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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

Commission File Number 000-23467

PENWEST PHARMACEUTICALS CO.

Registrant’s telephone number, including area code: (877) 736-9378

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock, $.001 par value
(Including Associated Preferred Stock Purchase Rights)

Indicate by 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 at least the past 90 days. Yes [X] No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

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

The aggregate market value of the Registrant’s Common Stock held by non-affiliates as of June 30, 2003 was approximately $381 million based on the last sale price of the Registrant’s Common Stock on the Nasdaq National Market. The number of shares of the Registrant’s Common Stock outstanding as of February 29, 2004 was 18,446,648.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our definitive Proxy Statement relating to the 2004 Annual Meeting of Shareholders to be held on June 2, 2004 is incorporated by reference into Part III of this Form 10-K.

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PENWEST PHARMACEUTICALS CO.
INDEX TO FORM 10-K

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PART I

ITEM 1: BUSINESS

Overview

     We develop pharmaceutical products based on innovative proprietary oral drug delivery technologies. The foundation of our technology platform is TIMERx, an extended release delivery system that is adaptable to soluble and insoluble drugs and that is flexible for a variety of controlled release profiles. We have 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. SyncroDose is a drug delivery system that is designed to release the active ingredient of a drug at the desired site and time in the digestive tract.

     Our proprietary TIMERx drug delivery technology is utilized in four products that were developed with collaborators and have been approved and are for sale in various countries. In addition, we have a number of product candidates in our drug development pipeline. The most advanced of these is oxymorphone ER, an extended release formulation of oxymorphone, a narcotic analgesic being developed for the treatment of moderate to severe pain. We are developing oxymorphone ER with Endo Pharmaceuticals, Inc. In October 2003, the United States Food and Drug Administration, or 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 New Drug Application, or NDA, for oxymorphone ER. Endo has stated it expects to meet with the FDA during the first quarter of 2004 to clarify the issues raised in the letter, review the necessity for additional trials and discuss its responses to the approvable letter. We anticipate that Endo will receive information at that meeting about the final path to regulatory approval and whether any additional trials will be required by the FDA. We are also developing PW2101, a branded product for the treatment of hypertension, which we have formulated using our TIMERx technology. We completed a pivotal clinical trial of this product candidate in the fourth quarter of 2003, and anticipate releasing results of this study in the first quarter of 2004. We expect to file an NDA for this product by the end of 2004.

     Prior to February 27, 2003, we 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, we sold substantially all of the assets used in our excipient business to subsidiaries and affiliates of Josef Rettenmaier Holding GmbH & Co. KG. We received $39.5 million in cash and a promissory note for $2.25 million in consideration for the excipient business.

Our Strategy

     Our strategy is to develop pharmaceutical products utilizing our innovative extended release oral drug delivery technologies.

	•		Leverage our drug delivery technologies into a portfolio of product candidates for development. We believe that we have significant expertise in drug formulation and in oral drug delivery technologies. Our proprietary drug delivery technologies, TIMERx extended release, Geminex dual delivery and SyncroDose chronotherapeutic delivery, are applicable to a wide range of drugs with different physical and chemical properties including water soluble and insoluble drugs as well as high dose and low dose drugs. Using these technologies, we can formulate drugs with precise release profiles. In selecting product candidates for development, we focus on opportunities in which our drug delivery technologies can provide benefits to patients and result in branded, proprietary products. We do not limit the products we develop by therapeutic area.
	•		Expand our product development pipeline to include drugs in various stages of development. We intend to aggressively add product candidates into our development pipeline and control more of the clinical development process than we have in the past. Historically, we have formulated product candidates and then relied upon third party collaborators to complete the remainder of the clinical development program and market the drugs. Although we still expect that we will out-license a portion of our product portfolio prior to regulatory submission, we intend to develop a greater portion of our products on our own. We believe that by controlling development we will be better able to control the development timelines of our product candidates and retain more of their economic value. We expect to continue to seek collaborators earlier in the process for product candidates for which we believe that the development process is too expensive or too risky and for product candidates that require specialized marketing input.

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	•		Increase participation in the funding of drug development to capture an increased share of the economic value of the product if and when it is marketed. Developing pharmaceutical products is expensive. If we develop products on our own or jointly with third parties, we will need to devote significant resources to the costs of development of the products. However, we believe that by assuming a larger role in the funding of a product’s development, we will be able to receive a greater share of any returns from the product.
	•		Expand the core drug delivery technologies. Our expertise is in oral drug delivery technologies and drug formulation. We intend to continue to develop our core technologies as well as to seek to develop, in-license or acquire new technologies that are synergistic with our product development capabilities.
	•		Establish collaborations for development, manufacturing and marketing. We expect that we will continue to seek to enter into collaborations to develop some of our products. In addition, because we do not anticipate establishing manufacturing or sales and marketing capabilities within the next few years, we also expect that we will seek to enter into collaborations for the manufacturing and the selling and marketing of our products. We are a party to a number of collaborative agreements including agreements with Endo, Mylan Pharmaceuticals Inc. and Sanofi-Synthelabo S.A.

Drug Delivery Technologies

   TIMERx Extended Release Delivery Systems

     We developed our TIMERx delivery system to address the limitations of other oral extended release delivery systems. We believe that the TIMERx system has advantages over other oral drug delivery technologies, as it is readily manufactured, adaptable to soluble and insoluble drugs and flexible for a variety of controlled release profiles. Pharmaceutical products containing TIMERx have been approved and are being marketed, and we are developing additional products in our pipeline using TIMERx.

     The patented TIMERx drug delivery system is based on 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. The physical interaction between these components works to form a strong, binding gel in the presence of water. Drug release is controlled by the rate of water penetration from the gastrointestinal tract into the TIMERx gum matrix, which expands to form a gel and subsequently releases the active drug substance. The TIMERx system can precisely control the release of the active drug substance in a tablet by varying the proportion of the gums, together with the tablet coating and the tablet manufacturing process. Drugs using TIMERx technology are formulated by combining the active drug substance, the TIMERx drug delivery system and additional excipients, and compressing such materials into a tablet.

   Geminex Dual Release Technology

     We developed our patented Geminex dual release technology to provide for the independent release of the same active ingredient or different active ingredients contained in one pharmaceutical product at different rates. The release of the active ingredients can each involve two different controlled release profiles, or involve controlled release and immediate release profiles. The technology is based on a bi-layer tablet that utilizes TIMERx in the controlled release layer. We are utilizing Geminex technology in several product candidates that are currently in the formulation stage.

   SyncroDose Drug Delivery

     We developed our patented SyncroDose drug delivery system to deliver drugs chronotherapeutically in the body or to deliver a drug within a specific site in the gastrointestinal tract. SyncroDose is a technology based on our underlying TIMERx platform. We believe that there are several disease states that can benefit from chronotherapeutic delivery including: arthritis, cardiovascular disorders, asthma, neurological disorders and site specific diseases. The SyncroDose technology utilizes the TIMERx gum matrix in the coating combined with the active and various other excipients in the core.

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Products

   Marketed and Approved Products

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

	•		Cystrin CR, an extended release version of oxybutynin for the treatment of urge urinary incontinence, is being marketed in Finland by Schering Oy.
	•		Slofedipine XL, an extended release version of nifedipine for the treatment of angina, is being marketed in the United Kingdom and Italy by Sanofi-Synthelabo.
	•		Cronodipin, an extended release version of nifedipine for the treatment of angina, was licensed to Merck S.A. Industries Quimicas for marketing in Brazil.

     In December 1999, the FDA approved the 30 mg strength of Nifedipine XL, a generic version of Procardia XL that is used for the treatment of hypertension and angina. The 30 mg strength of Nifedipine XL is not being marketed in the United States by our collaborator Mylan. In March 2000, Mylan signed a supply and distribution agreement with Pfizer, Inc. to market a generic version of all three strengths, 30 mg, 60 mg and 90 mg, of Pfizer’s Procardia XL. In connection with that agreement, Mylan agreed to pay us a royalty on net sales of Pfizer’s 30 mg strength of generic Procardia XL. The royalties are comparable to those called for in our original agreement with Mylan for Nifedipine XL. Mylan has retained the marketing rights to the 30 mg strength of Nifedipine XL.

   Products in Our Pipeline

     We also have a number of TIMERx products in our development pipeline. The table below summarizes each of the principal products in this pipeline, including the therapeutic use, the development status and our collaborator, if any, for each product:

     Oxymorphone ER

          The most advanced of the products in our development pipeline is an extended release formulation of oxymorphone incorporating TIMERx technology, which we are developing with Endo. Oxymorphone ER, a narcotic analgesic, is being developed for twice a day dosing in patients with moderate to severe pain. Oxymorphone, which is currently given in the parenteral and suppository dosage form, is marketed by Endo and had sales in the United States in 2003 of approximately $536,000. Oxymorphone ER, if successfully developed, would represent the first oral extended release version of oxymorphone and would compete in the moderate to severe long acting opioid market with products such as MS Contin, Purdue Pharma’s OxyContin and Johnson & Johnson’s Duragesic patch, which had aggregate sales in the United States in 2003 of approximately $3.3 billion.

          Endo, which is responsible for conducting the clinical trials and seeking regulatory approval of the product, submitted the NDA to the FDA in December 2002. 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 has stated it expects to meet with the FDA during the first quarter of 2004 to clarify the issues raised in the letter, review the necessity for additional trials and discuss its responses to the approvable letter. We anticipate that Endo will receive information at that meeting about the final path to regulatory approval and whether any additional trials will be required by the FDA.

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     PW3101

     PW3101 is an oral asthma product that we are developing in collaboration with IVAX Corporation based on our TIMERx technology. PW3101 is a reformulation of a branded product that is marketed for oral asthma. The branded product had U.S. sales of approximately $20 million in 2003. IVAX filed an NDA for PW3101 in late 2002. IVAX received an approvable letter from the FDA for PW3101 in the second half of 2003 and resubmitted the NDA to the FDA in the first quarter of 2004.

     PW2101

     PW2101 is a formulation of a competitive product candidate to a branded product that is marketed for hypertension. This product is being developed utilizing our TIMERx technology. The branded product had U.S. sales of approximately $1 billion in 2003. We intend to file a 505(b)2 NDA with the FDA for PW2101 by the end of 2004. We are also developing a lower strength of PW2101. In order to obtain marketing approval of this lower strength dosage form, we will need to conduct additional clinical trials. We believe that we can complete these additional trials and submit an NDA for the lower strength dosage form in early 2005. We are currently seeking a marketing partner for PW2101 and expect to out-license the marketing rights by mid-2004.

     Phase I Products

     We are currently conducting pilot scale biostudies of several product candidates. In these studies, we are seeking to obtain proof of principal data in humans. If the pilot scale biostudies of any of these product candidates shows proof of principal and the commercial returns appear attractive, we will most likely seek to advance the product candidate into further clinical trials on our own. The decision to develop the product candidate on our own will be based on our available resources after consideration of a number of factors, including the size of the potential market, competitors in the potential market, the availability of intellectual property protection, the regulatory pathway and the development status of our other product candidates.

Collaborative Arrangements

     We enter into collaborative agreements with pharmaceutical companies to develop, market or manufacture products developed with our drug delivery technologies.

     We currently have two primary types of collaborative agreements. In revenue sharing collaborative agreements, we jointly fund research and development with our collaborator, and we receive no up-front licensing fees or milestone payments. In these arrangements, we share in a pre-determined percentage of the net operating profits. Technology licensing collaborative agreements involve the straight licensing of our technology to a collaborator. We have no obligation to fund the ongoing clinical development or marketing costs of the product. Under these collaborative agreements, we receive up-front license fees and milestone payments. In addition, under all our current collaborative arrangements, we are entitled to receive royalties on our collaborators’ sales of the products covered by such collaborative arrangements and payments for the purchase of formulated TIMERx material. Our principal collaborative arrangements are described below.

     In the future, we expect that our collaborative agreements are likely to involve the licensing of an NDA to a marketing partner after we complete the development of a product and submit the application to the FDA. Under this type of collaborative agreement, we anticipate that we would receive up-front license fees, milestone payments and royalties.

   Revenue Sharing Collaborative Agreements

   Endo Pharmaceuticals, Inc.

     In September 1997, we entered into a strategic alliance agreement with Endo with respect to the development of oxymorphone ER, an extended release formulation of oxymorphone based on our TIMERx technology. This agreement was amended and restated in April 2002. Endo is a fully integrated specialty pharmaceutical company with a market leadership position in pain management. Endo has a broad product line, including established brands such as Percodan, Percocet and Lidoderm. Endo is registered with the United States Drug Enforcement Administration as a developer, manufacturer and marketer of controlled narcotic substances.

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

     Prior to March 17, 2003, we shared with Endo the costs involved in the development of oxymorphone ER. On March 17, 2003, we notified Endo that we were discontinuing our participation in the funding of the development and marketing of oxymorphone ER effective April 17, 2003. We took this action because we believed that our strategic focus should be on funding other products in our development pipeline. As a result of this termination of funding, 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 us. Endo may recoup such development costs through a temporary adjustment in the royalty rate payable to us, which will return to its pre-adjustment level once Endo has recovered such costs. Endo may also allow us to reimburse Endo directly for the unfunded amounts. We estimate that through December 31, 2003, these unfunded development costs approximated $6.7 million. We expect these costs to increase as Endo continues to invest in oxymorphone ER. We have agreed with Endo 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 between Endo and us, subject to adjustment for unfunded development costs. 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 specified 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 us at specified prices, and include these purchases in cost of goods sold of the product prior to determining net realization.

   Technology Licensing Collaborative Agreements

   Mylan Pharmaceuticals Inc.

     In August 1994, we entered into product development and supply agreements with Mylan with respect to the development of Nifedipine XL, a generic version of Procardia XL based on our TIMERx technology. Procardia XL is a branded drug for the treatment of hypertension and angina that utilizes nifedipine as its active ingredient. Under the agreement, we were responsible for the formulation, manufacture and supply of TIMERx material for use in the product, and Mylan was responsible for conducting all bioequivalence studies, preparing all regulatory applications and submissions, and manufacturing and marketing the Nifedipine XL in North America. In December 1999, the FDA approved the 30 mg strength of Nifedipine XL.

     On March 2, 2000, Mylan announced that it had signed a supply and distribution agreement with Pfizer to market a generic version of all three strengths, 30 mg, 60 mg and 90 mg, of Pfizer’s Procardia XL. In connection with that agreement, Mylan decided not to market Nifedipine XL and agreed to pay us 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 our original agreement with Mylan for Nifedipine XL. Mylan has retained the marketing rights for the 30 mg strength of Nifedipine XL. Mylan’s sales in the United States in 2003 of the 30 mg dosage strength version of Pfizer’s generic Procardia XL totaled approximately $36.8 million. The term of this agreement continues until such time as Mylan permanently ceases to market generic Procardia XL. In 2003, 2002 and 2001, royalties from Mylan accounted for approximately 88%, 87% and 82%, respectively, of our total revenue.

   Other Agreements

     We are a party to the following additional technology licensing collaborative agreements involving our TIMERx technology:

	•		Sanofi-Synthelabo S.A. Our agreement with Sanofi-Synthelabo relates to Slofedipine XL, an extended release version of nifedipine for the treatment of angina. Slofedipine XL was approved in the United Kingdom in 1998 and Italy in 2000. Sanofi-Synthelabo is marketing Slofedipine XL in both countries.
	•		Schering Oy. Our agreement with Schering Oy relates to Cystin CR, an extended release version of oxybutynin for the treatment of urge urinary incontinence. Schering began marketing Cystin CR in Finland after receiving approval for the product in 1997.
	•		E. Merck. Our agreement with E. Merck relates to an extended release version of nifedipine for the treatment of angina that was licensed to Merck S.A. Industries Quimicas for marketing in Brazil.

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	•		IVAX Corporation. Our agreement with IVAX relates to the development of PW3101 for the treatment of asthma.
	•		Ranbaxy Laboratories Ltd. Our agreement with Ranbaxy relates to the development of an extended release version of nifedipine for the treatment of angina.

Research and Development

     We conduct research and development activities on the development of product candidates utilizing our drug delivery technologies and on the development of additional drug delivery technologies. Our research and development expenses in 2003, 2002, and 2001 were $20.6 million, $17.0 million and $16.2 million. These expenses do not include amounts incurred by our collaborators in connection with the development of products under our collaboration agreements such as expenses for full-scale bioequivalence studies development, clinical trials performed by our collaborators, expenses incurred on oxymorphone ER subsequent to April 17, 2003, or our collaborators’ share of funding.

Manufacturing

     We currently have no internal manufacturing capabilities. Generally, our collaborators manufacture the pharmaceutical products, and we are responsible for supplying them with bulk TIMERx. We have outsourced the commercial manufacture of TIMERx materials to a third-party pharmaceutical company, Draxis Pharmaceuticals, Inc., under a manufacturing agreement that expires in September 2004. The agreement will automatically renew 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. During the year, we also completed initial validation work on a second contract manufacturer. However, there is some additional follow-up work required before the site is fully validated. We believe that there are a limited number of manufacturers that operate under cGMP regulations capable of manufacturing our TIMERx materials. There can be no assurance that Draxis or any other third parties upon which we rely for supply of our TIMERx material will perform, and any failures by third parties may delay development or the submission of products for regulatory approval, impair our collaborators’ ability to commercialize products as planned and deliver products on a timely basis, or otherwise impair our competitive position, which could have a material adverse effect on our business, financial condition and results of operations.

     Our TIMERx technology is based on a hydrophilic matrix combining a heterodispersed mixture primarily composed of two polysaccharides, xanthan and locust bean gums, in the presence of dextrose. We purchase these gums from a primary supplier. Although we have qualified alternate suppliers with respect to these gums and to date we have not experienced difficulty acquiring these materials, there can be no assurance that interruptions in supplies will not occur in the future or that we will not have to obtain substitute suppliers. Any of these events could have a material adverse effect on our ability to manufacture bulk TIMERx for delivery to our collaborators, which could have a material adverse effect on our business, financial condition and results of operations.

     In those cases where we are developing products on our own and have not entered into any collaboration agreements with respect to such products, we rely on third party contract manufacturers. For instance, Patheon, Inc. manufactured PW2101 for use in our clinical trials and also manufactured the commercial batches for stability studies. We believe there are many companies which are capable of manufacturing these products.

Marketing and Distribution

     Pursuant to our collaborative agreements, our collaborators have, or are expected to have, responsibility for the marketing and distribution of any pharmaceuticals developed based on our drug delivery technologies. Because we do not currently market any pharmaceuticals without a collaborator, we have not developed any sales force with respect to such products. As a result, we are substantially dependent on the efforts of our collaborators to market the products. In selecting a collaborator for a drug candidate, some of the factors we consider include the collaborator’s market presence in the therapeutic area targeted by the drug candidate and the collaborator’s sales force and distribution network.

Patents and Proprietary Rights

     We believe that patent and trade secret protection of our drug delivery technology is important to our business and that our success will depend in part on our ability to maintain existing patent protection, obtain additional patents, maintain trade secret protection and operate without infringing the proprietary rights of others.

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   Patents and Protection of Proprietary Information

     As of February 29, 2004, we owned 31 U.S. and 177 foreign patents relating to our controlled release drug delivery technology. The U.S. patents principally cover our TIMERx technology and new technologies based on the TIMERx technology, including the combination of the xanthan and locust bean gums, the oral solid dosage form of TIMERx and the method of preparation, as well as the application of TIMERx technology to various active drug substances, including both methods of treatment and methods of preparation. All these patents will expire between 2008 and 2020. Based on a patent review conducted in 2003, the most important patents relating to our TIMERx technology begin to expire in 2014.

     The issuance of a patent is not conclusive as to its validity or as to the enforceable scope of the claims of the patent. There is no assurance that our patents or any future patents we obtain will prevent other companies from developing non-infringing similar or functionally equivalent products or from successfully challenging the validity of our patents. Furthermore, there is no assurance that:

	•		any of our future processes or products will be patentable;
	•		any pending or additional patents will be issued in any or all appropriate jurisdictions;
	•		our processes or products will not infringe upon the patents of third parties; or
	•		we will have the resources to defend against charges of infringement by, or protect our own patent rights against, third parties.

     Our inability to protect our patent rights, or infringement by us of the patent or proprietary rights of others, could have a material adverse effect on our business, financial condition and results of operations.

     We also rely on trade secrets and proprietary knowledge, which we generally seek to protect by confidentiality and non-disclosure agreements with employees, consultants, licensees and pharmaceutical companies. There can be no assurance, however, that these agreements have or in all cases will be obtained, that these agreements will not be breached, that we will have adequate remedies for any breach or that our trade secrets will not otherwise become known by competitors.

     There has been substantial litigation in the pharmaceutical industry with respect to the manufacture, use and sale of new products that are the subject of conflicting patent rights. Some of the controlled release products that we are developing with our collaborators are generic versions of brand name controlled release products that are covered by one or more patents. Under the Waxman-Hatch Act, when an applicant files an ANDA with the FDA for a generic version of a brand name product covered by an unexpired patent listed with the FDA, the applicant must certify to the FDA that such patent will not be infringed by the applicant’s product or that such patent is invalid or unenforceable. Notice of such certification must be given to the patent owner and the sponsor of the NDA for the brand name product. If a patent infringement lawsuit is filed within 45 days of the receipt of such notice, the FDA will conduct a substantive review of the ANDA, but will not grant final marketing approval of the generic product until a final judgment on the patent suit is rendered in favor of the applicant or until 30 months (or such longer or shorter period as a court may determine) have elapsed from the date of the certification, whichever is earlier. Should a patent owner commence a lawsuit with respect to alleged patent infringement by us or our collaborators, the uncertainties inherent in patent litigation make the outcome of such litigation difficult to predict. Our collaborators are responsible for all legal costs under Waxman-Hatch lawsuits. We evaluate the probability of patent infringement litigation with respect to our collaborators’ ANDA submissions on a case by case basis. The delay in obtaining FDA approval to market our products as a result of litigation, whether or not we are successful, could have a material adverse effect on our business, financial condition and results of operations.

     Trademarks

     TIMERx and Geminex are our registered trademarks. SyncroDose is also our trademark. Other tradenames and trademarks appearing in this annual report on Form 10-K are the property of their respective owners.

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Government Regulation

   FDA Regulation of Pharmaceutical Products

     All pharmaceutical manufacturers are subject to extensive regulation by the federal government, principally the FDA, and, to a lesser extent, by state and local governments. The Federal Food, Drug and Cosmetic Act, or the FDCA, and other federal statutes and regulations govern or influence the development, testing, manufacture, safety, labeling, storage, record keeping, approval, advertising, promotion, sale and distribution of prescription products. Pharmaceutical manufacturers are also subject to specific record keeping and reporting requirements, establishment registration, product listing and FDA inspections.

     Drugs can be approved by the FDA based on three types of marketing applications: an NDA, an ANDA or a license application under the Public Health Service Act. A full NDA must include complete reports of preclinical, clinical and other studies to prove adequately that the product is safe and effective for its intended use. The FDCA also provides for NDA submissions that may rely in whole or in part on publicly available clinical and other data on safety and efficacy under section 505(b)(2) of the FDCA. These types of NDAs may be appropriate for certain drugs containing previously approved active ingredients but differing with regard to other characteristics such as indications for use, dosage form or method of delivery.

     As an initial step in the FDA regulatory approval process for an NDA, preclinical studies are typically conducted in animal models to assess the drug’s efficacy and to identify potential safety problems. The results of these studies must be submitted to the FDA as part of an Investigational New Drug Application, which must be reviewed by the FDA before proposed clinical testing can begin. Typically, clinical testing involves a three-phase process. Phase I trials are conducted with a small number of subjects and are designed to provide information about both product safety and the expected dose of the drug. Phase II trials are designed to provide additional information on dosing and preliminary evidence of product efficacy. Phase III trials are large scale studies designed to provide statistical evidence of efficacy and safety in humans. The results of the preclinical testing and clinical trials of a pharmaceutical product are then submitted to the FDA in the form of an NDA for approval to commence commercial sales. Preparing such applications involves considerable data collection, verification, analysis and expense. In responding to an NDA, the FDA may grant marketing approval, request additional information or deny the application if it determines that the application does not satisfy its regulatory approval criteria.

     This regulatory process can require many years and the expenditure of substantial resources. Data obtained from preclinical testing and clinical trials are subject to varying interpretations, which can delay, limit or prevent FDA approval. In addition, changes in FDA approval policies or requirements may occur or new regulations may be promulgated which may result in delay or failure to receive FDA approval.

     Some products containing our TIMERx formulation will require the filing of an NDA. The FDA will not accept ANDAs when the delivery system or duration of drug availability differs significantly from the Listed Drug. However, we may be able to rely on existing publicly available safety and efficacy data to support section 505(b)(2) NDAs for controlled release products when such data exists for an approved immediate release version of the same chemical entity. However, there can be no assurance that the FDA will accept such section 505(b)(2) NDAs, 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 an application submitted under section 505(b)(2) will be approved, or will be approved in a timely manner.

     Although the FDA has approved the ANDA filed by our collaborator Mylan for the 30 mg dosage strength of a generic version of Procardia XL and Endo has received an approvable letter for oxymorphone ER and Ivax for PW3101, there can be no assurance that applications filed by our collaborators with respect to other products will receive FDA approval on a timely basis.

     Sponsors of ANDAs and section 505(b)(2) NDAs, with the exception of applications for certain antibiotic drugs, must include, as part of their applications, certifications with respect to certain patents on Listed Drugs that may result in significant delays in obtaining FDA approvals. Sponsors who believe that patents that are listed in an FDA publication entitled “Approved Drug Products With Therapeutic Equivalence Evaluations” are invalid, unenforceable, or not infringed, must notify the patent owner. If the patent owner initiates an infringement lawsuit against the sponsor within 45 days of the notice, the FDA’s final approval of the ANDA or section 505(b)(2) NDA may be delayed for a period of thirty months or longer. This delay may also apply to other ANDAs or 505(b)(2) NDAs for the same Listed Drug. Moreover, the approval of an ANDA involved in such a patent lawsuit may under certain circumstances require a further delay in the final approval of other ANDAs for the same Listed Drug for an additional 180 days. In addition, recent court decisions have raised the possibility that, under some circumstances, ANDAs other than the first ANDA for a Listed Drug may be delayed indefinitely and thereby effectively denied approval if the drug that is the subject of the first ANDA is not brought to market.

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     ANDAs and section 505(b)(2) NDAs are also subject to so-called market exclusivity provisions that delay the submission or final approval of the applications. The submission of ANDAs and section 505(b)(2) NDAs may be delayed for five years after approval of the Listed Drug if the Listed Drug contains a new active molecular entity. The final approval of ANDAs and section 505(b)(2) NDAs may also be delayed for three years where the Listed Drug or a modification of the Listed Drug was approved based on new clinical investigations. The three-year marketing exclusivity period would potentially be applicable to Listed Drugs with novel drug delivery systems.

     Sponsors of drug applications affected by patents may also be adversely affected by patent term extensions provided under the FDCA to compensate for patent protection lost due to time taken in conducting FDA required clinical studies or during FDA review of data submissions. Patent term extensions may not exceed five additional years nor may the total period of patent protection following FDA marketing approval be extended beyond 14 years. In addition, by virtue of the Uruguay Round Agreements Act of 1994 that ratified the General Agreement on Tariffs and Trade, certain brand name drug patent terms have been extended to 20 years from the date of filing of the pertinent patent applications (which can be longer than the former 17-year patent term starting from the date of patent issuance). Patent term extensions may delay our ability and the ability of our collaborators to use our proprietary technology in the future, market new controlled release products, file section 505(b)(2) NDAs referencing approved products, or file ANDAs based on Listed Drugs when those approved products or Listed Drugs have acquired patent term extensions.

     Manufacturers of marketed drugs must conform to the FDA’s cGMP standard or risk sanctions such as the suspension of manufacturing or the seizure of drug products and the refusal to approve additional marketing applications. The FDA conducts periodic inspections to implement these rules. There can be no assurance that a manufacturer’s facility will be found to be in compliance with cGMP or other regulatory requirements. Failure to comply could result in significant delays in the development, testing and approval of products manufactured at such facility, as well as increased costs.

     Noncompliance with applicable requirements can also result in total or partial injunctions against production and/or distribution, refusal of the government to enter into supply contracts or to approve NDAs, ANDAs or biologics applications, criminal prosecution and product recalls. The FDA also has the authority to revoke for cause drug or biological approvals previously granted.

     Other Regulations. We are governed by federal, state and local laws of general applicability, such as laws regulating working conditions and environmental protection. Oxymorphone ER and other drugs that we are developing are subject to regulations under the Controlled Substances Act and related statutes.

Competition

     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, technical, marketing, legal and other resources than us and some of our collaborators. In addition, many of our competitors have significantly greater experience than we have in conducting clinical trials of pharmaceutical products, obtaining FDA and other regulatory approvals of products, and marketing and selling approved products. We expect that we will be subject to competition from numerous other entities that currently operate or intend to operate in the pharmaceutical and specialty pharmaceutical industry.

     The key competitive factors affecting the success of our drug delivery products are likely to include, among other things:

	•		the safety and efficacy of our products;
	•		the relative speed with which we can develop products;
	•		generic competition for any product that we develop;
	•		our ability to differentiate our products; and
	•		external factors affecting pricing.

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     Most of our products under development are extended release versions of existing immediate release drugs. Our products will face competition from existing products with the same indication, as well as other products that may be developed in the future. For example, if oxymorphone ER receives marketing approval, it will compete against MS Contin, Purdue Pharma’s OxyContin and Johnson & Johnson’s Duragesic patch, as well as any generic competitors to those products. If PW2101 receives marketing approval, it will compete against the extended release product being marketed by the original developer of the branded product and any approved generic competitors. In addition, PW2101 would also compete against other drugs that have been developed for the treatment of hypertension.

Employees

     As of February 29, 2004, we employed approximately 71 people, of whom 46 were primarily involved in research and development activities, and 25 were primarily involved in selling, general and administrative activities. As of February 29, 2004, none of our employees were covered by collective bargaining agreements. We consider our employee relations to be good.

Information Available on the Internet

     Our internet address is www.penwest.com. We make available free of charge through our web site, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 12(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such materials with the Securities and Exchange Commission. We also include on our website our corporate governance guidelines, our code of business conduct and ethics, and the charters for our audit committee, our compensation committee and our nominating and corporate governance committee. In addition, we intend to disclose on our website any amendments to, or waivers from, our code of business conduct and ethics that are required to be publicly disclosed pursuant to rules of the SEC and the Nasdaq.

ITEM 2:  PROPERTIES

     Our corporate offices, comprising approximately 11,000 square feet, are located in Danbury, Connecticut. We lease these offices under a lease that expires on January 31, 2006, with renewal options through December 30, 2006. We are currently negotiating for additional office space in this same building. If acquired, we expect that the additional space will have the same cost per square foot as the existing lease, and that the lease term may extend to December 2006, plus renewal options.

     We also have research facilities, comprising approximately 14,000 square feet, in Patterson, New York, which we owned prior to the sale of our excipient business. Under our agreement with Rettenmaier, we have the right to occupy this laboratory and office space until February 2005 on a rent-free basis and then pursuant to three successive one-year options at a rental rate of $12 per square foot.

     The space we currently lease is adequate for our current needs, but we are beginning to plan for the additional laboratory space that we will need when our Patterson lease expires.

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EXECUTIVE OFFICERS OF THE REGISTRANT

     The following table sets forth the names, ages and positions of our executive officers.

PART II

ITEM 5: MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

     Our common stock, $.001 par value, is listed with and trades on the Nasdaq National Market under the symbol “PPCO.” The high and low sale prices of our common stock during 2003 and 2002 are set forth below. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

     On February 29, 2004 there were 787 shareholders of record.

     We have never paid cash dividends on our common stock. We presently intend to retain earnings, if any, for use in the operation of our business, and therefore do not anticipate paying any cash dividends in the foreseeable future.

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ITEM 6:  SELECTED FINANCIAL DATA

     The following selected financial data are derived from our consolidated financial statements. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information included herein.

(a)		Reclassification recorded of amounts in 1999 for the adoption of EITF No. 00-10 “Accounting for Shipping and Handling Fees and Costs.”
(b)		Cumulative effect of adopting Staff Accounting Bulletin No. 101 (“SAB No. 101”) in 2000.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

     We develop pharmaceutical products based on innovative oral drug delivery technologies. The foundation of our technology platform is TIMERx, an extended release delivery system that is adaptable to soluble and insoluble drugs, and that is flexible for a variety of controlled release profiles. We have 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. SyncroDose is a drug delivery system that is designed to release the active ingredient of a drug at the desired site and time in the digestive tract.

     Our 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, we have a number of product candidates in our drug development pipeline. The most advanced of these is oxymorphone ER, an extended release formulation of oxymorphone, a narcotic analgesic being developed for the treatment of moderate to severe pain. We are developing oxymorphone ER with Endo Pharmaceuticals, Inc. In October 2003, Endo received an approvable letter from the FDA 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 has stated it expects to meet with the FDA during the first quarter of 2004 to clarify the issues raised in the letter, review the necessity for additional trials and discuss its responses to the approvable letter. We anticipate that Endo will receive information at that meeting about the final path to regulatory approval and whether any additional trials will be required by the FDA. We are also developing PW2101, a branded product for the treatment of hypertension that we have formulated using our TIMERx technology. In the fourth quarter of 2003, we completed a pivotal clinical trial of this product candidate and anticipate releasing results of this study in the first quarter of 2004. We expect to file an NDA for this product by the end of 2004.

     Prior to February 27, 2003, we 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, we sold substantially all of the assets used in our excipient business to subsidiaries and affiliates of Josef Rettenmaier Holding GmbH & Co. KG. We received $39.5 million in cash and a promissory note for $2.25 million in consideration for the excipient business. We received $1.0 million of the $2.25 million promissory note in April 2003 with the balance due in May 2004. We used approximately $5.5 million of proceeds of the sale of our excipient business to repay outstanding debt. Commencing in the first quarter of 2003, we reported the operating results of the excipient business as a discontinued operation. As a result of the sale of the excipient business, our audited consolidated financial statements included in this annual report on Form 10-K present our excipient business as a discontinued operation for all periods presented.

     On August 5 and August 6, 2003, we 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 us, after fees and expenses, of approximately $49.3 million. As part of this transaction, we 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 expired on December 9, 2003 without being exercised.

     We have incurred net losses since 1994. As of December 31, 2003, our accumulated deficit was approximately $94.4 million. We expect operating losses and negative cash flows to continue until substantial sales of products commercialized utilizing TIMERx technology occur. A substantial portion of our revenues through February 27, 2003 were generated from sales of our pharmaceutical excipient product line. During 2001, 2002, and 2003 through the date that we sold our excipient business, sales of our excipient products generated positive cash flows from operations, although as a whole we had negative cash flows from operations. Our revenues for 2003 were generated primarily from Mylan royalties and shipments of bulk TIMERx. Our future profitability will depend on several factors, including:

•		the successful commercialization of TIMERx controlled release products, including in particular oxymorphone ER;
•		royalties from Mylan’s sales of Pfizer’s 30 mg generic version of Procardia XL; and
•		the level of our investment in research and development activities.

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     Our strategy includes a significant commitment to spending on research and development targeted at identifying and developing modified release products that can be formulated using our 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 acquisitions. Our spending in the area of new technology however, is discretionary and is subject to identifying appropriate opportunities, as well as the availability of funds from our operations, cash resources, collaborative research and development arrangements and external financing.

     Our results of operations may fluctuate from quarter to quarter depending on if and when oxymorphone ER is approved, the amount and timing of royalties on Mylan’s sales of Pfizer’s 30 mg generic version of Procardia XL, volume and timing of shipments of formulated bulk TIMERx, and on variations in payments under our collaborative agreements, including payments upon the achievement of specified milestones.

Critical Accounting Policies and Estimates

     The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us 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. We base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances. We regard an accounting estimate underlying our financial statements as a “critical accounting estimate” if the nature of the estimate or assumption is material due to the level of subjectivity and judgment involved or the susceptibility of such matter to change and if the impact of the estimate or assumption on our financial condition or performance may be material. On an ongoing basis, we evaluate these estimates and judgments. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are fully described in Note 2 to our consolidated financial statements included in this annual report, we regard the following as critical accounting estimates.

   Revenue Recognition

     Revenues 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 our 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 us 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, we review 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, as reported by our collaborators, and are generally subject to review or audit.

   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 our 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 our collaborators. These arrangements may require estimates to be made of related service fees or our share of development costs. These arrangements may also require us to pay termination costs to the third parties for reimbursement of costs and expenses incurred in the orderly termination of contractual services.

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     These estimates involve identifying services, which have been performed on our behalf, and estimating the level of service performed and associated cost incurred for such service as of each balance sheet date in our consolidated financial statements. In connection with such service fees, our estimates are most affected by our understanding of the status and timing of services provided relative to the actual levels of service incurred by such service providers. In the event that we do not identify specific costs which have begun to be incurred or we under- or over-estimate the level of services performed or the costs of such services, our reported expenses for such period could be too low or too high. The date on which services commence, the level of services performed on or before a given date, and the cost of such services are often judgmental. We make these judgments based upon the facts and circumstances known to us in accordance with generally accepted accounting principles.

   Deferred Taxes — Valuation Allowance

     We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we may consider any potential future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. At December 31, 2003, we had recorded full valuation allowances totaling approximately $26.5 million against our net deferred tax assets.

   Impairment of Long-Lived Assets

     For purposes of recognizing and measuring impairment to our long-lived assets, including intangible assets such as our intellectual property, we assess the recoverability of the carrying amount of these assets whenever facts and circumstances indicate that the carrying amount may not be fully recoverable. We measure the impairment related to long-lived assets by the amount by which the carrying amount of the assets exceeds the fair value of the assets. In assessing the recoverability of our intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. Estimated cash flow assumptions include profitability projections provided by our marketing partners or developed internally, based upon historical revenues or projected market share for new products. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets.

Results of Operations for Years Ended December 31, 2003, 2002 and 2001

   Revenues

     The decreases in total revenues in 2003 and 2002 from the prior year were the result of decreases during each period for both components of our total revenues, product sales revenues, and royalty and licensing revenues. Our product sales consist of sales of formulated bulk TIMERx. Our royalty and licensing revenues primarily consist of royalties from Mylan.

     The decrease in product sales in 2003 was primarily due to the timing of a shipment to a European customer of formulated bulk TIMERx that did not occur until the first quarter of 2004. The decrease in product sales in 2002 was primarily due to decreased orders for formulated bulk TIMERx from a European customer, believed to be due to their lower sales as a result of additional generic entrants to the marketplace.

     In 2003, 2002 and 2001, royalties and licensing revenues consisted primarily of the royalties from Mylan on their sales of Pfizer’s 30 mg generic Procardia XL. Royalties and licensing revenues decreased in 2003 and 2002 primarily due to pricing pressure from additional generic competition.

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   Selling, General and Administrative Expense

     Selling, general and administrative expenses increased by 37% in 2003 to $10.4 million as compared with $7.6 million for 2002. The increase was primarily due to increased professional fees associated with a strategic review of our product pipeline, an increase in rent and lease expense related to office space, and increased personnel costs to support our business development and market research capabilities. The increase also reflects certain selling, general and administrative expenses that were incurred after February 27, 2003, the date of the sale of our excipient business, which were previously allocated to the excipient business but did not cease with the sale and were fully absorbed in continuing operations for the balance of 2003.

     Selling, general and administrative expenses increased by 19% in 2002 to $7.6 million as compared with $6.4 million in 2001. The increase was primarily due to an increase in our share of marketing expenses on oxymorphone ER, increased compensation expense primarily due to hiring additional personnel and increased business insurance costs.

   Research and Product Development Expense

     In the preceding table, research and development expenses are set forth in the following four categories:

	•		Oxymorphone ER – These expenses reflect our direct external expenses relating to the development of oxymorphone ER. These expenses consist primarily of payments to third parties, including payments to Endo for our share of development costs under our collaboration agreement with Endo;
	•		PW2101 – These expenses reflect our direct external expenses relating to the development of PW2101. These expenses consist primarily of payments to third parties in connection with clinical trials and the manufacturing of products prior to regulatory approval for clinical use and for commercial use;
	•		Research and New Technology Development – These expenses reflect both our direct external expenses and our internal expenses relating to the development of new drug delivery technologies. These direct external expenses consist primarily of payments to third parties in connection with outside laboratory and consulting fees. Our internal expenses primarily include salaries and benefits, and other costs such as depreciation on purchased equipment and amortization of patent costs.
	•		Phase I Products and Internal Costs – These expenses reflect both our direct external expenses and our internal expenses relating to the development of phase I product candidates and reflect other unallocated research and development expenses. Our direct external expenses primarily reflect payments to third parties for the active drug and proof-of-principle biostudies conducted for our phase I products. Our internal expenses include expenses such as salaries and benefits and laboratory facility costs.

     Total research and product development expenses increased in 2003 primarily due to increased costs relating to the development of PW2101, as well as increased costs relating to the development of phase I product candidates and new drug delivery technologies, partially offset by decreased costs relating to the development of oxymorphone ER. Total research and product development expenses increased in 2002 due to increased costs relating to the development of oxymorphone ER, PW2101 and new drug delivery technologies, partially offset by decreased costs related to the development of phase I product candidates.

     Oxymorphone ER, which we are developing with Endo, is the most advanced of our product candidates. 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

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Endo’s NDA for oxymorphone ER. Endo has stated it expects to meet with the FDA during the first quarter of 2004 to clarify the issues raised in the letter and discuss its responses. We anticipate that Endo will receive information at that meeting about the final path to regulatory approval and whether any additional trials will be required by the FDA. Research and development expenses related to oxymorphone ER decreased in 2003, due to the discontinuation of our funding of the development of oxymorphone ER effective April 17, 2003. Research and development expenses related to oxymorphone ER increased in 2002 as a result of increased costs of clinical trials for oxymorphone ER. We have not incurred any research and development expenses related to oxymorphone ER since April 17, 2003, and we do not expect to incur any additional research and development expenses relating to oxymorphone ER unless we resume our participation in the funding of the expenses of oxymorphone ER.

     Approximately 46% of the research and development spending in 2003 related to the direct costs associated with clinical development and manufacturing scale-up of PW2101. We have recently completed a pivotal trial of PW2101 for the treatment of hypertension and expect to release those results in the first quarter of 2004. In this trial we dosed 163 patients. The remainder of the development program includes additional work on a manufacturing site change, stability, and the compilation of the NDA. Assuming that the trials and the rest of the development work are successful, we expect that we would submit an NDA for this product in late 2004. Research and development expenses related to PW2101 increased in 2003 as a result of clinical trials and the scale-up and manufacturing of commercial batches, and increased in 2002 as a result of proof-of-principle biostudies and the manufacturing of clinical supplies. Although we have developed PW2101 on our own, we do not intend to market PW2101. As a result, we are currently seeking a marketing partner for this product.

     There can be no assurance that any of our 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. Due to the variability in the length of time necessary to develop a product, the uncertainties related to the estimated cost of the development projects and ultimate ability to obtain governmental approval for commercialization, accurate and meaningful estimates of the ultimate cost to bring our product candidates to market are not available.

     Research and new technology development expenses increased in 2003 due primarily to our focus during the period on the expansion of the applications of our TIMERx technology and the intellectual property underlying our TIMERx technology. The increase in research and new technology development in 2002 was primarily due to our completion of the development of our SyncroDose technology.

     Phase I products and internal costs increased in 2003 primarily as a result of an increase in the number of phase I product candidates in our pipeline, an increase in external costs incurred in connection with proof-of-principle biostudies for these phase I product candidates and an increase in the number of employees engaged in our research and development efforts and the costs associated with such employees.

     Tax Rates

     For continuing operations, the effective tax rates for 2003, 2002 and 2001 were essentially zero. The effective tax rates are higher than the federal statutory rate of a 34% benefit due primarily to valuation allowances recorded to offset net deferred tax assets relating to our net operating losses, and foreign income taxes.

Liquidity and Capital Resources

   Sources of Liquidity

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

     We are a party to an agreement with Endo with respect to the development of oxymorphone ER. On April 17, 2003, we discontinued our participation in the funding of the development and marketing of oxymorphone ER. Accordingly, our research and development, and selling, general and administrative expenses with respect to oxymorphone ER decreased significantly in the second, third and fourth quarters of 2003 compared to the corresponding periods in 2002. We do not expect any expenses relating to oxymorphone ER in 2004 unless we resume our participation in the funding of the development and marketing of oxymorphone ER. We estimate that through December 31, 2003, the unfunded development costs under our agreement with Endo approximated $6.7 million.

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     On February 27, 2003, we completed the sale of our excipient business to Rettenmaier. As a result of the sale of our excipient business, we had approximately $35 million of net cash proceeds available after the closing. However, as a result of the sale of our excipient business, we no longer derive cash flow from the sale of excipients. A portion of the proceeds from the sale of our excipient business was used to repay the $3.3 million of outstanding borrowings under our line of credit, which was terminated on February 27, 2003. In addition, we used the proceeds from the sale of our excipient business to repay in full a $2.25 million note payable to AstraZeneca AB, incurred in connection with our acquisition of specified intellectual property related to the excipient business.

     On August 5 and August 6, 2003, we 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 us, after fees and expenses, of approximately $49.3 million. As part of this transaction, we 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 expired on December 9, 2003. None of these additional investment rights were exercised.

   Cash Flows

     As of December 31, 2003, we had cash, cash equivalents, and short-term investments of $63.9 million. We have no committed sources of capital other than Rettenmaier’s commitment to repay us $1.25 million in May 2004, pursuant to a promissory note in connection with the sale of the excipient business.

     We had negative cash flow from operations for 2003 of $22.2 million, primarily due to the loss from continuing operations of $26.0 million in the period, partially offset by net cash provided by discontinued operations operating activities of $874,000 for the period prior to the sale of our excipient business on February 27, 2003, and net increases in payables and accrued expenses of $2.1 million. We had negative cash flow from operations for 2002 of $14.8 million, primarily due to the loss from continuing operations of $19.0 million in the period, partially offset by net cash provided by discontinued operations operating activities of $2.2 million, and net increases in payables and accrued expenses of $1.6 million. Our cash flow in 2003 has differed from our cash flow during 2002 primarily because we no longer derive revenues from sales of our excipient products and do not incur expenses in connection with our excipient business, except for the related revenues and expenses during the period from January 1, 2003 through February 26, 2003.

     Net cash used in investing activities totaled $2.7 million for 2003, primarily reflecting our receipt of cash proceeds from the sale of our excipient business of $36.9 million, net of transaction costs paid of $1.4 million, and our net investment in marketable securities of $36.7 million. In addition, investing activities also reflected $1.8 million in capital expenditures for the acquisitions of fixed assets primarily related to the second phase of an implementation project relating to our information system and laboratory equipment for drug development activities. Funds expended for intangible assets totaled $1.0 million and include costs to secure patents on technology developed by us.

     Financing activities provided $48.5 million in cash, primarily due to the cash received from the private placement of our common stock in August 2003, as well as $2.2 million in cash provided by discontinued operations, which was offset by the net repayment of approximately $5.7 million in loans, primarily in connection with the sale of our excipient business.

   Funding Requirements

     We anticipate that, excluding any revenues from oxymorphone ER, 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 operations on an ongoing basis without requiring us to seek external financings through at least 2005. We expect to continue to invest in capital expenditures in 2004 at levels similar to 2003 capital spending, primarily for laboratory equipment for our drug development activities and for patents on technology and products developed by us.

     Our requirements for capital in our business are substantial and will depend on many factors, including:

•		whether oxymorphone ER is approved on a timely basis, or at all;
•		whether we resume our participation in the funding of the development and marketing of oxymorphone ER;

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•		the timing and amount of payments received under existing and possible future collaborative agreements, in particular oxymorphone ER;
•		the structure of any future collaborative or development agreements;
•		the progress of our collaborative and independent development projects, funding obligations with respect to the projects, and the related costs to us of clinical studies for our products;
•		the costs and timing of adding drug development capabilities;
•		royalties received from Mylan; 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 or debt 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. 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.

   Contractual Obligations

     Our outstanding contractual cash obligations relate to our operating leases, primarily for facilities, and purchase obligations relating to capital expenditures and clinical development. Below is a table summarizing our contractual cash obligations under our operating leases having initial lease terms of more than one year and our purchase obligations, as of December 31, 2003:

Net Operating Loss Carryforwards

     At December 31, 2003, we had federal net operating loss, or NOL, carryforwards of approximately $63.8 million for income tax purposes, of which approximately $6.2 million, $8.4 million, $9.1 million, $17.7 million, $19.3 million and $3.1 million expire in 2018, 2019, 2020, 2021, 2022, and 2023, respectively. In addition, we had research and development tax credit carryforwards of approximately $2.2 million of which $299,000, $306,000, $777,000, and $828,000 expire in 2019, 2020, 2021, and 2022 respectively. The use of the NOL carryforwards and research and development tax credit carryforwards are limited to our future taxable earnings. For financial reporting purposes, at December 31, 2003 a valuation allowance of $26.5 million has been recognized to offset net deferred tax assets, primarily attributable to the NOL carryforwards. Utilization of the operating losses are subject to a limitation due to the ownership change provisions of the Internal Revenue Code.

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. Our operations are exposed to financial market risks, primarily changes in interest rates. Our interest rate risk primarily relates to our investments in marketable securities.

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     The primary objectives for our investment portfolio are liquidity and safety of principal. Investments are made to achieve the highest rate of return to us, consistent with these two objectives. Our investment policy limits investments to specific types of instruments issued by institutions with investment grade credit ratings and places restrictions on maturities and concentration by issuer.

     At December 31, 2003, marketable securities consisted primarily of corporate debt, U.S. Government-agency backed discounted notes and certificates of deposit, and approximated $38.6 million. 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 significant market risk. At December 31, 2003, market values approximated carrying values. At December 31, 2003 we had approximately $63.9 million in cash, cash equivalents and investments in marketable securities, and accordingly, a sustained decrease in the rate of interest earned of 1% would have caused a decrease in the annual amount of interest earned of up to approximately $639,000.

     At December 31, 2002, marketable securities consisted of corporate debt and approximated $2.1 million. These securities had contractual maturity dates of up to eleven months. At December 31, 2002, market values approximated carrying values. At December 31, 2002, the Company had approximately $6.5 million in cash, cash equivalents and investments in marketable securities, and accordingly, a sustained decrease in the rate of interest earned of 1% would cause a decrease in the annual amount of interest earned of up to approximately $65,000.

Recent Accounting Pronouncements

     In November 2002, the Emerging Issues Task Force, or 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 an effect on our financial position or results of operations.

     In June 2002, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” The statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 states that a liability for a cost associated with an exit or disposal activity shall be recognized and measured initially at its fair value in the period in which the liability is incurred, except for a liability for one-time termination benefits that are incurred over a period of time. The statement is effective for exit or disposal activities initiated after December 31, 2002. The adoption of SFAS 146 did not have an effect on our financial position or results of operations.

     In December 2003, the FASB issued SFAS No. 132 (revised 2003) “Employers’ Disclosures about Pensions and Other Postretirement Benefits an amendment of FASB Statements No. 87, 88, and 106.” This Statement revises employers’ disclosures about pension plans and other postretirement benefit plans. It does not change the measurement or recognition of those plans required by FASB Statements No. 87, Employers’ Accounting for Pensions, No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions. This Statement retains the disclosure requirements contained in FASB Statement No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits”, which it replaces. It requires additional disclosures to those in the original Statement No. 132 about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The adoption of SFAS No. 132 (revised 2003) had no impact 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 our financial statements.

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Forward Looking Statements

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

Risk Factors

     Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below in addition to the other information included or incorporated by reference in this prospectus before purchasing our common stock. If any of the following risks actually occur, our business, financial condition or results of operations would likely suffer. In that case, the trading price of our common stock could fall, and you may lose all or part of the money you paid to buy our common stock.

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

     We have incurred net losses since 1994, including net losses of $15.9 million, $17.1 million and $16.0 million, during 2003, 2002, and 2001, respectively. We had a loss from continuing operations of $26.0 million, $19.0 million, and $16.8 million in 2003, 2002, and 2001, respectively. As of December 31, 2003, our accumulated deficit was approximately $94.4 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 2003, 2002 and 2001 were reduced as a result of the operating results of our excipient business. Since February 27, 2003, we have not generated any revenues from the sales of excipient products and our business depends exclusively on our drug delivery and drug development 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;
	•		royalties from Mylan’s sales of Pfizer’s 30 mg generic version of Procardia XL; and
	•		the level of investment in research and development activities.

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

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

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

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     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 perception of us 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 have and than some of our collaborators have.

     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 we are developing. For instance, we expect extended release oxymorphone ER will face competition from MS Contin, Purdue Pharma’s OxyContin and Duragesic marketed by Johnson & Johnson.

     In addition to developing controlled release versions of immediate and other controlled release products, we also selectively develop generic versions of branded controlled release products. In development, we utilize our TIMERx technology and generic active ingredients to formulate product candidates. The success of these product candidates 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.

     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.

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

     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.

     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.

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

     Certain 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 we or our 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 December 31, 2003, we had cash, cash equivalents, and short-term investments of $63.9 million. We have no committed sources of capital other than Rettenmaier Holding GmbH & Co. KG’s commitment to repay us $1.25 million due in May 2004, in connection with the sale of the excipient business.

     We anticipate that, excluding any revenues from oxymorphone ER, 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 operations on an ongoing basis without requiring us to seek external financings through at least 2005.

     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:

•

whether oxymorphone ER is approved on a timely basis, or at all;

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	•		whether we resume our participation in the funding of the development and marketing of oxymorphone ER;
	•		the timing and amount of payments received under existing and possible future collaborative agreements, in particular oxymorphone ER;
	•		the structure of any future collaborative or development agreements;
	•		the progress of our collaborative and independent development projects, funding obligations with respect to the projects, and the related costs to us of clinical studies for our products;
	•		the costs and timing of adding drug development capabilities;
	•		royalties received from Mylan; 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 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 covered by one or more patents of the branded product. 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 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.

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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 are issued, 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, interference and other proceedings regarding patents, patent applications and other intellectual property rights. The types of situations in which we may become parties to such litigation or proceedings include:

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

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

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

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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 cGMP 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.

     We believe that there are a limited number of manufacturers that operate under cGMP regulations capable of manufacturing our TIMERx materials. Although we have qualified alternate suppliers with respect to the xanthan and locust bean gums used to manufacture our TIMERx material, if Draxis 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. There can be no assurance that Draxis or any other third parties upon which we rely for supply of our TIMERx material will perform, and any failures by third parties may delay development or the submission of products for regulatory approval, impair our collaborators’ ability to commercialize products as planned and deliver products on a timely basis, or otherwise impair our competitive position, which could have a material adverse effect on our business, financial condition and results of operations.

     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 primary 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

     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 specific 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 may be assigned an AB rating if the FDA considers the product to be therapeutically equivalent to the branded controlled release drug. Failure to obtain an AB rating from the FDA would indicate that for certain purposes the drug would not be deemed to be therapeutically equivalent, would not be fully substitutable for the branded controlled release drug and would not be relied upon by Medicaid and Medicare formularies for reimbursement.

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

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     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 minimum amounts 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.

Specific 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 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Reference is made to the disclosure under the caption “Market Risk and Risk Management Policies” in “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     All financial statements required to be filed hereunder are filed as Appendix A hereto and are listed under Item 15(a) included herein.

ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     None.

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ITEM 9A. CONTROLS AND PROCEDURES

     (a)  Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act) as of December 31, 2003. Based on this evaluation, our CEO and CFO concluded that, as of December 31, 2003, our disclosure controls and procedures were (1) designed to ensure that material information relating to us, is made known to our CEO and CFO by others within our 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 us in the reports that we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

     (b)  Changes in Internal Controls. No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act) occurred during the fiscal quarter ended December 31, 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART III

ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The information set forth under “Election of Directors,” “Committees of the Board,” “Code of Ethics” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive Proxy Statement for the 2004 Annual Meeting of Shareholders is incorporated herein by reference.

     Information regarding our executive officers is set forth in Part I, under the caption “Executive Officers of the Registrant.”

ITEM 11: EXECUTIVE COMPENSATION

     The information set forth under “Executive Compensation,” “Director Compensation” and “Compensation Committee Interlocks and Insider Participation” in our definitive Proxy Statement for the 2004 Annual Meeting of Shareholders is incorporated herein by reference.

ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

     The information set forth under “Security Ownership of Certain Beneficial Owners and Management” and “Securities Authorized for Issuance Under the Equity Compensation Plans” in our definitive Proxy Statement for the 2004 Annual Meeting of Shareholders is incorporated herein by reference.

ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information relating to certain relationships and related transactions set forth under “Certain Relationships and Related Transactions” in our definitive Proxy Statement for the 2004 Annual Meeting of Shareholders is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

     The information set forth under “Independent Auditor Fees and Other Matters” in our definitive Proxy Statement for the 2004 Annual Meeting of Shareholders is incorporated herein by reference.

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PART IV

ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)		(1) Financial Statements and Financial Statement Schedule
		The following documents are filed as Appendix A hereto and are included as part of this Annual Report on Form 10-K.
		The consolidated balance sheets as of December 31, 2003 and 2002 and the related statements of operations, cash flows and shareholders’ equity for each of the three years in the period ended December 31, 2003.
		Schedule II — Valuation and Qualifying Accounts
		All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are omitted because they are not applicable or because the information is presented in the financial statements or notes thereto.

		(2) Exhibits
		The list of Exhibits filed as part of this Annual Report on Form 10-K are set forth on the Exhibit Index immediately preceding such exhibits, and is incorporated herein by reference. This list includes a subset containing each management contract, compensatory plan, or arrangement required to be filed as an exhibit to this report.
(b)		Reports on Form 8-K.
		On October 20, 2003, we filed a report on Form 8-K announcing that the United States Food and Drug Administration had issued to Endo Pharmaceuticals Inc. an approvable letter for oxymorphone ER.
		On October 30, 2003, we filed a report on Form 8-K announcing our results for the third quarter ended September 30, 2003.
		On November 21, 2003, we filed a report on Form 8-K announcing that in its Quarterly Report on Form 10-Q for the quarter ended September 20, 2003, Endo addressed the status of the FDA approval process for oxymorphone ER and stated that it no longer believed that the launch date of the product would be the first quarter of 2004.
		On December 22, 2003, we filed a report on Form 8-K announcing that in a press release issued on December 18, 2003, Endo stated that it expected to meet with the FDA prior to the end of the first quarter of 2004 to discuss the approvable letter it received for oxymorphone ER and that it anticipated having further clarity as to the path required to obtain final approval from the FDA subsequent to such meeting.

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SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) 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.

     Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

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APPENDIX A

PENWEST PHARMACEUTICALS CO.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULE

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REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders
Penwest Pharmaceuticals Co.

We have audited the accompanying consolidated balance sheets of Penwest Pharmaceuticals Co. as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Penwest Pharmaceuticals Co. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

                     /s/ ERNST & YOUNG LLP

Stamford, Connecticut
February 6, 2004

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

See accompanying notes

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