10-Q

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 June 30, 2008

OR

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

For the transition period from                    to

Commission File Number 000-23467

PENWEST PHARMACEUTICALS CO.

(Exact name of registrant as specified in its charter)

Washington (State or other jurisdiction of incorporation or organization)	91-1513032 (I.R.S. Employer Identification No.)
39 Old Ridgebury Road Suite 11 Danbury, Connecticut (Address of Principal Executive Offices)	06810-5120 (Zip Code)

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

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

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

Large accelerated filer o Accelerated filer þ  Non-accelerated filer o
(Do not check if a smaller reporting company) Smaller reporting company o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of August 4, 2008.

Class	Outstanding
Common Stock, par value $.001	31,654,967

PENWEST PHARMACEUTICALS CO.
TABLE OF CONTENTS

		Page
PART I — FINANCIAL INFORMATION
Item 1.	Condensed Financial Statements (Unaudited):
	Condensed Balance Sheets		3
	Condensed Statements of Operations		4
	Condensed Statements of Cash Flows		5
	Notes to Condensed Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		27
Item 4.	Controls and Procedures		27
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings		28
Item 1A.	Risk Factors		29
Item 4.	Submission of Matters to a Vote of Security Holders		41
Item 6.	Exhibits		41
Signature			42
Exhibit Index			43
EX-10.1 2005 STOCK INCENTIVE PLAN, AS AMENDED
EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
EX-32.1 SECTION 906 CERTIFICATION OF THE CEO
EX-32.2 SECTION 906 CERTIFICATION OF THE CFO

     TIMERx®, Geminex® and SyncroDose® are our registered trademarks. GastroDose™ is also our trademark. Other tradenames and trademarks appearing in this quarterly report, including Endo Pharmaceuticals Inc.’s Opana® trademark, 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, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts, included or incorporated in this report regarding our strategy, future operations, financial position, future revenues, projected costs, prospects, plans and objectives 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 Securities and Exchange Commission (“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.

2

PART I — FINANCIAL INFORMATION

Item 1. Condensed Financial Statements (Unaudited)

PENWEST PHARMACEUTICALS CO.

CONDENSED BALANCE SHEETS

	June 30,			December 31,
	2008			2007
	(Unaudited)			(Note 2)
	(In thousands,
	except share amounts)
ASSETS
Current assets:
Cash and cash equivalents	$	23,318		$	15,680
Marketable securities		5,359			7,293
Trade accounts receivable		738			781
Inventories:
Raw materials and other		36			37
Finished goods		552			630
Total inventories		588			667
Prepaid expenses and other current assets		834			1,489
Total current assets		30,837			25,910
Fixed assets, net		3,045			3,582
Patents, net		2,541			2,539
Deferred charges		2,389			2,479
Other assets, net		2,303			2,472
Total assets	$	41,115		$	36,982
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	424		$	2,239
Accrued expenses		1,669			1,602
Accrued development costs		973			1,483
Loan payable — current portion		3,944			2,405
Deferred compensation — current portion		290			290
Total current liabilities		7,300			8,019
Loan payable		6,854			9,595
Accrued financing fees		360			360
Deferred revenue		290			183
Deferred compensation		2,458			2,588
Total liabilities		17,262			20,745
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 31,646,899 shares at June 30, 2008 and 23,426,323 shares at December 31, 2007		32			23
Additional paid in capital		247,762			222,927
Accumulated deficit		(224,119	)		(206,893	)
Accumulated other comprehensive income		178			180
Total shareholders’ equity		23,853			16,237
Total liabilities and shareholders’ equity	$	41,115		$	36,982

See accompanying notes to condensed financial statements

3

PENWEST PHARMACEUTICALS CO.

CONDENSED STATEMENTS OF OPERATIONS

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
	(Unaudited)						(Unaudited)
	(In thousands, except						(In thousands, except
	per share data)						per share data)
Revenues:
Royalties and licensing fees	$	670		$	546		$	1,101		$	1,265
Product sales		302			166			530			289
Research and development reimbursements		344			—			424			—
Total revenues		1,316			712			2,055			1,554
Cost of revenues:
Cost of product sales		148			144			246			254
Cost of research and development reimbursements.		360			—			431			—
Total cost of revenues		508			144			677			254
Gross profit		808			568			1,378			1,300
Operating expenses:
Selling, general and administrative		3,071			3,667			7,395			7,388
Research and product development		4,524			6,042			10,909			10,426
Total operating expenses		7,595			9,709			18,304			17,814
Loss from operations		(6,787	)		(9,141	)		(16,926	)		(16,514	)
Investment income		180			530			379			1,019
Interest expense		(321	)		(347	)		(678	)		(417	)
Loss before income tax expense		(6,928	)		(8,958	)		(17,225	)		(15,912	)
Income tax expense		—			—			—			—
Net loss	$	(6,928	)	$	(8,958	)	$	(17,225	)	$	(15,912	)
Net loss per common share	$	(0.22	)	$	(0.39	)	$	(0.61	)	$	(0.69	)
Weighted average shares of common stock outstanding		31,486			23,185			28,299			23,164

See accompanying notes to condensed financial statements

4

PENWEST PHARMACEUTICALS CO.

CONDENSED STATEMENTS OF CASH FLOWS

	Six Months Ended
	June 30,
	2008			2007
	(Unaudited)
	(In thousands)
Operating activities:
Net loss	$	(17,225	)	$	(15,912	)
Adjustments to reconcile net loss to net cash used in operating activities		2,169			619
Net cash used in operating activities		(15,056	)		(15,293	)
Investing activities:
Acquisitions of fixed assets, net		(31	)		(399	)
Patent costs		(201	)		(141	)
Proceeds from maturities of marketable securities		9,800			25,304
Purchases of marketable securities		(7,859	)		(17,403	)
Loan disbursed to collaborator		(1,000	)		—
Net cash provided by investing activities		709			7,361
Financing activities:
Proceeds from loan payable		—			12,000
Repayment of debt		(1,202	)		—
Debt issuance costs		—			(112	)
Issuance of common stock, net		23,187			849
Net cash provided by financing activities		21,985			12,737
Net increase in cash and cash equivalents		7,638			4,805
Cash and cash equivalents at beginning of period		15,680			16,182
Cash and cash equivalents at end of period	$	23,318		$	20,987

See accompanying notes to condensed financial statements

5

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

1. Business

     Penwest Pharmaceuticals Co. (“Penwest” or the “Company”) is a drug development company dedicated to bringing to the marketplace innovative products that help improve the lives of patients. The Company’s goal is to identify, develop and commercialize products that address unmet medical needs, primarily for disorders of the nervous system. The Company is currently applying its drug development and drug delivery expertise to a pipeline of potential products that are in various stages of development, and which it intends to commercialize independently or through third party alliances.

     On June 22, 2006, the United States Food and Drug Administration (“FDA”) approved Opana^® ER. Opana ER, an extended release formulation of oxymorphone hydrochloride, is a product that the Company developed with Endo Pharmaceuticals Inc. (“Endo”) using its proprietary TIMERx^® drug delivery technology. Opana ER is approved 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 and is being marketed by Endo in the United States.

     The Company is currently developing product candidates designed for the treatment of pain, mitochondrial diseases and Parkinson’s disease. The Company is developing nalbuphine ER, a controlled release formulation of nalbuphine hydrochloride, for the treatment of moderate chronic pain. In addition, the Company is developing A0001, a product candidate designed for the treatment of mitochondrial diseases, under a collaboration and license agreement with Edison Pharmaceuticals, Inc. (“Edison”) that the Company entered into in July 2007 (the “Edison Agreement”). Under the Edison Agreement, the Company has agreed to collaborate with Edison on the development of A0001 and up to one additional drug candidate of Edison’s. The Company initially intends to develop A0001 for the treatment of mitochondrial diseases. Finally, the Company has a product candidate in development for the treatment of the symptoms of Parkinson’s disease.

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 charge the Company recorded in the three month period ended March 31, 2008 to selling, general and administrative expense in the amount of $1.0 million to establish a reserve against a loan receivable from Edison (see Note 11). Operating results for the three and six month periods ended June 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. 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, 2007.

     The balance sheet at December 31, 2007 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.

     During the three and six month periods ended June 30, 2008, there were no significant changes in the Company’s significant accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007.

3. Recent Accounting Pronouncements

     In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007 and, as such, the Company adopted the provisions of SFAS 159 as of January 1, 2008. The Company chose not to elect the fair value option to measure its financial assets and liabilities existing at January 1, 2008 that had not been previously carried at fair value, or of financial assets and liabilities it

6

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

transacted in the three and six month periods ended June 30, 2008. Therefore, the adoption of SFAS No. 159 had no effect on the Company’s condensed financial statements. The Company continues to carry its marketable securities at fair value in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, as amended.

     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 provides a common definition of fair value to be applied to existing generally accepted accounting principles (“GAAP”) requiring the use of fair value measures, establishes a framework for measuring fair value and enhances disclosure about fair value measures under other accounting pronouncements, but does not change existing guidance as to whether or not an asset or liability is carried at fair value. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 for all financial assets and liabilities, and any other assets and liabilities that are recognized or disclosed at fair value on a recurring basis. For nonfinancial assets and liabilities, SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2008. The Company’s adoption of the provisions of SFAS No. 157 as of January 1, 2008 did not have a material effect on its results of operations, financial position or cash flows.

     In June 2007, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities” (“EITF No. 07-3”). The consensus reached on EITF No. 07-3, which was ratified by the FASB on June 27, 2007, requires companies that are involved in research and development activities to defer nonrefundable advance payments for future research and development activities, and to recognize those payments as goods and services are delivered. The Company is required to assess on an ongoing basis whether or not the goods or services will be delivered, and to expense the nonrefundable advance payments immediately if it determines that delivery is unlikely. EITF No. 07-3 is effective for fiscal years beginning after December 15, 2007 and, as such, the Company adopted the provisions of EITF No. 07-3 as of January 1, 2008. EITF No. 07-3 is applied prospectively for new contracts entered into on or after the effective date. The Company’s adoption of this pronouncement did not have a material effect on its results of operations, financial position or cash flows.

     In December 2007, the EITF reached a consensus on Issue No. 07-1, “Accounting for Collaborative Arrangements” (“EITF No. 07-1”). The EITF concluded on the definition of a collaborative arrangement, and that revenues and costs incurred with third parties in connection with collaborative arrangements would be presented gross or net based on the criteria in EITF No. 99-19 and other accounting literature. Based on the nature of the arrangement, payments to or from collaborators would be evaluated, and its terms, the nature of the entity’s business, and whether those payments are within the scope of other accounting literature would be presented. Companies are also required to disclose the nature and purpose of collaborative arrangements, along with the accounting policies, and the classification and amounts of significant financial statement amounts related to the arrangements. Activities in the arrangement conducted in a separate legal entity should be accounted for under other accounting literature; however required disclosure under EITF No. 07-1 applies to the entire collaborative agreement. EITF No. 07-1 is effective for fiscal years beginning after December 15, 2008 and is to be applied retrospectively to all periods presented for all collaborative arrangements existing as of the effective date. The Company is in the process of evaluating the effect the adoption of this pronouncement will have on its results of operations, financial position, cash flows and related disclosures.

     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.

4. Other Assets

     Other assets are comprised of the following:

	June 30,			December 31,
	2008			2007
	(unaudited)
	(in thousands)
Assets held in a trust for the Company’s Supplemental Executive Retirement Plan and Deferred Compensation Plan (see Note 9):
Cash surrender value of life insurance policies	$	2,222		$	2,468
Money market account		81			4
		2,303			2,472
Loan receivable from collaborator (see Note 11)		1,000			—
		3,303			2,472
Allowance for loan receivable from collaborator		(1,000	)		—
Other assets, net	$	2,303		$	2,472

7

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

5. Loans Payable

Credit Facility

     On March 13, 2007, the Company entered into a $24.0 million senior secured credit facility (the “Credit Facility”) with Merrill Lynch Capital, a division of Merrill Lynch Business Financial Services Inc., which was acquired by GE Capital in February 2008, and is now known as GE Business Financial Services Inc. The Credit Facility consists of: (i) a $12.0 million term loan advanced upon the closing of the Credit Facility and (ii) a $12.0 million term loan that the Company may access until September 15, 2008, subject to conditions specified in the Credit Facility. Under the Credit Facility, the Company may not access this second amount unless the Company’s market capitalization at the time of the advance request is greater than $250 million and an additional patent relating to Opana ER has been issued and listed in the FDA’s list of Approved Drug Products with Therapeutic Equivalence Evaluations, which is commonly called the Orange Book. On October 2, 2007, an additional patent relating to Opana ER was issued and listed in the Orange Book. As a result, the Company may access the additional $12.0 million at any time prior to September 15, 2008 that the Company’s market capitalization is greater than $250 million. As of August 4, 2008, the Company’s market capitalization was approximately $110 million.

     In connection with the Credit Facility, the Company granted the lender a perfected first priority security interest in all existing and after-acquired assets of the Company, excluding: its intellectual property, which is subject to a negative pledge; royalty payments from Mylan Pharmaceuticals Inc. (“Mylan”) on their sales of Pfizer Inc.’s (“Pfizer”) generic version of Procardia XL 30 mg, if the Company pledges such royalty payments to another lender; up to $3.0 million of equipment which the Company may, at its election, pledge to another lender in connection with an equipment financing facility separate from the Credit Facility; and the assets of the Company’s trust described in Note 9. In addition, the Company is precluded from paying cash dividends to its shareholders during the term of the Credit Facility. Each loan has a term of 42-months from the date of advance with interest-only payments for the first nine months, but in any event, not beyond September 30, 2008; interest plus monthly principal payments equal to 1.67% of the loan amount for the period from the end of the interest-only period through December 2008; and interest plus straight-line amortization payments with respect to the remaining principal balance for the remainder of the term.

     Amounts outstanding under the Credit Facility bear interest at an annual rate of one-month LIBOR at the time of the advance plus 5%. The rate will be fixed for the term of the applicable loan. At the time of final payment of each loan under the Credit Facility, the Company will pay an exit fee of 3.0% of the original principal loan amount. Should any prepayment occur, the Company is also required to pay prepayment penalties of 3.0% of any prepaid amount in the first year, 2.0% of any prepaid amount in the second year and 1% of any prepaid amount thereafter. As of June 30, 2008, the interest rate on the Credit Facility was 10.32% and $10.8 million was outstanding.

     Pursuant to the repayment terms, principal payments on the term loan outstanding commenced in January 2008. As of June 30, 2008, principal payments due on the $10.8 million term loan outstanding under the Credit Facility are as follows:

	(unaudited)
	(in thousands)
Less than one year	$	3,944
One to two years		5,483
Two to three years		1,371
	$	10,798

     The Company accrued an exit fee as noted above of $360,000 in connection with the $12.0 million term loan advanced upon the closing of the Credit Facility. These costs, as well as other debt issuance costs incurred by the Company in securing the Credit Facility, were deferred and are included in deferred charges in the Company’s condensed balance sheets as of June 30, 2008 and December 31, 2007. These costs are being amortized over the term of the loan with such amortization included in interest expense in the Company’s condensed statements of operations.

8

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

6. Fair Value Measurement

     As stated in Note 3. “Recent Accounting Pronouncements”, on January 1, 2008, the Company adopted the methods of fair value as described in SFAS No. 157 to value its financial assets and liabilities. As defined in SFAS No. 157, fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, SFAS No. 157 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value.

Financial assets and liabilities carried at fair value as of June 30, 2008 are classified in the table below in one of the three categories described above:

	Level 1		Level 2		Level 3		Total
	(unaudited) (in thousands)
Corporate debt securities	$	2,693	$	—	$	—	$	2,693
Government sponsored enterprises		2,666		—		—		2,666
Total	$	5,359	$	—	$	—	$	5,359

     The Company chose not to elect the fair value option as prescribed by SFAS No. 159 for its financial assets and liabilities that had not been previously carried at fair value.

7. Shareholders’ Equity

Private Placement

     On March 11, 2008, the Company sold units representing of an aggregate of 8,140,600 shares of its Common Stock, together with warrants to purchase an aggregate of 4,070,301 shares of its Common Stock, in a private placement, for a total purchase price of approximately $25.1 million. The Company received net proceeds of approximately $23.1 million from this private placement, after deducting the placement agent’s fees and other expenses.

     The warrants are exercisable on or prior to March 11, 2013 at an exercise price of $3.62 per share. The warrants may also be exercised pursuant to cashless exercise provisions under certain circumstances.

     Pursuant to the securities purchase agreement entered into in connection with the private placement, the Company filed a registration statement with the Securities and Exchange Commission (“SEC”) on April 10, 2008, registering for resale the shares and shares issuable under the warrants. The registration statement was declared effective by the SEC on April 28, 2008. The Company has agreed to maintain the registration statement’s effectiveness until the earlier of (i) the later of (A) March 11, 2009, or (B) the twelve month anniversary of the last date on which warrant shares are issued upon exercise of warrants and (ii) the date all of the shares and warrant shares have been resold by the original purchasers.

9

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

Share-Based Compensation

     Total share-based compensation was recognized by the Company as follows:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2008		2007		2008		2007
	(unaudited)
	(in thousands)
Research and product development	$	215	$	198	$	450	$	(84	)
Selling, general and administration		526		927		1,207		1,526
Total stock based compensation	$	741	$	1,125	$	1,657	$	1,442

     The decrease in share-based compensation expense in the three month period ended June 30, 2008 as compared to the three month period ended June 30, 2007 is primarily attributable to lower expense associated with outstanding stock options in the 2008 three month period as compared to the 2007 three month period, primarily as a result of decreases in the price of the Company’s common stock.

     The increase in share-based compensation expense in the six month period ended June 30, 2008 as compared to the six month period ended June 30, 2007 is primarily attributable to higher levels of actual forfeitures of employee stock options recorded in the 2007 six month period as compared to the 2008 six month period.

Rights Agreement

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

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

     On April 18, 2008, the Company amended the Rights Agreement to provide that Perceptive Life Sciences Master Fund Ltd., together with its affiliates and associates (“Perceptive”), will be an Exempted Person under the Rights Agreement until the earlier of the date on which Perceptive beneficially owns more than 24% of the outstanding Common Stock or such date when Perceptive beneficially owns less than 10% of the outstanding Common Stock, at which time Perceptive shall cease to be an Exempted Person.

     On July 27, 2008, the Rights expired in accordance with the Rights Agreement.

8. Income Taxes

     The Company’s effective tax rates for the three and six month periods ended June 30, 2008 and 2007 were zero. The effective tax rates differ from 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.

9. 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, Tod R. Hamachek. Under the SERP, the Company is 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 $2,076,000 and $2,092,000 as of June 30, 2008

10

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

and December 31, 2007, respectively, including the current portion of approximately $147,000 at June 30, 2008, and is included in deferred compensation in the Company’s condensed balance sheets. 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				Six Months Ended
	June 30,				June 30,
	2008		2007		2008		2007
	(unaudited)
	(in thousands)
Interest cost	$	30	$	30	$	59	$	59
Amortization of prior service cost		—		—		1		1
Net periodic benefit cost	$	30	$	30	$	60	$	60

     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 $14,000 and $15,000 for the three month periods ended June 30, 2008 and 2007, respectively, and $30,000 and $32,000 for the six month periods ended June 30, 2008 and 2007, respectively. The liability for the DCP was approximately $672,000 and $786,000 as of June 30, 2008 and December 31, 2007, respectively, including the current portion of approximately $143,000 at June 30, 2008, 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, under the DCP, effective in May 2005, the Company commenced the payment of benefits to Mr. 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 “Trust”), the cash surrender value or death benefits of which are held in trust for the SERP and DCP liabilities. Mr. Hamachek’s SERP and DCP benefit payments are being made directly from the assets in the Trust. The cash surrender value of these life insurance policies totaled $2,222,000 as of June 30, 2008 and $2,468,000 as of December 31, 2007. Trust assets, including $81,000 and $4,000 held in a money market account at June 30, 2008 and December 31, 2007, respectively, are included in other assets in the Company’s condensed balance sheets.

10. Comprehensive Income (Loss)

     Accumulated other comprehensive income consists of the following:

	June 30,		December 31,
	2008		2007
	(unaudited)
	(in thousands)
Unrealized gains on marketable securities	$	4	$	7
Adjustment for funded status of post retirement plan		174		173
Accumulated other comprehensive income	$	178	$	180

     The components of comprehensive loss are as follows:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2008			2007			2008			2007
	(unaudited)						(unaudited)
	(in thousands)						(in thousands)
Net loss	$	(6,928	)	$	(8,958	)	$	(17,225	)	$	(15,912	)
Changes in unrealized net gains and losses on marketable securities		(8	)		—			(3	)		7
Adjustment for funded status of post retirement plan		—			1			1			1
Comprehensive loss	$	(6,936	)	$	(8,957	)	$	(17,227	)	$	(15,904	)

11. Collaboration and Licensing Agreements

     The Company enters into collaborative and licensing agreements with pharmaceutical companies to in-license, develop, manufacture and/or market products that fit within its business strategy. The Company also licenses its proprietary drug delivery technologies to other companies for their use in products outside the Company’s focus areas.

11

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

Endo Pharmaceuticals Inc.

     In September 1997, the Company entered into a strategic alliance agreement with Endo with respect to the development of Opana ER, an extended release formulation of oxymorphone hydrochloride using the Company’s TIMERx technology. This agreement was amended and restated in April 2002, and was further amended in January 2007 and in July 2008, as described below.

     Under the agreement, the Company agreed to supply bulk TIMERx material to Endo, the selling price of which is contractually determined and may be adjusted annually, and Endo agreed to manufacture and market Opana ER in the United States. The Company also agreed with Endo that any development and commercialization of Opana ER outside the United States would be accomplished through licensing to third parties approved by both Endo and the Company, and that the Company and Endo would divide equally any fees, royalties, payments or other revenue received by the parties in connection with such licensing activities. The Company and Endo are currently seeking a collaborator for Europe.

     Under the terms of the agreement:

• Endo has agreed to pay the Company royalties on U.S. sales of Opana ER calculated based on a royalty rate starting at 22% of annual net sales of the product up to $150 million of annual net sales, with the royalty rate then increasing, based on agreed-upon levels of annual net sales achieved, from 25% up to a maximum of 30%.

• No royalty payments will be due to the Company for the first $41 million of royalties that would otherwise have been payable beginning from the time of the product launch in July 2006 (the “Royalty Holiday”). If the Company was not subject to the Royalty Holiday, the Company would have recognized royalties from Endo of approximately $8.1 million and $15.4 million, respectively, for the three and six month periods ended June 30, 2008. Cumulatively, through June 30, 2008, approximately $35.1 million has been applied against the Royalty Holiday. The Company expects to begin to recognize royalties from Endo related to sales of Opana ER in the third quarter of 2008.

• Endo will pay the Company a percentage of any sublicense income it receives and milestone payments of up to $90 million based upon the achievement of agreed-upon annual net sales thresholds.

• The Company’s share of the development costs for Opana ER that it opted out of funding in April 2003 totaled $28 million and will be recouped by Endo through a temporary 50% reduction in royalties. This temporary reduction in royalties will not apply until the threshold for the Royalty Holiday has been met.

     The Company and Endo are currently in litigation with IMPAX Laboratories, Inc. (“IMPAX”) and Actavis South Atlantic LLC (“Actavis”) in connection with their respective Abbreviated New Drug Applications (“ANDAs”) for Opana ER (see Note 12).

     The Company and Endo entered into a Second Amendment to the Amended and Restated Strategic Alliance Agreement with respect to Opana ER, effective July 14, 2008. Under the terms of this amendment, Endo agreed to directly reimburse the Company for costs and expenses incurred by the Company in connection with patent enforcement litigation related to Opana ER. If any of such costs and expenses are not reimbursed to the Company by Endo, the Company may bill Endo for these costs and expenses through adjustments to the pricing of TIMERx material that the Company supplies to Endo for use in Opana ER. In connection with the amendment, in July 2008, Endo reimbursed the Company for such costs and expenses incurred prior to June 30, 2008, totaling approximately $470,000.

12

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

Edison Pharmaceuticals, Inc.

     On July 16, 2007, the Company entered into the Edison Agreement under which the Company and Edison agreed to collaborate on the development of Edison’s lead drug candidate, A0001, and up to one additional Edison drug candidate. The Company initially intends to develop A0001 for the treatment of mitochondrial diseases. A0001 has been granted orphan drug designation by the FDA for treatment of inherited mitochondrial respiratory chain diseases.

     In consideration for the rights granted to the Company under the Edison Agreement, the Company paid Edison an upfront cash payment of $1.0 million upon entering into the Edison Agreement and agreed to loan Edison up to an aggregate principal amount of $1.0 million. The Company also agreed to pay Edison a total of $5.5 million over the initial 18 months of the research period to fund Edison’s discovery and research activities during the period. As of June 30, 2008, the Company had paid $3.8 million of the $5.5 million to Edison. The payments are made in quarterly installments, with the final payment due in January 2009. The Company is also required to make payments to Edison upon the achievement of specified milestones set forth in the Edison Agreement and royalty payments based on net sales of products containing A0001, any other compound as to which the Company has exercised its option, or any replacement compound. In July 2008, a milestone was achieved in connection with the Company commencing dosing in a Phase Ia clinical trial of A0001, which will require a payment to Edison in August 2008.

     On February 5, 2008, the Company loaned Edison $1.0 million pursuant to the loan agreement provisions of the Edison Agreement. The loan bears interest at an annual rate of one month LIBOR at the time of the loan plus 5%, or a total of 8.14%, which rate is fixed for the term of the loan. The loan matures as of the earlier of July 16, 2012 and the occurrence of an event of default, as defined in the Edison Agreement. All accrued and unpaid interest is payable on the maturity date; however, interest accruing on any outstanding loan amount after July 16, 2010 is due and payable monthly in arrears. During the three month period ended March 31, 2008, the Company recorded an impairment charge of $1.0 million to selling, general and administrative expense as a result of its collectability assessment of the loan to Edison. In addition, as a result of the Company’s continuing collectability assessment, the Company is not recognizing any accrued interest income on the loan to Edison. The amount of such accrued interest income not recognized by the Company approximated $21,000 and $33,000, respectively, for the three and six month periods ended June 30, 2008.

Mylan Pharmaceuticals Inc.

     In March 2000, Mylan announced that it had signed a supply and distribution agreement with Pfizer to market generic versions of all three strengths (30 mg, 60 mg, 90 mg) of Pfizer’s generic Procardia XL. In connection with that agreement, Mylan decided not to market Nifedipine XL, a generic version of Procardia XL that the Company had developed in collaboration with Mylan. As a result, Mylan entered into a letter agreement with the Company whereby Mylan agreed to pay Penwest a royalty on all future net sales of Pfizer’s generic version of Procardia XL 30 mg. Mylan’s sales in the United States in 2007 of Pfizer’s generic version of Procardia XL 30 mg totaled approximately $21.3 million. The term of the letter agreement continues until such time as Mylan permanently ceases to market Pfizer’s generic version of Procardia XL 30 mg. In 2007, 2006 and 2005, royalties from Mylan were approximately $2.6 million, $3.1 million and $3.9 million, respectively, or 77%, 89% and 63%, respectively, of the Company’s total revenue. Royalties from Mylan were approximately $537,000 and $542,000 for the three month periods ended June 30, 2008 and 2007, respectively, and approximately $959,000 and $1.3 million for the six month periods ended June 30, 2008 and 2007, respectively.

Drug Delivery Technology Collaborations

     The Company enters into development and licensing agreements with third parties under which the Company develops formulations of third parties’ compounds, utilizing the Company’s TIMERx drug delivery technologies. In connection with these agreements, the Company generally receives nonrefundable up-front payments which are recorded as deferred revenue upon receipt and are recognized as revenue over the respective contractual performance periods. Under these agreements, the Company may also be reimbursed for development costs incurred up to amounts specified in each agreement. Additionally, under these agreements, the Company may receive milestone payments upon the achievement of specified events. Finally, these agreements may provide for the Company to receive payments from the sale of bulk TIMERx material and royalties on product sales upon

13

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

commercialization of the product. The Company is a party to two such drug delivery technology collaborations, including a development and licensing agreement with Cobalt Laboratories Inc., which was entered into during the three month period ended June 30, 2008.

12. 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 involving the Company could cause the Company to pay substantial damages, alter its products or processes, obtain additional licenses and/or cease certain activities. Even if the outcome is favorable to the Company, the Company could incur substantial litigation costs.

Impax ANDA Litigation

     On October 3, 2007, the Company received a letter from IMPAX notifying the Company of its filing of an ANDA containing a Paragraph IV certification under 21 U.S.C. § 355(j) for Opana ER in four strengths, 5 mg, 10 mg, 20 mg and 40 mg. This Paragraph IV certification notice referred to the Company’s patent, U.S. Patent No. 7,276,250, which covers the formulation of Opana ER and was listed in the Orange Book as of October 2, 2007. On October 4, 2007, IMPAX announced in a press release that the FDA had rescinded the acceptance of IMPAX’s ANDA filing. On November 5, 2007, the Company received a letter from IMPAX notifying it of additional Paragraph IV certifications relating to the Company’s patents, U.S. Patent Nos. 5,622,933 and 5,958,456, which were listed in the Orange Book as of October 19, 2007. On November 15, 2007, Endo and the Company filed a lawsuit against IMPAX in the United States District Court for the District of Delaware (“U.S. Dist. Delaware”). The lawsuit against IMPAX not only alleged infringement of certain of these Orange Book-listed U.S. patents but also sought declaratory judgment that, among other things, IMPAX had no legitimate basis to trigger the Hatch-Waxman ANDA patent litigation process because the FDA, according to IMPAX, had rescinded its acceptance of IMPAX’s ANDA. It further asked the court to declare that the Paragraph IV certification notices that IMPAX served on Endo and the Company are null, void and of no legal effect. On December 14, 2007, the Company received a letter from IMPAX notifying it of a refiling of its ANDA for Opana ER that was accepted by the FDA as of November 23, 2007. The notice letter states that IMPAX’s ANDA contains Paragraph IV certifications for the three patents noted above and that the FDA had required IMPAX to notify Endo and the Company of these certifications. In this notice, IMPAX also stated that it would not withdraw its prior Paragraph IV certification notices because it believed they were properly provided and because IMPAX was continuing to seek to convince the FDA to assign an earlier filing date to its ANDA. As a result of the FDA’s determination of IMPAX’s ANDA filing date and the receipt of the new Paragraph IV certification notice, on December 20, 2007, the Company and Endo filed a notice of dismissal of the portion of its November 15, 2007 complaint seeking declaratory judgment that, among other things, IMPAX had no basis to trigger the Hatch-Waxman ANDA patent litigation process and that any Paragraph IV certification notices served prior to November 23, 2007 were null, void and of no legal effect. The Company and Endo did not dismiss the patent infringement claims because IMPAX refused to withdraw its prior Paragraph IV certification notices. On January 25, 2008, Endo and the Company filed a lawsuit against IMPAX in U.S. Dist. Delaware, alleging infringement of certain Orange Book-listed patents in response to IMPAX’s December notice.

     On June 14, 2008, the Company and Endo each received a notice from IMPAX advising the Company and Endo that IMPAX had amended its ANDA for Opana ER to include three additional strengths, 7.5 mg, 15 mg and 30 mg. This ANDA amendment contained a Paragraph IV certification against the Company’s Orange Book listed patents, U.S. Patent Nos. 5,662,933, 5,958,456 and 7,276,250. On July 25, 2008, the Company and Endo filed a lawsuit against IMPAX in U.S. Dist. Delaware, alleging infringement of certain Orange Book — listed patents in response to the notice.

Actavis ANDA Litigation

     On February 14, 2008, the Company and Endo each received a notice from Actavis advising of the filing by Actavis of an ANDA containing a Paragraph IV certification under 21 U.S.C. Section 355(j) for Opana ER in four strengths, 5 mg, 10 mg, 20 mg and 40 mg. The Actavis Paragraph IV certification notice refers to the Company’s Orange Book listed patents, U.S. Patent Nos. 5,128,143, 5,662,933, 5,958,456 and 7,276,250, which cover the formulation of Opana ER. These patents expire in 2008, 2013, 2013 and 2023, respectively. On March 28, 2008,

14

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

Endo and the Company filed a lawsuit against Actavis in the United States District Court for the District of New Jersey (“U.S. Dist. Ct., NJ”) alleging infringement of U.S. Patent No. 5,958,456.

     On June 2, 2008, the Company and Endo each received a notice from Actavis advising the Company and Endo that Actavis had amended its ANDA for Opana ER to include two additional strengths, 7.5 mg and 15 mg. On July 2, 2008, the Company and Endo each received a third notice from Actavis advising that Actavis had further amended its ANDA to include the 30 mg strength. Each ANDA amendment contained a Paragraph IV certification against the Company’s Orange Book listed patents, U.S. Patent Nos. 5,128,143, 5,662,933, 5,958,456 and 7,276,250. On July 11, 2008, Endo and the Company filed a lawsuit against Actavis in the U.S. Dist. Ct., NJ, alleging infringement of U.S. Patent No. 5,958,456 in response to these two additional Paragraph IV certification notices from Actavis.

     The Company is a party from time to time to certain other types of 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.

13. Subsequent Events

Sandoz Paragraph IV Patent Certification Notice

     On July 10, 2008, the Company and Endo each received a notice from Sandoz Inc. (“Sandoz”) advising the Company and Endo that Sandoz had filed with the FDA an ANDA for Opana ER in four strengths, 5 mg, 10 mg, 20 mg and 40 mg. This ANDA contained a Paragraph IV certification against the Company’s Orange Book listed patents, U.S. Patent Nos. 5,662,933, 5,958,456 and 7,276,250. The Company and Endo are currently reviewing this Paragraph IV certification notice and Sandoz’s ANDA and evaluating all available legal and regulatory options.

15

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

     Overview

     We are a drug development company dedicated to bringing to the marketplace innovative products that help improve the lives of patients. Our goal is to identify, develop and commercialize products that address unmet medical needs, primarily for disorders of the nervous system. We are currently applying our drug development and drug delivery expertise to a pipeline of potential products that are in various stages of development, and that we intend to commercialize independently or through third party alliances.

     On June 22, 2006, the United States Food and Drug Administration, or FDA, approved Opana^® ER. Opana ER, an extended release formulation of oxymorphone hydrochloride, is a product that we developed with Endo Pharmaceuticals Inc., or Endo, using our proprietary TIMERx^® drug delivery technology. Opana ER is approved 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 and is being marketed by Endo in the United States.

     We are currently developing product candidates designed for the treatment of pain, mitochondrial diseases and Parkinson’s disease. We are developing nalbuphine ER, a controlled release formulation of nalbuphine hydrochloride, for the treatment of moderate chronic pain. In addition, we are developing A0001, a product candidate designed for the treatment of mitochondrial diseases, under a collaboration and license agreement with Edison Pharmaceuticals, Inc, or Edison, that we entered into in July 2007. Under the Edison agreement, we have agreed to collaborate with Edison on the development of A0001 and up to one additional drug candidate of Edison’s. We initially intend to develop A0001 for the treatment of mitochondrial diseases. Finally, we are developing one other product candidate for the treatment of the symptoms of Parkinson’s disease.

     On March 11, 2008, we sold units representing an aggregate of 8,140,600 shares of our common stock, together with warrants to purchase an aggregate of 4,070,301 shares of our common stock, in a private placement, for a total purchase price of approximately $25.1 million. We received net proceeds of approximately $23.1 million from this private placement, after deducting the placement agent’s fees and other expenses. The warrants are exercisable on or prior to March 11, 2013 at an exercise price of $3.62 per share. The warrants may also be exercised pursuant to cashless exercise provisions under certain circumstances.

     Products

     Opana^® ER. Opana ER is an oral extended-release opioid analgesic, which we developed with Endo, using our proprietary TIMERx^® technology. In June 2006, the FDA approved for marketing Opana ER, for twice-a-day dosing in patients with moderate to severe pain requiring continuous, around-the-clock opioid treatment for an extended period of time. Under the terms of our collaboration with Endo, Endo launched Opana ER in the United States in July 2006 in 5 mg, 10 mg, 20 mg and 40 mg tablets. In March 2008, Endo launched three new dosage strengths of Opana ER including 7.5 mg, 15 mg and 30 mg tablets.

     Under the terms of our collaboration with Endo, Endo will pay us royalties based on U.S. sales of Opana ER. No payments are due to us for the first $41 million of royalties otherwise payable to us beginning from the time of the product launch, a period we refer to as the royalty holiday. We believe that, based upon the sales estimates provided to us by Endo and the current sales growth of Opana ER, we will begin to recognize royalties from Endo related to sales of Opana ER in the third quarter of 2008. In addition, under the terms of the agreement with Endo, any fees, royalties, payments or other revenues received by the parties in connection with any collaborator outside of the United States will be divided equally between Endo and us. We and Endo are currently seeking a collaborator to develop and commercialize Opana ER in Europe. A description of our agreement with Endo is included under the caption “Collaboration and Licensing Agreements” in “Part I. Item 1. Notes to Condensed Financial Statements”.

     We and Endo entered into a Second Amendment to the Amended and Restated Strategic Alliance Agreement with respect to Opana ER, effective July 14, 2008. Under the terms of this amendment, Endo agreed to directly reimburse us for costs and expenses incurred by us in connection with patent enforcement litigation related to Opana ER. If any of such costs and expenses are not reimbursed to us by Endo, we may bill Endo for these costs and expenses through adjustments to the pricing of TIMERx material that we supply to Endo for use in Opana ER. In

16

connection with the amendment, in July 2008, Endo reimbursed us for such costs and expenses incurred prior to June 30, 2008, totaling approximately $470,000.

     We and Endo are parties to two lawsuits against IMPAX Laboratories, Inc., or IMPAX, in connection with IMPAX’s Abbreviated New Drug Application, or ANDA, for Opana ER in four strengths, 5 mg, 10 mg, 20 mg and 40 mg. On July 25, 2008, we and Endo filed a third lawsuit against IMPAX in connection with its amended ANDA for Opana ER 7.5mg, 15 mg and 30 mg. IMPAX notified Endo and us in October and November of 2007 that its ANDA contained Paragraph IV certifications for our patents, U.S. Patent Nos. 5,662,933, 5,958,456, and 7,276,250, listed in the Orange Book for Opana ER. We and Endo originally filed a lawsuit against IMPAX in the United States District Court for the District of Delaware, or U.S. Dist. Delaware, on November 15, 2007 alleging infringement of certain of these patents, and seeking a declaratory judgment that, among other things, IMPAX had no basis to trigger the ANDA patent litigation process under the Hatch-Waxman Act because the FDA, according to IMPAX’s press releases, had rescinded its acceptance of IMPAX’s original ANDA before the date of IMPAX Paragraph IV certification notices. In addition, we and Endo asked the court to declare these Paragraph IV certification notices to be null, void and of no legal effect.

     On December 14, 2007, we received a letter from IMPAX notifying us that the refiling of its ANDA was accepted by the FDA as of November 23, 2007. The notice letter stated that IMPAX’s ANDA contained Paragraph IV certifications for the three patents noted above and that the FDA had required IMPAX to notify Endo and us of these certifications. In this December notice, IMPAX also stated that it would not withdraw its prior Paragraph IV certification notices because it believed they were properly provided and because IMPAX was continuing its efforts to convince the FDA to assign an earlier filing date to its ANDA. As a result of the FDA’s determination of IMPAX’s ANDA filing date and the receipt of the new Paragraph IV certification notice, on December 20, 2007, we and Endo filed a notice of dismissal of the portion of our November 15, 2007 complaint seeking declaratory judgment as described above. We and Endo did not dismiss the patent infringement claims in the November lawsuit because IMPAX refused to withdraw its prior Paragraph IV certification notices. On January 25, 2008, we and Endo filed a second lawsuit against IMPAX in U.S. Dist. Delaware, alleging infringement of two of these patents noted above in response to IMPAX’s December notice.

     On June 14, 2008, we and Endo each received a notice from IMPAX advising us and Endo that IMPAX had amended its ANDA for Opana ER to include three additional strengths, 7.5 mg, 15 mg and 30 mg. This ANDA amendment contained a Paragraph IV certification against our Orange Book listed patents, U.S. Patent Nos. 5,662,933, 5,958,456 and 7,276,250. On July 25, 2008, we and Endo filed a lawsuit against IMPAX in U.S. Dist. Delaware, alleging infringement of certain of these Orange Book — listed patents in response to the notice.

     On February 14, 2008, we, along with Endo, received a notice from Actavis South Atlantic LLC, or Actavis, advising of the filing by Actavis of an ANDA containing a Paragraph IV certification for Opana ER in four strengths, 5 mg, 10 mg, 20 mg and 40 mg. The Actavis Paragraph IV certification notice refers to our patents, U.S. Patent Nos. 5,128,143, 5,662,933, 5,958,456, and 7,276,250, which cover the formulation of Opana ER. These patents are listed in the FDA’s Orange Book and expire in 2008, 2013, 2013, and 2023, respectively. On March 28, 2008, we and Endo filed a lawsuit against Actavis in the United States District Court for the District of New Jersey or U.S. Dist. Ct., NJ, alleging infringement of U.S. Patent No. 5,958,456. We believe that we are entitled to a 30-month stay under the Hatch-Waxman Act beginning February 14, 2008. On June 2, 2008, we and Endo each received a notice from Actavis advising us that Actavis had amended its ANDA for Opana ER to include two additional strengths, 7.5 mg and 15 mg. On July 2, 2008, we and Endo each received a third notice from Actavis advising that Actavis had further amended its ANDA to include the 30 mg strength. Each ANDA amendment contained a Paragraph IV certification against our Orange Book listed patents, U.S. Patent Nos. 5,128,143, 5,662,933, 5,958,456 and 7,276,250. On July 11, 2008, we and Endo filed a lawsuit against Actavis in the U.S. Dist. Ct., NJ alleging infringement of U.S. Patent No. 5,958,456 in response to these two additional Paragraph IV certification notices from Actavis.

     A description of the lawsuits related to Opana ER are included in “Part II. Item 1 — Legal Proceedings.” We and Endo intend to pursue all available legal and regulatory avenues defending Opana ER.

     On July 10, 2008, we and Endo each received a notice from Sandoz Inc., or Sandoz, advising us and Endo that Sandoz had filed with the FDA an ANDA for Opana ER in four strengths, 5 mg, 10 mg, 20 mg and 40 mg. This

17

ANDA contained a Paragraph IV certification against our Orange Book listed patents, U.S. Patent Nos. 5,662,933, 5,958,456 and 7,276,250. We and Endo are currently reviewing this Paragraph IV certification notice and Sandoz’s ANDA, and are evaluating all available legal and regulatory options.

     Nalbuphine ER. Nalbuphine ER is a drug candidate we are developing for the treatment of moderate chronic pain. In January 2008, we reported the results of a Phase IIa trial that we conducted to determine the safety and efficacy of nalbuphine ER compared to placebo for the treatment of moderate chronic pain. The trial was a randomized, double-blind, placebo-controlled design, with a forced weekly dose escalation with the main objective to evaluate the analgesic efficacy of nalbuphine ER in a patient population experiencing chronic pain. We designed the trial with multiple endpoints related to clinical pain relief in an effort to understand the activity of the drug and to provide the basis for designing a Phase IIb study. Based on the Phase IIa study results, we concluded that nalbuphine ER demonstrated trends of efficacy sufficient to support continued development of the drug.

     We are planning a Phase IIb trial which we expect to be prepared to commence in late 2008. Initiation of the trial will be subject to the availability of resources. We are currently seeking to enter into a collaboration agreement with a third party for the development and commercialization of nalbuphine ER. We expect that the goals of the Phase IIb trial will be to demonstrate statistically significant analgesic efficacy of the drug versus placebo using an accepted clinical endpoint, and to characterize a clinically meaningful titration regimen. We believe that this trial will take approximately one year to complete. We expect that if we complete all the clinical trials required by the FDA for nalbuphine ER, we would seek FDA approval of nalbuphine ER through the filing of a 505 (b)(2) NDA.

     A0001. A0001 is a drug candidate we in-licensed from Edison under our collaboration and license agreement. A0001, a coenzyme Q molecular analog, has shown biological activity in cell assays developed by Edison to test the ability of this class of compounds to improve mitochondrial function. Impairment of mitochondrial function is commonly believed to be a significant factor in a number of inherited disorders, including Friedreich’s Ataxia, Leber’s Hereditary Optical Neuropathy, Coenzyme Q10 Deficiency Syndrome and MELAS syndrome. A0001 has received orphan drug designation from the FDA for the treatment of inherited mitochondrial respiratory chain diseases.

     In May 2008, we submitted an Investigational New Drug application, or IND, for A0001 for certain indications. On July 14, 2008, we began dosing in a Phase Ia placebo-controlled single ascending dose trial designed to evaluate the safety and tolerability of A0001, and to collect pharmacokinetic data. The trial is also designed to determine if there is a maximum tolerated dose of the drug. We plan to enroll a total of 60 healthy volunteers in the trial. We anticipate that, based upon the results of this trial, further development of A0001 would involve a Phase Ib multiple ascending dose trial in healthy volunteers for which dosing could begin in early 2009, followed by a Phase IIa proof of concept trial in patients with mitochondrial diseases. In accordance with the Edison agreement, we are required to make a milestone payment to Edison in August 2008, in connection with the dosing which commenced for the Phase Ia trial noted above.

     Under the terms of the Edison agreement, we have exclusive, worldwide rights to develop and commercialize A0001 and up to one additional compound of Edison’s as to which we exercise our option, for the treatment of all indications, subject to the terms and conditions in the agreement. A description of the Edison agreement is included under the caption “Collaborations and Licensing Agreements” in “Part I. Item 1. — Notes to Condensed Financial Statements”.

     PW4153. PW4153 is a drug candidate we are developing for the treatment of symptoms of Parkinson’s disease. We submitted an IND for PW4153 in May 2008. In July 2008, we began dosing in a Phase I clinical trial for PW4153. PW4153 is an extended release (ER) formulation of a marketed drug that is dosed multiple times a day that we reformulated using our TIMERx technology. The goal of our formulation is to extend the dosing interval of the drug while minimizing the peak-to-trough ratio, which we believe may enhance the efficacy, tolerability and convenience of the drug for Parkinson’s patients. The purpose of the Phase I trial of PW4153 is to assess the pharmacokinetics of our formulation in healthy volunteers. We expect data from this study in the fourth quarter of 2008.

     We have incurred net losses since 1994, including net losses of $34.5 million, $31.3 million and $22.9 million during 2007, 2006 and 2005, respectively. For the six month period ended June 30, 2008, our net loss was $17.2

18

million. As of June 30, 2008, our accumulated deficit was approximately $224 million. We expect operating losses and negative cash flows to continue until substantial sales of Opana ER or other products that we develop occur. We currently generate revenues primarily from royalties received from Mylan Pharmaceuticals Inc.’s, or Mylan, net sales of Pfizer Inc.’s, or Pfizer, generic version of Procardia XL 30 mg, and to a lesser extent, from bulk sales of TIMERx to Endo for Opana ER. Our future profitability will depend on several factors, including:

• the commercial success of Opana ER, and the timing and amount of royalties from Endo’s sales of Opana ER which may be affected by any potential generic entry;

• our ability to successfully defend our intellectual property protecting our products;

• our ability to access funding support for our development programs from third party collaborators;

• the level of our investment in research and development activities, including the timing and costs of conducting clinical trials of our products;

• the timing and amount of payments to Edison in connection with the Edison agreement, as well as our costs of development for drug candidates to which we acquire rights under the Edison agreement;

• the successful development and commercialization of product candidates in our portfolio;

• the level of investment for acquisitions or in-licensing of compounds or technologies intended to support our growth; and

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

     Our results of operations may fluctuate from quarter to quarter depending on the amount and timing of royalties on Endo’s sales of Opana ER, which we expect to begin to recognize in the third quarter of 2008, Mylan’s sales of Pfizer’s generic version of Procardia XL 30 mg, the volume and timing of shipments of formulated bulk TIMERx material, including to Endo, the variations in payments under our collaborative agreements, and 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. We evaluate these estimates and judgments on an ongoing basis. 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, impairment of long-lived assets and share-based compensation. 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, 2007.

Recent Accounting Pronouncements

     A detailed description of recent accounting pronouncements is included under the caption “Recent Accounting Pronouncements” in “Part I. Item 1. — Notes to Condensed Financial Statements”.

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Results of Operations for the Three and Six Month Periods Ended June 30, 2008 and 2007

Revenues

	Three months					Three months		Six months					Six months
	ended		Percentage			ended		ended		Percentage			ended
	June 30,		Increase			June 30,		June 30,		Increase			June 30,
	2008		(decrease)			2007		2008		(decrease)			2007
	(in thousands, except percentages)							(in thousands, except percentages)
Royalties and licensing fees	$	670		23	%	$	546	$	1,101		(13	)%	$	1,265
Product sales		302		82			166		530		83			289
Research and development reimbursements		344		n/a			—		424		n/a			—
Total revenue	$	1,316		85	%	$	712	$	2,055		32	%	$	1,554

     Royalties and licensing fees for the three and six month periods ended June 30, 2008 and 2007 primarily related to royalties received from Mylan on its sales of Pfizer’s generic version of Procardia XL 30 mg. Royalties and licensing fees increased in the 2008 three month period as compared to the 2007 three month period due to licensing revenue from a drug delivery collaboration, recognized in the 2008 three month period. Royalties and licensing fees decreased in the 2008 six month period as compared to the 2007 six month period due to decreased royalties from Mylan as a result of a decrease in Mylan’s net sales of Pfizer’s generic version of Procardia XL 30 mg, which were partially offset by licensing revenue from a drug delivery collaboration, recognized in the 2008 six month period.

     Pursuant to our strategic alliance agreement with Endo with respect to the development of Opana ER, no royalty payments will be due to us for the first $41 million of royalties that would otherwise have been payable beginning from the time of the product launch in July 2006. If we were not subject to the royalty holiday as described above, we would have recognized royalties from Endo of approximately $8.1 million and $15.4 million, respectively, for the three and six month periods ended June 30, 2008. Cumulatively, through June 30, 2008, approximately $35.1 million has been applied against the royalty holiday. We believe that, based upon the sales estimates provided to us by Endo and the current sales growth of Opana ER, we will begin to recognize royalties from Endo related to sales of Opana ER in the third quarter of 2008.

     Our product sales in the three and six month periods ended June 30, 2008 and 2007 consisted of sales of formulated TIMERx material to Endo for use in Opana ER. Product sales increased in the 2008 three and six month periods in comparison with the respective 2007 three and six month periods as a result of an increase in the selling price of TIMERx material to Endo, as provided for under our agreement. In connection with the amendment to the Endo agreement we entered into with Endo in July 2008, we expect the selling price of TIMERx material to Endo to decrease for the remainder of 2008 to approximately the levels which were in effect for 2007.

     Revenue from research and development reimbursements consists of reimbursements of our expenses under a research and development collaboration agreement involving the development of a product candidate using our TIMERx technology.

Cost of Revenues

	Three months		Percentage			Three months		Six months		Percentage			Six months
	ended		increase			ended		ended		increase			ended
	June 30, 2008		(decrease)			June 30, 2007		June 30, 2008		(decrease)			June 30, 2007
	(In thousands, except percentages)							(In thousands, except percentages)
Cost of product sales	$	148		3	%	$	144	$	246		(3	)%	$	254
Cost of research and development reimbursements		360		n/a			—		431		n/a			—
Total cost of revenues	$	508		253	%	$	144	$	677		167	%	$	254

     Cost of product sales primarily consists of the costs related to sales of formulated TIMERx material to Endo for use in Opana ER, as well as amortization of related patent and deferred royalty costs.

     Cost of research and development reimbursements consists of our expenses under a research and development collaboration agreement involving the development of a product candidate using our TIMERx technology.

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Selling, General and Administrative Expenses

Three months

Percentage

Three months

Six months

Percentage

Six months

ended

increase

ended

ended

increase

ended

June 30, 2008

(decrease)

June 30, 2007

June 30, 2008

(decrease)

June 30, 2007

(In thousands, except percentages)

(In thousands, except percentages)

Selling, general and administrative expenses

$

3,071

(16

)%

$

3,667

$

7,395

n/a

$

7,388

     The decrease in selling, general and administrative, or SG&A, expenses for the three month period ended June 30, 2008 as compared to the comparable period in 2007 was primarily attributable to lower share-based compensation expense and lower facility related costs. The decrease in our facility-related costs noted above was primarily attributable to our efforts in 2007 to explore alternative locations for our facilities. In June 2007, we extended the lease terms of our two facilities.

     For the six month period ended June 30, 2008, total SG&A expenses were comparable to the six month period ending June 30, 2007. Included in the 2008 six month period was an impairment charge we recorded in the first quarter of 2008 in the amount of $1.0 million to establish a reserve against the collectability of the loan that we made to Edison in February 2008 under our agreement with Edison. This charge was offset by lower facility related costs, as discussed above, and lower share-based compensation expense in the 2008 six month period as compared to the 2007 six month period, primarily attributable to lower expense associated with outstanding stock options in 2008, primarily as a result of decreases in the price of our common stock.

     In March 2008, we undertook measures, including headcount reductions, to reduce our overhead expenses and to more closely control our future costs. We expect that the annualized cost savings from these actions will reduce our SG&A expenses over the course of 2008 as compared to 2007.

Research and Product Development Expenses

     Research and product development, or R&D, expenses were $4.5 million and $10.9 million, respectively, for the three and six month periods ended June 30, 2008, as compared to $6.0 million and $10.4 million for the three and six month periods ended June 30, 2007.

     The decrease for the 2008 three month period as compared to the 2007 three month period was primarily due to lower expenses related to nalbuphine ER, reflecting the cost in 2007 of the Phase IIa proof of concept trial of nalbuphine ER that we completed in January 2008 and lower expenses on other early stage product candidates, including torsemide ER, on which we ceased development efforts in the third quarter of 2007. Offsetting these lower expenses were payments to Edison for sponsored research and expenses related to preclinical work we conducted on A0001, the lead candidate licensed under the Edison agreement.

     The increase for the 2008 six month period as compared to the 2007 six month period was primarily due to payments to Edison for sponsored research, expenses related to preclinical work we conducted on A0001 in 2008 and higher share-based compensation expense due to higher levels of actual forfeitures of employee stock options recorded in the 2007 six month period as compared to the 2008 six month period. Partially offsetting these expenses were lower expenses related to nalbuphine ER and lower expenses on early stage product candidates.

     In March 2008, we undertook measures, including headcount reductions, to reduce our overhead expenses and to more closely control our future costs. We expect the annualized cost savings from these actions will reduce our internal R&D expenses over the course of 2008 as compared to 2007.

     For the remainder of 2008, we currently anticipate that our project spending will be largely related to further development of A0001, payments to Edison in connection with the Edison agreement and on advancing our PW4153 candidate. We are currently designing a Phase IIb trial for nalbuphine ER and may incur additional spending on this program, depending upon our available financial resources and the status of collaboration discussions, as described further below.

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     In the table below, R&D expenses are set forth in the following categories:

	Three months					Three months		Six months					Six months
	ended		Percentage			ended		ended		Percentage			ended
	June 30,		Increase			June 30,		June 30,		Increase			June 30,
	2008		(Decrease)			2007		2008		(Decrease)			2007
	(in thousands, except percentages)							(in thousands, except percentages)
Nalbuphine ER	$	519		(79	)%	$	2,522	$	1,635		(53	)%	$	3,487
Edison Program		1,454		n/a			—		3,634		n/a			—
PW4153		104		112			49		149		2			146
Other Phase I Products and Internal Costs		2,447		(30	)		3,471		5,491		(19	)		6,793
Total Research and Product Development Expense	$	4,524		(25	)%	$	6,042	$	10,909		5	%	$	10,426

     Our quarterly reports filed in 2007 included separate categories for Phase I Products and Internal Costs, and for Research and New Technology development, which included costs related to research on drug delivery systems. Because of our increased focus on product development and minimal research being done on new technology, these costs are now all included in Phase I Products and Internal Costs.

• Nalbuphine ER — These expenses reflect our direct external expenses relating to the development of nalbuphine ER. These expenses approximated 11% and 15%, respectively, of our R&D expenses for the three and six month periods ended June 30, 2008 and consisted primarily of payments to third parties in connection with clinical trials of nalbuphine ER. The expenses for this program decreased in the 2008 periods as compared to the 2007 periods, as the 2007 periods reflect costs we incurred in connection with a Phase I safety trial that we completed in 2007, a Phase IIa trial that we completed in January 2008 and costs for the purchase of drug active. For the remainder of 2008, the level of our spending related to nalbuphine ER will depend on the terms of any collaboration agreement we enter into and the timing of the Phase IIb trial, which will be subject to the availability of resources.

• Edison Program — These expenses reflect our funding of Edison’s research activities under the Edison agreement as well as our direct external expenses relating to the development of A0001. These expenses approximated 32% and 33%, respectively, of our R&D expenses for the three and six month periods ended June 30, 2008 and included quarterly research and development payments to Edison totaling $2.0 million. We anticipate that these expenses will continue to increase in 2008 as we make further quarterly research and development payments for the remainder of 2008 as well as a milestone payment to Edison noted above, and increase our activity with respect to the development of A0001, including conducting a Phase Ia clinical trial that was commenced in July 2008. The quarterly research and development payments to Edison end in January 2009.

• PW4153 — These expenses reflect our direct external expenses relating to the development of PW4153. These expenses approximated 2% and 1%, respectively, of our R&D expenses for the three and six month periods ended June 30, 2008 and consisted primarily of payments to third parties in connection with clinical trials and other development work. We anticipate that these expenses will increase in 2008 as we conduct the Phase Ia clinical trial of PW4153 that we commenced in July 2008.

• Other Phase I Products and Internal Costs — These expenses reflect internal and external expenses not separately reported under a product development program noted above, and include the areas of pharmaceutical development, clinical and regulatory. The types of expenses included in internal expenses primarily are salary and benefits, stock-based compensation costs, depreciation on purchased equipment, and the amortization or any write-downs of patent costs, other than product patent write-offs charged directly to a separately reported product development program or amortization of patent costs relating to commercialized products, which are included in cost of revenues. The types of expenses included in external expenses are

22

primarily related to preclinical studies, proof-of-principle biostudies conducted on our Phase I product candidates and payments to third parties for drug active.

These costs decreased in the three and six month periods ended June 30, 2008 from the three and six month periods ended June 30, 2007, primarily as a result of the termination of certain programs in 2007 as well as the termination of our program for PW4110 in the first quarter of 2008. 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.

     There can be no assurance that any of our product candidates will advance through or into 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.

Share-Based Compensation

     Share based compensation was recorded as follows:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2008		2007		2008		2007
	(unaudited)
	(in thousands)
Research and product development	$	215	$	198	$	450	$	(84	)
Selling, general and administration		526		927		1,207		1,526
Total stock based compensation	$	741	$	1,125	$	1,657	$	1,442

     The decrease in share-based compensation expense in the three month period ended June 30, 2008 as compared to the three month period ended June 30, 2007 is primarily attributable to lower expense associated with outstanding stock options in the 2008 three month period as compared to the 2007 three month period, primarily as a result of decreases in the price of our common stock.

     The increase in share-based compensation expense in the six month period ended June 30, 2008 as compared to the six month period ended June 30, 2007 is primarily attributable to higher levels of actual forfeitures of employee stock options recorded in the 2007 six month period as compared to the 2008 six month period.

Tax Rates

     The effective tax rates for the three and six month periods ended June 30, 2008 and 2007 were zero. The effective tax rates differ from 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.

Liquidity and Capital Resources

Sources of Liquidity

     Since 1998, when we became an independent, publicly owned company, we have funded our operations and capital expenditures from the proceeds of the sale and issuance of shares of common stock, sales of excipients, the sale of our excipients business, sales of formulated bulk TIMERx material, royalties and milestone payments from Mylan and other collaborators, and advances under credit facilities. As of June 30, 2008, we had cash, cash equivalents and short-term investments of $28.7 million.

     Private Placement. On March 11, 2008, we sold units representing an aggregate of 8,140,600 shares of our common stock, $0.001 par value per share, together with warrants to purchase an aggregate of 4,070,301 shares of

23

our common stock, in a private placement, for a total purchase price of approximately $25.1 million. We received net proceeds of approximately $23.1 million from this private placement, after deducting the placement agent’s fees and other expenses. The warrants are exercisable on or prior to March 11, 2013, at an exercise price of $3.62 per share. The warrants may also be exercised pursuant to cashless exercise provisions under certain circumstances.

     Pursuant to the securities purchase agreement entered into in connection with the private placement, we filed a registration statement with the Securities and Exchange Commission, or SEC, on April 10, 2008, registering for resale the shares and shares issuable under the warrants. This registration statement was declared effective by the SEC on April 28, 2008. We have agreed to maintain the registration statement’s effectiveness until the earlier of (i) the later of (A) March 11, 2009, or (B) the twelve month anniversary of the last date on which warrant shares are issued upon exercise of warrants and (ii) the date all of the shares and warrant shares have been resold by the original purchasers.

     Senior Secured Credit Facility. On March 13, 2007, we entered into a $24.0 million senior secured credit facility with Merrill Lynch Capital, a division of Merrill Lynch Business Financial Services Inc., which was acquired by GE Capital in February 2008, and is now known as GE Business Financial Services Inc. The credit facility consists of: (i) a $12.0 million term loan advanced upon the closing of the credit facility and (ii) a $12.0 million term loan that we may access until September 15, 2008, subject to conditions specified in the agreement. Under the credit facility, we may not access this second amount unless our market capitalization at the time of the advance request is greater than $250 million and an additional patent relating to Opana ER has been issued and listed in the FDA’s Orange Book. On October 2, 2007, a patent relating to Opana ER was issued and listed in the Orange Book. As a result, we may access the additional $12.0 million at any time that our market capitalization is greater than $250 million up until September 15, 2008, as noted above. We do not currently anticipate that we will draw the second term loan due to our current market capitalization as well as our recently completed financing.

     Each loan has a term of 42 months from the date of advance with interest-only payments for the first nine months, but in any event, not beyond September 30, 2008; interest plus monthly principal payments equal to 1.67% of the loan amount for the period from the end of the interest-only period through December 2008; and interest plus straight line amortization payments with respect to the remaining principal balance for the remainder of the term.

     Amounts outstanding under the credit facility bear interest at an annual rate of one month LIBOR at the time of the advance plus 5%. The rate will be fixed for the term of the applicable loan. At the time of final payment of each loan under the credit facility, we will pay an exit fee of 3.0% of the original principal loan amount. Should any prepayment occur, we are also required to pay prepayment penalties of 3.0% of any prepaid amount in the first year, 2.0% of any prepaid amount in the second year and 1% of any prepaid amount thereafter. As of June 30, 2008, the interest rate on the credit facility was 10.32% and $10.8 million was outstanding. Beginning January 2008, we began making monthly principal payments on this loan, in addition to the monthly interest payments. Based on the terms of the credit facility, the loan amount currently outstanding will be fully paid by September 2010.

Cash Flows

     We had negative cash flow from operations for the six month period ended June 30, 2008 of $15.1 million, primarily due to a net loss of $17.2 million in the period, which included non-cash charges of $1.0 million for the establishment of a loan reserve for the Edison loan discussed below, $1.7 million for share-based compensation and $0.8 million for depreciation and amortization. Cash flow from operations also reflected approximately $2.3 million in the net pay down of accounts payable and accrued expenses.

     Investing activities provided $0.7 million in cash for the six month period ended June 30, 2008, primarily reflecting maturities of marketable securities, net of purchases, of $1.9 million. This was partially offset by the $1.0 million loan to Edison discussed below. Net cash provided by investing activities also reflected funds expended to secure patents on technology we have developed and for the acquisition of laboratory equipment for drug development activities. Financing activities provided $22.0 million in cash, primarily from the private placement discussed above, partially offset by repayments of principle on our outstanding term loan described above.

     On February 5, 2008, we loaned Edison $1.0 million pursuant to the loan provisions of the Edison agreement. The loan bears interest at an annual rate of one month LIBOR at the time of the loan, plus 5%, or a total of 8.14%,

24

which rate is fixed for the term of the loan. The loan matures on the earlier of July 16, 2012 and the occurrence of an event of default, as defined in the Edison agreement. All accrued and unpaid interest is payable on the maturity date; however, interest accruing on any outstanding loan amount after July 16, 2010 is due and payable monthly in arrears. As of August 4, 2008, $1.0 million in principal is outstanding under this loan. During the three month period ended March 31, 2008, we recorded an impairment charge of $1.0 million in our statement of operations as a result of our collectability assessment of the loan to Edison. In addition, as a result of our continuing collectability assessment, we are not recognizing any accrued interest income on the loan to Edison. The amount of such accrued interest income we have not recognized approximated $21,000 and $33,000, respectively, for the three and six month periods ended June 30, 2008.

Funding Requirements

     We anticipate that, based upon our current operating plan, our existing capital resources, together with expected royalties from third parties, will be sufficient to fund our operations on an ongoing basis until at least late 2009.

     In order to achieve this, we have taken a series of measures to reduce our spending and manage our costs more closely, including adjusting the pace and timing of our planned clinical programs to match these costs with our financial resources. We plan to seek to enter into collaboration and licensing agreements for our product candidates, including nalbuphine, and technologies that may provide additional funding of our operations. If we are unsuccessful with these efforts, or we do not receive royalties from Endo in such amounts or at such times as we anticipate, we may not be able to fund our ongoing operations until at least late 2009 without seeking additional funding from the capital markets.

     We currently do not anticipate that we will draw the second $12 million term loan under our credit facility with GE Business Financial Services due to the level of our market capitalization and our recent financing. We expect our capital expenditures to be lower in 2008 as compared to 2007 and to not exceed approximately $250,000 for the year ending December 31, 2008 as we closely manage our capital spending.

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

• the commercial success of Opana ER;

• the timing and amount of payments received under collaborative agreements, including in particular our agreement with Endo with respect to Opana ER and our agreement with Mylan with respect to Pfizer’s generic version of Procardia XL 30 mg;

• the timing and amount of payments to Edison in connection with the Edison agreement, as well as our internal costs of development for drug candidates for which we acquire rights under the Edison agreement;

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

• our ability to access funding support for our development programs from third party collaborators;

• the level of investment for the acquisition or in-licensing of technologies or compounds intended to support our growth;

• our ability to enter into additional collaborations for our product candidates and technologies, and the structure and terms of any such future collaborative agreements;

• the prosecution, defense and enforcement of our patents and other intellectual property rights, such as our Orange Book listed patents for Opana ER;

• the level of our investment in capital expenditures for facilities or equipment; and

25

• our success in reducing our spending and managing our costs.

     If we determine to acquire additional product candidates or technologies, or accelerate the development of any of our own product candidates, we may need to seek additional funding through collaborative agreements, or public financings of equity or debt securities.

     We plan to meet our long-term cash requirements through our existing levels of cash and marketable securities, and revenues from collaborative agreements, as well as through equity or debt 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. Under the rules adopted by the Securities and Exchange Commission in 2005, this shelf registration statement will expire on December 1, 2008. As of August 4, 2008, no securities have been issued under this shelf registration statement.

     If we raise additional funds by issuing equity securities, further dilution to our then-existing shareholders may result. Additional debt financing, such as the credit facility noted above, 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, or research and development with third parties, it may be necessary to relinquish valuable rights to our technologies, research programs or potential products, 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, including our planned clinical trials, which could harm our financial condition and operating results.

Contractual Obligations

     Our outstanding contractual cash obligations include obligations under our operating leases primarily for facilities, purchase obligations primarily relating to clinical development, payments due under our credit facility relating to interest, principal and exit fees, obligations under deferred compensation plans as discussed below and obligations under our Edison agreement as described above. Following is a table summarizing our contractual obligations as of June 30, 2008 (in thousands).

			Less Than		1-3		4-5		After 5
	Total		One Year		Years		Years		Years
Operating leases	$	1,029	$	741	$	288	$	—	$	—
Purchase obligations		2,938		2,938		—		—		—
Payments due under credit facility		12,617		4,925		7,692		—		—
Deferred compensation, including current portion		2,748		294		587		587		1,280
Edison collaboration		1,667		1,667		—		—		—
Total	$	20,999	$	10,565	$	8,567	$	587	$	1,280

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

• 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

26

liabilities. Effective in June 2006, Mr. Hamachek’s SERP and DCP benefit payments are being made directly from the assets in the trust. The cash surrender value of these life insurance policies approximated $2.2 million as of June 30, 2008. Total trust assets, including amounts held in a money-market account, approximated $2.3 million as of June 30, 2008.

     The Edison collaboration included in the Contractual Obligations table above reflects our obligation to fund Edison’s discovery and research activities into the first quarter of 2009. Under the terms of the Edison agreement, we are obligated to make milestone payments to Edison upon the achievement of certain clinical and regulatory events. We will not be responsible for the payment of future milestone and/or royalty payments in the event that the development program is discontinued and the agreement is terminated. Preclinical and clinical development of drug candidates is a long, expensive and uncertain process. At any stage of the preclinical or clinical development process, we may decide to discontinue the development of the product candidates under the Edison agreement. As a result, the contractual obligations as of June 30, 2008 listed in the table above do not include any such future potential milestone or royalty payments to Edison, and excludes the milestone payment due to Edison in August 2008, as noted above.

Net Operating Loss Carryforwards

     As of December 31, 2007, we had federal net operating loss, or NOL, carryforwards of approximately $191 million for income tax purposes, which expire beginning in 2018 through 2027. The use of the NOLs is limited to our future taxable earnings. Utilization of the operating losses are subject to limitations in the event of an ownership change under the 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 outstanding term loan under the credit facility is at a fixed rate of interest and therefore, has minimal exposure to 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 June 30, 2008, marketable securities consisted primarily of corporate debt and U.S. Government agency-backed discounted notes, and approximated $5.4 million. Our marketable securities had maturity dates of up to four months. Due to the relatively short-term maturities of these securities, management believes there is no significant market risk. At June 30, 2008, market values approximated carrying values. At June 30, 2008, we had approximately $28.7 million in cash, cash equivalents and short-term investments, and accordingly, a sustained decrease in the rate of interest earned of 1% would cause a decrease in the annual amount of interest earned on such balance of up to approximately $287,000.

Item 4. Controls and Procedures

     (a) Evaluation of Disclosure Controls and Procedures. Our management, with the participation of Jennifer L. Good, in her capacity as our principal executive officer and Benjamin L. Palleiko, in his capacity as our principal financial officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2008. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“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

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U.S. Securities and Exchange Commission’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 June 30, 2008, Ms. Good, our principal executive officer and Mr. Palleiko, our 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 Exchange Act) occurred during the fiscal quarter ended June 30, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

     Impax ANDA Litigation

     On October 3, 2007, the Company received a letter from IMPAX notifying the Company of its filing of an ANDA containing a Paragraph IV certification under 21 U.S.C. § 355(j) for Opana ER in four strengths, 5 mg, 10 mg, 20 mg and 40 mg. This Paragraph IV certification notice referred to the Company’s patent, U.S. Patent No. 7,276,250, which covers the formulation of Opana ER and was listed in the Orange Book as of October 2, 2007. On October 4, 2007, IMPAX announced in a press release that the FDA had rescinded the acceptance of IMPAX’s ANDA filing. On November 5, 2007, the Company received a letter from IMPAX notifying it of additional Paragraph IV certifications relating to the Company’s patents, U.S. Patent Nos. 5,622,933 and 5,958,456, which were listed in the Orange Book as of October 19, 2007. On November 15, 2007, Endo and the Company filed a lawsuit against IMPAX in the U.S. District Court of Delaware, or U.S. Dist. Delaware. The lawsuit against IMPAX not only alleged infringement of certain of these Orange Book-listed U.S. patents but also sought declaratory judgment that, among other things, IMPAX had no legitimate basis to trigger the Hatch-Waxman ANDA patent litigation process because the FDA, according to IMPAX, had rescinded its acceptance of IMPAX’s ANDA. It further asked the court to declare that the Paragraph IV certification notices that IMPAX served on Endo and the Company are null, void and of no legal effect. On December 14, 2007, the Company received a letter from IMPAX notifying it of a refiling of its ANDA for Opana ER that was accepted by the FDA as of November 23, 2007. The notice letter states that IMPAX’s ANDA contains Paragraph IV certifications for the three patents noted above and that the FDA had required IMPAX to notify Endo and the Company of these certifications. In this notice, IMPAX also stated that it would not withdraw its prior Paragraph IV certification notices because it believed they were properly provided and because IMPAX was continuing to seek to convince the FDA to assign an earlier filing date to its ANDA. As a result of the FDA’s determination of IMPAX’s ANDA filing date and the receipt of the new Paragraph IV certification notice, on December 20, 2007, the Company and Endo filed a notice of dismissal of the portion of its November 15, 2007 complaint seeking declaratory judgment that, among other things, IMPAX had no basis to trigger the Hatch-Waxman ANDA patent litigation process and that any Paragraph IV certification notices served prior to November 23, 2007 were null, void and of no legal effect. The Company and Endo did not dismiss the patent infringement claims because IMPAX refused to withdraw its prior Paragraph IV certification notices. On January 25, 2008, Endo and the Company filed a lawsuit against IMPAX in U.S. Dist. Delaware, alleging infringement of certain Orange Book-listed patents in response to IMPAX’s December notice. Given the FDA’s acceptance of IMPAX’s ANDA as of November 23, 2007, we believe that we are entitled to a 30-month stay under the Hatch-Waxman Act beginning on December 14, 2007.

     On June 14, 2008, we and Endo each received a notice from IMPAX advising us and Endo that IMPAX had amended its ANDA for Opana ER to include three additional strengths, 7.5 mg, 15 mg and 30 mg. This ANDA amendment contained a Paragraph IV certification against our Orange Book listed patents, U.S. Patent Nos. 5,662,933, 5,958,456 and 7,276,250. On July 25, 2008, we and Endo filed a lawsuit against IMPAX in U.S. Dist.

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Delaware, alleging infringement of certain Orange Book — listed patents in response to the notice. We believe that we are entitled to a 30-month stay under the Hatch-Waxman Act beginning on June 14, 2008 with respect to IMPAX’s amended ANDA for 7.5 mg, 15 mg and 30mg.

     Actavis ANDA Litigation.

     On February 14, 2008, the Company received a notice from Actavis advising of the filing by Actavis of an ANDA containing a Paragraph IV certification under 21 U.S.C. Section 355(j) for Opana ER in four strengths, 5 mg, 10 mg, 20 mg and 40 mg. The Actavis Paragraph IV certification notice refers to the Company’s Orange Book listed patents, U.S. Patent Nos. 5,128,143, 5,662,933, 5,958,456 and 7,276,250, which cover the formulation of Opana ER. These patents expire in 2008, 2013, 2013 and 2023, respectively. On March 28, 2008, Endo and the Company filed a lawsuit against Actavis in the U.S. District Court of New Jersey, or U.S. Dist. Ct., NJ, alleging infringement of U.S. Patent No. 5,958,456. On June 2, 2008, we and Endo each received a notice from Actavis advising us and Endo that Actavis had amended its ANDA for Opana ER to include two additional strengths, 7.5 mg and 15 mg. On July 2, 2008, we and Endo each received a third notice from Actavis advising that Actavis had further amended its ANDA to include the 30mg strength. Each ANDA amendment contained a Paragraph IV certification against our Orange Book listed patents, U.S. Patent Nos. 5,128,143, 5,662,933, 5,958,456 and 7,276,250. On July 11, 2008, we and Endo filed a lawsuit against Actavis in the U.S. Dist. Ct., NJ alleging infringement of U.S. Patent No. 5,958,456 based on these two additional Paragraph IV certification notices from Actavis. We believe we are entitled to a 30-month stay with respect to Actavis’ ANDA covering Opana ER 5 mg, 10 mg, 20 mg and 40 mg beginning February 14, 2008, with respect to Actavis’ amended ANDA covering Opana ER 7.5 mg and 15 mg beginning June 2, 2008 and against its amended ANDA covering Opana ER 30 mg beginning July 2, 2008.

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. An updated description of the risk factors associated with our business is set forth below. This description includes any material changes to and supersedes the description of the risk factors associated with our business previously disclosed in Part II, Item 1A of our Quarterly Report on Form 10-Q for the three months ended March 31, 2008.

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

     We have incurred net losses since 1994, including net losses of $34.5 million, $31.3 million and $22.9 million during 2007, 2006 and 2005, respectively. For the six month period ended June 30, 2008, our net loss was $17.2 million. As of June 30, 2008, our accumulated deficit was approximately $224 million.

     Our strategy includes developing drug candidates to treat disorders of the nervous system which will require us to incur substantial costs and expenses associated with clinical trials, regulatory approvals and commercialization. As a result, we expect to continue to incur net losses until such time as we can generate significant revenue from Opana ER or other products that we develop. Net losses have had and will continue to have an adverse effect on our shareholders’ equity, total assets and working capital.

     Our future profitability will depend on several factors, including:

• the commercial success of Opana ER, and the timing and amount of royalties from Endo’s sales of Opana ER which may be affected by any potential generic entry;

• our ability to successfully defend our intellectual property protecting our products;

• our ability to access funding support for our development programs from third party collaborators;

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• the level of our investment in research and development activities, including the timing and costs of conducting clinical trials of our products;

• the timing and amount of payments to Edison in connection with the Edison agreement, as well as our costs of development for drug candidates to which we acquire rights under the Edison agreement;

• the successful development and commercialization of product candidates in our portfolio;

• the level of investment for acquisitions or in-licensing of compounds or technologies intended to support our growth; and

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

     We may require additional funding which may be difficult to obtain

     As of June 30, 2008, we had cash, cash equivalents and short-term investments of $28.7 million. We anticipate that, based upon our current operating plan, our existing capital resources, together with expected royalties from third parties, will be sufficient to fund our operations on an ongoing basis into at least late 2009. We currently anticipate that we will begin to recognize royalties from Endo related to Opana ER in the third quarter of 2008. In addition, we have taken measures to reduce our spending and to manage our costs more closely and are adjusting the pace and timing of our planned clinical programs to match these costs with our financial resources. Finally, we plan to seek to enter into collaboration and licensing agreements for nalbuphine ER and other of our products and technologies. If we are unsuccessful with these efforts, we may not be able to fund our ongoing operations until at least late 2009 without seeking additional funding from the capital markets. If the anticipated Opana ER royalties are delayed or less than we anticipate, if we are not successful in managing our costs more closely, or if we are unable to enter into collaboration and licensing agreements for our products or technologies on favorable terms or at all, we may need to seek financing sooner than we anticipate.

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

• the commercial success of Opana ER;

• the timing and amount of payments received under collaborative agreements, including in particular our agreement with Endo with respect to Opana ER and our agreement with Mylan with respect to Pfizer’s generic version of Procardia XL 30 mg;

• the timing and amount of payments to Edison in connection with the Edison agreement, as well as our internal costs of development for product candidates for which we acquired rights under this agreement;

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

• the level of investment for the acquisition or in-licensing of technologies or compounds intended to support our growth;

• our ability to enter into additional collaborations for our product candidates and technologies, and the structure and terms of any such future collaborative agreements;

• the prosecution, defense and enforcement of our patents and other intellectual property rights, such as our Orange Book listed patents for Opana ER;

• the level of our investments in capital expenditures for facilities and equipment; and

• our success in reducing our spending and managing our costs.

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     If we raise additional funds by issuing equity securities, it will result in further dilution to our then-existing shareholders. Debt financing, such as that under our current credit facility, 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 also 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 products, 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 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, including our planned clinical trials, which could harm our business, financial condition and operating results.

     Our ability to generate revenues depends heavily on the success of Opana ER

     We made a significant investment of our financial resources in the development of Opana ER. In the near term, our ability to generate significant revenues will depend primarily on the growth of Opana ER sales by Endo. Opana ER competes with a number of approved drugs manufactured and marketed by major pharmaceutical companies and generic versions of some of these drugs. It may have to compete against new drugs and generic versions of Opana ER that may enter the market in the future.

     The degree of market success of Opana ER depends on a number of factors, including:

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

• Endo’s ability to educate the medical community about the benefits, safety profile and efficacy of Opana ER;

• the effectiveness of Endo’s sales and marketing activities;

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

• the reimbursement policies of government and third party payors with respect to Opana ER;

• the pricing of Opana ER;

• the level of stocking of Opana ER by wholesalers and retail pharmacies; and

• the availability of generic versions of Opana ER and the timing of generic competition.

     IMPAX and Actavis have each filed an ANDA that, together with their respective amendments, cover all seven strengths of Opana ER. Sandoz has also filed an ANDA that covers the Opana ER 5 mg, 10 mg, 20 mg and 40 mg strengths. We and Endo have filed patent infringement lawsuits against each of IMPAX and Actavis in connection with their respective ANDAs. Descriptions of these lawsuits are included in “Part II. Item 1. — Legal Proceedings.”

     We and Endo intend to pursue all available legal and regulatory avenues defending Opana ER. We believe that we are entitled to a 30-month stay against IMPAX’s ANDA and Actavis’ ANDA. We are currently evaluating our options with regard to the Sandoz ANDA. IMPAX also announced that it is seeking to reinstate an earlier filing date of its ANDA covering Opana ER 5mg, 10 mg, 20 mg and 40 mg. If this occurs or if we and Endo are unsuccessful in our Hatch-Waxman suits, Opana ER could be subject to generic competition as early as June 2009 when the new dosage form exclusivity expires. We expect that competition from at least three generic companies could cause significant erosion to the pricing of Opana ER, which in turn would adversely affect the royalties that we expect to receive from Endo and our results of operations and financial condition.

     If Opana ER sales do not grow steadily or substantially, it would have a material adverse effect on our business, financial condition and results of operations.

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     In the event that we are able to obtain regulatory approval of any of our other products candidates, the success of those products would also depend upon their acceptance by physicians, patients, third party payors or the medical community in general. There can be no assurance as to market acceptance of our drug products or our drug delivery technologies.

     Our success depends on our ability to protect our patents and other intellectual property rights

     Our success depends in significant part on our ability to obtain patent protection for our products, both in the United States and in other countries, and our ability to enforce these patents. Patent positions can be uncertain and may involve complex legal and factual questions. Patents may not be issued from any patent applications that we own or license. If patents are issued, the claims allowed may not be as broad as we have anticipated and may not sufficiently cover our drug products or our technologies. In addition, issued patents that we own or license may be challenged, invalidated or circumvented and we may not be able to bring suit to enforce these patents. We have four issued U.S. patents listed in the Orange Book for Opana ER. As the owner of the patents listed in the Orange Book for Opana ER, we may become a party to Hatch-Waxman litigation. We and Endo filed patent infringement suits against IMPAX and Actavis in connection with their respective ANDAs for Opana ER. We believe that we are entitled to the “30-month stay” available under the Hatch-Waxman Act against each of IMPAX and Actavis because we initiated the suit within 45 days of our receipt of their respective notice letters. However, IMPAX has publicly disclosed that it is seeking to reinstate an earlier filing date of its ANDA covering Opana ER 5 mg, 10 mg, 20 mg and 40 mg. If IMPAX is successful, we will not be entitled to the 30-month stay against IMPAX in these four strengths. If we proceed with the Hatch-Waxman litigation, we may not prevail on defending our patents. Litigation is inherently unpredictable and unfavorable rulings do occur. An unfavorable ruling or loss of 30-month stay could subject Opana ER to generic competition as early as June 2009 when the new dosage form exclusivity for Opana ER expires. We expect that generic competition would adversely affect the pricing of Opana ER, the royalties that we expect to receive from Endo and results of our operations and financial condition.

     Our research, development and commercialization activities or any products in development may infringe or be claimed to infringe patents of competitors or other third parties. In such event, we may be ordered to pay such third party lost profits or punitive damages. We may have to seek a license from a third party and pay license fees or royalties. Awards of patent damages can be substantial. Licenses may not be available or available on acceptable terms, or the licenses 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 ability to maintain the confidentiality of our trade secrets. We seek to protect such information by entering into confidentiality agreements with employees, consultants, licensees and other companies. These agreements may be breached by such parties. We may not be able to obtain an adequate remedy to such a breach. In addition, our trade secrets may otherwise become publicly known or be independently developed by our competitors.

     We are dependent on our collaborators to manufacture and commercialize our products

     We have historically collaborated with partners to facilitate the manufacture and commercialization of our products and product candidates. We continue to depend on our collaborators to manufacture, market and sell our products. In particular, we are dependent on Endo to manufacture, market and sell Opana ER in the United States and on Mylan to market and sell Pfizer’s generic version of Procardia XL 30 mg.

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

     Our existing collaborations may be subject to termination on short notice under certain circumstances such as upon a bankruptcy event or if we breach the agreement. If any of our collaborations are terminated, we may be

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required to devote additional internal 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:

• 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 could reduce the revenues we receive on the products.

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

• Disputes may arise between us and our collaborators from time to time regarding contractual or other matters. In 2006, we were engaged in a dispute with Endo with regard to the sharing of marketing expenses during the period prior to when Opana ER reaches profitability. In January 2007, we resolved our dispute as part of an amendment to the strategic alliance agreement between us and Endo. Any other such disputes with Endo or other collaborators could be time consuming and expensive, and could impact our anticipated rights under our agreements with those collaborators.

     We have limited experience in developing, manufacturing, marketing and selling pharmaceutical products

     We have limited experience in developing, manufacturing, marketing and selling pharmaceutical products. In the past, we have relied on our collaborators to manufacture, market and sell our products. We intend to develop more drug candidates independently and be responsible for the manufacturing, marketing and selling of these products. Under our collaboration with Edison, we are responsible for pharmaceutical and clinical development, seeking regulatory approvals, manufacturing, and marketing of the products we license from Edison. Accordingly, we will have to continue to develop our own capabilities in these areas.

     If we cannot establish our own capabilities successfully and on a timely basis, we may not be able to develop or commercialize these drug candidates. Developing our own capabilities may be expensive and time consuming and could delay the commercialization of the products we are developing.

The Drug Enforcement Agency, or DEA, limits the availability of the active drug substances used in Opana ER. As a result, Endo’s procurement quota may not be sufficient to meet commercial demand

     Under the Controlled Substances Act of 1970, the DEA regulates chemical compounds as Schedule I, II, III, IV or V substances, with Schedule I substances considered to present the highest risk of substance abuse and Schedule V substances the lowest risk. The active drug substance in Opana ER, oxymorphone hydrochloride, is listed by the DEA as a Schedule II substance. Consequently, the manufacture, shipment, storage, sale, prescribing, dispensing and use of Opana ER are subject to a higher degree of regulation. For example, all Schedule II drug prescriptions must be written and signed by a physician, physically presented to a pharmacist and may not be refilled without a new prescription.

     Furthermore, the DEA limits the availability of the active drug substance used in Opana ER. As a result, Endo’s procurement quota of the active drug substance may not be sufficient to meet commercial demands. Endo must apply to the DEA annually for procurement quota in order to obtain the substance. Any delay or refusal by the DEA in establishing the procurement quota could cause trade inventory disruptions, which could have a material adverse effect on our business, financial condition and results of operations.

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

     The pharmaceutical industry is highly competitive and is affected by new technologies, governmental regulations, healthcare legislation, availability of financing 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 drug 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; or

• 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, pricing, patent position and other factors. Our competitors may develop or commercialize more effective, safer or more affordable products, or obtain more effective patent protection. 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 the oral osmotic pump (OROS) technology marketed by Johnson & Johnson, multiparticulate systems marketed by Elan Corporation plc, Biovail Corporation and KV Pharmaceutical Company, and traditional matrix systems marketed by SkyePharma plc.

     Opana ER faces, and our products in development will face, competition from products with the same indications. For instance, Opana ER competes in the moderate to severe long acting opioid market with products such as OxyContin and MS Contin, Duragesic patch, Avinza and Kadian and the generic versions of some of these drugs. Opana ER may also be subject to competition from generic versions of the product, such as the generic versions being developed by IMPAX, Actavis and Sandoz.

     Nalbuphine ER, if approved, will face competition from products in the moderate chronic pain market. A number of pharmaceutical companies currently market and sell products to treat moderate chronic pain that we expect will compete with nalbuphine ER ranging from NSAIDs to strong opioids and including products containing tramadol, hydrocodone, codeine or propoxyphine such as Ultram, Vicodin and Darvon.

     Products developed through our collaboration with Edison may compete against products being developed by numerous private and public companies for at least some of the indications we may pursue. Various companies and institutions are conducting studies in the area of inherited mitochondrial disease. At least two companies have announced that they are pursuing programs based upon mitochondrial disease pathways. Santhera Pharmaceuticals is developing the coenzyme Q analog molecule, idebenone. They are in active clinical development in the diseases of Friedreich’s ataxia, Duchenne muscular dystrophy, and Leber’s Hereditary Optic Neuropathy. GlaxoSmithKline plc. is targeting the mitochondrial metabolic pathways and is planning to study the mitochondrial respiratory chain disease MELAS (mitochondrial myopathy, encephalopathy, lactic acidosis and stroke) syndrome. If these companies are able to receive regulatory approvals for their products before we do, it may negatively impact our ability to achieve market acceptance of our products. If their products are more effective, safer or more affordable, our products may not be competitive.

     Some of the products we are developing are proprietary products that are based on active drug substances that are not protected by patents. These products will compete against other products developed using the same or similar

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active drug substances, including branded products, as well as their generic versions, based primarily on price. In addition, our products may compete against other competitive products in the same therapeutic class.

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, either because the FDA or other regulatory agencies object or for other reasons. With respect to our approved products, including Opana ER, we have relied on our collaborators to conduct clinical trials and obtain regulatory approvals. We intend to develop the product candidates we obtain under our collaboration with Edison independently, including controlling the clinical trials and regulatory submissions with the FDA. We have limited experience in conducting Phase II and Phase III clinical trials and to date have not obtained approval for the marketing of a drug product. In 2005, we submitted an NDA for a product we were developing, PW2101, but we received a non-approvable letter from the FDA and terminated the development program.

     Even if we complete a clinical trial of one of our potential products, the clinical trial may not prove 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. We or our collaborators may decide, or regulators may require us or our collaborators, to conduct additional clinical trials. For example, Endo received an approvable letter for Opana ER from the FDA in response to its NDA for Opana ER, which required Endo to conduct an additional clinical trial and which significantly delayed the approval of Opana ER. In addition, regulators may require post-marketing testing and surveillance to monitor the safety and efficacy of a product.

     Some of the drug candidates we are developing are in the early stages of development. There is limited information and understanding of the safety and efficacy of these drug candidates. There may not be any clinical data available. We will have to conduct preclinical testing and clinical studies to demonstrate the safety and efficacy of these drug candidates. 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, and IRB 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

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

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

     We have received Orphan Drug designation for A0001 from the FDA for the treatment of inherited mitochondrial respiratory chain diseases. We plan to file for orphan drug status for A0001 in the European Union. The FDA and the European Union regulatory authorities grant Orphan Drug designation to drugs intended to treat a rare disease or condition, which is generally a disease or

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condition that affects fewer than 200,000 individuals in the United States and fewer than five in 10,000 individuals in the European Union.

     Generally, if a product with an orphan drug designation subsequently receives the first marketing approval for the indication for which it has such designation, the product is entitled to orphan drug exclusivity. Orphan drug exclusivity means that another application to market the same drug for the same indication may not be approved for a period of up to 10 years in the European Union, and for a period of seven years in the United States, except in limited circumstances set forth in the U.S. Federal Food, Drug and Cosmetic Act. Obtaining orphan drug designations and orphan drug exclusivity for our products for the treatment of inherited mitochondrial respiratory chain diseases may be critical to the success of these products. If our competitor receives marketing approval before we do for a drug that is considered the same as our drug candidate for the same indication we are pursuing, we will be prevented from receiving marketing approval for our drug candidate during the orphan drug exclusivity period of the competitor.

     Even if we obtain orphan drug exclusivity for any of our potential products, we may not be able to maintain it. If a competitor product, containing the same drug as our product and seeking approval for the same indication, is shown to be clinically superior to our product, any orphan drug exclusivity we have obtained will not block the approval of such competitor product. In addition, if a competitor develops a different drug for the same indication as our approved indication, our orphan drug exclusivity will not prevent the competitor drug from obtaining marketing approval.

     Orphan Drug designation does not convey any advantage in, or shorten the duration of, the regulatory review and approval process. Obtaining Orphan Drug designation may not provide us with a material commercial advantage.

Even if we are able to obtain regulatory approvals for any of our product candidates, if they exhibit harmful side effects after approval, our regulatory approvals could be revoked or otherwise negatively impacted, and we could be subject to costly and damaging product liability claims

     Even if we receive regulatory approval for A0001 or any other product candidate developed through our collaboration with Edison, we will have tested them in only a small number of carefully selected patients during our clinical trials. If our applications for marketing are approved and more patients from the general population begin to use our products, new risks and side effects associated with our products may be discovered. As a result, regulatory authorities may revoke their approvals. In addition, we may be required to conduct additional clinical trials, make changes in labeling of our products, reformulate our product or make changes and obtain new approvals for our and our suppliers’ manufacturing facilities. We might have to withdraw or recall our products from the marketplace. We may also experience a significant drop in the potential sales of our product if and when regulatory approvals for such product are obtained, experience harm to our reputation in the marketplace or become subject to lawsuits, including class actions. Any of these results could decrease or prevent any sales of our approved product or substantially increase the costs and expenses of commercializing and marketing our product.

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

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

     In 2005, Purdue Pharma voluntarily withdrew from the market its product Palladone^® (hydromorphone hydrochloride extended release capsules), 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 the drug with alcohol use, showed that when Palladone is taken with alcohol, the extended release mechanism can fail and may lead to dose-dumping. In anticipation of questions from the FDA with respect to the potential dose-dumping effect of Opana ER given the FDA’s experience with Palladone, Endo conducted both

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in vitro and human testing of the effect of alcohol on Opana ER. In the in vitro testing, Endo did not find any detectible effect of alcohol on the time release mechanism of the product. In the human testing in the presence of alcohol, there was evidence of an increase in blood levels. The FDA received this data before approving the NDA and required that the Opana ER labeling specifically warn against taking the drug with alcohol of any kind.

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 or does not approve them in a timely fashion, our business and financial condition may be adversely affected. Furthermore, the terms of marketing approval of any application, including the labeling content, may be more restrictive than we desire and could affect the marketability of our products.

     Certain products containing our controlled release technologies require the submission of a full NDA. A full NDA must include complete reports of preclinical, clinical and other studies to prove adequately that the product is safe and effective. These studies may involve, among other things, full clinical testing, which requires the expenditure of substantial resources. The drug candidates we are developing in collaboration with Edison will also require submission of full NDAs. In certain other cases when we seek to develop a controlled release formulation of an FDA-approved drug with the same active drug substance, we may be able to rely on previous FDA determinations of safety and efficacy of the approved drug to support a section 505(b)(2) NDA. We can provide no assurance, however, that the FDA will accept a submission of a section 505(b)(2) NDA for any particular product. Even if the FDA did accept such a submission, the FDA may not approve the application in a timely manner or at all. The FDA may also require us to perform additional studies to support the modifications of the reference listed drug.

     In addition, both before and after regulatory approval, we, our collaborators, our products, and our product candidates are subject to numerous FDA regulations, among other things, covering testing, manufacturing, quality control, current Good Manufacturing Practices or cGMP, adverse event reporting, labeling, advertising, promotion, distribution and export of drug products. We and our collaborators are subject to surveillance and periodic inspection by the FDA to ascertain compliance with these regulations. The relevant law and regulations may also 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.

The recently enacted Food and Drug Administration Amendment Act of 2007, or FDAAA, may make it more difficult and costly for us to obtain regulatory approval of our product candidates and to produce, market and distribute products after approval.

     The FDAAA grants a variety of new powers to the FDA, many of which are aimed at improving the safety of drug products before and after approval. Under the FDAAA, companies that violate the new law are subject to substantial civil monetary penalties. While we expect the FDAAA to have a substantial effect on the pharmaceutical industry, the extent of that effect is not yet known. As the FDA issues regulations, guidances and interpretations relating to the new legislation, the impact on the industry, as well as our business, will become clearer. The new requirements and other changes that the FDAAA imposes may make it more difficult, and likely more costly, to obtain approval of new pharmaceutical products and to produce, market and distribute products after approval.

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Opana ER contains a narcotic ingredient. As a result of reported misuse and abuse of prescription narcotics, the sale of Opana ER is subject to additional regulations, including compliance with risk management programs, which may prove difficult or expensive to comply with; and we and Endo may face lawsuits

     Opana ER contains a narcotic ingredient. Misuse or abuse of drugs containing narcotic ingredients can lead to physical or other harm. In the past few years, for example, reported misuse and abuse of OxyContin, a product containing the narcotic oxycodone, resulted in the strengthening of warnings on its labeling. The sponsor of OxyContin also faced numerous lawsuits, including class action lawsuits, related to OxyContin misuse or abuse. Misuse or abuse of Opana ER could also lead to additional regulation of Opana ER and subject us and Endo to litigation.

We may become involved in patent litigation or other proceedings relating to our products or processes, which could result in liability for damages or termination of our development and commercialization programs

     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 intellectual property rights.

• 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 our rights in such proceedings.

     An adverse outcome in any litigation or other proceeding could subject us to significant liabilities and/or 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 to obtain it on commercially acceptable terms.

     The cost of any patent litigation or other proceeding, even if resolved in our favor, could be substantial. We could incur significant costs in participating or assisting in the litigation. Our competitors may have substantially greater resources to sustain the cost of such litigation and proceedings more effectively than we can. 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 materials or other products we are developing. We currently rely on Draxis Specialty Pharmaceuticals Inc. for the bulk manufacture of our TIMERx materials under a manufacturing and supply agreement with an initial term that expires in November 2009. The agreement automatically renews for successive one-year periods, unless either party gives notice of its intent not to renew the agreement at least 180 days prior to the end of the then-current term. 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 that comply with cGMP regulations who are capable of manufacturing our TIMERx materials. Although we have qualified alternate suppliers with respect to the xanthan gum and locust bean gum used to manufacture our TIMERx materials, we currently do not have a second supplier of TIMERx materials. If Draxis is unable to manufacture the TIMERx materials in the required quantities or fails to do so on a timely basis, or if Draxis does not agree to renew our agreement when it expires or renew it on terms acceptable to us, we may not be able 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, particularly as drug candidates advance through clinical development and

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move closer to regulatory approval, our business and the development and commercialization of our products could be materially adversely affected. There can be no assurance that Draxis or any other third parties we rely on for supply of our TIMERx materials or other products will perform. Any failures by third party manufacturers may delay the development of products or the submission for regulatory approval, impair our or 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 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 Opana ER or our other products;

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

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

     We may not be able to successfully develop our own manufacturing capabilities. If we decide to develop our own manufacturing capabilities, we will need to recruit qualified personnel, and build or lease the requisite facilities and equipment we currently do not have. Moreover, it may be very costly and time consuming to develop such capabilities.

     The manufacture of our products is subject to regulations by the FDA and similar agencies in foreign countries. Any delay in complying or failure to comply with such manufacturing regulations 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 materials

     Our TIMERx drug delivery systems are based on a hydrophilic matrix combining a heterodispersed mixture primarily composed of two polysaccharides, xanthan gum and locust bean gum, in the presence of dextrose. These gums are also used in our Geminex, gastroretentive and SyncroDose drug delivery systems. We and Draxis 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. Any interruption in these supplies could have a material adverse effect on our ability to manufacture bulk TIMERx materials for delivery to our collaborators.

If we or our collaborators fail to obtain an adequate level of reimbursement by governmental or third party payors for Opana ER or any other products we develop, we may not be able to successfully commercialize the affected product

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

     In both the United States and certain foreign jurisdictions, there have been a number of legislative and regulatory proposals to change the healthcare system. Further proposals are likely. The final adoption of these proposals may affect our or our collaborators’ ability to set prices which provide an adequate return on our investment.

     We expect Endo to experience pricing pressure with respect to Opana ER. We may experience similar pressure for other products for which we obtain marketing approvals in the future due to the trend toward managed healthcare, the increasing influence of health maintenance organizations and additional legislative proposals. Neither we nor our collaborators may be able to sell 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.

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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 that are inherent in the testing, manufacturing, marketing and sale of pharmaceutical products. Product liability claims might be made by consumers, healthcare providers, other pharmaceutical companies, or third parties that sell our products. These claims may be made even with respect to those products that are manufactured in regulated facilities or that otherwise possess regulatory approval for commercial sale.

     We are currently covered by a 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 all 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 potential liability claims. Claims that are not covered by product liability insurance could have a material adverse effect on our business, financial condition and results of operations.

If we are unable to retain our key personnel and continue to attract additional professional staff, we may not be able to maintain or expand our business

     Because of the scientific nature of our business, our ability to develop products and compete with our current and future competitors will remain highly dependent upon our ability to attract and retain qualified scientific, technical, commercial and managerial personnel. The loss of key scientific, technical, commercial or managerial personnel or the failure to recruit additional key scientific, technical, commercial or managerial personnel could have a material adverse effect on our business. We do not have employment agreements with our key executives and we cannot guarantee that we will succeed in retaining all of our key personnel. There is intense competition for qualified personnel in our industry, and there can be no assurance that we will be able to continue to attract and retain the qualified personnel necessary for the success of our business.

The market price of our common stock may be volatile

     The market price of our common stock, like the market prices for securities of other pharmaceutical, biopharmaceutical and biotechnology companies, has been volatile. For example, the high and low closing prices of our common stock were $5.41 per share and $2.50 per share, respectively, for the six months ended June 30, 2008. On August 4, 2008, the closing price of our common stock was $3.46. The market from time to time experiences significant price and volume fluctuations that are unrelated to the operating performance of particular companies. The market price of our common stock may also fluctuate as a result of our operating results, sales of Opana ER, future sales of our common stock, announcements of technological innovations, new therapeutic products or new generic products by us or our competitors, announcements regarding collaborative agreements, clinical trial results, government regulations, 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 other general market conditions.

Specific provisions of our Shareholder Rights Plan, Articles of Incorporation and Bylaws and the laws of Washington State make a takeover of Penwest or a change in control or management of Penwest more difficult

     Various provisions of our Articles of Incorporation, our Bylaws and Washington law may have the effect of deterring hostile takeovers or delaying or preventing changes in control or management of our company, including transactions in which our 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. Until July 27, 2008, we had a shareholder rights plan, often referred to as a poison pill. We may in the future adopt a rights plan or other measures that may have the effect of deterring hostile takeovers or delaying or preventing changes in control or management of our company.

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

     At our Annual Meeting of Shareholders held on June 11, 2008, the following proposals were adopted by the vote specified below:

a. Election of directors by class:

	For		Withheld
Class I
Christophe Bianchi		22,966,592		1,032,067
Class II
Peter F. Drake		22,879,284		1,119,375
David P. Meeker		22,966,605		1,032,054
Anne M. VanLent		22,959,205		1,039,454
Class III
William James O’Shea		22,885,472		1,113,187

     Mr. Bianchi was elected for a term until the annual meeting of shareholders to be held in 2010 or until his successor is duly elected and qualified; Drs. Drake and Meeker and Ms. VanLent were each elected for a term until the annual meeting of shareholders to be held in 2011 or until his or her successor is duly elected and qualified; and Mr. O’Shea was elected for a term until the annual meeting of shareholders to be held in 2009 or until his successor is duly elected and qualified.

     The following directors did not stand for reelection as their terms of office continued after the annual meeting: Paul E. Freiman, Jennifer L. Good, Robert J. Hennessey, and John N. Staniforth.

b. Ratification of the selection of Ernst & Young LLP as our independent registered public accounting firm for the current year:

For	Against	Abstain
23,909,580	28,232	60,847

c. Approval of the amendment to the 2005 Stock Incentive Plan to increase the number of shares of common stock authorized for issuance under the plan from 1,650,000 to 4,150,000, and to increase the maximum number of shares of common stock with respect to which restricted stock awards and other stock unit awards that either require no purchase by a participant or vest on the basis of the passage of time alone that may be granted under the 2005 plan from 1,000,000 to 1,500,000:

For	Against	Abstain	Broker Non-Votes
12,250,416	3,106,759	7,996	8,633,488

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.

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SIGNATURE

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

	PENWEST PHARMACEUTICALS CO.
Date: August 6, 2008	/s/ Benjamin L. Palleiko
	Benjamin L. Palleiko
	Senior Vice President, Corporate Development and Chief Financial Officer (Principal Financial Officer)

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EXHIBIT INDEX

Exhibit
Number		Description
	4.1	Amendment No 3. to Rights Agreement, dated as of April 18, 2008, between the Registrant and Mellon Investor Services LLC (incorporated herein by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on April 23, 2008 (File No. 000-23467)).
	10.1	2005 Stock Incentive Plan, as amended.
	31.1	Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
	31.2	Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
	32.1	Certification of Principal Executive 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.
	32.2	Certification of 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.

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EX-10.1

Exhibit 10.1

PENWEST PHARMACEUTICALS CO.

2005 STOCK INCENTIVE PLAN¹

1. Purpose

     The purpose of this 2005 Stock Incentive Plan (the “Plan”) of Penwest Pharmaceuticals Co., a Washington corporation (the “Company”), is to advance the interests of the Company’s shareholders by enhancing the Company’s ability to attract, retain and motivate persons who are expected to make important contributions to the Company and by providing such persons with equity ownership opportunities and performance-based incentives that are intended to align their interests with those of the Company’s shareholders. Except where the context otherwise requires, the term “Company” shall include any of the Company’s present or future parent or subsidiary corporations as defined in Sections 424(e) or (f) of the Internal Revenue Code of 1986, as amended, and any regulations promulgated thereunder (the “Code”) and any other business venture (including, without limitation, joint venture or limited liability company) in which the Company has a controlling interest, as determined by the Board of Directors of the Company (the “Board”).

2. Eligibility

     All of the Company’s employees, officers, directors, consultants and advisors are eligible to receive options, stock appreciation rights, restricted stock, restricted stock units and other stock-based awards (each, an “Award”) under the Plan. Each person who receives an Award under the Plan is deemed a “Participant”.

3. Administration and Delegation

     (a) Administration by Board of Directors. The Plan will be administered by the Board. The Board shall have authority to grant Awards and to adopt, amend and repeal such administrative rules, guidelines and practices relating to the Plan as it shall deem advisable. The Board may correct any defect, supply any omission or reconcile any inconsistency in the Plan or any Award in the manner and to the extent it shall deem expedient to carry the Plan into effect and it shall be the sole and final judge of such expediency. All decisions by the Board shall be made in the Board’s sole discretion and shall be final and binding on all persons having or claiming any interest in the Plan or in any Award. No director or person acting pursuant to the authority delegated by the Board shall be liable for any action or determination relating to or under the Plan made in good faith.

¹ Reflects amendments to the plan approved by the Company’s Board of Directors on September 7, 2006 and amendments to the plan approved by the Company’s Board of Directors on April 24, 2008 and the Company’s shareholders on June 11, 2008.

     (b) Appointment of Committees. To the extent permitted by applicable law, the Board may delegate any or all of its powers under the Plan to one or more committees or subcommittees of the Board (a “Committee”). All references in the Plan to the “Board” shall mean the Board or a Committee of the Board to the extent that the Board’s powers or authority under the Plan have been delegated to such Committee.

     (c) Delegation to Officers. To the extent permitted by applicable law, the Board may delegate to one or more officers of the Company the power to grant Awards to employees or officers of the Company or any of its present or future subsidiary corporations and to exercise such other powers under the Plan as the Board may determine, provided that the Board shall fix the terms of the Awards to be granted by such officers (including the exercise price of such Awards, which may include a formula by which the exercise price will be determined) and the maximum number of shares subject to Awards that the officers may grant; provided further, however, that no officer shall be authorized to grant Awards to any “executive officer” of the Company (as defined by Rule 3b-7 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) or to any “officer” of the Company (as defined by Rule 16a-1 under the Exchange Act).

4. Stock Available for Awards

     (a) Number of Shares. Subject to adjustment under Section 9, Awards may be made under the Plan for up to 4,150,000 shares of common stock, $0.001 par value per share, of the Company (the “Common Stock”). If any Award expires or is terminated, surrendered or canceled without having been fully exercised or is forfeited in whole or in part (including as the result of shares of Common Stock subject to such Award being repurchased by the Company at the original issuance price pursuant to a contractual repurchase right) or results in any Common Stock not being issued, the unused Common Stock covered by such Award shall again be available for the grant of Awards under the Plan, subject, however, in the case of Incentive Stock Options (as hereinafter defined), to any limitations under the Code. Shares issued under the Plan may consist in whole or in part of authorized but unissued shares or treasury shares.

     (b) Sub-limits. Subject to adjustment under Section 9, the following sub-limits on the number of shares subject to Awards shall apply:

          (1) Section 162(m) Per-Participant Limit. The maximum number of shares of Common Stock with respect to which Awards may be granted to any Participant under the Plan in any calendar year shall be 500,000 per calendar year. For purposes of the foregoing limit, the combination of an Option in tandem with an SAR (as each is hereafter defined) shall be treated as a single Award. The per-Participant limit described in this Section 4(b)(1) shall be construed and applied consistently with Section 162(m) of the Code or any successor provision thereto, and the regulations thereunder (“Section 162(m)”).

          (2) Limit on Awards that Vest Based Upon the Passage of Time Alone. The maximum number of shares of Common Stock with respect to which Restricted Stock Awards

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and Other Stock Unit Awards (as defined in Section 8) that either require no purchase by the Participant or vest on the basis of the passage of time alone may be granted shall be 1,500,000.

5. Stock Options

     (a) General. The Board may grant options to purchase Common Stock (each, an “Option”) and determine the number of shares of Common Stock to be covered by each Option, the exercise price of each Option and the conditions and limitations applicable to the exercise of each Option, including conditions relating to applicable federal or state securities laws, as it considers necessary or advisable. An Option which is not intended to be an Incentive Stock Option (as hereinafter defined) shall be designated a “Nonstatutory Stock Option”.

     (b) Incentive Stock Options. An Option that the Board intends to be an “incentive stock option” as defined in Section 422 of the Code (an “Incentive Stock Option”) shall only be granted to employees of Penwest Pharmaceuticals Co., any of Penwest Pharmaceutical Co.’s present or future parent or subsidiary corporations as defined in Sections 424(e) or (f) of the Code, and any other entities the employees of which are eligible to receive Incentive Stock Options under the Code, and shall be subject to and shall be construed consistently with the requirements of Section 422 of the Code. The Company shall have no liability to a Participant, or any other party, if an Option (or any part thereof) that is intended to be an Incentive Stock Option is not an Incentive Stock Option or for any action taken by the Board pursuant to Section 10(f), including without limitation the conversion of an Incentive Stock Option to a Nonstatutory Stock Option.

     (c) Exercise Price. The Board shall establish the exercise price at the time each Option is granted and specify such exercise price in the applicable option agreement; provided, however, that the exercise price shall be not less than 100% of the Fair Market Value (as defined in Section 5(h)(3) below) at the time the Option is granted.

     (d) Duration of Options. Each Option shall be exercisable at such times and subject to such terms and conditions as the Board may specify in the applicable option agreement; provided, however, that no Option will be granted for a term in excess of 10 years.

     (e) Limitation on Repricing. Unless such action is approved by the Company’s shareholders: (1) no outstanding Option granted under the Plan may be amended to provide an exercise price per share that is lower than the then-current exercise price per share of such outstanding Option (other than adjustments pursuant to Section 9) and (2) the Board may not cancel any outstanding Option (whether or not granted under the Plan) and grant in substitution therefor new Awards under the Plan covering the same or a different number of shares of Common Stock and having an exercise price per share lower than the then-current exercise price per share of the cancelled Option.

     (f) No Reload Rights. No Option granted under the Plan shall contain any provision entitling the optionee to the automatic grant of additional Options in connection with any exercise of the original Option.

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     (g) Exercise of Option. Options may be exercised by delivery to the Company of a written notice of exercise signed by the proper person or by any other form of notice (including electronic notice) approved by the Board together with payment in full as specified in Section 5(h) for the number of shares for which the Option is exercised. Shares of Common Stock subject to the Option will be delivered by the Company following exercise either as soon as practicable or, subject to such conditions as the Board shall specify, on a deferred basis (with the Company’s obligation to be evidenced by an instrument providing for future delivery of the deferred shares at the time or times specified by the Board).

     (h) Payment Upon Exercise. Common Stock purchased upon the exercise of an Option granted under the Plan shall be paid for as follows:

          (1) in cash, by wire transfer to the Company, by bank transfer to the Company or by check, payable to the order of the Company;

          (2) if provided by the Board in an option agreement, by (i) delivery of an irrevocable and unconditional undertaking by a creditworthy broker to deliver promptly to the Company sufficient funds to pay the exercise price and any required tax withholding or (ii) delivery by the Participant to the Company of a copy of irrevocable and unconditional instructions to a creditworthy broker to deliver promptly to the Company cash or a check sufficient to pay the exercise price and any required tax withholding;

          (3) if provided by the Board and for so long as the Common Stock is registered under the Securities Exchange Act of 1934 (the “Exchange Act”), by delivery of shares of Common Stock owned by the Participant valued at their fair market value as determined by (or in a manner approved by) the Board (“Fair Market Value”), provided (i) such method of payment is then permitted under applicable law, (ii) such Common Stock, if acquired directly from the Company, was owned by the Participant for such minimum period of time, if any, as may be established by the Board in its discretion and (iii) such Common Stock is not subject to any repurchase, forfeiture, unfulfilled vesting or other similar requirements;

          (4) to the extent permitted by applicable law and by the Board, by (i) delivery of a promissory note of the Participant to the Company on terms determined by the Board, or (ii) payment of such other lawful consideration as the Board may determine; or

          (5) by any combination of the above permitted forms of payment.

     (i) Substitute Options. In connection with a merger or consolidation of an entity with the Company or the acquisition by the Company of property or stock of an entity, the Board may grant Options in substitution for any options or other stock or stock-based awards granted by such entity or an affiliate thereof. Substitute Options may be granted on such terms as the Board deems appropriate in the circumstances, notwithstanding any limitations on Options contained in the other sections of this Section 5 or in Section 2.

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6. Stock Appreciation Rights

     (a) General. A Stock Appreciation Right, or SAR, is an Award entitling the holder, upon exercise, to receive an amount in Common Stock determined by reference to appreciation, from and after the date of grant, in the fair market value of a share of Common Stock. The date as of which such appreciation or other measure is determined shall be the exercise date.

     (b) Grants. Stock Appreciation Rights may be granted in tandem with, or independently of, Options granted under the Plan.

          (1) Tandem Awards. When Stock Appreciation Rights are expressly granted in tandem with Options, (i) the Stock Appreciation Right will be exercisable only at such time or times, and to the extent, that the related Option is exercisable (except to the extent designated by the Board in connection with a Reorganization Event) and will be exercisable in accordance with the procedure required for exercise of the related Option; (ii) the Stock Appreciation Right will terminate and no longer be exercisable upon the termination or exercise of the related Option, except to the extent designated by the Board in connection with a Reorganization Event and except that a Stock Appreciation Right granted with respect to less than the full number of shares covered by an Option will not be reduced until the number of shares as to which the related Option has been exercised or has terminated exceeds the number of shares not covered by the Stock Appreciation Right; (iii) the Option will terminate and no longer be exercisable upon the exercise of the related Stock Appreciation Right; and (iv) the Stock Appreciation Right will be transferable only with the related Option.

          (2) Independent SARs. A Stock Appreciation Right not expressly granted in tandem with an Option will become exercisable at such time or times, and on such conditions, as the Board may specify in the SAR Award.

     (c) Exercise. Stock Appreciation Rights may be exercised by delivery to the Company of a written notice of exercise signed by the proper person or by any other form of notice (including electronic notice) approved by the Board, together with any other documents required by the Board.

     (d) Duration of SARs. Each SAR shall be exercisable at such times and subject to such terms and conditions as the Board may specify in the applicable agreement; provided, however, that no SAR will be granted for a term in excess of 10 years.

     (e) Limitation on Repricing. Unless such action is approved by the Company’s shareholders: (1) no outstanding SAR granted under the Plan may be amended to provide an exercise price per share that is lower than the then-current exercise price per share of such outstanding SAR (other than adjustments pursuant to Section 9) and (2) the Board may not cancel any outstanding SAR (whether or not granted under the Plan) and grant in substitution therefor new Awards under the Plan covering the same or a different number of shares of Common Stock and having an exercise price per share lower than the then-current exercise price per share of the cancelled SAR.

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7. Restricted Stock; Restricted Stock Units

     (a) General. The Board may grant Awards entitling recipients to acquire shares of Common Stock (“Restricted Stock”), subject to the right of the Company to repurchase all or part of such shares at their issue price or other stated or formula price (or to require forfeiture of such shares if issued at no cost) from the recipient in the event that conditions specified by the Board in the applicable Award are not satisfied prior to the end of the applicable restriction period or periods established by the Board for such Award. Instead of granting Awards for Restricted Stock, the Board may grant Awards entitling the recipient to receive shares of Common Stock to be delivered at the time such shares of Common Stock vest (“Restricted Stock Units”) (Restricted Stock and Restricted Stock Units are each referred to herein as a “Restricted Stock Award”).

     (b) Terms and Conditions. The Board shall determine the terms and conditions of a Restricted Stock Award, including the conditions for repurchase (or forfeiture) and the issue price, if any.

     (c) Stock Certificates. Any stock certificates issued in respect of a Restricted Stock Award shall be registered in the name of the Participant and, if determined by the Board, deposited by the Participant, together with a stock power endorsed in blank, with the Company (or its designee). At the expiration of the applicable restriction periods, the Company (or such designee) shall deliver the certificates no longer subject to such restrictions to the Participant or if the Participant has died, to the beneficiary designated, in a manner determined by the Board, by a Participant to receive amounts due or exercise rights of the Participant in the event of the Participant’s death (the “Designated Beneficiary”). In the absence of an effective designation by a Participant, “Designated Beneficiary” shall mean the Participant’s estate.

8. Other Stock-Based Awards

     Other Awards of shares of Common Stock, and other Awards that are valued in whole or in part by reference to, or are otherwise based on, shares of Common Stock or other property, may be granted hereunder to Participants (“Other Stock Unit Awards”), including without limitation Awards entitling recipients to receive shares of Common Stock to be delivered in the future. Such Other Stock Unit Awards shall also be available as a form of payment in the settlement of other Awards granted under the Plan or as payment in lieu of compensation to which a Participant is otherwise entitled. Other Stock Unit Awards may be paid in shares of Common Stock or cash, as the Board shall determine. Subject to the provisions of the Plan, the Board shall determine the conditions of each Other Stock Unit Awards, including any purchase price applicable thereto.

9. Adjustments for Changes in Common Stock and Certain Other Events

     (a) Changes in Capitalization. In the event of any stock split, reverse stock split, stock dividend, recapitalization, combination of shares, reclassification of shares, spin-off or other

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similar change in capitalization or event, or any distribution to holders of Common Stock other than an ordinary cash dividend, (i) the number and class of securities available under this Plan, (ii) the sub-limits set forth in Section 4(b), (iii) the number and class of securities and exercise price per share of each outstanding Option, (iv) the share- and per-share provisions of each Stock Appreciation Right, (v) the repurchase price per share subject to each outstanding Restricted Stock Award and (vi) the share- and per-share-related provisions of each outstanding Other Stock Unit Award, shall be appropriately adjusted by the Company (or substituted Awards may be made, if applicable) to the extent determined by the Board.

     (b) Reorganization Events.

          (1) Definition. A “Reorganization Event” shall mean: (a) any merger or consolidation of the Company with or into another entity as a result of which all of the Common Stock of the Company is converted into or exchanged for the right to receive cash, securities or other property or is cancelled, (b) any exchange of all of the Common Stock of the Company for cash, securities or other property pursuant to a share exchange transaction or (c) any liquidation or dissolution of the Company.

          (2) Consequences of a Reorganization Event on Awards Other than Restricted Stock Awards. In connection with a Reorganization Event, the Board shall take any one or more of the following actions as to all or any outstanding Awards on such terms as the Board determines: (i) provide that Awards shall be assumed, or substantially equivalent Awards shall be substituted, by the acquiring or succeeding corporation (or an affiliate thereof), (ii) upon written notice to a Participant, provide that the Participant’s unexercised Options or other unexercised Awards shall become exercisable in full and will terminate immediately prior to the consummation of such Reorganization Event unless exercised by the Participant within a specified period following the date of such notice, (iii) provide that outstanding Awards shall become realizable or deliverable, or restrictions applicable to an Award shall lapse, in whole or in part prior to or upon such Reorganization Event, (iv) in the event of a Reorganization Event under the terms of which holders of Common Stock will receive upon consummation thereof a cash payment for each share surrendered in the Reorganization Event (the “Acquisition Price”), make or provide for a cash payment to a Participant equal to (A) the Acquisition Price times the number of shares of Common Stock subject to the Participant’s Options or other Awards (to the extent the exercise price does not exceed the Acquisition Price) minus (B) the aggregate exercise price of all such outstanding Options or other Awards, in exchange for the termination of such Options or other Awards, (v) provide that, in connection with a liquidation or dissolution of the Company, Awards shall convert into the right to receive liquidation proceeds (if applicable, net of the exercise price thereof) and (vi) any combination of the foregoing.

          For purposes of clause (i) above, an Option shall be considered assumed if, following consummation of the Reorganization Event, the Option confers the right to purchase, for each share of Common Stock subject to the Option immediately prior to the consummation of the Reorganization Event, the consideration (whether cash, securities or other property) received as a result of the Reorganization Event by holders of Common Stock for each share of Common

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Stock held immediately prior to the consummation of the Reorganization Event (and if holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding shares of Common Stock); provided, however, that if the consideration received as a result of the Reorganization Event is not solely common stock of the acquiring or succeeding corporation (or an affiliate thereof), the Company may, with the consent of the acquiring or succeeding corporation, provide for the consideration to be received upon the exercise of Options to consist solely of common stock of the acquiring or succeeding corporation (or an affiliate thereof) equivalent in value (as determined by the Board) to the per share consideration received by holders of outstanding shares of Common Stock as a result of the Reorganization Event.

          (3) Consequences of a Reorganization Event on Restricted Stock Awards. Upon the occurrence of a Reorganization Event other than a liquidation or dissolution of the Company, the repurchase and other rights of the Company under each outstanding Restricted Stock Award shall inure to the benefit of the Company’s successor and shall apply to the cash, securities or other property which the Common Stock was converted into or exchanged for pursuant to such Reorganization Event in the same manner and to the same extent as they applied to the Common Stock subject to such Restricted Stock Award. Upon the occurrence of a Reorganization Event involving the liquidation or dissolution of the Company, except to the extent specifically provided to the contrary in the instrument evidencing any Restricted Stock Award or any other agreement between a Participant and the Company, all restrictions and conditions on all Restricted Stock Awards then outstanding shall automatically be deemed terminated or satisfied.

10. General Provisions Applicable to Awards

     (a) Transferability of Awards. Except as the Board may otherwise determine or provide in an Award, Awards shall not be sold, assigned, transferred, pledged or otherwise encumbered by the person to whom they are granted, either voluntarily or by operation of law, except by will or the laws of descent and distribution or, other than in the case of an Incentive Stock Option, pursuant to a qualified domestic relations order, and, during the life of the Participant, shall be exercisable only by the Participant. References to a Participant, to the extent relevant in the context, shall include references to authorized transferees.

     (b) Documentation. Each Award shall be evidenced in such form (written, electronic or otherwise) as the Board shall determine. Each Award may contain terms and conditions in addition to those set forth in the Plan.

     (c) Board Discretion. Except as otherwise provided by the Plan, each Award may be made alone or in addition or in relation to any other Award. The terms of each Award need not be identical, and the Board need not treat Participants uniformly.

     (d) Termination of Status. The Board shall determine the effect on an Award of the disability, death, retirement, authorized leave of absence or other change in the employment or other status of a Participant and the extent to which, and the period during which, the Participant,

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or the Participant’s legal representative, conservator, guardian or Designated Beneficiary, may exercise rights under the Award.

     (e) Withholding. Each Participant shall pay to the Company, or make provision satisfactory to the Company for payment of, any taxes required by law to be withheld in connection with an Award to such Participant. Except as the Board may otherwise provide in an Award, for so long as the Common Stock is registered under the Exchange Act, Participants may satisfy such tax obligations in whole or in part by delivery of shares of Common Stock, including shares retained from the Award creating the tax obligation, valued at their Fair Market Value; provided, however, except as otherwise provided by the Board, that the total tax withholding where stock is being used to satisfy such tax obligations cannot exceed the Company’s minimum statutory withholding obligations (based on minimum statutory withholding rates for federal and state tax purposes, including payroll taxes, that are applicable to such supplemental taxable income). Shares surrendered to satisfy tax withholding requirements cannot be subject to any repurchase, forfeiture, unfulfilled vesting or other similar requirements. The Company may, to the extent permitted by law, deduct any such tax obligations from any payment of any kind otherwise due to a Participant.

     (f) Amendment of Award. Except as otherwise provided in Section 5(e), the Board may amend, modify or terminate any outstanding Award, including but not limited to, substituting therefor another Award of the same or a different type, changing the date of exercise or realization, and converting an Incentive Stock Option to a Nonstatutory Stock Option, provided that the Participant’s consent to such action shall be required unless the Board determines that the action, taking into account any related action, would not materially and adversely affect the Participant.

     (g) Conditions on Delivery of Stock. The Company will not be obligated to deliver any shares of Common Stock pursuant to the Plan or to remove restrictions from shares previously delivered under the Plan until (i) all conditions of the Award have been met or removed to the satisfaction of the Company, (ii) in the opinion of the Company’s counsel, all other legal matters in connection with the issuance and delivery of such shares have been satisfied, including any applicable securities laws and any applicable stock exchange or stock market rules and regulations, and (iii) the Participant has executed and delivered to the Company such representations or agreements as the Company may consider appropriate to satisfy the requirements of any applicable laws, rules or regulations.

     (h) Acceleration. The Board may at any time provide that any Award shall become immediately exercisable in full or in part, free of some or all restrictions or conditions, or otherwise realizable in full or in part, as the case may be.

     (i) Performance Conditions.

          (1) This Section 10(i) shall be administered by a Committee approved by the Board, all of the members of which are “outside directors” as defined by Section 162(m) (the “Section 162(m) Committee”).

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          (2) Notwithstanding any other provision of the Plan, if the Section 162(m) Committee determines, at the time a Restricted Stock Award or Other Stock Unit Award is granted to a Participant, that such Participant is, or may be as of the end of the tax year in which the Company would claim a tax deduction in connection with such Award, a Covered Employee (as defined in Section 162(m)), then the Section 162(m) Committee may provide that this Section 10(i) is applicable to such Award.

          (3) If a Restricted Stock Award or Other Stock Unit Award is subject to this Section 10(i), then the lapsing of restrictions thereon and the distribution of cash or Shares pursuant thereto, as applicable, shall be subject to the achievement of one or more objective performance goals established by the Section 162(m) Committee, which shall be based on the relative or absolute attainment of specified levels of one or any combination of the following: (a) earnings per share, (b) return on average equity or average assets with respect to a pre-determined peer group, (c) earnings, (d) earnings growth, (e) revenues, (f) expenses, (g) stock price, (h) market share, (i) return on sales, assets, equity or investment, (j) regulatory compliance, (k) achievement of balance sheet or income statement objectives, (l) total shareholder return, (m) net operating profit after tax, (n) pre-tax or after-tax income, (o) cash flow, (p) achievement of research, development, clinical or regulatory milestones, (q) product sales and (r) business development activities, and may be absolute in their terms or measured against or in relationship to other companies comparably, similarly or otherwise situated. Such performance goals may be adjusted to exclude any one or more of (i) extraordinary items, (ii) gains or losses on the dispositions of discontinued operations, (iii) the cumulative effects of changes in accounting principles, (iv) the writedown of any asset, and (v) charges for restructuring and rationalization programs. Such performance goals: (i) may vary by Participant and may be different for different Awards; (ii) may be particular to a Participant or the department, branch, line of business, subsidiary or other unit in which the Participant works and may cover such period as may be specified by the Section 162(m) Committee; and (iii) shall be set by the Section 162(m) Committee within the time period prescribed by, and shall otherwise comply with the requirements of, Section 162(m).

          (4) Notwithstanding any provision of the Plan, with respect to any Restricted Stock Award or Other Stock Unit Award that is subject to this Section 10(i), the Section 162(m) Committee may adjust downwards, but not upwards, the cash or number of Shares payable pursuant to such Award, and the Section 162(m) Committee may not waive the achievement of the applicable performance goals except in the case of the death or disability of the Participant.

          (5) The Section 162(m) Committee shall have the power to impose such other restrictions on Awards subject to this Section 10(i) as it may deem necessary or appropriate to ensure that such Awards satisfy all requirements for “performance-based compensation” within the meaning of Section 162(m)(4)(C) of the Code, or any successor provision thereto.

11. Miscellaneous

     (a) No Right To Employment or Other Status. No person shall have any claim or right to be granted an Award, and the grant of an Award shall not be construed as giving a Participant the

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right to continued employment or any other relationship with the Company. The Company expressly reserves the right at any time to dismiss or otherwise terminate its relationship with a Participant free from any liability or claim under the Plan, except as expressly provided in the applicable Award.

     (b) No Rights As Shareholder. Subject to the provisions of the applicable Award, no Participant or Designated Beneficiary shall have any rights as a shareholder with respect to any shares of Common Stock to be distributed with respect to an Award until becoming the record holder of such shares. Notwithstanding the foregoing, in the event the Company effects a split of the Common Stock by means of a stock dividend and the exercise price of and the number of shares subject to such Option are adjusted as of the date of the distribution of the dividend (rather than as of the record date for such dividend), then an optionee who exercises an Option between the record date and the distribution date for such stock dividend shall be entitled to receive, on the distribution date, the stock dividend with respect to the shares of Common Stock acquired upon such Option exercise, notwithstanding the fact that such shares were not outstanding as of the close of business on the record date for such stock dividend.

     (c) Effective Date and Term of Plan. The Plan shall become effective on the date on which it is adopted by the Board, but no Award may be granted unless and until the Plan has been approved by the Company’s shareholders. No Awards shall be granted under the Plan after the completion of 10 years from the earlier of (i) the date on which the Plan was adopted by the Board or (ii) the date the Plan was approved by the Company’s shareholders, but Awards previously granted may extend beyond that date.

     (d) Amendment of Plan. The Board may amend, suspend or terminate the Plan or any portion thereof at any time; provided that, to the extent determined by the Board, no amendment requiring shareholder approval under any applicable legal, regulatory or listing requirement shall become effective until such shareholder approval is obtained. No Award shall be made that is conditioned upon shareholder approval of any amendment to the Plan.

     (e) Provisions for Foreign Participants. The Board may modify Awards or Options granted to Participants who are foreign nationals or employed outside the United States or establish subplans or procedures under the Plan to recognize differences in laws, rules, regulations or customs of such foreign jurisdictions with respect to tax, securities, currency, employee benefit or other matters.

     (f) Compliance With Code Section 409A. No Award shall provide for deferral of compensation that does not comply with Section 409A of the Code, unless the Board, at the time of grant, specifically provides that the Award is not intended to comply with Section 409A of the Code.

     (g) Governing Law. The provisions of the Plan and all Awards made hereunder shall be governed by and interpreted in accordance with the laws of the State of Washington excluding choice-of-law principles of the law of such state that would require the application of the laws of a jurisdiction other than such state.

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EX-31.1

Exhibit 31.1

CERTIFICATION

I, Jennifer L. Good, in my capacity as principal executive officer of Penwest Pharmaceuticals Co., certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q, (“this report”) of Penwest Pharmaceuticals Co. (the “registrant”);
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

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

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 6, 2008	/s/ Jennifer L. Good
	Jennifer L. Good
	President and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Benjamin L. Palleiko, in my capacity as principal financial officer of Penwest Pharmaceuticals Co., certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q (“this report”) of Penwest Pharmaceuticals Co. (the “registrant”);
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

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

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 6, 2008	/s/ Benjamin L. Palleiko
	Benjamin L. Palleiko
	Senior Vice President, Corporate Development and Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION OF THE PRINCIPAL EXECUTIVE OFFICER PURSUANT TO RULE 13a-14(b) OF
THE SECURITIES EXCHANGE ACT OF 1934 AND 18 U.S.C. SECTION 1350

     In connection with the Quarterly Report on Form 10-Q of Penwest Pharmaceuticals Co. (the “Company”) for the period ended June 30, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, Jennifer L. Good, President and Chief Executive Officer of the Company, hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

     (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

     (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 6, 2008	/s/ Jennifer L. Good
	Jennifer L. Good
	President and Chief Executive Officer

EX-32.2

Exhibit 32.2

CERTIFICATION OF THE PRINCIPAL FINANCIAL OFFICER PURSUANT TO RULE 13a-14(b) OF
THE SECURITIES EXCHANGE ACT OF 1934 AND 18 U.S.C. SECTION 1350

     In connection with the Quarterly Report on Form 10-Q of Penwest Pharmaceuticals Co. (the “Company”) for the period ended June 30, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, Benjamin L. Palleiko, Senior Vice President, Corporate Development and Chief Financial Officer, hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

     (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

     (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 6, 2008	/s/ Benjamin L. Palleiko
	Benjamin L. Palleiko
	Senior Vice President, Corporate Development and Chief Financial Officer