be performed by the Companys collaborators. These
arrangements may require estimates be made of related service fees or
of
the Companys share of development costs, in which actual results could materially differ
from the estimates and affect the reported amounts in the Companys
financial statements.

Stock Options

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

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

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

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

forma amounts indicated below (in thousands, except per share data):

|                                                    |  |                    |        |                   |  |      |        |      |  |   |        |   |  |   |         |  
|--------------------------------------------------- |  | ------------------ | ------ | ----------------- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                    |  | Three Months Ended |        | Nine Months Ended
|                                                    |  | September 30,      |        | September 30,    
|                                                    |  |                    |        |                  
|                                                    |  | 2003               |        | 2002              |  | 2003 |        | 2002
|                                                    |  |                    |        |                   |  |      |        |     
|                                                    |  | (Unaudited)        |        | (Unaudited)      
|Net loss  as reported                              |  | $                  | (5,537 | )                 |  | $    | (4,476 | )    |  | $ | (8,172 | ) |  | $ | (14,112 | )
|Net loss  pro forma                                |  | $                  | (5,657 | )                 |  | $    | (4,733 | )    |  | $ | (9,661 | ) |  | $ | (15,574 | )
|Net loss per share, basic and diluted  as reported |  | $                  | (0.32  | )                 |  | $    | (0.29  | )    |  | $ | (0.51  | ) |  | $ | (0.91   | )
|Net loss per share, basic and diluted  pro forma   |  | $                  | (0.33  | )                 |  | $    | (0.31  | )    |  | $ | (0.60  | ) |  | $ | (1.01   | )

4. Issuance of Common Stock

On August 5 and August 6, 2003, the Company completed the sale of a total
of 2,507,762 shares of common stock through a private placement to selected
institutional investors (the Private Placement), resulting in net proceeds to
the Company, after fees and expenses, of approximately $49.3 million. As part
of the Private Placement, the Company granted the institutional investors
additional rights to purchase up to an additional 501,552 shares of common
stock at a price of $26.00 per share. These additional investment rights became
exercisable on September 12, 2003, and will expire on December 9, 2003, subject
to extension in specific circumstances. The Company intends to use the net
proceeds from the Private Placement to fund the research, development,
marketing and commercialization of its products and technologies, and for
general corporate purposes.

5. Recent Accounting Pronouncements

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

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

6. Loans and Notes Payable

Credit Facilities

On January 17, 2001, the Company completed arrangements for a revolving
line of credit (Revolver) with a financial institution. Under the terms of
the Revolver, the Company could borrow up to $10.0 million (Line of Credit)
as determined by a formula based on the Companys Eligible Accounts Receivable
and Eligible Saleable Inventory, as defined in the agreement. Under the
formula, generally 85% of the Companys U.S. and Canadian receivables, as well
as generally 60% of the Companys U.S. saleable inventories, were included in
the borrowing base. Amounts outstanding under the Revolver were collateralized
by the Companys U.S. and Canadian accounts receivable, and its inventory and
general intangibles. The Revolver had an initial term of three years, and
provided for annual renewals thereafter. On February 27, 2003, the Company paid
off the outstanding balance of $3.3 million and terminated the Revolver in
connection with the Asset Sale (see Note 9).

Note Payable to AstraZeneca AB

On October 25, 2002, the Company entered into an agreement with
AstraZeneca AB to acquire from AstraZeneca AB assets related to the excipient
product, Pruv, including trademarks and other intellectual property, for a
total purchase price of $3.0 million. Pursuant to this agreement, the Company
issued a note to AstraZeneca AB in the principal amount of $2.25 million. Under
the agreement, the note required the Company to pay all indebtedness
outstanding under the note upon the closing of the Asset Sale. As a result, the
note was paid in full in February 2003 in connection with the Asset Sale (see
Note 9).

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

Business Insurance Premium Financing

On September 24, 2002, the Company entered into a Premium Finance
Agreement (the Finance Agreement) through which it
financed approximated $1.1 million of premiums payable in connection with the
annual renewal of its general business insurance. Under the Finance Agreement,
Penwest was required to repay the amount financed in equal monthly installments
through June 2003,
plus interest at a rate of 3.11% per annum. In addition, the Company assigned,
as a security interest, any and all unearned premiums or other amounts which
may become payable to the Company under the insurance policies. The amount
financed under the Finance Agreement was paid in full in May 2003.

7. Income Taxes

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

The gain on sale of discontinued operations of approximately $9.5 million,
recorded in the nine months ended September 30, 2003, is net of tax expense of
$51,000, or less than 1% of the pretax gain. The tax expense is lower than the
federal statutory rate of 34% primarily due to net operating losses which
offset the gain. In addition, earnings from discontinued operations of $177,000
and $1,674,000, respectively, for the nine months ended September 30, 2003 and
September 30, 2002, are net of tax expenses of $26,000 and $337,000,
respectively, or 13% and 17% of pretax earnings, respectively. These tax
expenses, which include foreign taxes, are lower than the federal statutory
rate of 34% primarily due to overall U.S. net operating losses which offset the
U.S. earnings of the discontinued operation (see Note 9).

8. Comprehensive Loss

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

|                                                        |  |                    |        |                   |  |      |        |      |  |   |        |   |  |   |         |  
|------------------------------------------------------- |  | ------------------ | ------ | ----------------- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                        |  | Three Months Ended |        | Nine Months Ended
|                                                        |  | September 30,      |        | September 30,    
|                                                        |  |                    |        |                  
|                                                        |  | 2003               |        | 2002              |  | 2003 |        | 2002
|                                                        |  |                    |        |                   |  |      |        |     
|                                                        |  | (Unaudited)        |        | (Unaudited)      
|Net loss                                                |  | $                  | (5,537 | )                 |  | $    | (4,476 | )    |  | $ | (8,172 | ) |  | $ | (14,112 | )
|Foreign currency translation adjustments                |  |                    |       |                   |  |      | 7      |      |  |   | 109    |   |  |   | 615     |  
|Change in unrealized net gains on marketable securities |  |                    | 55     |                   |  |      | (9     | )    |  |   | 49     |   |  |   |        |  
|                                                        |  |                    |        |                   |  |      |        |      |  |   |        |   |  |   |         |  
|Comprehensive loss                                      |  | $                  | (5,482 | )                 |  | $    | (4,478 | )    |  | $ | (8,014 | ) |  | $ | (13,497 | )
|                                                        |  |                    |        |                   |  |      |        |      |  |   |        |   |  |   |         |  

Accumulated other comprehensive income (loss) equals the cumulative
translation adjustment and unrealized net gains on marketable securities which
are the only components of other comprehensive loss included in the Companys
financial statements. Effective on the date of the Asset Sale, accumulated
other comprehensive income (loss) is comprised solely of unrealized net gains
and losses on marketable securities.

9. Discontinued Operations

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

In the first quarter of 2003, the Company recorded a gain on the Asset
Sale of approximately $9.6 million, net of taxes of $62,000, and has reported
the operating results of the excipient business as a discontinued operation in
accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. In the second quarter of 2003, the Company recorded an
expense of $83,000 for the working capital adjustment, net of a tax benefit of
$11,000, for a total gain of $9.5 million, net of tax

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

expense of $51,000 for the nine months ended September 30, 2003. The net
carrying amount of the assets and liabilities on the date of the Asset Sale was
approximately $29.5 million. The approximate carrying values of the major
classes were: property, plant and equipment of $11.4 million; inventory of $8.3 million; receivables of $6.0
million; and intangible assets of $4.3 million offset by other net liabilities.
The Company has presented its December 31, 2002 balance sheet in the
consolidated financial statements to reflect the assets and liabilities of the
excipient business separately as assets held for sale and liabilities held for
sale. The gain on the Asset Sale is net of transaction related costs totaling
$3.1 million, primarily consisting of professional and advisory fees. As of
December 31, 2002, these costs approximated $1.7 million and were reflected as
deferred transaction costs on the condensed consolidated balance
sheet. Revenues and pretax profits for the excipient business approximated $6.1
million and $203,000, respectively, for the period January 1, 2003 through the
Asset Sale date of February 27, 2003, and approximated $9.4 million and
$583,000, respectively, and $27.6 million and $2.0 million, respectively, for
the quarter and nine months ended September 30, 2002.

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

10. Licensing Agreements

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

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

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

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

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

The FDA accepted for filing a new drug application, or NDA, submitted by
Endo for oxymorphone ER in February 2003. In October 2003, the FDA issued to
Endo an approvable letter for oxymorphone ER. In the letter, the FDA requested
that Endo address certain questions, provide additional clarification and information, and
conduct some form of additional clinical trials to further
confirm the safety and efficacy of oxymorphone ER, before the FDA would approve
Endos NDA for oxymorphone ER. Endo intends to communicate with the FDA
throughout the final approval process in order to address the issues raised in
the approvable letter and determine the appropriate course of action.

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

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Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations

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

Overview

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

Penwests proprietary controlled release drug delivery technology is
utilized in four products that were developed with collaborators and have been
approved in various countries. In addition, the Company has a number of product
candidates in its drug development pipeline. The most advanced of these is
oxymorphone ER, an extended release formulation of oxymorphone incorporating
TIMERx technology. The Company is developing oxymorphone ER with Endo. The FDA
accepted for filing a new drug application, or NDA, submitted by Endo for
oxymorphone ER in February 2003. In October 2003, the FDA issued to Endo an
approvable letter for oxymorphone ER. In the letter, the FDA requested that
Endo address certain questions, provide additional clarification and
information, and conduct some form of additional clinical trials to further
confirm the safety and efficacy of oxymorphone ER, before the FDA would approve
Endos NDA for oxymorphone ER. Endo intends to communicate with the FDA
throughout the final approval process in order to address the issues raised in
the approvable letter and determine the appropriate course of action. On March
17, 2003, the Company exercised its right under the oxymorphone ER agreement
and gave Endo notice that it was discontinuing its participation in the funding
of the development and marketing of oxymorphone ER, effective April 17, 2003.

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

On August 5 and August 6, 2003, the Company completed the sale of a total
of 2,507,762 shares of common stock through a private placement to selected
institutional investors (the Private Placement), resulting in net proceeds to
the Company, after fees and expenses, of approximately $49.3 million. As part
of the Private Placement, the Company granted the institutional investors
additional rights to purchase up to an additional 501,552 shares of common
stock at a price of $26.00 per share. These additional investment rights became
exercisable on September 12, 2003, and will expire on December 9, 2003, subject
to extension in specific circumstances. The Company intends to use the net
proceeds from the Private Placement to fund the research, development,
marketing and commercialization of its products and technologies, and for
general corporate purposes.

The Company has incurred net losses since 1994. As of September 30, 2003,
the Companys accumulated deficit was approximately $86.7 million. The Company
expects operating losses and negative cash flows to continue until substantial
sales of products commercialized utilizing TIMERx technology occur. A
substantial portion of the Companys revenues through February 27, 2003 were
generated from sales of the Companys pharmaceutical excipient product line.
The Company expects that the balance of its revenues for 2003 will be generated
primarily from Mylan royalties and shipments of bulk TIMERx. The Companys
future profitability will depend on several factors, including the successful
commercialization of TIMERx controlled release products, including in
particular oxymorphone ER; approval of Endos NDA for oxymorphone ER and the
timing thereof; the Companys ability to use net proceeds from the Asset Sale
and the Private Placement to expand its drug development product pipeline;
royalties from Mylans sales of Pfizers 30 mg generic version of Procardia XL;
and the level of the Companys investment in research and development
activities.

The Companys strategy includes a significant commitment to spending on
research and development targeted at identifying and

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

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

The Companys results of operations may fluctuate from quarter to quarter
depending on the amount and timing of royalties on Mylans sales of Pfizers 30
mg generic version of Procardia XL, volume and timing of orders of formulated
bulk TIMERx, and on variations in payments under the Companys collaborative
agreements, including payments upon the achievement of specified milestones.
The Companys quarterly operating results may also fluctuate depending on other
factors, including variations in gross margins of the Companys products, the
mix of product sales and royalty revenues, competition and regulatory actions.

Critical Accounting Policies and Estimates

The Companys discussion and analysis of its financial condition and
results of operations are based upon its condensed consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The Companys significant accounting
policies are more fully described in the notes to the consolidated financial
statements in the Companys Current Report on Form 8-K filed with the SEC on
September 4, 2003. These policies are important to the portrayal of the
Companys financial condition and results of operations. The preparation of
these financial statements requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Areas where significant judgments are
made include, but are not limited to, revenue recognition, deferred
taxes-valuation allowance and impairment of long-lived assets. Actual results
could differ materially from these estimates. For a more detailed explanation
of the judgments made in these areas, refer to Managements Discussion and
Analysis of Financial Condition and Results of Operations in the Companys
Current Report on Form 8-K filed with the SEC on September 4, 2003.

The
Company also makes significant judgments in determining research and
development expenses. Research
and development expenses consist of costs associated with products
being developed internally as well as products being developed under
collaboration agreements and include related salaries, benefits and other personnel
related expenses, clinical trial costs, and contract and other outside service
fees. Research and development costs are expensed as incurred.
Certain reimbursements of costs, generally related to drug formulation on
feasibility studies, are netted against research and development expense. A
significant portion of the Companys development activities are outsourced to
third parties including contract research organizations, and contract
manufacturers in connection with the production of clinical materials, or may be performed by the Companys collaborators. These
arrangements may require estimates be made of related service fees or
of
the Companys share of development costs, in which actual results could materially differ
from the estimates and affect the reported amounts in the Companys
financial statements.

Results of Operations  Continuing Operations

Quarters Ended September 30, 2003 and 2002

Total revenues for the third quarter of 2003 and the third quarter of 2002
were $1.0 million and $1.7 million, respectively. There were no revenues from
sales of formulated bulk TIMERx for the quarter ended September 30, 2003
compared to $201,000 for the quarter ended September 30, 2002. The decrease in
these product sales was primarily due to the timing of shipments of formulated
bulk TIMERx to the Companys primary customer for bulk TIMERx. Royalties and
licensing fees decreased by $464,000 for the third quarter of 2003 to $1.0
million from $1.5 million in the third quarter of 2002, primarily due to lower
royalties from Mylan attributable to Mylans decreased sales of Pfizers 30 mg
generic version of Procardia XL, due to increased generic competition.

Selling, general and administrative expenses increased by $55,000 to
approximately $2.3 million for the third quarter of 2003 from approximately
$2.2 million in the third quarter of 2002. The increase in selling, general and
administrative expenses was partially due to increased facility rent expenses,
state taxes on capital, and personnel costs primarily associated with the
expansion of the business

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development and marketing teams. The increase also reflects certain
selling, general and administrative overhead expenses being fully absorbed in
continuing operations during the quarter ended September 30, 2003, that were
previously allocated between continuing operations and discontinued operations
for the quarter ended September 30, 2002. These increases were offset by the
Companys termination of its participation in the funding of marketing costs
related to oxymorphone ER effective during the second quarter of 2003, as well
as an adjustment recorded in the third quarter of 2003 to reduce the
Companys accrual
for these marketing costs by $72,000. No selling, general and administrative
expenses related to oxymorphone ER are expected to be incurred during the
remainder of 2003, unless the Company resumes its participation in the funding
of the development and marketing of oxymorphone ER. In addition, the
increase in selling, general and administrative expenses were offset
by an adjustment of approximately $202,000 in the third quarter of 2003
that the Company recorded to reduce its accrual for 2003
compensation. The Company also capitalized approximately
$200,000 of internal general and administrative personnel costs that
would otherwise have been recorded as selling, general and
administrative expense during the third quarter of 2003 as part of an implementation
project relating to the Companys information system.

Research and product development expenses increased by $58,000 to
approximately $4.4 million for the third quarter of 2003 as compared to
approximately $4.3 million in the third quarter of 2002. The Company incurred
no costs on the development of oxymorphone ER in the third quarter of 2003. In
the third quarter of 2002, the Company incurred $2.2 million of research and
development expenses in connection with funding research and development
relating to oxymorphone ER. The third quarter of 2003 also included an
adjustment to reduce the Companys accrual for development costs of oxymorphone ER by
$266,000. This decrease was offset by an increase in the Companys research
and development expenses relating to its other products. During the third
quarter of 2003, the Company incurred research and development costs primarily
in connection with conducting clinical development and manufacturing scale-up
for PW2101, the Companys hypertension product, as well as clinical trials of
several product candidates utilizing TIMERx technology.

The most advanced of the Companys product candidates is oxymorphone ER,
which the Company is developing with Endo. Endo, which is responsible for
conducting the clinical trials and seeking regulatory approval of the product,
completed the clinical trials for this product in 2002 and the FDA accepted for
filing the NDA for oxymorphone ER in February 2003. In October 2003, the FDA
issued to Endo an approvable letter for oxymorphone ER. In the letter, the FDA
requested that Endo address certain questions, provide additional clarification
and information, and conduct some form of additional clinical trials to further
confirm the safety and efficacy of oxymorphone ER, before the FDA would approve
Endos NDA for oxymorphone ER. Endo intends to communicate with the FDA
throughout the final approval process in order to address the issues raised in
the approvable letter and determine the appropriate course of action. No
additional research and development expenses are expected to be incurred by the
Company with respect to oxymorphone ER after April 17, 2003, unless the Company
resumes its participation in the funding of the development and marketing of
oxymorphone ER.

Of the product candidates for which the Company is conducting clinical
trials, the majority of spending in the third quarter of 2003 related to the
clinical development and manufacturing scale-up of PW2101. The Company is
currently conducting a Phase III clinical trial of PW2101 for the treatment of
hypertension. The Company completed the enrollment of the approximately 100
patients who are participating in the trial in the third quarter of 2003 and
expects to complete the trial in the first quarter of 2004. The
Company is also completing three Phase I studies to support this
filing. Assuming that the
trials are successful, the Company expects that it would submit an NDA for this
product in the second half of 2004. Although the Company has developed PW2101
on its own, the Company does not intend to market PW2101. As a result, the
Company is currently seeking one or more marketing partners for this product.

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. 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.

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

Nine Months Ended September 30, 2003 and 2002

Total revenues for the nine months ended September 30, 2003 and September
30, 2002 were $3.4 million and $4.1 million, respectively. Product sales
increased by $104,000 to $455,000 for the nine months ended September 30, 2003
compared to $351,000 for the nine months ended September 30, 2002. The increase
in product sales was primarily due to the timing of shipments of formulated
bulk TIMERx to the Companys primary customer for bulk TIMERx. Royalties and
licensing revenues decreased by $731,000 to approximately $3.0 million for the
first nine months of 2003, as compared to approximately $3.7 million in the
comparable period in 2002, primarily due to lower royalties from Mylan,
attributable to Mylans decreased sales of Pfizers 30 mg generic version of
Procardia XL, due to increased generic competition.

Selling, general and administrative expenses increased $2.1 million to
approximately $7.8 million for the nine months ended

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September 30, 2003, from $5.7 million for the nine months ended September
30, 2002. This increase is primarily attributable to increased facility rent
expenses, increases in the cost of business insurance, increased state taxes on
capital, and increased personnel costs primarily associated with the expansion
of the business development and marketing teams. The increase also reflects
certain selling, general and administrative overhead expenses that were
incurred subsequent to February 27, 2003, the date of the Asset Sale, being
fully absorbed in continuing operations for the nine months ended September 30,
2003, that were previously allocated between continuing operations and
discontinuing operations for the nine months ended September 30, 2002. The nine
months ended September 30, 2003 only include marketing costs for oxymorphone ER
through April 17, 2003. No selling, general and administrative expenses
related to oxymorphone ER are expected to be incurred by the Company during the
remainder of 2003, unless the Company resumes its participation in the funding
of the development and marketing of oxymorphone ER.

Research and development expenses during the nine months ended September
30, 2003 were $13.6 million, compared to $14.2 million for the comparable
period of 2002. This lower spending reflects the completion of clinical trials
for oxymorphone ER in the second half of 2002 to support the NDA
filing, as well as Penwests decision to
cease its participation in the funding of the development costs of oxymorphone
ER in 2003, as compared to the comparable period of 2002, when the Company was
participating in the development costs of oxymorphone ER for the full nine
months. This lower spending was partially offset by increased development costs
for other products in the Companys development pipeline, primarily the
Companys hypertension product, PW2101.

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

The gain on sale of discontinued operations of approximately $9.5 million,
recorded in the nine months ended September 30, 2003, is net of tax expense of
$51,000, or less than 1% of the pretax gain. The tax expense is lower than the
federal statutory rate of 34% primarily due to net operating losses which
offset the gain. In addition, earnings from discontinued operations of $177,000
and $1,674,000, respectively, for the nine months ended September 30, 2003 and
September 30, 2002, are net of tax expenses of $26,000 and $337,000,
respectively, or 13% and 17% of pretax earnings, respectively. These tax
expenses, which include foreign taxes, are lower than the federal statutory
rate of 34% primarily due to overall U.S. net operating losses which offset the
U.S. earnings of the discontinued operation.

Liquidity and Capital Resources

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

The Company is a party to an agreement with Endo with respect to the
development of oxymorphone ER. On April 17, 2003, the Company discontinued its
participation in the funding of the development and marketing of oxymorphone
ER. Accordingly, the Companys research and development, and selling, general
and administrative expenses with respect to oxymorphone ER has decreased
significantly in the second and third quarters of 2003, and the Company expects
no significant expenses relating to oxymorphone ER for the remainder of 2003
unless the Company resumes its participation in the funding of the development
and marketing of oxymorphone ER. The Company anticipates using the funds that
otherwise would have been expended on oxymorphone ER to increase its investment
in the development of additional products utilizing TIMERx technologies and in
research and development involving new drug delivery technologies.

On February 27, 2003, the Company completed the sale of its excipient
business to Rettenmaier. As a result of the Asset Sale, the Company had
approximately $35 million of net cash proceeds available after the closing,
which the Company plans to use to fund development of products in its pipeline
as well as the rest of the Companys operations. However, as a result of the
Asset Sale, the Company no longer derives cash flow from the sale of
excipients. A portion of the proceeds from the sale of the excipient business
was used to pay the $3.3 million of outstanding borrowings under the Companys
line of credit, which was terminated on February 27, 2003. In addition, the
Company used the proceeds from the Asset Sale to repay in full a $2.25 million
note payable to AstraZeneca AB, incurred in connection with the Companys
acquisition of certain intellectual property related to the excipient business.

On August 5 and August 6, 2003, the Company completed the sale of a total
of 2,507,762 shares of common stock through a private placement to selected
institutional investors (the Private Placement), resulting in net proceeds to
the Company, after fees and expenses, of approximately $49.3 million. As part
of the Private Placement, the Company granted the institutional investors
additional rights to purchase up to an additional 501,552 shares of common
stock at a price of $26.00 per share. These additional investment rights became
exercisable on September 12, 2003 and will expire on December 9, 2003, subject
to extension in specific circumstances. The Company intends to use the net
proceeds from the Private Placement to fund the research, development,
marketing and

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commercialization of its products and technologies, and for general
corporate purposes.

As of September 30, 2003, the Company had cash, cash equivalents, and
short-term investments of $69.6 million. The Company has no committed sources
of capital other than Rettenmaiers commitment to repay the Company $1.25
million pursuant to promissory notes in May 2004, issued in connection with the
sale of the excipient business.

The Company had negative cash flow from operations for the nine months
ended September 30, 2003 of $16.4 million, primarily due to a loss from
continuing operations of $17.8 million in the period. The Company had negative
cash flow from operations for the nine months ended September 30, 2002 of $14.3
million, primarily due to the loss from continuing operations of $15.8 million
in the period partially offset by cash flows from discontinued operations
operating activities of $2.0 million. Investing activities provided $7.6
million in cash for the nine months ended September 30, 2003, primarily
reflecting the Companys receipt of cash proceeds from the Asset Sale of $36.9
million, net of transaction costs paid of $1.4 million, and the Companys net
investment in marketable securities of $26.8 million. Net cash
provided by investing activities also reflected funds expended for the
acquisitions of fixed assets related to the second phase of an
implementation project relating to the Companys information system and
laboratory equipment for drug development activities, and funds expended for
intangible assets, which included costs to secure patents on technology developed by
the Company. Financing activities provided $47.8 million in cash, primarily
due to the cash received in the Private Placement, as well as $2.2 million in
cash provided by discontinued operations, which was offset by the repayment of
approximately $5.5 million in loans in connection with the Asset Sale. The
Companys cash flow in 2003 has differed from its cash flow during 2002
primarily because the Company no longer derives revenues from sales of its
excipient products and does not incur expenses in connection with its excipient
business, except for the related revenues and expenses during the period ended
February 26, 2003.

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

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



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

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

Contractual Obligations

The Companys major outstanding contractual cash obligations relate to its
operating leases, primarily for facilities. Below is a

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table summarizing the Companys contractual obligations under its
operating leases having initial lease terms of more than one year, as of
September 30, 2003 (in thousands):

|                 |  |       |     |          |  |           |     |       |  |       |     |         |  |   |   |  |  |   |   | 
|---------------- |  | ----- | --- | -------- |  | --------- | --- | ----- |  | ----- | --- | ------- |  | - | - |  |  | - | - | 
|                 |  |       |     |          |  | Less than |     | 1-3   |  | 4-5   |     | After 5
|                 |  | Total |     | One Year |  | Years     |     | Years |  | Years
|                 |  |       |     |          |  |           |     |       |  |      
|Operating Leases |  | $     | 627 |          |  | $         | 277 |       |  | $     | 350 |         |  | $ |  |  |  | $ |  | 
|                 |  |       |     |          |  |           |     |       |  |       |     |         |  |   |   |  |  |   |   | 

Net Operating Loss Carryforwards

At September 30, 2003, the Company had federal net operating loss (NOL)
carryforwards of approximately $60.6 million for income tax purposes, of which
approximately $6.2 million, $8.4 million, $9.1 million, $17.8 million and $19.1
million expire in 2018, 2019, 2020, 2021 and 2022, respectively. In addition,
the Company had research and development tax credit carryforwards of
approximately $1.4 million of which $299,000, $306,000 and $777,000 expire in
2019, 2020, and 2021, respectively. The use of the NOLs and research and
development tax credit carryforwards are limited to future taxable earnings of
the Company. Due to the degree of uncertainty related to the ultimate
realization of such carryforwards, at September 30, 2003, a valuation allowance
of approximately $23.3 million has been recognized to offset net deferred tax
assets, primarily attributable to the NOL carryforward. Utilization of the
operating losses may be subject to a limitation due to the ownership change
provisions of the Internal Revenue Code. The Company does not expect to use any
of its NOL carryforwards to offset the Companys taxable capital gains and
ordinary income from the sale of the excipient business, as current year losses
are expected to fully offset such gains and ordinary income.

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Forward Looking Statements

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

Risk Factors

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

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

We have incurred net losses since 1994, including net losses of $17.1
million, $16.0 million and $8.8 million, during 2002, 2001, and 2000,
respectively. For the nine months ended September 30, 2003, we had a loss from
continuing operations of $17.8 million, income from discontinued operations of
$177,000 and a gain on the sale of the excipient business of $9.5 million. This
resulted in a net loss for the nine months ended September 30, 2003 of $8.2
million. As of September 30, 2003, our accumulated deficit was approximately
$86.7 million.

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

A substantial portion of our revenues since 1994 has been generated from
the sales of our pharmaceutical excipients. Our net losses in 2000, 2001 and
2002 were reduced as a result of the operating results of our excipient
business. Effective February 27, 2003, we ceased generating any revenues from
the sales of excipient products; our business depends exclusively on our drug
delivery business.

Our future profitability will depend on several factors, including:



| |  |  | the successful commercialization of TIMERx controlled release products, including in particular oxymorphone
ER, a narcotic analgesic for the treatment of moderate to severe pain, being developed with Endo;                                                      
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | our ability to use the net proceeds from the sale of our excipient business and the net proceeds from the
private placement of our common stock in August 2003 to fund the research, development, marketing and
commercialization of our products and technologies;
|
| |  |  | royalties from Mylan Pharmaceuticals Inc.s sales of Pfizer, Inc.s 30 mg generic version of Procardia XL; and                                                                                                                                                     
|
| |  |  | the level of investment in research and development activities                                                                                                                                                                                                     

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

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

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Many of our TIMERx controlled release products have been or are being
developed and commercialized in collaboration with pharmaceutical companies.
Under these collaborations, depending on the structure of the collaboration, we
are dependent on our collaborators to fund some portion of development, to
conduct clinical trials, obtain regulatory approvals for, and manufacture,
market and sell products utilizing our TIMERx controlled release technology.
For instance, we are dependent on Endo to obtain the regulatory approvals
required to market oxymorphone ER and will be dependent on Endo to manufacture
and market oxymorphone ER in the United States. We are also dependent on
Sanofi-Synthelabo S.A. and Leiras OY to manufacture and market Slofedipine XL
and Cystrin CR, respectively. In addition, we are dependent on Mylan with
respect to the marketing and sale of the 30 mg strength of Pfizers generic
version of Procardia XL.

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

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

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

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



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

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

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

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

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

In addition to developing controlled release versions of immediate release
products, we also selectively develop generic versions of branded controlled
release products, and controlled release products which we refer to as branded
generic products, that utilize our TIMERx technology and generic active chemical
ingredients which are utilized in branded controlled release
products. The success of these generic versions of branded controlled release
products and these branded generic products will
depend, in large part, on the intensity of competition from the branded
controlled release product, other generic versions of the branded controlled
release product and other drugs and technologies that compete with the branded
controlled release product, as well as the timing of product approval.

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

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

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

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

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

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

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



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

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

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

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



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

We also have a number of TIMERx products in our development pipeline. The
most advanced of these is oxymorphone ER, which we are developing with Endo. In
February 2003, the FDA accepted for filing an NDA for oxymorphone ER. In
October 2003, the FDA issued to Endo an approvable letter for oxymorphone ER.
In the letter, the FDA requested that Endo address certain questions, provide
additional clarification and information, and conduct some form of additional
clinical trials to further confirm the safety and efficacy of oxymorphone ER,
before the FDA would approve Endos NDA for oxymorphone ER. Endo intends to
communicate with the FDA throughout the final approval process in order to
address the issues raised in the approvable letter and determine the
appropriate course of action. If the NDA for oxymorphone ER is not approved on
a timely basis or at all, it would have a material adverse effect on our
business, financial condition and results of operations.

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

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

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

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

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

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

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

If we fail to comply with applicable regulatory requirements, we may be
subject to fines, suspension or withdrawal of regulatory approvals, product
recalls, seizure of products, operating restrictions and criminal prosecution.

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

As of September 30, 2003, we had cash, cash equivalents, and short-term
investments of $69.6 million. We have no committed sources of capital other
than Rettenmaier Holding GmbH & Co. KGs commitment to repay us $1.25 million
in May 2004 pursuant to promissory notes issued in connection with the sale of
the excipient business.

We anticipate that 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 be sufficient to fund our
currently planned operations for the foreseeable future if oxymorphone ER is
approved by the FDA during 2004.

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

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

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



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

If our existing resources are insufficient to satisfy our need for capital
due to a delay in the approval for oxymorphone ER, lower than expected revenues
from oxymorphone ER or otherwise, or if we acquire additional product
candidates or technologies, we may need to sell additional equity or debt
securities or seek additional financing through other arrangements. If we
determine to seek additional funding, we may do so through collaborative
agreements or research and development arrangements and public or private
financings. Additional financing may not be available to us on acceptable
terms, if at all.

If we raise additional funds by issuing equity securities, further
dilution to our then existing shareholders may result. In addition, the terms
of the financing may adversely affect the holdings or the rights of such
shareholders. Any sale of additional equity or debt securities may result in
additional dilution to our shareholders, and we cannot be certain that
additional public or private financing will be available in amounts or on terms
acceptable to us, if at all. If we are unable to obtain this additional
financing, we may be required to delay, reduce the scope of, or eliminate one or more of our planned
research, development and commercialization activities, which could harm our
financial condition and operating results.

Our controlled release products
that are generic versions of branded controlled release products that
are covered by one or more patents and our branded generic products may be subject to litigation

We expect to file or have our collaborators file ANDAs or NDAs for our
controlled release products under development that are generic versions of branded controlled release products that are covered by one
or more patents, or are branded generic products. 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 was developed with Mylan. Any significant delay in obtaining FDA approval to market our product
candidates as a result of litigation, as well as the expense of such
litigation, whether or not we or our collaborators are successful, could have a
material adverse effect on our business, financial condition and results of
operations.

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

The commercial success of products incorporating our extended release
technology that are approved for marketing by the FDA and other regulatory
authorities will depend upon their acceptance by the medical community and
third party payors as clinically

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useful, cost-effective and safe. No product
based on our TIMERx or other extended release technology is marketed in the
United States, so there can be no assurance as to market acceptance.

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



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

Our success depends on our protecting our patents and patented rights

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

Our success also depends on our not infringing patents issued to
competitors or others. We are aware of patents and patent applications
belonging to competitors and others that may require us to alter our products
or processes, pay licensing fees or cease certain activities.

We may not be able to obtain a license to any technology owned by a third
party that we require to manufacture or market one or more products. Even if we
can obtain a license, the financial and other terms may be disadvantageous.

Our success also depends on our maintaining the confidentiality of our
trade secrets and patented know-how. We seek to protect such information by
entering into confidentiality agreements with employees, consultants, licensees
and pharmaceutical companies. These agreements may be breached by such parties.
We may not be able to obtain an adequate, or perhaps, any remedy to such a
breach. In addition, our trade secrets may otherwise become known or be
independently developed by our competitors.

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

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



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

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

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

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and continuation of patent litigation or other proceedings could have a
material adverse effect on our ability to complete in the marketplace. Patent
litigation and other proceedings may also absorb significant management time.

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

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

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

If our third party manufacturers fail to perform their obligations, we may
be adversely affected in a number of ways, including:



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

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

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

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

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

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

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

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

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

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

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

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

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

The market price of our common stock may be volatile

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

Certain provisions of our Shareholder Rights Plan, Certificate of Incorporation and Bylaws and of Washington law make a takeover of Penwest or a change in control or management of Penwest more difficult

We have adopted a shareholder rights plan, often referred to as a poison
pill. The rights issued under the plan will cause substantial dilution to a
person or group that attempts to acquire us on terms that are not approved by
our board of directors, unless the board first determines to redeem the rights.
Various provisions of our Certificate of Incorporation, our Bylaws and
Washington law may also have the effect of deterring hostile takeovers or
delaying or preventing changes in control or management of our company,
including transactions in which our shareholders might otherwise receive a
premium for their shares over then current market prices. In addition, these
provisions may limit the ability of shareholders 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, primarily changes in interest rates. The
Companys interest rate risk primarily relates to its investments in marketable
securities.

The primary objectives for the Companys investment portfolio are
liquidity and safety of principal. Investments are made to achieve the highest
rate of return to the Company, consistent with these two objectives. The
Companys investment policy limits investments to certain types of instruments
issued by institutions with investment grade credit ratings and places
restrictions on maturities and concentration by issuer. Marketable securities
primarily consist of corporate debt, certificates of deposit and U.S.
Government Agency-backed notes, and approximated $28.8 million at September 30,
2003. These securities have contractual maturity dates of up to twenty-three
months. Due to the relatively short-term maturities of these securities,
management believes there is no

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significant market risk. At September 30, 2003,
market values approximated carrying values. At September 30, 2003, the Company
had approximately $69.6 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 $696,000.




Item 4.Controls and Procedures

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

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

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PART II  OTHER INFORMATION

Item 2.Changes in Securities and Use of Proceeds

On August 5 and August 6, 2003, the Company completed the sale of a total
of 2,507,762 shares of common stock through a private placement to selected
institutional investors, resulting in net proceeds to the Company, after fees
and expenses, of approximately $49.3 million. As part of the private placement,
the Company granted the institutional investors additional rights to purchase
up to an additional 501,552 shares of common stock at a price of $26.00 per
share. These additional investment rights became exercisable on September 12,
2003, and will expire on December 9, 2003, subject to extension in specific
circumstances. The shares and additional investment rights were offered and
sold to accredited investors without registration under the Securities Act of
1933, as amended, or the securities laws of certain states, in reliance on the
exemptions provided by Section 4(2) of the Securities Act and Regulation D
promulgated thereunder and in reliance on similar exemptions under applicable
state laws.




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 5, 2003, the Company filed a report on Form 8-K reporting it had
entered into definitive agreements for the sale of approximately 1.9 million
shares of common stock and additional rights to purchase up to an additional
380,952 shares of common stock at a price of $26.00 per share in a private
placement to selected institutional and other accredited investors for a total
of $40 million.

On August 6, 2003, the Company filed a report on Form 8-K reporting it had
entered into definitive agreements for the sale of approximately 603,000 shares
of common stock and additional rights to purchase up to an additional 120,600
shares of common stock at a price of $26.00 per share in a private placement to
selected institutional and other accredited investors for a total of $12.7
million.

On August 6, 2003, the Company filed a report on Form 8-K under Item 9,
containing a copy of its earnings release for the period ended June 30, 2003
(including financial statements) pursuant to Item 12 (Results of Operations and
Financial Condition).

On September 4, 2003, the Company filed a report on Form 8-K for the
purpose of filing with the Securities and Exchange Commission audited
consolidated financial statements, including its consolidated balance sheets as
of December 31, 2002 and December 31, 2001 and related consolidated statements
of operations, shareholders equity and cash flows for each of the three years
in the period ended December 31, 2002. The consolidated financial statements
included in this current report were prepared and were filed solely for the
purpose of presenting as a discontinued operation, the Companys excipient
business, which was sold on February 27, 2003 and was previously included in
continuing operations. The Company also included in this current report its
related Managements Discussion and Analysis of Financial Conditions and
Results of Operations, which reflected Penwests excipient business as a
discontinued operation.

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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: October 30, 2003

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EXHIBIT INDEX

|        |  |                                                                                                                                                                                                                              
|------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                                                                              
|Number  |  | Description                                                                                                                                                                                                                  
|        |  |                                                                                                                                                                                                                              
|4.1(1)  |  | Form of Additional Investment Right issued in the August 2003 Private Placement.                                                                                                                                             
|        |  |                                                                                                                                                                                                                              
|10.1(1) |  | Securities Purchase Agreement dated as of August 1, 2003 among Penwest
Pharmaceuticals Co. and the purchasers identified therein.                                                                                            
|        |  |                                                                                                                                                                                                                              
|10.2(2) |  | Securities Purchase Agreement dated as of August 5, 2003 among Penwest
Pharmaceuticals Co. and the purchasers identified therein.                                                                                            
|        |  |                                                                                                                                                                                                                              
|31.1    |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or Rule
15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to
Section 302 of The Sarbanes-Oxley Act of 2002                           
|        |  |                                                                                                                                                                                                                              
|31.2    |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or Rule
15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to
Section 302 of The Sarbanes-Oxley Act of 2002                           
|        |  |                                                                                                                                                                                                                              
|32.1    |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(b) or Rule
15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002
|        |  |                                                                                                                                                                                                                              
|32.2    |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(b) or Rule
15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002



|(1) |  | Incorporated by reference to Exhibits to the Registrants Current Report on
Form 8-K (No. 000-23467) filed with the Commission on August 5, 2003
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(2) |  | Incorporated by reference to Exhibits to the Registrants Current Report on
Form 8-K (No. 000-23467) filed with the Commission on August 6, 2003

30