Penwest Pharmaceuticals 10Q 2006 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q


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

For the quarterly period ended March 31, 2006


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

For the transition period from to

Commission File No. 000-23467

Penwest Pharmaceuticals Co.

(Exact name of registrant as specified in its charter)


Washington		91-1513032

(State of Incorporation)		(I.R.S. Employer Identification No.)


39 Old Ridgebury Road, Suite 11, Danbury, Connecticut		06810-5120

(Address of principal executive offices)		(Zip Code)

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

Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large accelerated filero Accelerated filerþ Non-accelerated filero

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of May 4, 2006.


Class		Outstanding

Common stock, par value $.001		22,835,925

PENWEST PHARMACEUTICALS CO.
TABLE OF CONTENTS

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

Forward-Looking Statements

This quarterly 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 are forward-looking statements. The words “believes,” “anticipates,” “estimates,” “plans,” “expects,” “intends,” “may,” “projects,” “will,” and “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We cannot guarantee that we actually will achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. There are a number of important factors that could cause our actual results to differ materially from those indicated or implied by forward-looking statements. These important factors include those set forth below under “Part II – Item 1A, Risk Factors.” In addition, any forward-looking statements represent our estimates only as of the date this quarterly report is filed with the SEC and should not be relied upon as representing our estimates as of any subsequent date. We do not assume any obligation to update any forward-looking statements.

PART I — FINANCIAL INFORMATION

Item 1.Condensed Financial Statements (Unaudited)

PENWEST PHARMACEUTICALS CO.

CONDENSED BALANCE SHEETS


	March 31,			December 31,
	2006			2005
	(Unaudited)			(Note 2)
	(In thousands,
	except share amounts)
ASSETS
Current assets:
Cash and cash equivalents	$	26,003		$	15,917
Marketable securities		31,700			39,377
Trade accounts receivable		929			942
Inventories:
Raw materials and other		178			44
Finished goods		85			96

Total inventories		263			140
Prepaid expenses and other current assets		873			1,112

Total current assets		59,768			57,488
Fixed assets, net		2,793			2,990
Patents, net		3,359			3,383
Cash surrender value of life insurance policies		3,195			3,160

Total assets	$	69,115		$	67,021


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	1,435		$	1,064
Accrued expenses		1,638			1,722
Accrued development costs		372			499
Deferred compensation – current portion		294			291

Total current liabilities		3,739			3,576
Deferred revenue		53			57
Deferred compensation		2,984			2,977

Total liabilities		6,776			6,610
Shareholders’ equity:
Preferred stock, par value $.001, authorized 1,000,000 shares, none outstanding Common stock, par value $.001, authorized 60,000,000 shares, issued and outstanding 22,779,799 shares at March 31, 2006 and 21,889,940 shares at December 31, 2005		23			22
Additional paid in capital		209,868			201,659
Accumulated deficit		(147,418	)		(141,116	)
Accumulated other comprehensive loss		(134	)		(154	)

Total shareholders’ equity		62,339			60,411

Total liabilities and shareholders’ equity	$	69,115		$	67,021

See accompanying notes to condensed financial statements.

PENWEST PHARMACEUTICALS CO.

CONDENSED STATEMENTS OF OPERATIONS


	Three Months Ended
	March 31,
	2006			2005
	(Unaudited)
	(In thousands, except
	per share data)
Revenues:
Royalties and licensing fees	$	931		$	982
Product sales		34			—

Total revenues		965			982
Cost of revenues		22			8

Gross profit		943			974
Operating expenses:
Selling, general and administrative		3,463			5,292
Research and product development		4,344			5,065

Total operating expenses		7,807			10,357

Loss from operations		(6,864	)		(9,383	)
Investment income		561			436

Loss before income tax expense		(6,303	)		(8,947	)
Income tax expense		—			—

Net loss	$	(6,303	)	$	(8,947	)


Net loss per common share	$	(0.28	)	$	(0.41	)


Weighted average shares of common stock outstanding		22,246			21,656

See accompanying notes to condensed financial statements

PENWEST PHARMACEUTICALS CO.

CONDENSED STATEMENTS OF CASH FLOWS


	Three Months Ended
	March 31,
	2006			2005
	(Unaudited)
	(In thousands)
Operating activities:
Net loss	$	(6,303	)	$	(8,947	)
Adjustments to reconcile net loss to net cash used in operating activities		2,174			1,425

Net cash used in operating activities		(4,129	)		(7,522	)

Investing activities:
Acquisitions of fixed assets, net		(37	)		(66	)
Patent costs		(132	)		(82	)
Proceeds from maturities of marketable securities		8,075			6,153
Proceeds from sales of marketable securities		1,600			23,850
Purchases of marketable securities		(2,014	)		(18,426	)

Net cash provided by investing activities		7,492			11,429

Financing activities:
Issuance of common stock, net		6,723			99

Net cash provided by financing activities		6,723			99

Net increase in cash and cash equivalents		10,086			4,006
Cash and cash equivalents at beginning of period		15,917			14,249

Cash and cash equivalents at end of period	$	26,003		$	18,255

See accompanying notes to condensed financial statements.

PENWEST PHARMACEUTICALS CO.

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

1. Business

Penwest Pharmaceuticals Co. (the “Company” or “Penwest”) develops pharmaceutical products based on innovative proprietary drug delivery technologies. The Company is focusing its development efforts principally on products that address disorders of the nervous system. The most advanced product in the Company’s drug development pipeline is oxymorphone ER, an extended release formulation of oxymorphone that the Company is developing with Endo Pharmaceuticals Inc. Oxymorphone ER is a narcotic analgesic using our proprietary TIMERx technology for twice-a-day dosing in patients with moderate to severe pain requiring continuous, around-the-clock opioid therapy for an extended period of time. The Company is also developing several additional product candidates designed for the treatment of depression, pain, epilepsy and Parkinson’s disease, as well as a product candidate designed for the treatment of edema resulting from congestive heart failure. The Company conducts is business primarily in North America.

The Company is subject to the risks and uncertainties associated with drug development. These risks and uncertainties include, but are not limited to, a history of net losses, technological changes, dependence on oxymorphone ER, dependence on collaborators and key personnel, the successful completion of development efforts and of obtaining regulatory approval, the successful commercialization of products based on the Company’s proprietary drug delivery technologies, compliance with government regulations, patent infringement litigation, competition from current and potential competitors, some with greater resources than the Company, dependence on third party manufacturers and a requirement for additional funding.

2. Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information, and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation for the interim periods presented have been included. All such adjustments are of a normal recurring nature, except for a $3.0 million compensation charge recognized in the first quarter of 2005 (see Note 7). Operating results for the three month period ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. For further information, refer to the financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

The balance sheet at December 31, 2005, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.

3. Summary of Significant Accounting Policies

Revenue Recognition

Royalties and licensing fees- The Company recognizes revenues from non-refundable up-front licensing fees received under collaboration agreements ratably over the development period of the related collaboration agreement when this period involves development risk associated with the incomplete stage of a product’s development, or over the estimated or contractual licensing and supply term when there exists an obligation to supply inventory for manufacture. Non-refundable milestone fees received for the development funding of a product are partially recognized upon receipt based on the Company’s proportionate development efforts achieved to date relative to the total expected development efforts and the remainder is generally recognized ratably over the remaining expected development period. The proportionate development efforts achieved are measured by estimating the percentage of work completed that is required of the Company in the development effort for the product. This estimate is primarily derived from the underlying project plans and timelines, developed by qualified personnel who work closely on such projects. In particular, the Company reviews output measures such as job specifications and tasks completed, compared to all such job specifications and tasks outlined for a particular project. Job specifications vary with each project and primarily include development activities regarding initial formulation work, manufacturing scale-up,

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

proof-of-principle biostudies, clinical development and regulatory matters. Non-refundable 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. Upon termination of a collaboration agreement, any remaining non-refundable licensing fees received by the Company, which had been deferred, are generally recognized in full. Product royalty fees are recognized when earned, as reported by the Company’s collaborators, and are generally subject to review or audit by the Company.

Product sales —The Company recognizes revenues from product sales when title transfers and customer acceptance provisions have lapsed, provided that collections of the related accounts receivable are probable. Shipping and handling costs are included in cost of revenues.

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. A significant portion of the Company’s development activities are outsourced to third parties including contract research organizations, and contract manufacturers in connection with the production of clinical materials, or may be performed by the Company’s collaborators. These arrangements may require estimates to be made of related service fees or the Company’s share of development costs, in which actual results could materially differ from the estimates and affect the reported amounts in the Company’s financial statements. These arrangements may also require the Company to pay termination costs to the third parties for reimbursement of costs and expenses incurred in the orderly termination of contractual services.

Income Taxes

The liability method, prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes,” is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities. The Company recorded no income tax benefits relating to the net operating losses generated during the three month periods ended March 31, 2006 and 2005, as such losses were offset by valuation allowances. Valuation allowances are established against the recorded deferred income tax assets to the extent that management believes it is more likely than not that a portion of the deferred income tax assets are not realizable.

Impairment of Long-Lived Assets

The Company reviews the recoverability of its long-lived assets, including definite-lived intangible assets, whenever facts and circumstances indicate that the carrying amount may not be fully recoverable. For purposes of recognizing and measuring impairment, the Company evaluates long-lived assets based upon the lowest level of independent cash flows ascertainable to evaluate impairment. If the sum of the undiscounted future cash flows expected over the remaining asset life is less than the carrying value of the assets, the Company may recognize an impairment loss. The impairment related to long-lived assets is measured as the amount by which the carrying amount of the assets exceeds the fair value of the asset. When fair values are not readily available, the Company estimates fair values using expected discounted future cash flows.

Share-Based Compensation

Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) using the modified prospective transition method. SFAS 123R requires all share-based payments to employees, including grants of employee stock options as well as compensatory employee stock purchase plans, to be recognized as an expense in the statement of operations based on their fair values as they are earned by the employees under the vesting terms. Pro forma disclosure of stock-based compensation expense, as was the Company’s practice under SFAS 123, “Accounting for Stock-Based Compensation”, is no longer permitted (see Note 5).

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

The valuation of employee stock options is an inherently subjective process, since market values are generally not available for long-term, non-transferable employee stock options. Accordingly, an option pricing model is utilized to derive an estimated fair value. In calculating the estimated fair value of stock options granted, a Black-Scholes-Merton pricing model is used which requires the consideration of the following six variables for purposes of estimating fair value:

	•		the stock option exercise price;

	•		the expected term of the option;

	•		the grant date price of our common stock, which is issuable upon exercise of the option;

	•		the expected volatility of our common stock;

	•		expected dividends on our common stock (we do not anticipate paying dividends for the foreseeable future); and

	•		the risk free interest rate for the expected option term.

Of the variables above, the Company believes that the selection of an expected term and expected stock price volatility are the most subjective. The Company uses historical employee exercise and option expiration data to estimate the expected term assumption for the Black-Scholes-Merton grant date valuation. The Company believes that this historical data is currently the best estimate of the expected term of a new option, and that generally, all groups of its employees exhibit similar exercise behavior. In general, the longer the expected term used in the Black-Scholes-Merton pricing model, the higher the grant-date fair value of the option. For options granted prior to 2006, the Company used historical volatility to estimate the grant-date fair value of stock options. Historical volatility is calculated based on a period equal to the expected term of stock option awards, and actual stock prices during this period. The Company changed its method of estimating expected volatility for all stock options granted after 2005 from exclusively relying on historical volatility to using an average of implied volatility and historical volatility. This change was the result of a thorough review the Company undertook. The Company selected the average of implied volatility and historical volatility as it believes neither of these measures is better than the other in estimating the expected volatility of the Company’s common stock. The Company believes that its estimates, both expected term and stock price volatility, are reasonable in light of the historical data analyzed; however, as with any estimate, the ultimate accuracy of these estimates is only verifiable over time.

The valuation assumptions selected upon the adoption of SFAS 123R, were applied to stock options that we granted subsequent to our adoption of SFAS 123R; however, the majority of the stock option expense recorded in the three month period ended March 31, 2006 related to the continued vesting of stock options that were granted prior to January 1, 2006. In accordance with the transition provisions of SFAS 123R, the grant date estimates of fair value associated with prior awards, which were also calculated using a Black-Scholes-Merton option pricing model, have not been changed. The Company uses the accelerated attribution method to recognize expense for all options granted.

Upon the adoption of SFAS 123R, the Company was also required to estimate the level of award forfeitures expected to occur, and record compensation cost only for those awards that are ultimately expected to vest. This requirement applies to all awards that are not yet vested, including awards granted prior to January 1, 2006. Accordingly, the Company performed a historical analysis of option awards that were forfeited (such as by employee separation) prior to vesting, and ultimately recorded stock option expense that reflected the estimated forfeiture rate.

4. Recent Accounting Pronouncements

In June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3”. This standard replaces APB Opinion No. 20, “Accounting Changes",and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”, and changes the requirements for the accounting and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle and to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. SFAS No. 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be

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

accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS No. 154 requires that the change in accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings for that period, rather than being reported in an income statement. Such a change would require a Company to restate its previously issued financial statements to reflect the change in accounting principle to prior periods presented. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 had no impact on the Company’s results of operations, financial position or cash flows.

In November 2004, the FASB issued Statement No. 151, “Inventory Costs — an amendment of ARB No. 43, Chapter 4”. This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43, Chapter 4, previously stated that “...under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges...” This Statement requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this Statement are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of Statement No. 151 had no effect on the Company’s results of operations, financial position or cash flows.

See Note 5 for a discussion of SFAS 123R. Other pronouncements issued by the FASB or other authoritative accounting standards groups with future effective dates are either not applicable or not significant to the financial statements of the Company.

5. Share-Based Compensation

In December 2004, the Financial Accounting Standards Board (the “FASB”) issued SFAS 123R, which is a revision of SFAS 123. SFAS 123R supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and amends SFAS No. 95, “Statement of Cash Flows”. The approach to quantifying stock-based compensation expense in SFAS 123R is similar to SFAS 123. However, the revised statement requires all share-based payments to employees, including grants of employee stock options as well as compensatory employee stock purchase plans, to be recognized as an expense in the statement of operations based on their fair values as they are earned by the employees under the vesting terms. Pro forma disclosure of stock-based compensation expense, as was the Company’s practice under SFAS 123, is no longer permitted. The Company adopted SFAS 123R effective beginning January 1, 2006 using the modified prospective transition method. The effect of the adoption was an additional $1.1 million in compensation expense, or approximately $.05 per share, basic and diluted, substantially all related to employee stock options. Of such amount, $628,000 and $433,000 were recorded to selling, general and administrative expense, and research and product development expense, respectively. Total share-based compensation expense recognized in the three month periods ended March 31, 2006 and 2005 were $1.5 million and $2.5 million, respectively (see Note 7).

Under the modified prospective transition method, prior periods are not restated for the effect of SFAS 123R. Had the Company accounted for stock-based compensation plans using the fair value based accounting method proscribed by SFAS 123R for the periods prior to 2006, our net loss and net loss per share would have approximated the pro forma amounts indicated below:

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


	Three Months Ended
	March 31, 2005
	(unaudited)
	(in thousands, except per
	share data)
Net loss reported	$	(8,947	)
Stock-based compensation expense included in reported net loss		2,537
Stock-based compensation under fair value method		(1,604	)

Net loss — pro forma after stock–based compensation under fair value method	$	(8,014	)


Net loss per share, basic and diluted — as reported	$	(0.41	)
Net loss per share, basic and diluted — pro forma after stock-based compensation under fair value method	$	(0.37	)

Penwest Stock Option Plans

As of March 31, 2006, the Company had three stock option plans: the 2005 Stock Incentive Plan (the “2005 Plan”), the 1998 Spin-off Option Plan (the “Spin-off Plan”) and the 1997 Equity Incentive Plan (the “1997 Plan”). The 2005 Plan and the 1997 Plan provide for the grants of incentive stock options, nonstatutory stock options, restricted stock awards and other stock-based awards, including the grant of securities convertible into common stock and the grant of stock appreciation rights (collectively “Awards”). Since the 2005 Plan was approved, the Company has granted options and issued other securities to employees, directors and consultants under the 2005 Plan. No additional awards have been made under the Spin-off Plan or the 1997 Plan. A total of 1,650,000 shares of common stock may be issued pursuant to Awards granted under the 2005 Plan. Such awards generally may not be granted at an exercise price that is less than the fair market value of the common stock on the date of grant, as determined by the Company’s Board of Directors. Stock option awards currently vest over a one to four year period and expire no later than ten years from the date of grant. Restricted stock awards entitle recipients to acquire shares of common stock, subject to the right of the Company to purchase all or part of such shares from the recipient in the event that the conditions specified in the applicable award are not satisfied prior to the end of the applicable restriction period established for such award. Restricted stock awards currently vest over a one to four year period and are recorded at fair value, which is based on the fair market value of the common stock on the date of grant. Under the terms of executive retention agreements entered into with each executive officer, if, within 12 months following a change in control of the Company, the executive’s employment is terminated by the Company other than for cause, death or disability, or by the executive for good reason, as such terms are defined, the vesting of all stock options and restricted stock held by the executive will be accelerated in full, to the extent not already vested, and all shares of stock underlying stock options and all shares of restricted stock will be free of any right of repurchase by the Company. The retention agreements terminate if a change in control of the Company does not occur prior to December 31, 2008.

On June 21, 2004, the Company granted nonstatutory stock options outside of any equity compensation plan pursuant to a Nonstatutory Stock Option Agreement entered into with one of its officers, providing for the purchase of 100,000 shares of its common stock at an exercise price equal to the fair market value of the common stock on the date of grant. These options vest over a four year period, and are subject to acceleration upon the occurrence of a change in control of the Company.

On August 31, 1998, Penford Corporation (“Penford”) distributed to the holders of Penford common stock, all of the outstanding shares of the Company’s common stock (the “Distribution”). In connection with such transaction, the Company’s 1998 Spin-off Option Plan was adopted in June 1998 to provide for the grant of stock options to employees of Penwest and non-employee directors of Penford who held options to purchase Penford common stock as of the Distribution date and who ceased to be employees of Penford under the terms of Penford’s stock option plans. As of the Distribution date, options to purchase 1,000,722 shares of common stock were granted to the Company’s employees and non-employee directors of Penford under the Spin-off Plan, of which 5,233 options are outstanding as of March 31, 2006. The exercise price and number of options were calculated so as to preserve the Penford options’ approximate value as of the Distribution date. The Board may not grant any additional options under the Spin-off Plan. If any option expires or is terminated,

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

surrendered, canceled or forfeited, the unused common stock covered by such option will cease to be available for grant under the Spin-off Plan.

The following table presents a summary of the Company’s stock option activity and related information for the three month period ended March 31, 2006:


						Weighted-Average
				Weighted		Remaining		Aggregate
				Average		Contractual Terms		Intrinsic
	Shares			Exercise Price		in Years		Value
BALANCE, DECEMBER 31, 2005		3,015,563		$	10.88

Options Exercisable		2,120,947		$	9.99


Granted		345,250		$	22.44
Exercised		(864,513	)	$	7.78
Forfeited		(6,801	)	$	12.53
Expired		(625	)	$	16.39

BALANCE, MARCH 31, 2006		2,488,874		$	13.55		6.3	$	20,879,431

Options Exercisable		1,457,052		$	11.75		4.5	$	14,698,936

The weighted average fair values of options granted during the three month periods ended March 31, 2006 and 2005 were $12.23 and $6.05, respectively. Total cash received by the Company from the exercise of stock options during the three months ended March 31, 2006 was approximately $6.7 million. The total intrinsic values of options exercised during the three month periods ended March 31, 2006 and 2005 were approximately $12.0 million and $59,000, respectively. As of March 31, 2006, there was approximately $5.7 million of unrecognized compensation cost related to stock option awards that is expected to be recognized as expense over a weighted average period of 1.2 years.

The fair values of each option grant in the respective three month periods ending March 31 were estimated using the Black-Scholes-Merton option pricing model with the following weighted average assumptions:


	Three Months Ended
	March 31,
	2006			2005
Expected dividend yield	None			None
Risk free interest rate		4.6	%		4.0	%
Expected volatility		55	%		50	%
Expected life of options	5.8 years			7.5 years

The following table presents a summary of restricted stock activity for the three month period ended March 31, 2006:


				Weighted-Average
				Grant-Date		Aggregate Intrinsic
	Shares			Fair Value		Value
Restricted stock outstanding at December 31, 2005		68,000		$	11.37	$	1,308,660

Granted		24,000		$	19.41
Vested		(35,500	)	$	10.91

Restricted stock outstanding at March 31, 2006		56,500		$	15.05	$	1,233,678

The total fair value of restricted stock which vested and the total compensation cost recognized for restricted stock awards in the three months ended March 31, 2006 were approximately $387,000 and $342,000, respectively. As of March 31, 2006, there was approximately $506,000 of unrecognized compensation cost related to restricted stock awards that is expected to be recognized as expense over a weighted average period of 1.3 years.

Employee Stock Purchase Plan

The Employee Stock Purchase Plan was approved in October 1997 and enables all employees to subscribe “during specified offering periods” to purchase shares of common stock at the lower of 85% of the fair market value of the shares on the first or last day of such offering period. A maximum of 228,000 shares are authorized for issuance under the Plan. The current offering period began January 1, 2006 and is scheduled to end on June 30,

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

2006; therefore, June 30, 2006 is considered the grant date for the purposes of recognizing the stock-based compensation for this offering period.

6. Income Taxes

The Company’s effective tax rates for the three month periods ended March 31, 2006 and 2005 were zero. The effective tax rates are higher than the federal statutory rate of a 34% benefit primarily due to valuation allowances recorded to offset deferred tax assets relating to the Company’s net operating losses.

7. Compensation Charge

On February 14, 2005, Tod R. Hamachek resigned from his positions as the Company’s Chief Executive Officer and Chairman of the Board of Directors, and as a member of the Board, and entered into a Severance and Settlement Agreement and Release with the Company (the “Agreement”). Under the Agreement, the Company agreed that, in consideration of Mr. Hamachek’s release and other agreements under the Agreement, it would pay Mr. Hamachek eighteen months base salary ($594,000), pay all premium costs relating to medical insurance continuation coverage for eighteen months and provide certain other benefits. The Company also agreed to accelerate in full the vesting of all unvested stock options (146,000 shares) held by Mr. Hamachek, and to extend the period during which he could exercise his stock options to the earlier of two years or their original expiration date. On December 27, 2005, the Company agreed with Mr. Hamachek to change the date through which Mr. Hamachek could exercise his stock options from February 14, 2007 to December 31, 2006. In connection with the Agreement, the Company recorded a charge to its statement of operations totaling approximately $3.0 million in the first quarter of 2005. This charge, included in selling, general and administrative expense, includes a non-cash charge of approximately $2.4 million relating to the modifications of the stock options noted above.

8. Supplemental Executive Retirement Plan and Deferred Compensation Plan

The Company has a Supplemental Executive Retirement Plan (“SERP”), a nonqualified plan, which covers the former Chairman and Chief Executive Officer of Penwest. On February 14, 2005, Mr. Hamachek resigned from his positions as Chairman and Chief Executive Officer (see Note 7). Under the SERP, effective in May 2005, the Company became obligated to pay Mr. Hamachek approximately $12,600 per month over the lives of Mr. Hamachek and his spouse. The actuarially determined liability for the SERP was approximately $2,319,000 and $2,326,000 as of March 31, 2006 and December 31, 2005, respectively, including the current portion of approximately $151,000 at March 31, 2006, and is included in deferred compensation in the Company’s condensed balance sheet. The Company has not funded this liability and no assets are held by the SERP. The Company uses a measurement date of December 31 for its SERP. The following disclosures summarize information relating to the SERP:

Components of net periodic benefit cost:


	Three Months Ended
	March 31,
	2006		2005
	(unaudited)
	(in thousands)
Interest cost	$	30	$	30
Amortization of prior service cost		—		1

Net periodic benefit cost	$	30	$	31

In addition, the Company has a Deferred Compensation Plan (“DCP”), a nonqualified plan which covers Mr. Hamachek. Under the DCP, the Company recognized interest expense of $18,000 and $19,000 for the three month periods ended March 31, 2006 and 2005, respectively. The liability for the DCP was approximately $959,000 and $942,000 as of March 31, 2006 and December 31, 2005, respectively, including the current portion of approximately $143,000 at March 31, 2006, and is included in deferred compensation on the Company’s condensed balance sheets. The Company has not funded this liability and no assets are held by the DCP. In connection with the resignation and retirement of Mr. Hamachek in February 2005 (see Note 7), under the DCP, effective in May 2005, the Company commenced the payment of benefits to Mr.

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

Hamachek, which are to be paid in ten annual installments, each approximating $140,000; however, these installments are recalculated annually based on market interest rates, as provided for under the DCP.

The Company has two whole-life insurance policies held in a rabbi trust, the cash surrender value or death benefits of which are held in trust for the SERP and DCP liabilities. The Company is entitled to borrow against or withdraw from these policies to fund the liabilities under the SERP and the DCP as provided by the terms of the trust. The cash surrender value of these polices totaled $3,195,000 as of March 31, 2006 and $3,160,000 as of December 31, 2005.

9. Comprehensive Loss

The components of comprehensive loss for the three month periods ended March 31, 2006 and 2005 are as follows:


	Three Months Ended
	March 31,
	2006			2005
	(unaudited)
	(in thousands)
Net loss	$	(6,303	)	$	(8,947	)
Changes in unrealized net gains and losses on marketable securities		20			(79	)

Comprehensive loss	$	(6,283	)	$	(9,026	)

Accumulated other comprehensive loss equals the cumulative unrealized net gains and losses on marketable securities, which are the only components of other comprehensive loss included in the Company’s condensed financial statements.

10. Licensing Agreements

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

Endo Pharmaceuticals Inc.

In September 1997, the Company entered into a strategic alliance agreement with Endo Pharmaceuticals Inc. with respect to the development of oxymorphone ER, an extended release formulation of oxymorphone, based on the Company’s TIMERx technology. Oxymorphone ER is a narcotic analgesic for the treatment of moderate to severe pain in patients requiring continuous, around-the-clock opioid therapy for an extended period of time. This agreement was amended and restated in April 2002. Endo has a broad product line, including established brands such as DepoDur, Frova, Lidoderm, Percodan, Percocet and Zydone. Endo is registered with the U.S. Drug Enforcement Administration as a developer, manufacturer and marketer of controlled narcotic substances.

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

Prior to April 17, 2003, the Company shared with Endo the costs involved in the development and pre-marketing of oxymorphone ER. On April 17, 2003, the Company discontinued its participation in the funding of the development and pre-marketing of oxymorphone ER. The Company took this action because it believed that its strategic focus should be on funding other products in its 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

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

development and pre-marketing costs incurred by Endo that otherwise would have been funded by the Company through a temporary adjustment in the royalty rate payable to the Company, which will return to its pre-adjustment level once Endo has recovered such costs. Endo may also allow the Company to reimburse Endo directly for the unfunded amounts. The Company estimates that through December 31, 2005, these unfunded costs approximated $23.0 million. The Company expects these costs to increase as Endo incurs pre-launch marketing costs.

The Company has 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 the Company, 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 the Company at specified prices, and include these purchases in cost of goods sold of the product prior to determining net realization, on which the royalty payment is calculated.

Mylan Pharmaceuticals Inc.

In March 2000, Mylan announced that it had signed a supply and distribution agreement with Pfizer, Inc. (“Pfizer”) to market a generic version of all three strengths (30 mg, 60 mg, 90 mg) of Pfizer’s Procardia XL. In connection with that agreement, Mylan decided not to market Nifedipine XL, a product the Company had developed in collaboration with Mylan, and agreed to pay Penwest a royalty on all future net sales of the 30 mg strength of Pfizer’s generic version of Procardia XL. The royalty percentage was comparable to the percentage called for in Penwest’s original agreement with Mylan for Nifedipine XL. Mylan has retained the marketing rights to the 30 mg strength of Nifedipine XL. Mylan’s sales in the United States in 2005 of the 30 mg strength of Pfizer’s generic version of Procardia XL totaled approximately $32.9 million. The term of this agreement continues until such time as Mylan permanently ceases to market the generic version of Procardia XL.

Prism Pharmaceuticals, Inc.

In April 2005, the Company entered into a licensing agreement (the “License Agreement”) with Prism Pharmaceuticals, Inc. (“Prism”) granting Prism exclusive rights to market Penwest’s PW2101 product in the United States and Canada. Under the terms of the License Agreement, Penwest granted Prism an exclusive license under certain Penwest intellectual property to develop, make, use and commercialize PW2101 in the United States and Canada for all indications except the treatment and/or prophylaxis of migraine. Prism made a non-refundable $4.0 million payment to the Company upon signing the License Agreement and had agreed to pay Penwest milestone payments upon achievement of milestones related to FDA approval and launch of PW2101, and royalties on net sales. Upon receipt, the Company deferred the $4.0 million received from Prism.

In June 2005, the FDA issued a non approvable letter for the Company’s NDA for PW2101. Given the FDA’s concerns expressed in the non approvable letter, the time and resources the Company expected it would take to address them, and the commercial window for this product opportunity, Penwest decided not to undertake the additional activities on PW2101 that it believed would be required to address the FDA’s concerns. On July 7, 2005, the Company was notified by Prism that Prism also did not intend to proceed with development activities on PW2101 under the License Agreement. As a result, the License Agreement terminated effective July 20, 2005. In connection with the termination, Penwest and Prism signed a settlement agreement in September 2005, and Penwest repaid Prism $1.75 million of the $4.0 million payment Penwest received from Prism, and recognized the remaining $2.25 million as licensing fee revenue in the third quarter of 2005.

11. Contingencies

Substantial patent litigation exists in the pharmaceutical industry. Patent litigation generally involves complex legal and factual questions, and the outcome frequently is difficult to predict. An unfavorable outcome in any patent litigation affecting the Company could cause the Company to pay substantial damages, alter its products or

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

processes, obtain licenses and/or cease certain activities. Even if the outcome is favorable to the Company, the Company could incur substantial litigation costs.

The Company is a party to certain claims and proceedings in the ordinary course of business. The Company does not believe any of these matters will result, individually or in the aggregate, in a material adverse effect upon its financial condition or future results of operations.

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

Overview

We develop pharmaceutical products based on innovative proprietary drug delivery technologies. We are focusing our development efforts principally on products that address disorders of the nervous system. The most advanced product in our drug development pipeline is oxymorphone ER, an extended release formulation of oxymorphone that we are developing with Endo Pharmaceuticals Inc., or Endo. We are also developing several additional product candidates designed for the treatment of depression, pain, epilepsy and Parkinson’s disease, as well as a product candidate designed for the treatment of edema resulting from congestive heart failure.

Oxymorphone ER.Oxymorphone ER is a narcotic analgesic that we are developing with Endo using our proprietary TIMERx technology for twice-a-day dosing in patients with moderate to severe pain requiring continuous, around-the-clock opioid therapy for an extended period of time. Under the terms of our collaboration with Endo, Endo is responsible for conducting the clinical trials and seeking regulatory approval of oxymorphone ER. In October 2003, the United States Food and Drug Administration, or FDA, issued an approvable letter in response to the new drug application, or NDA, for oxymorphone ER. In the letter, the FDA requested that Endo address certain questions, provide additional clarification and information, and conduct additional clinical trials to further confirm the safety and efficacy of oxymorphone ER. In August 2005 and October 2005, Endo reported the results of two studies that were designed to provide the additional safety and efficacy data requested by the FDA. These trials were conducted to evaluate oxymorphone ER in two distinct groups of patients with chronic low back pain: opioid-naïve patients and opioid-experienced patients. The trial involving opioid-naïve patients was conducted under the FDA’s special protocol assessment, or SPA, process. In each of the studies, the primary endpoints of the trial were achieved. These studies demonstrated statistically significant (p<0.0001) differences in pain scores between oxymorphone ER and placebo. In December 2005, Endo submitted a response to the FDA’s approvable letter on its NDA for oxymorphone ER. This submission was accepted for filing as a complete response by the FDA in January 2006. Under Prescription Drug User Fee Act, or PDUFA, guidelines, the FDA confirmed to Endo a six-month PDUFA date of June 22, 2006, which is the date by which we expect Endo to receive an action letter from the FDA on this filing. If the FDA approves oxymorphone ER in the second quarter of 2006, we expect Endo to begin marketing oxymorphone ER in the second half of 2006.

Oxymorphone ER, if approved, would compete in the market for long acting, strong opioids with products such as Purdue Pharma’s OxyContin and Johnson and Johnson’s Duragesic patch. Products in the long acting, strong opioids market had aggregate sales in the United States in 2005 of approximately $3.7 billion according to data obtained from IMS. Under our collaboration agreement with Endo, Endo will market oxymorphone ER, and we will be entitled to a 40-50% royalty on the net realization, as defined in our agreement with Endo, relating to the sales of oxymorphone ER, subject to specified adjustments.

Additional Product Candidates.In addition to oxymorphone ER, we have three product candidates in clinical development that we are developing internally.

•

Nalbuphine ER(PW4142). We are developing nalbuphine ER, a controlled release formulation of nalbuphine hydrochloride, for the treatment of pain. Nalbuphine ER, which we are developing using our Geminex dual drug delivery technology, is designed to be taken as a tablet twice daily. We expect that nalbuphine ER, if approved, would compete in the moderate pain market with products such as tramadol, codeine and propoxyphene. We have completed a Phase I pharmacokinetic study of nalbuphine ER that confirmed that our formulation achieved the targeted blood levels and a Phase IIa trial in which nalbuphine ER positively reduced mean pain intensity in a dose-dependent manner over the 12-hour study period when compared to placebo. We recently completed market research, which we believe confirms this drug should be positioned in the moderate chronic pain market. We are now determining the appropriate pain population in which to conduct further clinical studies. We plan to meet with the FDA to discuss the regulatory approval pathway for nalbuphine ER in the second half of 2006, including a proposed Phase IIb study, and to commence the Phase IIb study in the appropriate patient population by early 2007.

	•		Torsemide ER(PW2132). We are developing torsemide ER, a loop diuretic, for the management of chronic edema, a condition involving excess fluid accumulation, resulting from congestive heart failure, or CHF. Torsemide ER, a controlled release formulation of torsemide developed using our Geminex dual drug delivery technology, is designed to be taken as a tablet once daily. We expect that torsemide ER, if approved, would compete with furosemide and other loop diuretics. We are developing this product using a 505(b)(2) regulatory strategy referencing torsemide. We have completed Phase I pharmacokinetic studies of torsemide ER that confirmed that our formulation achieved the targeted plasma profiles and completed a Phase IIa study that confirmed the proof of concept that torsemide ER would cause prolonged urinary sodium excretion in CHF patients. We are discussing with the FDA the possibility that only one pivotal safety and efficacy trial would be necessary for approval of torsemide ER based on the FDA’s previous finding that torsemide is safe and effective. During 2006, we will determine the design of that pivotal study, which we believe will have a comparator and placebo arm. During 2006, we also expect to determine whether to continue development of torsemide ER on our own, or to seek a collaborator to complete the development work and market the product.

	•		Venlafaxine ER(PW4112).We are developing venlafaxine ER, using our TIMERx technology, as a once daily tablet for the treatment of depression. We are developing this product using a 505(b)(2) regulatory strategy referencing Wyeth’s Effexor XR. We expect that venlafaxine ER, if approved, would compete in a segment of the market for antidepressants, which includes Effexor XR. We have completed Phase I pharmacokinetic studies that confirmed that our formulation achieved the targeted blood levels. We have confirmed with the FDA the design of the pivotal trials required for the development of this product. We believe the FDA will only require three additional Phase I pharmacokinetic trials that could be conducted in 2006. If the trials are successful, we expect that we will submit the NDA to the FDA in early 2007. We are currently seeking a collaborator to market this product.

We are also developing six other product candidates for the treatment of nervous system disorders. We are currently developing formulations and conducting pilot scale biostudies of these product candidates to obtain pharmacokinetic data in humans.

Under a collaboration agreement with Mylan Pharmaceuticals Inc., we developed Nifedipine XL, a generic version of Procardia XL based on our TIMERx technology. In March 2000, Mylan announced that it had signed a supply and distribution agreement with Pfizer, Inc. to market Pfizer’s generic version of all three strengths (30 mg, 60 mg, 90 mg) of 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.

Effective January 1, 2006, all share-based payments to employees, including grants to employees of stock options, will be recognized as an expense in the statement of operations based on their fair values as they are earned by the employees under the vesting terms, in accordance with Statement of Financial Accounting Standards, or SFAS, No. 123R, “Share-Based Payment”. The effect of our adoption of SFAS 123R was an additional $1.1 million of compensation expense, or approximately $.05 per share, basic and diluted, in the three month period ended March 31, 2006, substantially all related to employee stock options. Of such amount, $628,000 and $433,000 were recorded to selling, general and administrative expense, and research and product development expense, respectively.

Total share-based compensation expense recognized in the three month periods ended March 31, 2006 and 2005 were $1.5 million and $2.5 million, respectively.

We have incurred net losses since 1994. As of March 31, 2006, our accumulated deficit was approximately $147 million. We expect operating losses and negative cash flows to continue until substantial sales of oxymorphone ER or other products commercialized using drug delivery technologies occur. We currently generate revenues primarily from royalties received from Mylan. Our future profitability will depend on several factors, including:

•

the successful commercialization of oxymorphone ER;

•

royalties from Mylan’s sales of Pfizer’s 30 mg generic version of Procardia XL;

•

the level of our investment in research and development activities; and

•

the successful development and commercialization of product candidates other than oxymorphone ER in our portfolio.

Our strategy includes a significant commitment to spending on research and development targeted at identifying and developing products that can be formulated using drug delivery technologies. We also expect to expend resources on the expansion of our own drug delivery technologies, as well as on new technologies obtained through in-licenses or acquisition. 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, the volume and timing of shipments of formulated bulk TIMERx, if any, the variations in payments under our collaborative agreements, and on the amount and timing of our investment in research and development activities.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our condensed financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. 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. Areas where significant judgments are made include, but are not limited to: revenue recognition, research and development expenses, deferred taxes-valuation allowance and impairment of long-lived assets. For a more detailed explanation of the judgments we make in these areas, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2005.

In addition, with the adoption of Statement of Financial Accounting Standards (or SFAS) 123R on January 1, 2006 as described below, we have identified the estimates and assumptions applied in the fair value determination of our stock option awards as critical, as discussed below. It is important that the discussion of our operating results that follows be read in conjunction with the critical accounting policies discussed below as well as those disclosed in our Annual Report on Form 10K.

Share-Based Compensation

Effective January 1, 2006, we adopted SFAS 123R, “Share-Based Payment” requiring the expense recognition of the estimated fair value of all share-based payments granted to employees. Prior to this, the estimated fair value associated with such awards was not recorded as an expense, but rather was disclosed in a footnote to our financial statements. For the three month period ended March 31, 2006, we recorded approximately $1.5 million of expense associated with share-based payments, with the majority of this expense, approximately $1.1 million, attributable to employee stock options, and $342,000 attributable to restricted stock awards.

The valuation of employee stock options is an inherently subjective process, since market values are generally not available for long-term, non-transferable employee stock options. Accordingly, an option pricing model is utilized to derive an estimated fair value. In calculating the estimated fair value of our stock options, we used a Black-Scholes-Merton pricing model, which requires the consideration of the following six variables for purposes of estimating fair value:

	•		the stock option exercise price;

	•		the expected term of the option;

	•		the grant date price of our common stock, which is issuable upon exercise of the option;

	•		the expected volatility of our common stock;

	•		expected dividends on our common stock (we do not anticipate paying dividends for the foreseeable future); and

	•		the risk free interest rate for the expected option term.

Of the variables above, we believe that the selection of an expected term and expected stock price volatility are the most subjective. We use historical employee exercise and option expiration data to estimate the expected term assumption for the Black-Scholes-Merton grant date valuation. We believe that this historical data is currently the best estimate of the expected term of a new option, and that generally, all groups of our employees exhibit similar exercise behavior. In general, the longer the expected term used in the Black-Scholes-Merton pricing model, the higher the grant-date fair value of the option. For options granted prior to 2006, we used historical volatility to estimate the grant-date fair value of stock options. Historical volatility is calculated based on a period equal to the expected term of stock option awards, and actual stock prices during this period. We changed our method of estimating expected volatility for all stock options granted after 2005 from exclusively relying on historical volatility to using an average of implied volatility and historical volatility. This change was the result of a thorough review we undertook. We selected the average of implied volatility and historical volatility as we believe neither of these measures is better than the other in estimating the expected volatility of our common stock. We believe that our estimates, both expected term and stock price volatility, are reasonable in light of the historical data we analyzed. However, as with any estimate, the ultimate accuracy of these estimates is only verifiable over time.

The valuation assumptions selected were applied to stock options that we granted subsequent to our adoption of SFAS 123R; however, the majority of the stock option expense recorded in the three month period ended March 31, 2006 related to the continued vesting of stock options that were granted prior to January 1, 2006. In accordance with the transition provisions of SFAS 123R, the grant date estimates of fair value associated with prior awards, which were also calculated using a Black-Scholes-Merton option pricing model, have not been changed. The specific valuation assumptions that were utilized for purposes of deriving an estimate of fair value at the time that prior awards were issued are as disclosed in our prior annual reports on Form 10-K. We use the accelerated attribution method to recognize expense for all options granted.

Upon the adoption of SFAS 123R, we were also required to estimate the level of award forfeitures expected to occur, and record compensation cost only for those awards that are ultimately expected to vest. This requirement applies to all awards that are not yet vested, including awards granted prior to January 1, 2006. Accordingly, we performed a historical analysis of option awards that were forfeited (such as by employee separation) prior to vesting, and ultimately recorded stock option expense that reflected this estimated forfeiture rate.

Results of Operations for the Three Month Periods Ended March 31, 2006 and 2005


	Three months		Percentage			Three months
	ended March 31,		Increase			ended March 31,
	2006		(decrease)			2005
	(in thousands, except percentages)
Royalties and Licensing Fees	$	931		(5	)%	$	982
Product Sales		34		100	%		—

Total Revenues	$	965		(2	)%	$	982

Revenues

Royalties and licensing fees in both periods substantially all related to royalties from Mylan on its sales of Pfizer’s 30 mg generic version of Procardia XL. These royalties from Mylan decreased slightly in the three month period ended March 31, 2006 from the comparable period for 2005 as a result of a decrease in Mylan’s net sales of Pfizer’s 30 mg generic version of Procardia XL.

Our product sales in the three month period ended March 31, 2006 consisted of sales of formulated TIMERx to one of our collaborators, with no comparable product sales occurring in the three months ended March 31, 2005.

Selling, General and Administrative Expense

Selling, general and administrative, or SG&A, expenses for the three month period ended March 31, 2006 were $3.5 million as compared to $5.3 million for the comparable period in 2005. This decrease of $1.8 million is primarily due to a one-time charge of $3.0 million recorded in the first quarter of 2005 in connection with the agreement we entered into with Mr. Hamachek, our former Chairman and Chief Executive Officer, upon his resignation in February 2005. This one-time charge included a non-cash charge of $2.4 million relating to the accelerated vesting and extension of exercise periods of stock options held by Mr. Hamachek. This decrease was partially offset by compensation expense of $628,000 related to employee stock options, resulting from our adoption of SFAS 123R effective January 1, 2006. Also partially offsetting the decrease were increased market research costs for the 2006 three-month period compared with the 2005 three-month period.

Research and Product Development Expense

Total research and product development expense decreased by $721,000 in the three month period ended March 31, 2006 as compared to the comparable period in 2005, primarily due to a decrease in spending on PW2101. The decrease was partially offset by increased compensation expense of $433,000 related to employee stock options, resulting from our adoption of SFAS 123R effective January 1, 2006, increased spending on several other products in development, an increase in R&D staff levels, and increased professional fees primarily related to product portfolio development activities.


	Three months
	ended		Percentage			Three months
	March 31,		Increase			ended March 31,
	2006		(Decrease)			2005
	(in thousands, except percentages)
PW2101	$	—		(100	)%	$	1,326
Nalbuphine ER		305		16	%		262
Torsemide ER		92		109	%		44
Venlafaxine ER		261		27	%		205
Phase I Products and Internal Costs		3,189		15	%		2,776
Research and New Technology Development		497		10	%		452

Total Research and Product Development Expense	$	4,344		(14	)%	$	5,065

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

	•		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 of PW2101, the manufacturing of PW2101, including our development work related to the qualification of an alternative manufacturing site, and the preparation of the NDA for PW2101. These expenses approximated 26% of our research and development expenses for the three month period ended March 31, 2005. We received a nonapprovable letter on this drug in 2005, and we discontinued development work on PW2101 in the second quarter of 2005. We do not expect to incur additional research and development expenses with respect to PW2101 in future periods.

	•		Nalbuphine ER— These expenses reflect our direct external expenses relating to the development of nalbuphine ER. These expenses consist primarily of payments to third parties in connection with clinical trials of nalbuphine ER and approximated 7% and 5% of our research and development expenses in the three month periods ended March 31, 2006 and 2005, respectively. The expenses for this compound have increased in the 2006 period from the 2005 period, as we have advanced the drug from Phase I through Phase IIa clinical trials. During the remainder of 2006, we expect our research and product development expenses relating to nalbuphine ER to increase as we manufacture clinical supplies, and conduct animal toxicology work and additional Phase I studies.

	•		Torsemide ER— These expenses reflect our direct external expenses relating to the development of torsemide ER. These expenses consist primarily of payments to third parties in connection with clinical trials of torsemide ER and approximated 2% and 1% of our research and development expenses in the three month periods ended March 31, 2006 and 2005, respectively. The expenses for this compound increased in the 2006 period from the 2005 period, as the drug has advanced from Phase I into Phase IIa clinical trials. During 2006, we expect to determine whether to continue development of this product on our own or whether to seek a collaborator to complete the development work. If we continue development of torsemide ER on our own, we expect our research and product development expenses relating to toresemide ER to increase as we manufacture registration batches and commence the pivotal trial.

	•		Venlafaxine ER— These expenses reflect our direct external expenses relating to the development of venlafaxine ER. These expenses consist primarily of payments to third parties in connection with the manufacture of venlafaxine ER, including the costs of the active drug and approximated 6% and 4% of our research and development expenses in the three month periods ended March 31, 2006 and 2005, respectively. The expenses for this compound have increased in the 2006 period from the 2005 period, as the drug has advanced from Phase I clinical trials into full clinical development. During the remainder of 2006, we expect our research and product development expenses relating to venlafaxine ER to increase as we complete the manufacturing of registration batches and conduct the pivotal studies, which we believe will consist of three additional Phase I studies. We are currently seeking a marketing collaborator for this product.

	•		Phase I Products and Internal Costs— These expenses primarily reflect our expenses such as salaries and benefits of our product development personnel, including our formulation, clinical and regulatory groups, and other costs primarily related to our laboratory facilities that are not allocated to specific programs. These expenses also reflect both our direct external expenses and our allocated internal expenses relating to the development of Phase I product candidates. Our direct external expenses primarily reflect payments to third parties for the drug active and proof-of-principle biostudies conducted on our Phase I products. These costs increased in the three month period ended March 31, 2006 over the comparable period in 2005, primarily as a result of the recording of $433,000 in compensation expense related to employee stock options, resulting from our adoption of SFAS 123R effective January 1, 2006. We continually evaluate the Phase I product candidates we are developing, and may terminate or accelerate development of product candidates based on study results, product development risk, commercial opportunity, perceived time to market and other factors.

	•		Research and New Technology Development— These expenses reflect both our direct external expenses and our allocated 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 of our research and new technology development group, and other costs such as depreciation on purchased equipment, and the amortization or any write-downs of patent costs, other than product patent write-offs charged directly to a product development project. These expenses increased in the three month period ended March 31, 2006 over the comparable period in 2005, primarily due to legal expenses and amortization associated with our intellectual property.

There can be no assurance that any of our products will advance through the clinical development process and 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 process and the uncertainties involved in obtaining governmental approval for commercialization, accurate and meaningful estimates of the ultimate cost to bring our product candidates to market are not available.

Tax Rates

The effective tax rates for the three month periods ended March 31, 2006 and 2005 were zero. The effective tax rates are higher than the federal statutory rate of a 34% benefit primarily due to valuation allowances recorded to offset deferred tax assets relating to our net operating losses.

Share-Based Compensation

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, “Share-Based Payment”, which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. SFAS 123R supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and amends SFAS No. 95, “Statement of Cash Flows”. The approach to quantifying stock-based compensation expense in SFAS 123R is similar to SFAS 123. However, the revised statement requires all share-based payments to employees, including grants of employee stock options as well as compensatory employee stock purchase plans, to be recognized as an expense in the statement of operations based on their fair values as they are earned by the employees under the vesting terms. Pro forma disclosure of stock-based compensation expense, as was our practice under SFAS 123, is no longer permitted. We adopted SFAS 123R effective beginning January 1, 2006 using the modified prospective transition method. The effect of our adoption of SFAS 123R was an additional $1.1 million of compensation expense, or approximately $.05 per share, basic and diluted, substantially all related to employee stock options. Of such amount, $628,000 and $433,000 were recorded to selling, general and administrative expense, and research and product development expense, respectively. As of March 31, 2006, there was approximately $5.7 million of unrecognized compensation cost related to stock option awards that we expect to recognize over a weighted average period of 1.2 years.

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, sales of excipients, sales of formulated bulk TIMERx, royalties and milestone payments from Mylan and other collaborators, and advances under credit facilities. As of March 31, 2006, we had cash, cash equivalents and short-term investments of $57.7 million. We have no committed sources of capital.

We are a party to an agreement with Endo with respect to the development and commercialization of oxymorphone ER. On April 17, 2003, we discontinued our participation in the funding of the development and pre-launch marketing of oxymorphone ER. We did not incur any expenses relating to oxymorphone ER in the three month periods ended March 31, 2006 and 2005, and do not expect to incur any significant expenses relating to oxymorphone ER in 2006 unless we resume our participation in the funding of the development and marketing of oxymorphone ER. 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, through a temporary adjustment in the royalty rate payable to us that will return to its pre-adjustment level once Endo has recovered such unfunded development and marketing costs. Endo may also allow us to reimburse Endo directly for these unfunded amounts and, as a result, to receive the full royalty rate from Endo without adjustment. We estimate that through December 31, 2005, these unfunded costs approximated $23.0 million. We expect this unfunded amount to increase as Endo incurs pre-launch marketing costs.

Cash Flows

We had negative cash flow from operations for the three months ended March 31, 2006 of $4.1 million, primarily due to a net loss of $6.3 million in the period, which included depreciation and amortization of $391,000 and non-cash charges totaling $1.5 million relating to stock-based compensation. Investing activities provided $7.5 million in cash for the three months ended March 31, 2006, primarily reflecting sales and maturities of marketable securities, net of purchases, of $7.7 million. Net cash provided by investing activities also reflected funds expended for the acquisition of laboratory equipment for drug development activities, and funds expended to secure patents on technology developed by us. Financing activities provided $6.7 million in cash from the proceeds of stock option exercises during the three months ended March 31, 2006.

Funding Requirements

We anticipate that, based on our current operating plan, and excluding any potential revenues from oxymorphone ER, and excluding any reimbursement to Endo for unfunded oxymorphone ER costs and the continued funding of our share of pre launch costs thereafter, our existing capital resources and anticipated internally generated funds from royalties from Mylan will be sufficient to fund our operations on an ongoing basis without requiring us to seek external financing through 2007. We expect our investment in capital expenditures for the remainder of 2006 to increase from the first quarter of 2006 level to approximately $1.5 million for the year, primarily for laboratory equipment for our drug development activities. In 2006, we expect capital spending for patents to approximate 2005 levels or approximately $400,000.

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;

	•		the costs and timing of adding product candidates or technologies;

	•		whether we resume our participation in the funding of the development and marketing of oxymorphone ER;

	•		the timing and amount of payments received under collaborative agreements, including in particular with respect to oxymorphone ER;

	•		the structure and terms 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;

	•		royalties received from Mylan;

	•		the prosecution, defense and enforcement of potential patent claims and other intellectual property rights; and

	•		the level of capital expenditures.

If we determine to resume our participation in the funding of oxymorphone ER, or to acquire additional product candidates or technologies, we may need to seek additional funding through collaborative agreements or research and development arrangements, or through public or private financings of equity or debt securities.

We plan to meet our long-term cash requirements through our existing cash balance, revenues from collaborative agreements, as well as through financings. In July 2005, we filed a registration statement on Form S-3 with the SEC, which became effective on August 17, 2005. This shelf registration statement covers the issuance and sale by us, of any combination of common stock, preferred stock, debt securities and warrants having an aggregate purchase price of up to $75 million.

If we raise additional funds by issuing equity securities, further dilution to our then-existing shareholders may result. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. Any debt or equity financing may contain terms, such as liquidation and other preferences, that are not favorable to us or our shareholders. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish valuable rights to our technologies, research programs or potential product, or grant licenses on terms that may not be favorable to us. We cannot be certain that additional 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, purchase obligations primarily relating to clinical development and obligations under deferred compensation plans as discussed below. Following is a table summarizing our contractual obligations as of March 31, 2006 (in thousands).

Deferred compensation, including current portion reflects the commitments described below:


			Less than		1-3		4-5		After 5
	Total		One Year		Years		Years		Years
Operating Leases	$	1,087	$	680	$	407	$	—	$	—
Purchase Obligations		1,285		1,285		—		—		—
Deferred Compensation, including current portion		3,278		294		588		588		1,808

Total	$	5,650	$	2,259	$	995	$	588	$	1,808

	•		We have a Supplemental Executive Retirement Plan, or SERP, a nonqualified plan which covers our former Chairman and Chief Executive Officer, Tod R. Hamachek. Under the SERP, effective in May 2005, we became obligated to pay Mr. Hamachek approximately $12,600 per month over the lives of Mr. Hamachek and his spouse.

	•		We also have a Deferred Compensation Plan, or DCP, a nonqualified plan which covers Mr. Hamachek. Under the DCP, effective in May 2005, we became obligated to pay Mr. Hamachek approximately $140,000 per year, including interest, in ten annual installments; however, these installments are recalculated annually based on market interest rates as provided for under the DCP.

We do not fund these liabilities, and no assets are held by the plans. However, we have two whole-life insurance policies in a rabbi trust, the cash surrender value or death benefits of which are held in trust for the SERP and DCP liabilities. During 2006, we expect to begin drawing down against the cash surrender values of these policies to fund these liabilities as provided by the terms of the trust. The cash surrender value of these polices totaled $3.2 million as of March 31, 2006.

Net Operating Loss Carryforwards

We estimate that as of March 31, 2006, we had federal net operating loss, or NOL, carryforwards of approximately $133 million for income tax purposes, which expire beginning in 2018 through 2026. The use of the NOLs are limited to our future taxable earnings. Utilization of the operating losses is subject to limitation due to the ownership change provisions of the Internal Revenue Code.

Item 3.Quantitative and Qualitative Disclosures About Market Risk

Market Risk and Risk Management Policies

Market risk is the risk of loss to future earnings, to fair values or to future cash flows that may result from changes in the price of a financial instrument. The value of a financial instrument may change as a result of changes in interest rates, foreign currency exchange rates and other market changes. Market risk is attributed to all market sensitive financial instruments, including debt instruments. 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.

The primary objectives for our investment portfolio are liquidity and safety of principal. Investments are made to achieve the highest rate of return, 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 certain restrictions on maturities and concentration by issuer.

At March 31, 2006, marketable securities consisted primarily of corporate debt and U.S. Government-agency backed discounted notes, and approximated $31.7 million. Our marketable securities had maturity dates of up to thirteen months. Due to the relatively short-term maturities of these securities, management believes there is no significant market risk. At March 31, 2006, market values approximated carrying values. At March 31, 2006 we had approximately $57.7 million in cash, cash equivalents and short-term investments, 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 $577,000.

Item 4.Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures.Our management, with the participation of Jennifer L. Good, in her capacities as our principal executive officer and principle financial officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2006. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2006, Ms. Good, our principal executive officer and principal financial officer, concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

(b) Changes in Internal Control Over Financial Reporting.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 March 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1A. Risk Factors

Investing in our common stock involves a high degree of risk, and you should carefully consider the risks and uncertainties described below in addition to the other information included or incorporated by reference in this quarterly report. If any of the following risks actually occurs, our business, financial condition or results of operations would likely suffer, possibly materially. In that case, the trading price of our common stock could fall.

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

We have incurred net losses since 1994, including net losses of $22.9 million, $23.8 million and $15.9 million during 2005, 2004 and 2003, respectively. We had losses from continuing operations of $22.9 million, $23.8 million and $26.0 million in 2005, 2004 and 2003, respectively. For the three months ended March 31, 2006, our net loss was $6.3 million. As of March 31, 2006, our accumulated deficit was approximately $147.4 million.

Our strategy includes a significant commitment to spending on research and development targeted at identifying and developing products that can be formulated using drug delivery technologies. As a result, we expect to continue to incur net losses as we continue to conduct development of, and seek regulatory approvals for, products utilizing drug delivery technologies, until substantial sales of products commercialized utilizing drug delivery technologies occur. These net losses have had and will continue to have an adverse effect on, among other things, our shareholders’ equity, total assets and working capital.

Our future profitability will depend on several factors, including:

	•		the successful commercialization of oxymorphone ER;

	•		royalties from Mylan’s sale of Pfizer’s 30 mg generic version of Procardia XL;

	•		the level of our investment in research and development activities; and

	•		the successful development and commercialization of product candidates other than oxymorphone ER.

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

As of March 31, 2006, we had cash, cash equivalents and short-term investments of $57.7 million. We anticipate that, based on our current operating plan and excluding any potential revenues from oxymorphone ER, our existing capital resources and anticipated funds from royalties from Mylan will be sufficient to fund our operations on an ongoing basis without requiring us to seek external financing through 2007.

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;

	•		the costs and timing of adding additional products or technologies;

	•		whether we resume our participation in the funding of the development and marketing of oxymorphone ER;

	•		the timing and amount of payments received under collaborative agreements, including in particular with respect to oxymorphone ER;

	•		the structure and terms of any future collaborative or development agreements;

	•		the progress of our collaborative and internal development projects, funding obligations with respect to the projects, and the related costs to us of clinical studies for our product candidates;

	•		royalties received from Mylan;

	•		the prosecution, defense and enforcement of potential patent claims and other intellectual property rights; and

	•		the level of our investments in capital expenditures.

Subject to these factors, we may need to sell additional equity or debt securities or seek additional financing through other arrangements to fund operations beyond 2007. In addition, if we determine to resume our participation in the funding of oxymorphone ER or to acquire additional products or technologies, we may need to seek additional funding for such actions through collaborative agreements or research and development arrangements, or through public or private financing.

If we raise additional funds by issuing equity securities, further dilution to our then-existing shareholders will result. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. Any debt or equity financing may contain terms, such as liquidation and other preferences, that are not favorable to us or our shareholders. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish valuable rights to our technologies, research programs or potential product or grant licenses on terms that may not be favorable to us. Additional financing may not 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.

We depend heavily on the success of our lead product candidate, oxymorphone ER, and 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 have invested a significant portion of our financial resources in the development of oxymorphone ER. We anticipate that in the near term our ability to generate significant revenues will depend primarily on the successful development and commercialization of oxymorphone ER. Although we have several other products under development, they are at an earlier stage of development. We are developing oxymorphone ER under a collaboration agreement with Endo. Endo, which is responsible for conducting the clinical trials and seeking regulatory approval of the product, submitted an NDA for oxymorphone ER to the FDA in December 2002. In October 2003, Endo received 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. In discussions with Endo, the FDA advised Endo of its concern that the outcome of two of the Phase III efficacy trials submitted in the NDA that met their predefined primary end-points may have been favorably biased by the statistical handling of data from patients who did not complete the trials. In August 2005 and October 2005, Endo reported the results of two additional studies that were designed to provide the additional safety and efficacy data requested by the FDA. These trials were conducted to evaluate oxymorphone ER in two distinct groups of patients with chronic low back pain: opioid-naïve patients and opioid experienced patients. In December 2005, Endo submitted a response to the FDA’s approvable letter on Endo’s NDA for oxymorphone ER. This submission was accepted for filing as a complete response by the FDA in January 2006. Under PDUFA guidelines, the FDA confirmed to Endo a six-month PDUFA date of June 22, 2006, which is the date by which we expect Endo to receive an action letter from the FDA on this filing. 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.

If oxymorphone ER or one of our other product candidates is approved by the FDA, it may not be widely accepted by physicians, patients, third-party payors, or the medical community in general

Even if oxymorphone ER is approved by the FDA, its commercial success will depend upon its acceptance by the medical community. We cannot be sure that oxymorphone ER will be accepted by purchasers in the pharmaceutical market. Oxymorphone ER will compete with a number of approved drugs manufactured and marketed by major pharmaceutical companies, generic versions of these drugs and potentially against new drugs that

are not yet marketed. The degree of market acceptance of oxymorphone ER depends on a number of factors, including:

	•		the safety and efficacy of oxymorphone ER as compared to competitive products;

	•		the advantages and disadvantages of oxymorphone ER compared to alternative therapies;

	•		Endo’s ability to educate the medical community about the safety and effectiveness of oxymorphone ER;

	•		the strength of marketing distribution support;

	•		Endo’s ability to manufacture and maintain suitable inventory for sale on an ongoing basis;

	•		the cost-effectiveness of the product and the ability to receive third party reimbursement;

	•		the reimbursement policies of government and third party payors; and

	•		the market price of oxymorphone ER.

If we are able to obtain regulatory approval of any of our other product candidates, the success of those products would also depend upon their acceptance by physicians, patients, third-party payors, or the medical community in general. No product based on our drug delivery technologies is marketed in the United States, so there can be no assurance as to market acceptance.

We are dependent on our collaborator Endo to conduct clinical trials of, obtain regulatory approvals for, and manufacture, market, and sell oxymorphone ER, and are, and in the future expect to be, dependent on other collaborators with respect to manufacturing, marketing, and selling additional products

Some of our products, including oxymorphone ER, have been or are being developed and commercialized in collaboration with pharmaceutical companies. Under these collaborations, we have typically been 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 drug delivery technologies. For example, 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.

We have no experience in manufacturing, marketing and selling pharmaceutical products. Accordingly, if we cannot maintain our existing collaborations or establish new collaborations with respect to our other products in development, we will have to establish our own capabilities or discontinue the commercialization of the affected product. Developing our own capabilities would be expensive and time consuming and could delay the commercialization of the affected product. There can be no assurance that we would be successful in developing these capabilities.

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 any of our collaborations are terminated, we may be required to devote additional resources to the product, seek a new collaborator on short notice or abandon the product. The terms of any additional collaborations or other arrangements that we establish may not be favorable to us.

We are also at risk that these collaborations or other arrangements may not be 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 to the product on which we are collaborating, which could affect our collaborator’s commitment to our collaboration.

	•		Our collaborators may reduce marketing or sales efforts, or discontinue marketing or sales of our products. This would reduce our revenues received on the products.

	•		Our collaborators may terminate their collaborations with us. This could make it difficult for us to attract new collaborators or adversely affect perception of us in the business and financial communities.

	•		Our collaborators may pursue higher priority programs or change the focus of their development programs, which could affect the collaborator’s commitment to us. Pharmaceutical and biotechnology companies historically have re-evaluated their priorities from time to time, including following mergers and consolidations, which have been common in recent years in these industries.

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:

	•		significantly greater financial, technical and human resources than we have and may be better equipped to develop, manufacture and commercialize products;

	•		more extensive experience than we have in conducting preclinical studies and clinical trials, obtaining regulatory approvals and manufacturing and marketing pharmaceutical products;

	•		competing products that have already received regulatory approval or are in late-stage development; and

	•		collaborative arrangements in our target markets with leading companies and research institutions.

We face competition based on the safety and effectiveness of our products, the timing and scope of regulatory approvals, the availability and cost of supply, marketing and sales capabilities, reimbursement coverage, price, patent position and other factors. Our competitors may develop or commercialize more effective, safer or more affordable products, or obtain more effective patent protection, than we are able to develop or commercialize. Accordingly, our competitors may commercialize products more rapidly or effectively than we do, which would adversely affect our competitive position, the likelihood that our product will achieve initial market acceptance and our ability to generate meaningful revenues from our products. Even if our products achieve initial market acceptance, competitive products may render our products obsolete or noncompetitive. If our products are rendered obsolete, we may not be able to recover the expenses of developing and commercializing those products.

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 KV Pharmaceutical Company, traditional matrix systems marketed by SkyePharma plc and other controlled release technologies marketed or under development by Andrx Corporation, among others.

Our products in development will face competition from products with the same indication as the products we are developing. For instance, we expect oxymorphone ER, if approved, would compete in the moderate to severe long acting opioid market with products such as Purdue Pharma’s OxyContin and MS Contin, Johnson & Johnson’s Duragesic patch, generic competitors to OxyContin, Duragesic and MS Contin, Ligand’s Avinza and Alpharma’s Kadian.

Some of the products we are developing are proprietary products that are based on active chemical ingredients that are not subject to patents. These products will compete against other products developed using the same or a similar active chemical ingredient, including branded products, as well as any generic versions of these products, based primarily on price. In addition, our products will compete against other competitive products in the therapeutic class. For instance, torsemide ER is a product based on an active chemical ingredient that is no longer

subject to patents. Torsemide ER will compete against Demadex, which is an immediate release version of torsemide, as well as Lasix, which is an immediate release version of furosemide, which is a similar chemical active to torsemide.

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 products, we or our collaborators will be required to complete clinical trials in humans to demonstrate the safety and efficacy of the products. However, we may not be able to commence or complete these clinical trials in any specified time period, or at all, either because the FDA or other regulatory agencies object, or for other reasons. With respect to our approved products and oxymorphone ER, we have relied on our collaborators to conduct clinical trials and obtain regulatory approvals for our products. In the future we intend to develop a significant portion of our product candidates independently, including controlling the clinical trials and regulatory submissions with the FDA. We have limited experience conducting clinical trials and to date have not obtained approval for the marketing of a product.

Even if we complete a clinical trial of one of our potential products, the clinical trial may not indicate that our product is safe or effective to the extent required by the FDA, the European Commission, or other regulatory agencies to approve the product, and we or our collaborators may decide, or regulators may require us or our collaborators, to conduct additional clinical trials. For example, in response to the approvable letter for oxymorphone ER, the FDA required Endo to conduct an additional clinical trial of oxymorphone ER. In addition, we terminated the development of PW2101, a beta blocker that we were developing that was intended for the treatment of hypertension and angina, because we believed that if we had chosen to continue development of PW2101 we would have been required to conduct additional trials in order to address the concerns expressed in the non-approvable letter we received from the FDA in 2005. Alternatively, regulators may require post marketing testing and surveillance to monitor the safety and efficacy of a product.

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.

If clinical trials do not show any potential product to be safe or efficacious, if we are required to conduct additional clinical trials or other testing of our products in development beyond those that we currently contemplate or if we are unable to successfully complete our clinical trials or other testing, we may:

	•		be delayed in obtaining marketing approval for our products;

	•		not be able to obtain marketing approval for our products; or

	•		obtain approval for indications that are not as broad as intended.

Our product development costs may also increase if we experience delays in testing or approvals. In addition, significant clinical trial delays also could allow our competitors to bring products to market before we do and impair our ability to commercialize our products.

Our drug delivery technologies rely on the ability to control the release of the active drug ingredient and our business would be harmed if it was determined that there were circumstances under which the active ingredient from one of our extended release products would be released rapidly into the blood stream

Our products and product candidates rely on our ability to control the release of the active drug ingredient. Some of the active ingredients in our controlled release products, including oxymorphone ER, contain levels of active drug ingredient that could be harmful, even fatal, if the full dose of active drug ingredient were to be released over a short period of time, which is referred to as dose-dumping.

On July 13, 2005, Purdue Pharma voluntarily withdrew its product Palladone, hydromorphone hydrochloride extended-release capsules, from the market after acquiring new information that serious and potentially fatal adverse reactions can occur when the product is taken together with alcohol. The data, gathered from a study testing the potential effects of alcohol use, showed that when Palladone is taken with alcohol, the extended-release mechanism is harmed, which can lead to dose-dumping. In order to anticipate questions from the FDA with respect to the potential dose-dumping effect of opioids given the FDA’s experience with Palladone, Endo has conducted bothin vitroand human testing of the effect of alcohol on oxymorphone ER. In thein vitrotesting of alcohol and oxymorphone ER, Endo did not find any effect on the time release mechanism of the product. In the human testing of alcohol and oxymorphone ER, Endo does not believe that there was evidence of dose-dumping or signs of degradation of the controlled-release mechanism. Endo did note in this human testing a transient effect on blood levels which Endo believes reflects a short-lived increase in the absorption rate of oxymorphone already released from the tablet.

However, there is no certainty that the FDA will accept any of the above studies or what, if any, additional information the FDA will require regarding dose-dumping in connection with its review of the complete response letter. The FDA has not provided clear guidance as to whether or what type ofin vitroand/or human testing of new extended-release opioid formulations may be required to determine whether dose-dumping occurs when a product is taken together with alcohol, nor has the FDA indicated what action they might take based on any results from testing. The FDA has also not indicated what action it might take based on any results arising from this testing. There can be no assurance that the FDA will approve oxymorphone ER or if the FDA will require significant additional testing which could result in a substantial delay in launching these products, if at all. If such testing is conducted, we cannot predict what actions, if any, the FDA may take based on the results of such testing.

We are subject to extensive government regulation including the requirement of approval before our products may be marketed. Even if we obtain marketing approval, our products will be subject to ongoing regulatory review

We, our collaborators, our products, and our product candidates are subject to extensive regulation by governmental authorities in the United States and other countries. Failure to comply with applicable requirements could result in warning letters; fines and other civil penalties; delays in approving or refusal to approve a product candidate; product recall or seizure; withdrawal of product approvals; interruption of manufacturing or clinical trials; operating restrictions; injunctions; and criminal prosecution.

Our products cannot be marketed in the United States without FDA approval. Obtaining FDA approval requires substantial time, effort, and financial resources, and there can be no assurance that any approval will be granted on a timely basis, if at all. We have had only limited experience in preparing applications and obtaining regulatory approvals. If the FDA does not approve our product candidates in a timely fashion, or does not approve them at all, our business and financial condition may be adversely affected. 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 our or our collaborator’s products.

Certain products containing our controlled release technologies require the submission 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 drugs, we may be able to rely on previous FDA determinations of safety and efficacy of an approved drug to support an NDA for our products under section 505(b)(2) of the FDCA. We can provide no assurance, however, that the FDA will accept a section 505(b)(2) NDA for any particular product. The FDA may not approve an application submitted under section 505(b)(2) in a timely manner, or at all.

In addition, both before and after regulatory approval, we, our collaborators, our products, and our product candidates are subject to numerous FDA requirements covering testing, manufacturing, quality control, cGMP, adverse event reporting, labeling, advertising, promotion, distribution, and export. We and our collaborators are subject to surveillance and periodic inspections to ascertain compliance with these regulations. Further, the relevant law and regulations may change in ways that could affect us, our collaborators, our products, and our product candidates. Failure to comply with regulatory requirements could have a material adverse impact on our business.

Oxymorphone ER contains a narcotic ingredient. As a result of reports of misuse or abuse of prescription narcotics, the sale of oxymorphone ER may be subject to new regulations, including the development and implementation of risk management programs which may prove difficult or expensive to comply with, and we and Endo may face lawsuits

Oxymorphone ER contains a narcotic ingredient. Misuse or abuse of such drugs can lead to physical or other harm. Specifically, in the past few years, reportedly widespread misuse or abuse of OxyContin, a product containing the narcotic oxycodone, resulted in the strengthening of warnings on its labeling, and in the sponsor of OxyContin facing numerous lawsuits, including class action lawsuits, related to OxyContin misuse or abuse. Misuse or abuse of oxymorphone ER could lead to additional regulations of oxymorphone ER, or subject us and Endo to litigation.

Our controlled release products that are generic versions of approved products that are covered by one or more patents may be subject to litigation, which could delay FDA approval and commercial launch of our products

We expect to submit, or have our collaborators submit, ANDAs or NDAs for products of ours that may be covered by one or more patents of the approved product. It is likely that the owners of patents covering the same active ingredient as our product or the sponsors of the NDA for the product containing the same ingredient will sue or undertake regulatory initiatives to preserve marketing exclusivity, as Pfizer did with respect to our generic version of Procardia XL that we developed with Mylan. Any significant delay in obtaining FDA approval to market our products 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.

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 research, development and commercialization activities, as well as any products in development or products resulting from these activities, may infringe or be claimed to infringe patents or patent applications of competitors or other third parties. In such event, we or our collaborators may choose or may be required to seek a license from a third party and to pay license fees or royalties or both under such license. These licenses may not be available on acceptable terms, or at all. Even if we or our collaborators were able to obtain a license, the rights may be nonexclusive, which could result in our competitors gaining access to the same intellectual property. If we or our collaborators are not able to obtain a license, we could be prevented from commercializing a product, or be forced to cease some aspect of our business operations.

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 damages 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 we expect that the legal costs of defending litigation relating to a patent infringement claim will generally be the contractual responsibility of our marketing 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.

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. We currently rely on Draxis Specialty Pharmaceuticals, Inc. for the bulk manufacture of our TIMERx material under a contract that expires in September 2007, and on other third party manufacturers for the products that we are currently developing other than oxymorphone ER. The agreement with Draxis, by its terms is 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 are currently in discussions with Draxis to secure a longer-term manufacturing and supply agreement. We are not a party to any agreements with our third party manufacturers for the products that we are currently evaluating in clinical trials, except for purchase orders or similar arrangements.

We believe that there are a limited number of manufacturers subject to 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, and have done the initial work on a second supplier of TIMERx, if Draxis is unable to manufacture the TIMERx material in the required quantities, on a timely basis or at all, or if Draxis will not agree to renew our agreement when it expires on acceptable terms to us or at all, we may be unable to obtain alternative contract manufacturing, or obtain such manufacturing on commercially reasonable terms. In addition, if we are unable to enter into longer-term manufacturing arrangements for our products on acceptable terms to us or at all, particularly as these products advance through clinical development and move closer to regulatory approval, our business and the clinical development and commercialization of our products could be materially adversely effected. There can be no assurance that Draxis or any other third parties

upon which we rely for supply of our TIMERx material or our products in clinical development 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, require us or our collaborators to cease distribution or recall some or all batches of our products 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:

	•		we or our collaborators may not be able to meet commercial demands for our products on a timely basis;

	•		we may not be able to initiate or continue clinical trials of products that are under development; and

	•		we may be delayed in submitting applications for regulatory approvals of our products.

We have limited experience in manufacturing the material used in our drug delivery technologies 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 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, gastroretentive, 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 products, we 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.

Any generic versions of products that we are developing may be assigned an AB rating if the FDA considers the product to be therapeutically equivalent to the approved 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 United States and certain foreign jurisdictions, there have been a number of legislative and regulatory proposals to change the health care system. Further proposals are likely. The potential for adoption of these proposals may affect our ability to raise capital, obtain additional collaborative partners and market our products.

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

additional legislative proposals. We may not be able to sell our products profitably if access to managed care or government formularies is restricted or denied, or 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 amounts of $15 million per occurrence and $15 million annually in the aggregate on a claims-made basis, and by excess product liability insurance in the amount of $10 million. 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 our 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 6.Exhibits

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

SIGNATURE

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


		PENWEST PHARMACEUTICALS CO.

Date: May 8, 2006		/s/ Jennifer L. Good

		Jennifer L. Good
		President and Chief Operating Officer
		(Principal Financial Officer)

EXHIBIT INDEX


Exhibit
Number		Description
31		Certification of Principal Executive Officer and Principal Financial Officer pursuant to Exchange Act Rules 13a-14 or 15d-14, as adopted pursuant to Section 302 of Sarbanes-Oxley Act of 2002.

32		Certification of Principal Executive Officer and Principal Financial Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Avg

Penwest Pharmaceuticals (PPCO) Inactive 10-Q2006 Q1 Quarterly report

Content analysis

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents