PENWEST PHARMACEUTICALS CO, S-1/A, 1997-12-05

PENWEST PHARMACEUTICALS CO
S-1/A, 1997-12-05
PHARMACEUTICAL PREPARATIONS

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 5, 1997

REGISTRATION NO. 333-38389
================================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

------------------------

AMENDMENT NO. 2

FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

------------------------

PENWEST PHARMACEUTICALS CO.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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<S> <C> <C>
WASHINGTON 2834 91-1513032
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>

2981 ROUTE 22
PATTERSON, NY 12563-9970
(914) 878-3414

(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

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TOD R. HAMACHEK
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
PENWEST PHARMACEUTICALS CO.
2981 ROUTE 22
PATTERSON, NY 12563-9970
(914) 878-3414

(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)

COPIES TO:

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<S> <C> <C>
STEVEN D. SINGER, ESQ. EDMUND O. BELSHEIM, JR., ESQ. LESLIE E. DAVIS, ESQ.
HALE AND DORR LLP PENWEST PHARMACEUTICALS CO. TESTA, HURWITZ & THIBEAULT, LLP
60 STATE STREET 2981 ROUTE 22 HIGH STREET TOWER
BOSTON, MA 02109 PATTERSON, NY 12563-9970 125 HIGH STREET
(617) 526-6000 (914) 878-3414 BOSTON, MA 02110
(617) 248-7000
</TABLE>

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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this registration statement becomes effective.

If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]

If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act of 1933, please check the
following box and list the Securities Act registration number of the earlier
effective registration statement for the same offering. [ ]

If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act registration number of the earlier effective registration
statement for the same offering. [ ]

If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act of 1933, check the following box. [ ]

------------------------

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.

================================================================================
<PAGE> 2

INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES
MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE
REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT
CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY
NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH
OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR
QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.

SUBJECT TO COMPLETION, DATED DECEMBER 5, 1997

[PENWEST PHARMACEUTICALS CO. LOGO] PENWEST PHARMACEUTICALS CO.
2,500,000 SHARES

COMMON STOCK

All of the 2,500,000 shares of Common Stock offered hereby are being sold
by Penwest Pharmaceuticals Co. ("Penwest" or the "Company"), which is a
wholly-owned subsidiary of Penford Corporation (previously known as PENWEST,
LTD., "Penford"). Prior to this offering, there has been no public market for
the Common Stock of the Company. It is currently estimated that the initial
public offering price will be between $10.00 and $12.00 per share. See
"Underwriting" for information relating to the method of determining the initial
public offering price.

Upon completion of this offering, Penford will own approximately 85.3%
(approximately 83.5% if the Underwriters' over-allotment option is exercised in
full) of the outstanding Common Stock of the Company. Penford has announced its
intent, subject to the satisfaction of certain conditions, to divest its
ownership interest in the Company by means of a tax-free distribution to its
shareholders, which is anticipated to occur in the second quarter of 1998. See
"Background of the Planned Spin-off," "Principal Shareholders" and "Arrangements
Between the Company and Penford."

-----------------------

THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.

SEE "RISK FACTORS" BEGINNING ON PAGE 8.

-----------------------

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

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<CAPTION>
===================================================================================================
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS COMPANY(1)
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share................................. $ $ $
- ---------------------------------------------------------------------------------------------------
Total(2).................................. $ $ $
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</TABLE>

(1) Before deducting expenses payable by the Company, estimated at $1,000,000.

(2) The Company has granted to the Underwriters a 30-day option to purchase up
to an additional 375,000 shares of Common Stock solely to cover
over-allotments, if any. See "Underwriting." If such option is exercised in
full, the total Price to Public, Underwriting Discounts and Commissions, and
Proceeds to Company will be $ , $ and $ ,
respectively.

-----------------------

The Common Stock is offered by the Underwriters as stated herein, subject
to receipt and acceptance by them and subject to their right to reject any order
in whole or in part. It is expected that delivery of such shares will be made
through the offices of BancAmerica Robertson Stephens, San Francisco,
California, on or about , 1997.

BANCAMERICA ROBERTSON STEPHENS SBC WARBURG DILLON READ INC.

The date of this Prospectus is , 1997
<PAGE> 3

ADDITIONAL INFORMATION

The Company has filed with the Securities and Exchange Commission,
Washington, D.C. 20549 (the "Commission"), a Registration Statement on Form S-1
(including all amendments and exhibits thereto, the "Registration Statement")
under the Securities Act of 1933, as amended (the "Securities Act"), with
respect to the Common Stock offered hereby. This Prospectus, which constitutes
part of the Registration Statement, does not contain all the information set
forth in the Registration Statement and the exhibits and schedules thereto,
certain parts of which are omitted in accordance with the rules and regulations
of the Commission. For further information with respect to the Company and the
Common Stock, reference is hereby made to the Registration Statement including
exhibits, schedules and reports filed as a part thereof. Statements contained in
this Prospectus as to the contents of any contract or other document filed as an
exhibit to the Registration Statement are not necessarily complete, and in each
instance reference is made to the copy of such document filed as an exhibit to
the Registration Statement, each such statement being qualified in all respects
by such reference. The Registration Statement, including the exhibits and
schedules thereto, may be inspected without charge at the principal office of
the Commission in Washington, D.C., and copies of all or any part of which may
be inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and at
the Commission's Regional Offices located at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, 13th
Floor, New York, New York 10048. Copies of such material can also be obtained at
prescribed rates by mail from the Public Reference Section of the Commission at
450 Fifth Street, N.W., Washington, D.C. 20549. In addition, the Commission
maintains a Web site (http://www.sec.gov) that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the Commission.

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF
THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, OR
OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.

IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP
MEMBERS OR THEIR AFFILIATES MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN
THE COMMON STOCK OF THE COMPANY ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH
RULE 103 OF REGULATION M UNDER THE SECURITIES EXCHANGE ACT OF 1934. SEE
"UNDERWRITING."

2
<PAGE> 4

NO DEALER, SALES REPRESENTATIVE OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS
OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY
SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT RELATES OR AN OFFER
TO, OR SOLICITATION OF, ANY PERSON IN ANY JURISDICTION IN WHICH SUCH AN OFFER OR
SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT
THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR
THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO
THE DATE HEREOF.

UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS),
ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER
A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
------------------------

TABLE OF CONTENTS

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PAGE
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<S> <C>
Additional Information................................................................ 2
Summary............................................................................... 4
Background of the Planned Spin-off.................................................... 6
Risk Factors.......................................................................... 8
Use of Proceeds....................................................................... 20
Dividend Policy....................................................................... 20
Capitalization........................................................................ 21
Dilution.............................................................................. 22
Selected Financial Data............................................................... 23
Management's Discussion and Analysis of Financial Condition and Results of
Operations.......................................................................... 24
Business.............................................................................. 29
Management............................................................................ 53
Certain Transactions.................................................................. 62
Principal Shareholder................................................................. 63
Arrangements Between the Company and Penford.......................................... 65
Description of Capital Stock.......................................................... 70
Shares Eligible for Future Sale....................................................... 72
Underwriting.......................................................................... 74
Legal Matters......................................................................... 76
Experts............................................................................... 76
Index to Financial Statements......................................................... F-1
</TABLE>

------------------------

The Company was incorporated under the name Edward Mendell Co., Inc. in the
State of Washington in February 1991 as a wholly-owned subsidiary of Penford
(formerly known as PENWEST, LTD.) and has changed its name to Penwest
Pharmaceuticals Co. The Company's executive offices are located at 2981 Route
22, Patterson, NY 12563-9970. The Company's telephone number is (914) 878-3414.

TIMERx(R), EMCOCEL(R), EXPLOTAB(R), EMDEX(R), EMCOMPRESS(R) and CANDEX(R)
are registered trademarks of the Company, and PROSOLV SMCC(TM) is a trademark of
the Company. Other tradenames and trademarks appearing in this Prospectus are
the property of their respective owners.

3
<PAGE> 5

SUMMARY

This Prospectus contains forward-looking statements which involve risks and
uncertainties. The Company's actual results could differ materially from the
results discussed in the forward-looking statements as a result of certain
factors, including those set forth under "Risk Factors" and elsewhere in this
Prospectus.

The following summary is qualified in its entirety by the more detailed
information, including "Risk Factors," and the Financial Statements and Notes
thereto, appearing elsewhere in this Prospectus.

THE COMPANY

Penwest is engaged in the research, development and commercialization of
novel drug delivery technologies. Based on its extensive experience in
developing and manufacturing tabletting ingredients for the pharmaceutical
industry, the Company has developed its proprietary TIMERx(R) controlled release
drug delivery technology, which is applicable to a broad range of orally
administered drugs. The Company has applied TIMERx technology to the development
of oral formulations of generic versions of controlled release drugs and branded
controlled release versions of immediate release drugs. Each of these
formulations has been developed under a collaborative arrangement with a
pharmaceutical company. In October 1997, the Company's collaborator, Leiras OY,
a Finnish subsidiary of Schering AG ("Leiras"), received marketing approval in
Finland for Cystrin CR(R) (oxybutynin) for the treatment of urinary
incontinence. In May 1997, the Company's collaborator, Mylan Pharmaceuticals
Inc. ("Mylan"), filed an Abbreviated New Drug Application ("ANDA") with the U.S.
Food and Drug Administration (the "FDA") for the first generic version of the 30
mg dosage strength of Procardia XL(R) (nifedipine), a leading cardiovascular
drug for angina and hypertension.

The TIMERx drug delivery system is a hydrophilic matrix consisting primarily
of two natural polysaccharides, xanthan and locust bean gums, in the presence of
dextrose. The TIMERx system can precisely control the release of the active drug
ingredient in a tablet by varying the relative proportion of the gums, the
tablet coating and the tablet manufacturing process. The Company believes that
the TIMERx controlled release system is a major advancement in oral drug
delivery because it is applicable to a wide range of soluble and insoluble drugs
of varying dosages, it offers drug developers a flexible pharmacokinetic
profile, it is easy to scale up to commercial batch levels with consistent
reproducibility, and controlled release drugs based on the TIMERx controlled
release system can be manufactured cost effectively using existing equipment.

Penwest's strategy is to establish collaborations with leading
pharmaceutical companies to develop oral controlled release drugs. The Company
believes that this strategy will create significant operating, marketing and
financial advantages for the Company and will accelerate product development and
commercialization. The Company currently has six generic controlled release
products under development with three collaborators, Mylan, Kremers Urban
Development Company, the generics division of Schwarz Pharma, Inc. ("Kremers")
and Sanofi Winthrop International S.A. ("Sanofi"). All these products are
currently in full-scale bioequivalence studies or clinical trials, and none of
these products, except for Cystrin CR, has received regulatory approval for
commercial sale. Additionally, the Company has recently entered into a strategic
alliance with Endo Pharmaceuticals Inc., formerly a division of Dupont Merck
Pharmaceuticals ("Endo"), to develop jointly Numorphan TRx, a branded oral
controlled release version of the narcotic analgesic oxymorphone.

The Company is also an established manufacturer and distributor of
excipients to the pharmaceutical and nutritional industries. Excipients are the
inactive ingredients in tablets and capsules that enable tabletting of active
drug ingredients by enhancing binding, lubrication and disintegration
properties. The Company recently introduced ProSolv, a patented combination of
microcrystalline cellulose ("MCC") and colloidal silicon dioxide, which the
Company believes offers improvements over competing excipients in wet
granulation and direct compression, the most common processes of manufacturing
tabletted products in the pharmaceutical industry. In addition to ProSolv, the
Company markets a broad line of 27 other excipient products. Revenues from the
excipients business were $25.0 million for the year ended December 31, 1996.

SEPARATION FROM PENFORD

The Company is a wholly-owned subsidiary of Penford (formerly known as
PENWEST, LTD.). Penford has announced its intent, subject to the satisfaction of
certain conditions, to divest its ownership interest in the Company by means of
a tax-free distribution to its shareholders, which is anticipated to occur in
the second quarter of 1998 (the "Spin-off"). Such conditions include receipt of
a private letter ruling from the Internal Revenue Service ("IRS") or a written
opinion from Ernst & Young LLP to the effect that, among other things, the
Spin-off will qualify as a tax-free distribution. The Company and Penford will,
prior to the completion of this offering, enter into agreements that govern
various interim and ongoing relationships. See "Arrangements Between the Company
and Penford."

4
<PAGE> 6
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THE OFFERING

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<S> <C>
Common Stock Offered by the Company.......... 2,500,000 shares
Common Stock Outstanding after the Offering.. 17,038,282 shares(1)
Use of Proceeds.............................. For construction and equipping of a TIMERx
manufacturing facility, expansion of
existing laboratory facilities, working
capital and other general corporate
purposes. See "Use of Proceeds."
Proposed Nasdaq National Market Symbol....... PPCO
</TABLE>

SUMMARY FINANCIAL DATA
(in thousands, except per share data)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------- -------------------
1994 1995 1996 1996 1997
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................. $23,146 $25,089 $26,089 $19,958 $20,787
Cost of product sales.................... 15,910 17,267 18,690 14,033 14,660
------- ------- ------- ------- -------
Gross profit........................... 7,236 7,822 7,399 5,925 6,127
Selling, general and administrative
expenses............................... 7,021 7,676 6,776 5,264 5,747
Research and development expenses........ 2,322 2,719 3,723 2,636 2,994
Net loss................................. $(2,629) $(3,252) $(3,864) $(2,461) $(3,175)
======= ======= ======= ======= =======
Net loss per share....................... $ (0.18) $ (0.22) $ (0.27) $ (0.17) $ (0.22)
======= ======= ======= ======= =======
Weighted average shares outstanding...... 14,538 14,538 14,538 14,538 14,538
</TABLE>

<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
---------------------------
ACTUAL AS ADJUSTED(2)
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<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.......................................... $ 1,088 $ 25,663
Working capital.................................................... (27,885) 34,193
Total assets....................................................... 37,380 61,955
Accumulated deficit................................................ (15,508) (15,508)
Shareholders' equity (deficit)..................................... (8,078) 54,000
</TABLE>

- ---------------
(1) Excludes 715,000 shares of Common Stock issuable upon the exercise of
options to be granted to certain employees and directors on the date of this
Prospectus at an exercise price equal to the initial public offering price.
Also excludes an aggregate of 3,085,000 shares reserved for future grants or
purchases pursuant to the Company's 1997 Equity Incentive Plan and 1997
Employee Stock Purchase Plan. See "Management -- Employee Benefit Plans" and
Note 13 of Notes to Consolidated Financial Statements.

(2) As adjusted to reflect (i) the sale of the 2,500,000 shares of Common Stock
offered by the Company hereby at an assumed initial public offering price of
$11.00 per share and the receipt of the estimated net proceeds therefrom and
(ii) the contribution by Penford to the capital of the Company, effective
upon the closing of this offering, of the outstanding intercompany
indebtedness of the Company to Penford as of the date of the closing of this
offering (the "Penford Capital Contribution"). The intercompany indebtedness
was $37,503,000 as of September 30, 1997. See "Use of Proceeds" and Note 6
of Notes to Consolidated Financial Statements.

Unless otherwise indicated, all information contained in this Prospectus
assumes no exercise of the Underwriters' over-allotment option, and reflects a
2,907.66-for-1 stock split of the shares of Common Stock effected on October 8,
1997.
- --------------------------------------------------------------------------------
5
<PAGE> 7

BACKGROUND OF THE PLANNED SPIN-OFF

Prior to this offering, Penford owned 100% of the Company's outstanding
common stock, par value $0.001 per share (the "Common Stock"). Upon completion
of this offering, Penford will own 85.3% (approximately 83.5% if the
Underwriter's over-allotment option is exercised in full) of the Common Stock.

BACKGROUND OF THIS OFFERING AND THE SPIN-OFF

In October 1997, Penford announced its intent, subject to the satisfaction
of certain conditions, to divest its ownership interest in the Company by means
of the Spin-off, which is anticipated to occur in the second quarter of 1998. By
effecting the Spin-off, Penford would separate its pharmaceutical business from
its specialty chemical business for the paper and food industries. The Board of
Directors of Penford (the "Penford Board") intends to conduct the Spin-off
because it believes that the Spin-off will: (i) permit the managements of
Penford and Penwest to focus on their respective core businesses without regard
to the corporate objectives and policies of the other company; (ii) improve the
near-term earnings of Penford by eliminating from Penford's results of
operations the expenses associated with developing Penwest's TIMERx controlled
release technologies; (iii) permit the financial community to focus separately
on Penford and Penwest and their respective business opportunities; and (iv)
enable Penwest to have greater access to capital to finance its business.

The Company believes that there are a number of risks and uncertainties
associated with the Spin-off, including risks related to the control of the
Company by Penford prior to the Spin-off and the Company's inability to access
the resources of Penford following the Spin-off. For a discussion of these risks
and uncertainties, see "Risk Factors -- Control by Penford Pending the Spin-off;
Uncertainty of the Spin-off," "-- Possibility of Substantial Sales of Common
Stock," "-- History of Losses; Uncertainty of Future Profitability," "-- Need
for Additional Funding; Uncertainty of Access to Capital," "-- Relationship with
Penford; Conflicts of Interest" and "-- Risk of Product Liability Claims; No
Assurance of Adequate Insurance."

The Company and Penford have entered into or will, on or prior to the
completion of this offering, enter into agreements that govern various interim
and ongoing relationships. These agreements include (i) a Separation Agreement
setting forth the agreement of the parties with respect to the principal
corporate transactions required to effect the separation of Penford's
pharmaceutical business from its food and paper businesses, this offering and
the Spin-off, (ii) a Services Agreement pursuant to which Penford will continue
on an interim basis to provide specified services to the Company, (iii) a Tax
Allocation Agreement relating to, among other things, the allocation of tax
liability between the Company and Penford prior to the Spin-off, (iv) an
Excipient Supply Agreement pursuant to which Penford will manufacture and supply
exclusively to Penwest, and Penwest will purchase exclusively from Penford,
subject to certain exceptions, all Penwest's requirements for two excipients
marketed by the Company, and (v) an Employee Benefits Agreement setting forth
the parties' agreements as to the continuation of certain Penford benefits
arrangements for the employees of Penwest. See "Arrangements Between the Company
and Penford."

CONDITIONS TO THE SPIN-OFF

The Penford Board currently intends to effect the Spin-off in the second
quarter of 1998. Under the Separation Agreement between Penford and Penwest, the
Penford Board has the sole discretion to determine the date of consummation of
the Spin-off at any time on or after April 1, 1998 and prior to the date six
months after the closing of this offering. Following the date six months after
the closing of this offering, the Penford Board will be obligated to effect the
Spin-off as promptly as practicable, subject to the satisfaction, or waiver by
the Penford Board, in its sole discretion, of certain conditions including: (i)
a private letter ruling from the IRS shall have been obtained and shall continue
in effect, or a written opinion from Ernst & Young LLP shall have been received,
to the effect that, among other things, the Spin-off will qualify as tax-free
for federal income tax purposes under Sections 355 and 368

6
<PAGE> 8

of the Internal Revenue Code of 1986, as amended (the "Code"), and such ruling
or opinion shall be in form and substance satisfactory to Penford; (ii) any
material governmental approvals and consents necessary to consummate the
Spin-off shall have been obtained and shall be in full force and effect; (iii)
no order, injunction or decree issued by any court or agency of competent
jurisdiction or other legal restraint or prohibition preventing the consummation
of the Spin-off shall be in effect, and no other event outside the control of
Penford shall have occurred or failed to occur that prevents the consummation of
the Spin-off; and (iv) no material adverse change shall have occurred with
respect to the business or financial condition of Penford or Penwest that would,
in the reasonable judgment of the Penford Board, make the approval of the
Spin-off inadvisable.

7
<PAGE> 9

RISK FACTORS

In addition to the other information in this Prospectus, the following risk
factors should be considered carefully in evaluating the Company and its
business before purchasing shares of the Common Stock offered hereby.

CONTROL BY PENFORD PENDING THE SPIN-OFF; UNCERTAINTY OF THE SPIN-OFF

Upon completion of this offering, Penford will own approximately 85.3%
(approximately 83.5% if the Underwriters' over-allotment option is exercised in
full) of the outstanding Common Stock of Penwest. Penford has announced its
intent, subject to the satisfaction of certain conditions, to divest its
ownership interest in the Company by means of a tax-free distribution to its
shareholders, which the Company anticipates will occur in the second quarter of
1998. If the Spin-off occurs, the Company will no longer be a subsidiary of
Penford.

So long as Penford owns a majority of the outstanding Common Stock, it will
have the ability to elect all the members of the Board of Directors of the
Company (the "Board") and otherwise control the management and affairs of the
Company, including any determinations with respect to acquisitions,
dispositions, borrowings, issuances of Common Stock or other securities of the
Company or the declaration and payment of any dividends on the Common Stock.
Three of the Company's directors will continue to serve as directors of Penford
following this offering. Two of these individuals have informed the Company they
intend to resign from the Penford Board upon completion of the Spin-off. The
ability of Penford to control the Company could have an adverse effect on the
market price for shares of Common Stock. See "Principal Shareholders" and
"Shares Eligible for Future Sale."

There can be no assurance as to whether or when the conditions to the
Spin-off will be satisfied or the Spin-off will occur. Such conditions include
receipt of a favorable tax ruling from the IRS or an opinion from Ernst & Young
LLP to the effect that the Spin-off will be tax-free. Penford has not determined
what action, if any, it would take if such conditions are not satisfied. If the
Spin-off does not occur, Penford may maintain ownership of the Company as a
consolidated subsidiary or sell all or a portion of its ownership interest in
the Company through a public offering or private sale. The Company has agreed
that, if the Spin-off does not occur by September 30, 1998, Penford will have
the right to cause Penwest to register the shares of Penwest's Common Stock held
by Penford for resale under the Securities Act. See "Arrangements Between the
Company and Penford -- Separation Agreement -- Registration Rights." The
occurrence of any of these events could have a material adverse effect on the
Company's business, financial condition and results of operations and could
materially adversely affect the trading market for the Common Stock.

POSSIBILITY OF SUBSTANTIAL SALES OF COMMON STOCK

The Spin-off and future sales of substantial amounts of Common Stock
(including shares issued upon the exercise of options) in the public market or
the availability of such shares for sale, could have a material adverse effect
on the market price of the Common Stock and on the Company's ability to raise
any necessary capital to fund its future operations.

Upon completion of this offering, the Company will have 17,038,282 shares
of Common Stock outstanding. Of these shares, the 2,500,000 shares offered
hereby will generally be freely tradeable without restriction or further
registration under the Securities Act of 1933, as amended (the "Securities
Act"). The remaining 14,538,282 shares of Common Stock outstanding upon the
consummation of this offering will be shares of Common Stock held by Penford and
will be "restricted securities," as that term is defined in Rule 144,
promulgated under the Securities Act ("Rule 144"), that may be sold only if
registered under the Securities Act or in accordance with an applicable
exemption from registration.

The Company anticipates that the Spin-off will occur in the second quarter
of 1998. If the Spin-off occurs as planned, an aggregate of approximately
14,538,282 shares of Common Stock will be

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<PAGE> 10

distributed to the shareholders of Penford. Substantially all such shares would
be eligible for immediate resale in the public market. The Company is unable to
predict whether substantial amounts of Common Stock will be sold in the open
market in anticipation of, or following, the Spin-off. Sales of substantial
amounts of Common Stock in the public market, or the perception that such sales
might occur, whether as a result of the Spin-off or otherwise, could materially
adversely affect the market price of the Common Stock. See "Shares Eligible for
Future Sale."

Pursuant to the Underwriting Agreement (as defined below), the Company has
agreed, subject to limited exceptions, not to sell, offer, contract to sell,
pledge, grant any option to purchase or otherwise dispose of any shares of
Common Stock (or any securities convertible into or exchangeable for, or any
right to purchase or acquire, Common Stock) for a period of 180 days after the
date of this Prospectus without the prior written consent of BancAmerica
Robertson Stephens. Similarly, Penford and the officers and directors of the
Company have agreed, subject to limited exceptions (including, with respect to
Penford, the Spin-off), not to sell, offer, contract to sell, pledge, grant any
option to purchase or otherwise dispose of any shares of Common Stock (or any
securities convertible into or exchangeable for, or any right to purchase or
acquire, Common Stock) for a period of 180 days after the date of this
Prospectus without the prior written consent of BancAmerica Robertson Stephens.
None of the shares of Common Stock distributed pursuant to the Spin-off (other
than shares distributed to the Company's "affiliates") will be subject to any
contractual restriction on sale or disposition pursuant to the Underwriting
Agreement or otherwise.

CERTAIN RISKS AND LITIGATION RELATING TO NIFEDIPINE XL

In May 1997, one of the Company's collaborators, Mylan, filed an ANDA with
the FDA for the 30 mg dosage strength of Nifedipine XL, a generic version of
Procardia XL, a controlled release formulation of nifedipine. Nifedipine XL is
the first product using the Company's TIMERx controlled release technology for
which an ANDA has been filed in the United States.

In an ANDA filing, the FDA generally requires data demonstrating that the
drug formulation is bioequivalent to the branded drug. In addition, under the
Drug Price Competition and Patent Restoration Act of 1984 (the "Waxman-Hatch
Act"), when an applicant files an ANDA for a generic version of a brand name
product covered by an unexpired patent listed with the FDA, the applicant must
certify to the FDA that such patent will not be infringed by the applicant's
product or that such patent is invalid or unenforceable. Notice of such
certification must be given to the patent holder and the sponsor of the New Drug
Application ("NDA") for the brand name product.

Bayer AG ("Bayer") and ALZA Corporation ("ALZA") own patents listed for
Procardia XL, and Pfizer Inc. ("Pfizer") holds the NDA and markets the product.
In connection with the ANDA filing, Mylan certified in May 1997 to the FDA that
Nifedipine XL does not infringe these Bayer or ALZA patents and notified Bayer,
ALZA and Pfizer of such certification. Bayer and Pfizer sued Mylan in the United
States District Court for the Western District of Pennsylvania, alleging that
Nifedipine XL infringes Bayer's patent. The Company has been informed by Mylan
that ALZA does not believe that the notice given to it complied with the
requirements of the Waxman-Hatch Act, and there can be no assurance that ALZA
will not sue Mylan for patent infringement or take any other actions with
respect to such notice. Mylan has advised the Company that it intends to contest
vigorously the allegations made in the lawsuit. However, there can be no
assurance that Mylan will prevail in this litigation or that it will continue to
contest the lawsuit. An unfavorable outcome or protracted litigation for Mylan
would materially adversely affect the Company's business, financial condition
and results of operations. Delays in the commercialization of Nifedipine XL
could also occur because the FDA will not grant final marketing approval of
Nifedipine XL until a final judgment on the patent suit is rendered in favor of
Mylan by the district court, or in the event of an appeal, by the court of
appeals, or until 30 months (or such longer or shorter period as the court may
determine) have elapsed from the date of Mylan's certification, whichever is
sooner.

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<PAGE> 11

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

There can be no assurance that Pfizer will not seek to protect its
marketing exclusivity with respect to Procardia XL by pursuing additional
regulatory initiatives and lawsuits.

Most of the controlled release products that the Company is developing with
its collaborators are generic versions of brand name controlled release products
that are covered by one or more patents. The Company expects its collaborators
will file ANDAs for such product candidates. There can be no assurance that if
ANDAs are filed for any of such products, the holders of the patents covering
the brand name product or the holders of the NDA with respect to the brand name
product will not sue or undertake regulatory initiatives to preserve marketing
exclusivity. Any significant delay in obtaining FDA approval to market the
Company's product candidates as a result of litigation, as well as the expense
of such litigation, whether or not the Company or its collaborators are
successful, could have a material adverse effect on the Company's business,
financial condition and results of operations.

The FDA is reviewing an inactive ingredient contained in the TIMERx
delivery system in order to determine the allowable amount for inclusion in the
FDA's Inactive Ingredients Guide. At the request of the FDA, the Company is
conducting an animal toxicity study of such ingredient to enable the FDA to
determine the highest allowable amount. If the amount of such ingredient, or any
other ingredient, in a specified product exceeds the highest amount approved in
the Inactive Ingredients Guide, the Company would likely be required to
reformulate such product in order to be able to seek approval through the ANDA
process. Reformulation of a product would likely require new bioequivalence
studies. If reformulation were not possible, then new clinical studies and an
NDA filing for such product would likely be required for FDA approval of such
product. Any of such events could materially adversely affect the Company's
collaborative arrangements where ANDA filings had been made or were
contemplated, which would have a material adverse effect on the Company's
business, financial condition and results of operations.

In addition to filing an ANDA with respect to the 30 mg dosage strength of
Nifedipine XL, Mylan is conducting full scale bioequivalence studies of the 60
mg and 90 mg dosage strengths of Nifedipine XL. There can be no assurance that
Mylan will file ANDAs with respect to the 60 mg and 90 mg dosage strengths or
that, if Mylan does file such ANDAs, they will be the first ANDAs filed with
respect to such dosage strengths. Under the Waxman-Hatch Act, an applicant who
files the first ANDA with a certification of patent invalidity or
non-infringement with respect to a product may be entitled to receive, if such
ANDA is approved by the FDA, 180-day marketing exclusivity (a 180-day delay in
approval of other ANDAs for the same drug) from the FDA. However, there can be
no assurance that the FDA will not approve an ANDA filed by another applicant
with respect to a different dosage

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<PAGE> 12

strength prior to or during Mylan's 180-day marketing exclusivity period, if
obtained, for the 30 mg dosage strength of Nifedipine XL. See
"Business -- Government Regulation" and "-- Litigation."

DEPENDENCE ON COLLABORATIVE AGREEMENTS

The Company intends to develop and commercialize its TIMERx controlled
release products in collaboration with pharmaceutical companies. To date, the
Company has entered into collaborative agreements with Mylan, Leiras, Kremers,
Sanofi and Endo. The Company is particularly dependent on its collaboration with
Mylan, which covers three of the Company's products under development. Under its
current collaborative agreements, the Company's collaborators are generally
responsible for conducting full scale bioequivalence studies and clinical
trials, preparing and submitting all regulatory applications and submissions and
manufacturing, marketing and selling the TIMERx controlled release products.

There can be no assurance that the Company will be able to maintain
existing collaborative arrangements or establish new collaborative arrangements
on acceptable terms, if at all, or that any collaborative arrangements will be
commercially successful. To the extent that the Company is not able to maintain
or establish such arrangements, the Company would be required to undertake
product development and commercialization activities at its own expense, which
would increase the Company's capital requirements or require the Company to
limit the scope of its development and commercialization activities. Moreover,
the Company has limited or no experience in conducting full scale bioequivalence
studies and clinical trials, preparing and submitting regulatory applications
and manufacturing and marketing controlled release products. There can be no
assurance that it could be successful in performing these activities and any
failure to perform such activities could have a material adverse effect on the
Company's business, financial condition and results of operations.

The Company cannot control the amount and timing of resources that its
collaborative partners devote to the Company's programs or potential products,
which may vary because of factors unrelated to the potential products. If any of
the Company's collaborators breach or terminate their agreements with the
Company or otherwise fail to conduct their collaborative activities in a timely
manner, the preclinical and/or clinical development and/or commercialization of
product candidates will be delayed, and the Company would be required to devote
additional resources to product development and commercialization or terminate
certain development programs. Also, these relationships generally may be
terminated at the discretion of the Company's collaborators, in some cases with
only limited notice to the Company. For instance, Mylan may terminate its
agreements with the Company at any time upon 90 days' prior written notice under
specified circumstances. The termination of collaborative arrangements could
have a material adverse effect on the Company's business, financial condition
and results of operations. There also can be no assurance that disputes will not
arise with respect to the ownership of rights to any technology developed with
third parties. These and other possible disagreements with collaborators could
lead to delays in the development or commercialization of product candidates or
could result in litigation or arbitration, which could be time consuming and
expensive and could have a material adverse effect on the Company's business,
financial condition and results of operations.

In addition, Penwest's collaborators may develop, either alone or with
others, products that compete with the development and marketing of the
Company's potential products. Competing products of the Company's collaborators
may result in their withdrawal of support with respect to their products under
development using the Company's controlled release technology, which could have
a material adverse effect on the Company's business, financial condition and
results of operations. See "Business -- Collaborative Arrangements."

UNCERTAINTY OF COMMERCIALIZATION OF TIMERX CONTROLLED RELEASE PRODUCTS

Products using the Company's TIMERx controlled release technology are in
various stages of development. None of these products has been commercialized,
and the period required to achieve

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<PAGE> 13

commercialization is uncertain and may be lengthy, if commercialization is
achieved at all. Two products using TIMERx technology have been the subject of
regulatory filings by the Company's collaborators. In October 1997, Leiras
received marketing approval in Finland for Cystrin CR for the treatment of
urinary incontinence. In May 1997, Mylan filed an ANDA with the FDA for the 30
mg dosage strength of Nifedipine XL, a generic version of Procardia XL, a
calcium channel blocker for treating hypertension. No regulatory approval to
market Nifedipine XL has been received, and there can be no assurance as to when
or if regulatory approval will be received. Moreover, other than Cystrin CR, no
product based on TIMERx technology has ever received regulatory approval for
commercial sale, and there can be no assurance that the results from
bioequivalence studies or clinical trials will justify such regulatory approval.
Except for milestone fees received for products under development, the Company
has not generated any revenues from controlled release products. There can be no
assurance that the Company's controlled release product development efforts will
be successfully completed, that required regulatory approvals will be obtained
or that approved products will be successfully manufactured or marketed. See
"Business -- TIMERx Product Development," "-- Collaborative Arrangements" and
"-- Government Regulation."

HISTORY OF LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY

The Company incurred net losses of approximately $2.6 million, $3.3 million
and $3.9 million during 1994, 1995 and 1996, respectively, and $2.5 million and
$3.2 million during the nine months ended September 30, 1996 and 1997,
respectively. As of September 30, 1997, the Company's accumulated deficit was
approximately $15.5 million. The Company expects net losses to continue at least
into 1999. A substantial portion of the Company's revenues have been generated
from the sales of the Company's pharmaceutical excipients. The Company's future
profitability will depend on several factors, including the successful
commercialization by the Company and its collaborators of the controlled release
products for which regulatory approval currently is pending or has recently been
obtained, the completion of the development of other pharmaceuticals using the
Company's TIMERx controlled release technology and, to a lesser extent, an
increase in sales of its pharmaceutical excipient products. There can be no
assurance that the Company will achieve profitability or that it will be able to
sustain any profitability on a quarterly basis, if at all. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

INTENSE COMPETITION; RISK OF TECHNOLOGICAL CHANGE

The pharmaceutical industry is highly competitive and is affected by new
technologies, governmental regulations, health care legislation, availability of
financing, litigation and other factors. Many of the Company's competitors have
longer operating histories and greater financial, marketing, legal and other
resources than the Company and certain of its collaborators. The Company expects
that it will be subject to competition from numerous other entities that
currently operate or intend to operate in the pharmaceutical industry, including
companies that engage in the development of controlled release technologies. The
Company's TIMERx business faces competition from numerous public and private
companies and their controlled release technologies, including ALZA's oral
osmotic pump (OROS(R)) technology, multiparticulate systems marketed by Elan
Corporation, plc ("Elan") and Biovail Corporation International, traditional
matrix systems marketed by Jago Pharma AG, a subsidiary of SkyePharma, plc, and
other controlled release technologies marketed and under development by Andrx
Corporation, among others.

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<PAGE> 14

from therapeutic products that are functionally equivalent but produced by other
methods. In addition, under several of the Company's collaborative arrangements,
the payments due to the Company with respect to the controlled release products
covered by such collaborative arrangements will be reduced in the event that
there are competing generic controlled release versions of such products.

The generic drug industry is characterized by frequent litigation between
generic drug companies and branded drug companies. Those companies with
significant financial resources will be more able to bring and defend any such
litigation. See "Business -- Litigation."

In its excipients business, the Company competes with a number of large
manufacturers and other distributors of excipient products, many of which have
substantially greater financial, marketing and other resources than the Company.
The Company's principal competitor in this market is FMC Corporation, which
markets its own line of MCC excipient products.

The pharmaceutical industry is characterized by rapid and substantial
technological change. There can be no assurance that any products incorporating
TIMERx technology will not be rendered obsolete or non-competitive by new drugs,
treatments or cures for the medical conditions the TIMERx-based products are
addressing. Any of the foregoing could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Competition."

NEED FOR ADDITIONAL FUNDING; UNCERTAINTY OF ACCESS TO CAPITAL

The Company anticipates that its existing capital resources, together with
the net proceeds of this offering and interest earned thereon, will enable it to
maintain currently planned operations through at least 1999. However, this
expectation is based on the Company's current operating plan, which could change
as a result of many factors, and the Company could require additional funding
sooner than anticipated. The Company's requirements for additional capital could
be substantial and will depend on many factors, including the timing and amount
of payments received under existing and possible future collaborative
agreements; the structure of any future collaborative or development agreements;
the progress of the Company's collaborative and independent development
projects; revenues from the Company's excipients business, including from the
introduction of ProSolv; the costs to the Company of bioequivalence studies and
clinical trials for the Company's products; the prosecution, defense and
enforcement of patent claims and other intellectual property rights; and the
development of manufacturing, marketing and sales capabilities. Upon the closing
of this offering, the Company will have no credit facility or other committed
sources of capital. To the extent capital resources are insufficient to meet
future capital requirements, the Company will have to raise additional funds to
continue the development of its technologies. There can be no assurance that
such funds will be available on favorable terms, if at all. To the extent that
additional capital is raised through the sale of equity or convertible debt
securities, the issuance of such securities could result in dilution to the
Company's shareholders. If adequate funds are not available, the Company may be
unable to comply with its obligations under its collaborative agreements, which
could result in the termination of such collaborative agreements. In addition,
the Company may be required to curtail operations significantly or to obtain
funds through entering into collaboration agreements on unfavorable terms. The
Company's inability to raise capital would have a material adverse effect on the
Company's business, financial condition and results of operations. See "Use of
Proceeds" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."

UNCERTAINTIES RELATING TO PATENTS AND PROPRIETARY RIGHTS

The Company believes that patent and trade secret protection of its drug
delivery technologies is important to its business and that its success will
depend, in part, on its ability to maintain existing patent protection, obtain
additional patents, maintain trade secret protection and operate without
infringing on the rights of others. Penwest has been issued 19 U.S. patents and
40 foreign patents relating to its controlled release drug delivery and
excipient technologies. In addition, Penwest has

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<PAGE> 15

filed 12 U.S. patent applications and corresponding foreign patent applications
relating to its controlled release drug delivery technology. The issuance of a
patent is not conclusive as to its validity or as to the enforceable scope of
the claims of the patent. There can be no assurance that the Company's patents
or any future patents will prevent other companies from developing similar or
functionally equivalent products or from successfully challenging the validity
of the Company's patents. Furthermore, there can be no assurance that (i) any of
the Company's future processes or products will be patentable; (ii) any pending
or additional patents will be issued in any or all appropriate jurisdictions;
(iii) the Company's processes or products will not infringe upon the patents of
third parties; or (iv) the Company will have the resources to defend against
charges of patent infringement or protect its own patent rights against third
parties. The inability of the Company to protect its patent rights or
infringement by the Company of the patent or proprietary rights of others could
have a material adverse effect on the Company's business, financial condition
and results of operations.

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

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

The Company's collaborator Mylan is involved in patent litigation with
respect to Nifedipine XL. For a discussion of such patent litigation, see
"Business -- Litigation."

Penwest also relies on trade secrets and proprietary knowledge, which it
generally seeks to protect by confidentiality and non-disclosure agreements with
employees, consultants, licensees and pharmaceutical companies. There can be no
assurance, however, that these agreements have or in all cases will be obtained,
that these agreements will not be breached, that the Company will have adequate
remedies for any breach or that the Company's trade secrets will not otherwise
become known by others, any of which could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Business -- Patents and Proprietary Rights."

GOVERNMENT REGULATION; NO ASSURANCE OF REGULATORY APPROVAL

The development, clinical testing, manufacture, marketing and sale of
pharmaceutical products are subject to extensive federal, state and local
regulation in the United States. The Company cannot predict the extent to which
it may be affected by legislative and regulatory actions and developments
concerning various aspects of its operations, its products and the health care
field generally. Virtually all new prescription drugs, and many new
over-the-counter drugs, must be approved by the FDA before they can be
introduced onto the market in the United States. These approvals are based on
manufacturing, chemistry and control data, as well as safety and efficacy
studies and/or bioequivalence studies. The generation of the required data is
regulated by the FDA and can be time-consuming and expensive without assurance
that the results will be adequate to justify approval.

After submission of a marketing application, in the form of an NDA or an
ANDA, there can be substantial delays in obtaining FDA approval, including the
need to generate and submit additional data. Data submitted to the FDA is often
susceptible to varying interpretations that could delay, limit

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<PAGE> 16

or prevent regulatory approval. Also, delays or rejections may be encountered
during any stage of the regulatory approval process based upon the failure of
clinical data to demonstrate compliance with, or upon the failure of the product
to meet, the FDA's requirements for safety, efficacy and quality; and those
requirements may become more stringent due to changes in regulatory agency
policy or the adoption of new regulations. While the U.S. Food, Drug and
Cosmetic Act provides for a 180-day review period, the FDA commonly takes one to
two years to grant final approval to a marketing application (NDA or ANDA).
Further, the terms of approval of any marketing application, including the
labeling content, may be more restrictive than the Company desires and could
affect the marketability of products incorporating the Company's controlled
release technology.

Most of the controlled release products that the Company is developing with
its collaborators are generic versions of brand name controlled release
products, which require the filing of ANDAs. Certain ANDA procedures for generic
versions of controlled release products are the subject of petitions filed by
brand name drug manufacturers, which seek changes from the FDA in the approval
process for generic drugs. These requested changes include, among other things,
tighter standards for certain bioequivalence studies and disallowance of the use
by a generic drug manufacturer in its ANDA of proprietary data submitted by the
original manufacturer as part of an original new drug application. The Company
is unable to predict at this time whether the FDA will make any changes to its
ANDA procedures as a result of such petitions or any future petitions filed by
brand name drug manufacturers or the effect that such changes may have on the
Company. Any changes in FDA regulations which make ANDA approvals more difficult
could have a material adverse effect on the Company's business, financial
condition and results of operations.

The FDA also has the authority to revoke or suspend approvals of previously
approved products for cause, to debar companies and individuals from
participating in the drug-approval process, to request recalls of allegedly
violative products, to seize allegedly violative products, to obtain injunctions
to close manufacturing plants allegedly not operating in conformity with current
Good Manufacturing Practices ("cGMPs") and to stop shipments of allegedly
violative products. Such delays or FDA actions could have a material adverse
effect on the Company's business, financial condition and results of operations.
The FDA may seek to subject to pre-clearance requirements products currently
being marketed without FDA approval and there can be no assurance that the
Company or its third-party manufacturers or collaborators will be able to obtain
approval for such products within the time period specified by the FDA.

In May 1997, one of the Company's collaborators, Mylan, filed an ANDA with
the FDA for the 30 mg dosage strength of Nifedipine XL, a generic version of
Procardia XL. In addition, the Company expects that its collaborators will file
marketing applications for other products using the TIMERx controlled release
delivery system. There can be no assurance that approvals can be obtained, or be
obtained in a timely manner, for such applications or for other applications
that may be filed in the future. See "Business -- Government Regulation."

LIMITED MANUFACTURING CAPABILITY; DEPENDENCE ON SOLE SOURCE SUPPLIERS

The Company lacks commercial-scale facilities to manufacture its TIMERx
material in accordance with cGMP requirements prescribed by the FDA. To date,
the Company has relied on a large third-party pharmaceutical company, Boehringer
Ingelheim Pharmaceuticals, Inc., for the bulk manufacture of its TIMERx material
for delivery to its collaborators under an agreement that expires in June 1998.
Although the Company intends to use a portion of the proceeds of this offering
to build a manufacturing facility for its TIMERx material, the Company expects
to continue to be dependent on third-party manufacturers until its facility is
fully operational and in compliance with cGMP regulations. The Company believes
that there are a limited number of manufacturers that operate under cGMP
regulations capable of manufacturing the Company's products. In the event that
the Company is unable to obtain contract manufacturing, or obtain such
manufacturing on commercially reasonable terms, it may not be able to
commercialize its products as planned. There can be no assurance that third
parties upon which the Company relies for supply of its TIMERx materials will
perform and any

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failures by third parties may delay development or the submission of products
for regulatory approval, impair the Company's collaborators' ability to
commercialize products as planned and deliver products on a timely basis, or
otherwise impair the Company's competitive position, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.

In order for the Company to develop its own manufacturing capabilities for
TIMERx material, it will need to complete the construction and qualification of
a manufacturing facility, recruit qualified personnel and acquire or lease the
requisite equipment. There can be no assurance that the Company will be able to
successfully develop such manufacturing capabilities on a cost effective and
timely basis, if at all.

The manufacture of any products by the Company (both TIMERx material and
excipients) is subject to regulation by the FDA and comparable agencies in
foreign countries. Delay in complying or failure to comply with such
manufacturing requirements could materially adversely affect the marketing of
the Company's products and the Company's business, financial condition and
results of operations.

The Company's TIMERx drug delivery system is a hydrophilic matrix
consisting primarily of two natural polysaccharides, xanthan and locust bean
gums, in the presence of dextrose. The Company purchases these gums from a sole
source supplier. Most of the Company's excipients are manufactured from wood
pulp, which the Company also purchases from a sole source supplier. Although the
Company has qualified alternate suppliers with respect to these materials, there
can be no assurance that interruptions in supplies will not occur in the future
or that the Company will not have to obtain substitute suppliers. Any of these
events could have a material adverse effect on the Company's ability to
manufacture bulk TIMERx for delivery to its collaborators or manufacture its
excipients, which could have a material adverse effect on the Company's
business, financial condition and results of operations. See
"Business -- Manufacturing."

RELATIONSHIP WITH PENFORD; CONFLICTS OF INTEREST

Conflicts of interest may arise between the Company and Penford in a number
of areas relating to their past and ongoing relationships, including the
manufacture of certain excipients, tax and employee benefit matters, indemnity
arrangements, registration rights, sales or distributions by Penford of its
shares of Common Stock and the exercise by Penford of its ability to control the
management and affairs of the Company. Although Penford has advised the Company
that it does not currently intend to engage in the business of developing,
marketing and commercializing drug delivery products except through its
ownership of Common Stock and contractual relationships with the Company, other
than the agreement by Penford not to distribute certain products to the
pharmaceutical and nutritional industries (excluding food products), there are
no contractual or other restrictions on Penford's ability to engage in such
activities. Accordingly, circumstances could arise in which Penford would
compete with the Company.

In anticipation of this offering, and in view of Penford's intention to
undertake the Spin-off, the Company and Penford have entered into a number of
agreements, which will become effective upon the closing of this offering, for
the purpose of defining certain relationships between them. As a result of
Penford's ownership interest in the Company, the terms of such agreements were
not the result of arm's-length negotiations. Notwithstanding any tax allocation
agreement entered into between the Company and Penford, under federal income tax
law, each member of a consolidated group for federal income tax purposes is also
jointly and severally liable for the federal income tax liability of each other
member of the consolidated group. Similar rules may apply under state income tax
laws. If Penford or members of its consolidated tax group (other than the
Company and its subsidiaries) do not comply with the provisions of any such tax
allocation agreement and the Company is required to make payments in respect of
the tax liabilities allocated to Penford thereunder, such payments could
adversely affect the business, financial condition and results of operations of
the Company.

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<PAGE> 18

Three of the eight current directors of the Company are also directors of
Penford. Two of these individuals have informed the Company they intend to
resign from Penford's Board of Directors upon completion of the Spin-off, which
is expected to occur in the second quarter of 1998. Directors of the Company who
are also directors of Penford may have conflicts of interest with respect to
matters potentially or actually involving or affecting the Company and Penford
such as acquisitions, financings and other corporate opportunities that may be
suitable for the Company and Penford. To the extent that such opportunities
arise, such directors may consult with their legal advisors and make a
determination after consideration of a number of factors, including whether such
opportunity is presented to any such director in his capacity as a director of
the Company, whether such opportunity is within the Company's line of business
or consistent with its strategic objectives and whether the Company will be able
to undertake or benefit from such opportunity. In addition, determinations may
be made by the Board, when appropriate, by the vote of the disinterested
directors only. Notwithstanding the foregoing, there can be no assurance that
conflicts will be resolved in favor of the Company. See "Arrangements Between
the Company and Penford."

NO ASSURANCE OF ADEQUATE THIRD-PARTY REIMBURSEMENT

The commercialization of the controlled release product candidates under
development by the Company and its collaborators depends in part on the extent
to which reimbursement for the cost of such products will be available from
government health administration authorities, private health insurers and other
third party payors, such as health maintenance organizations and managed care
organizations. The generic versions of controlled release products being
developed by the Company and its collaborators may be assigned an AB rating if
the FDA considers the product to be therapeutically equivalent to the branded
controlled release drug. Failure to obtain an AB rating from the FDA would
indicate that for certain purposes the drug would not be deemed to be
therapeutically equivalent, would not be fully substitutable for the branded
controlled release drug and would not be relied upon by Medicaid and Medicare
formularies for reimbursement.

Third party payors are attempting to control costs by limiting the level of
reimbursement for medical products, including pharmaceuticals. Cost control
initiatives could decrease the price that the Company or any of its
collaborators receives for their drugs and have a material adverse affect on the
Company's business, financial condition and results of operations. Further, to
the extent that cost control initiatives have a material adverse effect on the
Company's collaborators, the Company's ability to commercialize its products and
to realize royalties may be adversely affected. Moreover, health care reform has
been, and may continue to be, an area of national and state focus, which could
result in the adoption of measures that adversely affect the pricing of
pharmaceuticals or the amount of reimbursement available from third party
payors. There can be no assurance that changes in health care reimbursement laws
or policies will not have a material adverse effect on the Company's business,
financial condition and results of operations. See "Business -- Pricing and
Third-Party Reimbursement."

RISK OF PRODUCT LIABILITY CLAIMS; NO ASSURANCE OF ADEQUATE INSURANCE

Testing, manufacturing, marketing and selling pharmaceutical products
entail a risk of product liability. The Company faces the risk of product
liability claims in the event that the use of its products is alleged to have
resulted in harm to a patient or subject. Such risks exist even with respect to
those products that are manufactured in licensed and regulated facilities or
that otherwise possess regulatory approval for commercial sale. Product
liability insurance coverage is expensive, difficult to obtain and may not be
available in the future on acceptable terms, if at all. Until the Spin-off, the
Company will be covered by primary product liability insurance maintained by
Penford in the amount of $1.0 million per occurrence and $2.0 million annually
in the aggregate on a claims-made basis and by umbrella liability insurance in
excess of $5.0 million which can also be used for product liability insurance.
There can be no assurance that this coverage is adequate to cover potential
liability claims or that Penwest will be able to obtain comparable coverage
following the Spin-off. Furthermore, this coverage

17
<PAGE> 19

may not be adequate as the Company develops additional products. As the Company
receives regulatory approvals for products under development, there can be no
assurance that additional liability insurance coverage for any such products
will be available in the future on acceptable terms, if at all. The Company's
business, financial condition and results of operations could be materially
adversely affected by the assertion of a product liability claim. See
"Business -- Product Liability Insurance."

INTERNATIONAL OPERATIONS AND CURRENCY EXCHANGE RATE FLUCTUATIONS

The Company's business is conducted internationally and may be affected by
fluctuations in currency exchange rates, as well as by governmental controls and
other risks associated with international sales (such as export licenses,
collectibility of accounts receivable, trade restrictions and changes in
tariffs). The Company's international subsidiaries transact a substantial
portion of their sales and purchases in European currencies other than their
functional currency, which can result in the Company having gains or losses from
currency exchange rate fluctuations. There can be no assurance that exchange
rate fluctuations or other risks associated with international operations will
not have a material adverse effect on the Company's business, financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and Note 12 of Notes to
Consolidated Financial Statements.

DEPENDENCE ON KEY PERSONNEL

The Company's success is dependent on the Company's attracting and
retaining highly skilled scientific, managerial and business development
personnel. The loss of services of any of these key personnel could materially
adversely affect the Company. The Company's business expansion plans require
additional, highly skilled employees, particularly highly skilled scientific
personnel. Competition for qualified personnel is intense. There can be no
assurance that the Company will be successful in hiring or retaining the
personnel it requires. See "Management."

RISKS ASSOCIATED WITH HAZARDOUS MATERIALS

The Company's research and development involves the controlled use of
hazardous materials and chemicals. Although the Company believes that its safety
procedures for handling and disposing of such materials comply with the
standards prescribed by state and federal regulations, the risk of accidental
contamination or injury from these materials cannot be completely eliminated. In
the event of such an accident, the Company could be held liable for any damages
that result and any such liability could exceed the resources of the Company and
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Business -- Government Regulation."

NO PRIOR PUBLIC MARKET; DETERMINATION OF PUBLIC OFFERING PRICE; POTENTIAL
VOLATILITY OF STOCK PRICE

Prior to this offering, there has been no public market for the Common
Stock and there can be no assurance that an active public market for the Common
Stock will develop or that the price at which the Common Stock will trade will
not be lower than the initial public offering price. The initial public offering
price will be determined through negotiations between the Company and the
Underwriters. See "Underwriting."

The market prices for securities of pharmaceutical, biopharmaceutical and
biotechnology companies have historically been highly volatile. The market from
time to time experiences significant price and volume fluctuations that are
unrelated to the operating performance of particular companies. In addition,
factors such as fluctuations in the Company's operating results, future sales of
Common Stock, announcements of technological innovations or new therapeutic
products by the Company or its competitors, announcements regarding
collaborative agreements, clinical trial results, government regulation,
developments in patent or other proprietary rights, public concern as to the
safety of drugs

18
<PAGE> 20

developed by the Company or others, changes in reimbursement policies, comments
made by securities analysts and general market conditions can have an adverse
effect on the market price of the Common Stock. In particular, the realization
of any of the risks described in these "Risk Factors," including the possibility
of substantial sales of Common Stock as a result of the Spin-off, could have a
significant and adverse impact on such market price.

DILUTION; ABSENCE OF DIVIDENDS

The public offering price is substantially higher than the net tangible
book value per share of the Company's Common Stock. Investors purchasing shares
of Common Stock in this offering will therefore incur immediate, substantial
dilution of approximately $7.95 per share. See "Dilution." The Company has not
paid any dividends on its Common Stock since inception and does not anticipate
paying any cash dividends in the foreseeable future. See "Dividend Policy."

ANTI-TAKEOVER EFFECTS OF WASHINGTON LAW AND CERTAIN CHARTER PROVISIONS

The Company's Board of Directors has the authority to issue up to 1,000,000
shares of Preferred Stock and to determine the price, rights, preferences and
privileges of those shares without any further vote or action by the Company's
shareholders. The rights of the holders of Common Stock will be subject to, and
may be adversely affected by, the rights of the holders of any Preferred Stock
that may be issued in the future. While the Company has no present intention to
issue shares of Preferred Stock, such issuance, while providing desirable
flexibility in connection with possible acquisitions and other corporate
purposes, could have the effect of making it more difficult for a third party to
acquire a majority of the outstanding voting stock of the Company. In addition,
the Company is subject to the anti-takeover provisions of Chapter 23B.19 of the
Washington Business Corporation Act, which prohibits the Company from engaging
in a "business combination" with an "interested shareholder" for a period of
three years after the date of the transaction in which the person became an
interested shareholder, unless the business combination is approved in a
prescribed manner. The application of Chapter 23B.19 could have the effect of
delaying or preventing a change of control of the Company. The Company's Amended
and Restated Articles of Incorporation provide for staggered terms for the
members of the Board of Directors. The staggered Board of Directors and certain
other provisions of the Company's Amended and Restated Articles of Incorporation
and Amended and Restated Bylaws may have the effect of delaying or preventing a
change of control of the Company, which could adversely affect the market price
of the Company's Common Stock. See "Description of Capital Stock -- Washington
Law and Certain Charter and Bylaw Provisions."

19
<PAGE> 21

USE OF PROCEEDS

The net proceeds to the Company from the sale of the 2,500,000 shares of
Common Stock offered hereby (2,875,000 if the Underwriters' over-allotment
option is exercised in full) at an assumed initial public offering price of
$11.00 per share, after deducting estimated underwriting discounts and
commissions and estimated offering expenses, are estimated to be approximately
$24,575,000 ($28,411,250 if the Underwriters' over-allotment option is exercised
in full).

The Company anticipates that approximately $15.0 million of the net
proceeds will be used for the construction and equipping of a TIMERx
manufacturing facility (approximately $9.0 million) and expansion of existing
laboratory facilities (approximately $6.0 million). The balance of the net
proceeds will be used for working capital and other general corporate purposes.
Although the Company may use a portion of the net proceeds to acquire or license
products or technologies complementary to those of the Company, there are no
current plans or commitments to do so.

The amounts actually expended for each purpose and the timing of such
expenditures will depend upon numerous factors, including: the timing and amount
of payments received under existing and possible future collaborative
agreements; the structure of any future collaborative or development agreements;
the progress of the Company's collaborative and independent development
projects; financing alternatives; revenues from the Company's excipients
business, including from the introduction of ProSolv; the costs to the Company
of bioequivalence studies and clinical trials for the Company's products; the
prosecution, defense and enforcement of patent claims and other intellectual
property rights; the defense of other litigation; and the development of
manufacturing, marketing and sales capabilities.

Pending such uses, the Company intends to invest the net proceeds of this
offering in short-term, interest-bearing, investment-grade securities.

DIVIDEND POLICY

The Company has never paid cash dividends on its Common Stock. The Company
presently intends to retain earnings, if any, for use in the operation of its
business, and therefore does not anticipate paying any cash dividends in the
foreseeable future.

20
<PAGE> 22

CAPITALIZATION

The following table sets forth the capitalization of the Company as of
September 30, 1997, and as adjusted to give effect to the sale of the 2,500,000
shares of Common Stock by the Company offered hereby based upon an assumed
initial public offering price of $11.00 per share and the application of the
estimated net proceeds therefrom and the Penford Capital Contribution. This
table should be read in conjunction with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the Financial Statements
and Notes thereto appearing elsewhere in this Prospectus.

<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
------------------------
ACTUAL AS ADJUSTED
-------- -----------
(in thousands)
<S> <C> <C>
Payable to Penford(1)................................................. $37,503 $ --
======= ========
Shareholders' equity (deficit):
Common stock, par value $0.001; 39,000,000 shares authorized;
14,538,282 shares issued and outstanding actual, and 17,038,282
shares issued and outstanding, as adjusted(2)...................... 15 17
Additional paid-in capital............................................ 8,075 70,151
Accumulated deficit................................................... (15,508) (15,508)
Cumulative translation adjustment..................................... (660) (660)
------- --------
Total shareholders' equity (deficit)............................... (8,078) 54,000
------- --------
Total capitalization............................................ $29,425 $ 54,000
======= ========
</TABLE>

- ---------------
(1) Represents the intercompany advances from Penford to fund Penwest's
operations, capital expenditures and the original acquisition of the
Company's predecessor, which will be contributed to the capital of Penwest
upon the closing of this offering.

(2) Excludes 715,000 shares of Common Stock issuable upon the exercise of
options to be granted to certain employees and directors on the date of this
Prospectus at an exercise price equal to the initial public offering price.
Also excludes an aggregate of 3,085,000 shares reserved for future grants or
purchases pursuant to the Company's 1997 Equity Incentive Plan and 1997
Employee Stock Purchase Plan. See "Management -- Employee Benefit Plans" and
Note 13 of Notes to Consolidated Financial Statements.

21
<PAGE> 23

DILUTION

The net tangible book value (deficit) of the Company as of September 30,
1997 was ($10,117,000) or ($0.70) per share of Common Stock ($27,386,000 or
$1.88 per share of Common Stock, adjusted for the Penford Capital Contribution).
Net tangible book value per share represents the amount of the Company's total
tangible assets less total liabilities, divided by the total number of shares of
Common Stock outstanding at September 30, 1997. After giving effect to the sale
by the Company of 2,500,000 shares of Common Stock offered hereby at an assumed
initial public offering price of $11.00 per share, after deducting the estimated
underwriting discounts and commissions and estimated offering expenses payable
by the Company, and after giving effect to the Penford Capital Contribution, the
adjusted net tangible book value of the Company as of September 30, 1997 would
have been $51,961,000 or $3.05 per share. This represents an immediate increase
in net tangible book value of $1.17 per share to the existing shareholder after
giving effect to the Penford Capital Contribution and an immediate dilution in
net tangible book value of $7.95 per share to purchasers of shares of Common
Stock in this offering. The following table illustrates this per share dilution:

<TABLE>
<S> <C> <C>
Assumed initial public offering price............................... $11.00
Net tangible book value as of September 30, 1997.................. $(0.70)
Increase attributable to the Penford Capital Contribution......... 2.58
Increase attributable to this offering............................ 1.17
------
Adjusted net tangible book value after this offering and after
giving effect to the Penford Capital Contribution................. 3.05
------
Dilution to new investors........................................... $ 7.95
======
</TABLE>

The following table summarizes, as of September 30, 1997, the difference
between the number of shares of Common Stock purchased from the Company, the
total consideration paid and the average price per share paid by Penford after
giving effect to the contribution of the amount due to parent and affiliates and
by new investors before deducting the estimated underwriting discounts and
commissions and estimated offering expenses payable by the Company at the
assumed initial public offering price of $11.00 per share.

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------------ ------------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Penford.............. 14,538,282 85.3% $45,593,000 62.4% $ 3.14
New investors........ 2,500,000 14.7 27,500,000 37.6 11.00
---------- ----- ----------- -----
Total.......... 17,038,282 100.0% $73,093,000 100.0%
========== ===== =========== =====
</TABLE>

The foregoing table assumes no exercise of options to purchase 715,000
shares of Common Stock to be granted to certain employees and directors on the
date of this Prospectus at an exercise price equal to the initial public
offering price. In addition to the shares reserved for issuance upon exercise of
these options, the Company has reserved an additional 3,085,000 shares of Common
Stock for future grants or purchases pursuant to the Company's 1997 Equity
Incentive Plan and 1997 Employee Stock Purchase Plan. See
"Management -- Employee Benefit Plans" and Note 13 of Notes to Consolidated
Financial Statements.

22
<PAGE> 24

SELECTED FINANCIAL DATA

The statement of operations data for the years ended December 31, 1994,
1995 and 1996 and the nine-month period ended September 30, 1997 and the balance
sheet data as of December 31, 1995 and 1996 and September 30, 1997 are derived
from the consolidated financial statements of the Company which have been
audited by Ernst & Young LLP, independent auditors. The statement of operations
data for the years ended December 31, 1992 and 1993 and the nine month period
ended September 30, 1996 and the balance sheet data as of December 31, 1992,
1993 and 1994 are derived from unaudited consolidated financial statements. The
unaudited consolidated financial statements include all adjustments, consisting
of normal recurring accruals, which the Company considers necessary for a fair
presentation of the financial position and results of operations for these
periods. Operating results for the nine-month period ended September 30, 1997
are not necessarily indicative of the results that may be expected for the
entire year ending December 31, 1997. The data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements, related
Notes thereto, and other financial information included elsewhere in this
Prospectus.

<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED SEPTEMBER 30,
---------------------------------------------------- -------------------
1992 1993 1994 1995 1996 1996 1997
-------- -------- -------- -------- -------- -------- --------
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenues................. $ 19,406 $ 21,355 $ 23,146 $ 25,089 $ 26,089 $ 19,958 20,787
Cost of product sales.... 13,088 13,708 15,910 17,267 18,690 14,033 14,660
-------- -------- -------- -------- -------- -------- --------
Gross profit........ 6,318 7,647 7,236 7,822 7,399 5,925 6,127
Selling, general and
administrative
expenses............... 5,024 6,383 7,021 7,676 6,776 5,264 5,747
Research and development
expenses............... 553 1,255 2,322 2,719 3,723 2,636 2,994
Net income (loss)........ $ 339 $ 8 $ (2,629) $ (3,252) $ (3,864) $ (2,461) $ (3,175)
======== ======== ======== ======== ======== ======== ========
Net income (loss) per
share.................. $ 0.02 $ 0.00 $ (0.18) $ (0.22) $ (0.27) $ (0.17) $ (0.22)
======== ======== ======== ======== ======== ======== ========
Weighted average shares
outstanding............ 14,538 14,538 14,538 14,538 14,538 14,538 14,538
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------- SEPTEMBER 30,
1992 1993 1994 1995 1996 1997
-------- -------- -------- -------- -------- -------------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash
equivalents............ -- $ 347 $ 668 $ 290 $ 695 $ 1,088
Working capital.......... $(6,226) (12,321) (14,592) (19,461) (23,362) (27,885)
Total assets............. 19,961 25,430 27,000 31,671 35,083 37,380
Accumulated deficit...... (2,596) (2,588) (5,217) (8,469) (12,333) (15,508)
Total shareholder's
equity (deficit)....... 5,576 5,011 2,641 (477) (4,412) (8,078)
</TABLE>

23
<PAGE> 25

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

The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements which involve
risks and uncertainties. The Company's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth under "Risk Factors" and elsewhere in
this Prospectus.

OVERVIEW

Since 1991, Penwest has been engaged in the research, development and
commercialization of novel drug delivery technologies, including the development
of its TIMERx controlled release drug delivery technology. The Company also
develops, manufactures, distributes and sells excipients to the pharmaceutical
and nutritional industries. Penwest was incorporated under the name Edward
Mendell Co., Inc. in the State of Washington in 1991 following Penford's
acquisition of substantially all the assets of its predecessor company.

Penford has announced its intent, subject to the satisfaction of certain
conditions, to divest its ownership interest in the Company by means of a
tax-free distribution to its shareholders, which is anticipated to occur in the
second quarter of 1998. There can be no assurance as to whether or when the
conditions to the Spin-off will be satisfied or the Spin-off will occur. Penford
has not determined what action, if any, it would take if the conditions to the
Spin-off are not satisfied. If the Spin-off does not occur, Penford may maintain
ownership of the Company as a consolidated subsidiary or sell all or a portion
of its ownership interest in the Company through a public offering or private
sale. The occurrence of any of these events could have a material adverse effect
on the Company's business, financial condition and results of operations. In
particular, if the Spin-off does not occur, the Company's future results of
operations would be affected by the continued utilization of the Company's net
operating losses by Penford without compensation to the Company. See Notes 8 and
13 of Notes to Consolidated Financial Statements.

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

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

24
<PAGE> 26

capital requirements or require the Company to limit the scope of its
development and commercialization activities. In addition, under these
collaborative agreements, the Company is entitled to receive milestone payments,
royalties on the sale of the products covered by such collaborative agreements
and payments for the purchase of formulated TIMERx material. Because the timing
and the amount of each of these payments are dependent on the continued
development and commercialization of the products covered by such agreements, as
to which the Company has limited control, there can be no assurance as to the
timing of receipt of some or all of these payments or as to the amount of
payments to be received by the Company.

Except for Cystrin CR, which received marketing approval in Finland, no
product based on TIMERx technology has ever received regulatory approval for
commercial sale. Virtually all the TIMERx revenues generated to date have been
milestone fees received for products under development. There can be no
assurance that the Company's controlled release product development efforts will
be successfully completed, that required regulatory approvals will be obtained
or that approved products will be successfully manufactured or marketed.

The Company has incurred net losses since 1994. As of September 30, 1997,
the Company's accumulated deficit was approximately $15.5 million. The Company
expects net losses to continue at least into 1999. A substantial portion of the
Company's revenues to date have been generated from the sales of the Company's
pharmaceutical excipients. The Company's future profitability will depend on
several factors, including the successful commercialization of TIMERx controlled
release products, and, to a lesser extent, an increase in sales of its
pharmaceutical excipients products. There can be no assurance that the Company
will achieve profitability or that it will be able to sustain any profitability
on a quarterly basis, if at all.

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

The Company's business is conducted internationally and may be affected by
fluctuations in currency exchange rates, as well as by governmental controls and
other risks associated with international sales (such as export licenses,
collectibility of accounts receivable, trade restrictions and changes in
tariffs). The Company's international subsidiaries transact a substantial
portion of their sales and purchases in European currencies other than their
functional currency, which can result in the Company having gains or losses from
currency exchange rate fluctuations. The Company does not use derivatives to
hedge the impact of fluctuations in foreign currencies. See Note 12 of Notes to
Consolidated Financial Statements.

RESULTS OF OPERATIONS

Nine Months Ended September 30, 1997 and 1996

Total revenues increased by 4.2% for the nine months ended September 30,
1997 to $20.8 million from $20.0 million for the nine months ended September 30,
1996. Product sales increased to $19.9 million for the nine months ended
September 30, 1997 from $19.1 million for the nine months ended September 30,
1996, primarily due to an increase in North American sales of EMCOCEL, one of
the Company's core excipient products, which increase was partially offset by a
decrease in average selling price for some excipients in Europe due to
competitive pricing pressures in European excipient operations. Licensing
revenues relating to the TIMERx drug delivery system increased to $911,000 for
the nine months ended September 30, 1997 from $850,000 for the nine months ended
September 30, 1996 due to the achievement of additional development milestones
during the 1997 period.

25
<PAGE> 27

Gross profit increased to $6.1 million or 29.5% of total revenues for the
nine months ended September 30, 1997 from $5.9 million or 29.7% of total
revenues for the nine months ended September 30, 1996. The decrease in gross
profit percentage was due to a change in product mix and pricing pressure in the
Company's European excipients operations, which were offset in part by a slight
increase in licensing revenues.

Selling, general and administrative expenses increased by 9.2% for the nine
months ended September 30, 1997 to $5.7 million from $5.3 million for the nine
months ended September 30, 1996. This increase was primarily due to additional
general and administrative expenses associated with increased business
development efforts with respect to the Company's TIMERx business.

Research and development expenses increased by 13.6% for the nine months
ended September 30, 1997 to $3.0 million from $2.6 million for the nine months
ended September 30, 1996. This increase was due to increased spending in the
development of the TIMERx drug delivery system and its applications as well as
increased spending on developing high performance excipients such as ProSolv.

For the nine months ended September 30, 1997 and 1996, respectively, the
Company did not record a benefit for federal or state taxes because net
operating losses were utilized by Penford in the year they were generated, and
the Company was not compensated by Penford for these losses. In addition, the
Company's provision for income taxes includes foreign taxes and federal and
state deferred tax liabilities that exceed deferred tax assets.

Years Ended December 31, 1996 and 1995

Total revenues increased by 4.0% in 1996 to $26.1 million from $25.1
million in 1995. Product sales equalled $25.0 million in 1996 and in 1995.
Licensing revenues relating to the TIMERx drug delivery system increased to $1.1
million in 1996 from $100,000 in 1995 due to the achievement of additional
development milestones during the 1996 period.

Gross profit decreased to $7.4 million or 28.4% of total revenues in 1996
from $7.8 million or 31.2% of total revenues in 1995. Gross margins in 1996
decreased due to higher unit costs with respect to EMCOCEL, which were partially
offset by an increase in licensing revenues. These higher unit costs resulted
from the underutilization of a new manufacturing plant opened in late 1993 to
produce EMCOCEL.

Selling, general and administrative expenses decreased by 11.7% in 1996 to
$6.8 million from $7.7 million in 1995. This decrease was due to reduced
property taxes on the Patterson facility and a reduction in professional
services.

Research and development expenses increased by 36.9% in 1996 to $3.7
million from $2.7 million in 1995. This increase was attributable primarily to
the hiring of additional research and development personnel in connection with
the development of the TIMERx drug delivery system and its applications.

For 1996 and 1995, the Company did not record a benefit for federal or
state taxes because net operating losses were utilized by Penford in the year
they were generated, and the Company was not compensated for these losses. In
addition, the Company's provision for income taxes includes foreign taxes and
federal and state deferred tax liabilities that exceed deferred tax assets.

Years Ended December 31, 1995 and 1994

Total revenues increased by 8.4% in 1995 to $25.1 million from $23.1
million in 1994. This increase was primarily due to growth in sales of the
Company's excipient products including the EMCOCEL and EXPLOTAB products.

Gross profit increased to $7.8 million or 31.2% of total revenues in 1995
from $7.2 million or 31.3% of total revenues in 1994. This change in gross
profit was primarily attributable to the increase in excipient product sales and
a change in product mix.

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<PAGE> 28

Selling, general and administrative expenses increased by 9.3% in 1995 to
$7.7 million from $7.0 million in 1994. This increase was primarily due to
additional staffing associated with the commencement of several development
programs related to the TIMERx drug delivery technology.

Research and development expenses increased by 17.1% in 1995 to $2.7
million from $2.3 million in 1994. This increase was due to additional staffing
and generation of clinical data to support the development of the TIMERx drug
delivery technology.

For 1995 and 1994, the Company did not record a benefit for federal or
state taxes because net operating losses were utilized by Penford in the year
they were generated, and the Company was not compensated for these losses. In
addition, the Company's provision for income taxes includes foreign taxes and
federal and state deferred tax liabilities that exceed deferred tax assets.

LIQUIDITY AND CAPITAL RESOURCES

Since its incorporation, the Company has received intercompany advances
from Penford to fund Penwest's operations, capital expenditures and the original
acquisition of the Company's predecessor, which equalled $37.5 million as of
September 30, 1997. Penford intends to continue to provide advances to Penwest
until the closing of this offering. After the closing of this offering, Penford
will no longer provide any financial support to the Company. Therefore,
regardless of whether the Spin-off occurs, Penwest will need to rely on the
proceeds of this offering and cash generated from operations. Penford has agreed
that it will contribute the outstanding intercompany indebtedness to the capital
of Penwest as of the closing of this offering.

As of September 30, 1997, Penwest had cash and cash equivalents of $1.1
million. Following the closing of this offering the Company will have no credit
facility or other committed sources of capital. In addition, the Company will
have no indebtedness to either third or related parties.

The Company had negative cash flow from operations in each of the periods
presented primarily due to net losses for the period as well as increasing
inventory levels. Inventory has increased as the Company began manufacturing
TIMERx inventory in 1995 for a variety of uses. These uses include the supply of
the drug delivery system for use in connection with products that are complete
and awaiting regulatory approval or completion of the commercialization efforts
where regulatory approval has been obtained, and the supply of the drug delivery
system to pharmaceutical companies for use in their development efforts or in
connection with new or existing collaborative arrangements. In all of these
cases, the Company receives revenue from the supply of the TIMERx inventory.
Additionally, the Company has alternative uses of the TIMERx inventory for other
drugs which the Company may research and formulate for commercialization. The
Company will continue to build inventories until the drugs under development are
commercialized. Funds expended for the acquisition of fixed assets were
primarily related to the expansion of the Company's manufacturing facilities and
laboratory space as well as the purchase of equipment used principally for
research and development efforts. The payable to Penford increased to fund the
operations and capital needs of the Company.

The Company anticipates that its existing capital resources, together with
the net proceeds of this offering and interest earned thereon, will enable it to
maintain its currently planned operations through at least 1999. The Company
expects negative cash flow and net losses to continue at least into 1999 because
the Company will require substantial funds for product development efforts with
collaborators as well as a $15.0 million investment in the planned new
manufacturing and laboratory space in Patterson, New York to support the growth
of the TIMERx technology which investment is anticipated to be made in 1998 and
1999.

The Company's requirements for additional capital could be substantial and
will depend on many factors, including the timing and amount of payments
received under existing and possible future collaborative agreements; the
progress of the Company's collaborative and independent development projects;
financing alternatives; revenues from the Company's excipients business,
including from the introduction of ProSolv; the costs to the Company of
bioequivalence studies and clinical trials for the Company's products; the
prosecution, defense and enforcement of patent claims and other intellectual

27
<PAGE> 29

property rights; the defense of other litigation; and the development of
manufacturing, marketing and sales capabilities. To the extent capital resources
are insufficient to meet future capital requirements, the Company will have to
raise additional funds to continue the development of its technologies. There
can be no assurance that such funds will be available on favorable terms, if at
all. To the extent that additional capital is raised through the sale of equity
or convertible debt securities, the issuance of such securities could result in
dilution to the Company's shareholders. If adequate funds are not available, the
Company may be required to curtail operations significantly or to obtain funds
through entering into collaboration agreements on unfavorable terms. The
Company's inability to raise capital would have a material adverse effect on the
Company's business, financial condition and results of operations.

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<PAGE> 30

BUSINESS

Penwest is engaged in the research, development and commercialization of
novel drug delivery technologies. Based on its extensive experience in
developing and manufacturing tabletting ingredients for the pharmaceutical
industry, the Company has developed its proprietary TIMERx controlled release
drug delivery technology, which is applicable to a broad range of orally
administered drugs. The Company has applied TIMERx technology to the development
of oral formulations of generic versions of controlled release drugs and branded
controlled release versions of immediate release drugs. Each of these
formulations has been developed under a collaborative arrangement with a
pharmaceutical company. In October 1997, the Company's collaborator, Leiras,
received marketing approval in Finland for Cystrin CR (oxybutynin) for the
treatment of urinary incontinence. In May 1997, the Company's collaborator,
Mylan, filed an ANDA with the FDA for the first generic version of the 30 mg
dosage strength of Procardia XL (nifedipine), a leading cardiovascular drug for
angina and hypertension. The Company is also an established manufacturer and
distributor of excipients to the pharmaceutical and nutritional industries.

DRUG DELIVERY OVERVIEW

Drug delivery technology is a critical component in the formulation of
pharmaceutical products. The formulation of a pharmaceutical product involves
selecting, combining and processing active and inactive ingredients. Drug
delivery technology is used to create or design a system that delivers a drug to
the body in a safe and efficacious manner. These drug delivery systems control
the dissolution, absorption and stability of the finished dosage form and
thereby enhance its safety and therapeutic effectiveness. Although there are
several routes of drug administration used in pharmaceutical products, oral
delivery (principally tablets and capsules) is the preferred delivery route due
to ease of manufacture and administration, as well as enhanced patient
compliance.

Oral Immediate Release Formulations

Oral drugs have traditionally been delivered through "immediate release"
formulations, which release all the active drug substance into the bloodstream
shortly after the patient takes the medication. Immediate release formulations
are beneficial for certain conditions where rapid concentration of the active
ingredient in the bloodstream is required, such as in acute pain relief.
However, immediate release formulations of certain drugs can cause side effects
due to toxicity associated with excessively high concentrations of the active
substance in the bloodstream. In addition, certain immediate release
pharmaceuticals have relatively short half-lives (the time required for half of
the drug to be eliminated from the body), requiring frequent dosing and rigorous
patient compliance in order to achieve successful outcomes.

Oral Controlled Release Formulations

Oral controlled release formulations are designed to alleviate the problems
associated with certain immediate release formulations by extending the period
over which the active ingredient is released into the bloodstream. This permits
the drug to be administered less frequently, enhancing patient compliance.
Controlled release drug delivery systems are typically designed to modulate peak
drug levels in order to reduce side effects such as toxicity associated with
immediate release pharmaceuticals.

In certain cases, a controlled release drug can reduce the total amount of
drug required because it is delivered over an extended period or at the
therapeutically beneficial time or site. The reduction in the total amount of
the active drug substance administered can result in diminished acute toxicity
or toxicity associated with chronic dosing and decrease or eliminate systemic
side effects. Controlled release systems can also improve drug bioavailability
(the relative amount of the active drug substance in the bloodstream). For
example, in drugs that have a narrow window for absorption, these systems can
enhance bioavailability by localizing the release of the active drug substance
in certain regions of the gastrointestinal tract. In addition, controlled
release systems can be designed to coordinate the release of the active drug
substance to coincide with the body's natural (circadian) rhythms when they are
associated with certain disease states, such as diabetes and myocardial
infarction.

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<PAGE> 31

The following chart compares the concentration of the active drug substance
in the bloodstream for a hypothetical drug over a period of time delivered with
an immediate release delivery system and a controlled release delivery system.

[Chart comparing the concentration of the active drug substance in the
bloodstream (x axis) over a period of 30 hours (y axis) delivered with an
immediate release delivery system and a constrolled release delivery system]

The controlled release system represented in the chart modulates the
release of the active drug substance which prevents the concentration of the
active drug substance at toxic levels and extends the period during which an
effective dose is provided to the body.

The usefulness of a number of types of drugs can be improved by a
controlled release delivery system. Drugs with short half-lives often require
frequent administration and are therefore candidates for controlled release
formulation. In addition, controlled release systems can be used for drugs with
a long half-life but with a narrow therapeutic index (the median toxic dose
divided by the median therapeutic dose).

The utilization of controlled release technologies also offers potential
benefits to the developers of pharmaceutical products. For instance, a drug
developer can continue to benefit from an established immediate release product
which is losing patent protection, by creating a controlled release version of
the immediate release product and then seeking patent protection for the
reformulated product based on the delivery system. By reformulating a product, a
drug developer can, in effect, develop a new product without many of the risks
and costs typically associated with the discovery and development of new drugs
such as new chemical entities ("NCEs"). While the development of a new drug
based on an NCE generally takes approximately 15 years from discovery to
regulatory approval and costs approximately $300 to $600 million, the
development and regulatory approval of a controlled release version of an
immediate release product generally takes between approximately five to seven
years and costs less than $50 million. Furthermore, under the Waxman-Hatch Act,
a drug developer can under certain circumstances obtain a three-year or
five-year period of marketing exclusivity for a controlled released product
approved under an NDA by the FDA.

Oral Controlled Release Delivery Systems

To date, drug developers have principally applied controlled release
technologies to oral and transdermal (across the skin) routes of administration.
The transdermal route of administration has not been widely commercialized
because most drugs cannot be absorbed through the skin in a sufficient

30
<PAGE> 32

therapeutic dose. Due to the limited applicability of this technology and
because oral delivery is the most prevalent and preferred route for delivery of
drugs to patients, most of the recent advances in controlled release drug
delivery technologies have focused on oral delivery. Three principal types of
oral controlled release systems are currently utilized.

Oral Osmotic Pump (OROS). The OROS drug delivery system was developed by
ALZA in the early 1980s. It consists of the active drug substance housed in a
reservoir, surrounded by a semi-permeable membrane and formulated into a tablet.
A drug portal for release of the active drug substance is created by a
laser-drilled hole in the tablet. Water from the gastrointestinal tract
permeates the semi-permeable membrane at a controlled rate, and the osmotic
pressure of this water forces the release of the active drug substance through
the drug portal.

The Company believes that each new drug which utilizes the OROS system
requires extensive and time consuming development. In addition, specialized
manufacturing equipment may be required to produce OROS-based products. Because
of the complexities inherent in the manufacturing process, the Company believes
that products formulated with the OROS system are more likely to suffer from
batch variability and validation difficulties, and the scale-up from the
laboratory to production can be difficult and expensive. Despite these
disadvantages, the OROS system has been used in several commercially successful
pharmaceutical products, including Procardia XL.

Multiparticulate Systems. Multiparticulate systems have been used in
commercially successful drugs since the 1960s. These systems consist of small
particles containing active drug substance and excipients that are coated with a
polymer to control the rate of release of the active drug substance. These small
particles are either compressed into tablets or packed into a capsule. The
active drug substance is released over time by diffusion from the particles.

The Company believes that scale-up from the laboratory to commercial-scale
production of formulations using a multiparticulate system can be lengthy,
costly and difficult. Multiparticulate systems require investment in specialized
equipment and the development of specialized solvents and solvent recovery
systems for the coatings of each small particle. The Company believes that the
major difficulty encountered in the production of multiparticulate systems is
that the size and thickness of the coating of each particle often differ, which
results in undesired variability in the release of the drug. Consequently, the
Company believes the manufacturers of drugs using multiparticulate systems often
have difficulties with reproducibility and content uniformity and experience
high batch failure rates. Multiparticulate systems have also demonstrated
limited applicability with insoluble active drug substances.

Traditional Matrix Systems. Traditional matrix systems consist of an
active drug substance, rate-controlling polymers and gel-forming excipients
mixed together and compressed in a manner similar to conventional immediate
release tablets. The matrix forms a gel after ingestion, and the active drug
substance is released over time by diffusion through the matrix.

Products using traditional matrix systems generally have low manufacturing
costs as they are manufactured in the same manner as conventional tablets.
However, the rate-controlling polymers used in such systems are not compatible
with the physical and chemical properties of a wide range of drugs. The
inconsistency of these polymers, as well as their limited drug carrying
capacity, often limits their duration to 12 hours or less, such that more
frequent dosing is often required to obtain efficacy. The usefulness of the
traditional matrix systems is also limited because these systems are difficult
to use with insoluble active drug substances.

Notwithstanding the shortcomings of existing controlled release
technologies, approximately 60 oral controlled release prescription drugs are
marketed currently. Sales of these products in the United States in 1996 were
approximately $6.0 billion.

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<PAGE> 33

TIMERX CONTROLLED RELEASE TECHNOLOGY

The Company has developed the TIMERx delivery system, a novel drug delivery
technology, to address the limitations of currently available oral controlled
release delivery systems. The TIMERx system has evolved from the Company's
extensive experience in developing, manufacturing and marketing tabletting
ingredients for use in the pharmaceutical industry. The Company believes that
the TIMERx system is a major advancement in oral drug delivery that represents
the first easily-manufactured oral controlled release drug delivery system that
is applicable to a wide variety of drug classes, including soluble drugs,
insoluble drugs and drugs with a narrow therapeutic index. The Company intends
to utilize the TIMERx system to formulate generic versions of controlled release
drugs, controlled release formulations of currently-marketed immediate release
drugs and NCEs.

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

The Company believes that the TIMERx controlled release system has several
advantages over other oral controlled release systems.

- Broad Applicability as a Drug Delivery System. The TIMERx system is
adaptable to a wide range of drugs with different physical and chemical
properties. For instance, the TIMERx system can be used to deliver both
low dose (less than 5 mg) and high dose (greater than 500 mg) drugs as
well as water soluble and insoluble drugs. Because of the high affinity
of xanthan and locust bean gums, the TIMERx system permits a formulation
with a high drug to gum ratio, which permits tablets to include a higher
dosage of the active drug substance.

- Flexible Pharmacokinetic Profile. The Company formulates the TIMERx
material to optimize the desired kinetic profile of the active drug
substance. In this manner, the TIMERx system can be designed to enhance
the therapeutic effect of the active drug substance. Depending on the
desired release profile, the Company can formulate the drug to be
released in the body (i) at a constant amount or linear rate over time,
(ii) at a decreasing amount over time where the rate is dependent on drug
concentration, or (iii) at a varied release rate.

- Ease of Manufacture. Drugs formulated using the TIMERx system are
designed for production on standard pharmaceutical processing equipment.
The TIMERx technology is easily and reproducibly scaled-up in a
commercial manufacturing environment often utilizing the direct
compression tabletting process.

- Cost-Effective System. The TIMERx system is a cost-effective drug
delivery system. It involves fewer and less complex ingredients than
other systems and does not require the manufacturer to purchase
specialized equipment. The Company believes that drug formulations using
the TIMERx system can be developed more rapidly than drugs formulated
with alternative controlled delivery systems and that the time to scale
up to commercial quantities is minimized.

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<PAGE> 34

PENWEST STRATEGY

Penwest's objective is to become a leader in the discovery, development and
commercialization of innovative drug delivery technologies for the
pharmaceutical industry. The Company's strategy consists of the following
principal elements:

Apply TIMERx Technology to Generic Versions of Controlled Release
Pharmaceuticals. The Company's principal focus to date has been the application
of its TIMERx technology to the development of generic versions of controlled
release drugs. The Company has focused its development efforts on these drugs in
order to accelerate the commercialization of the TIMERx delivery system, since
generic drugs are regulated through the less expensive and abbreviated ANDA
regulatory process applicable to generic drugs. In selecting generic controlled
release pharmaceutical candidates to develop, the Company targets high sales
volume, technically-complex controlled release pharmaceuticals. The Company
believes these drug candidates are difficult to replicate and, as a result,
TIMERx versions may have limited competition from other formulations.

Create Innovative Controlled Release Versions of Immediate Release
Pharmaceuticals. The Company has also focused on the application of its TIMERx
technology to the development of controlled release formulations of immediate
release drugs, which will be marketed as brand name pharmaceuticals. In
developing these controlled release formulations, the Company intends to seek
collaborations with developers of the immediate release drugs or with
pharmaceutical companies having a market presence in the applicable therapeutic
area. The development of these controlled release drugs is subject to the NDA
approval process, although the Company and its collaborators may be permitted to
rely on existing safety and efficacy data with respect to the immediate release
drug in submitting the NDA.

Apply TIMERx Technology to the Development of New Chemical Entities. The
Company believes that its TIMERx technology may be applicable to the development
of products containing NCEs by pharmaceutical companies. The development of such
NCEs is subject to the full NDA approval process, including conducting
preclinical studies, filing an Investigational New Drug ("IND") application,
conducting clinical trials and submitting an NDA.

Establish Collaborations for Development, Manufacture and Marketing. The
Company has existing collaborative agreements with Mylan, Leiras, Kremers,
Sanofi and Endo and intends to enter into additional collaborative agreements
with respect to other pharmaceuticals. The Company's existing and potential
future collaborations enable the Company to secure additional financial support
for its research and development activities, to obtain access to the clinical,
manufacturing and regulatory resources and expertise of its collaborators and to
rely on them for the sales and marketing, distribution and promotion of
TIMERx-based controlled release drugs on a worldwide basis.

Expand Pharmaceutical Excipients Business. The Company's excipients
business provides financial support for the development of the Company's TIMERx
drug delivery system. In order to expand the Company's excipients business, the
Company intends to develop new excipients, such as ProSolv, its recently
introduced MCC excipient for pharmaceutical and nutritional companies. In
addition to selling ProSolv as a bulk excipient, the Company intends to pursue
selected licensing opportunities for ProSolv with pharmaceutical companies that
are developing new drug candidates.

The achievement of the Company's strategy is subject to various risks and
uncertainties. In particular, there can be no assurance that the Company's
capital resources will be sufficient to fully implement its strategy. For a
discussion of these risks and uncertainties, see "Risk Factors" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

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<PAGE> 35

TIMERx PRODUCT DEVELOPMENT

The following table provides information relating to the therapeutic area,
the development status and the collaborator for each product under development
utilizing the Company's TIMERx technology and is qualified by reference to the
more detailed descriptions included elsewhere in this Prospectus.

- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
BRAND NAME THERAPEUTIC DEVELOPMENT
(COMPOUND) AREA STATUS COLLABORATOR (5)
- ------------------------------ -------------- --------------- ----------------
<S> <C> <C> <C>
GENERIC CONTROLLED RELEASE (1)

Procardia XL Hypertension, ANDA filed (3) Mylan
(nifedipine) Angina
Adalat CC Hypertension Bioequivalence Mylan
(nifedipine) Studies
Adalat LA Hypertension, Clinical/ Sanofi
(nifedipine) Angina Bioequivalence
Studies

Cardizem CD Hypertension, Bioequivalence Kremers
(diltiazem) Angina Studies
Glucotrol XL Diabetes Bioequivalence Mylan
(glipizide) Studies
Covera HS Hypertension, Bioequivalence Kremers
(verapamil Angina Studies
hydrochloride)

BRANDED CONTROLLED RELEASE (2)
Cystrin CR Urinary Approved (4) Leiras
(oxybutynin) Incontinence
Numorphan TRx Pain Relief Formulation Endo
(oxymorphone)
</TABLE>

- ---------------
(1) Generic versions of controlled release products are developed in three basic
stages:

Formulation. Involves the utilization or adaptation of drug delivery
technologies to the product candidate and evaluation in in vitro dissolution
studies.

Bioequivalence Studies. (a) Pilot bioequivalence studies involve testing in
10 to 15 human subjects to determine if the formulation yields a blood level
comparable to the existing controlled release drug; (b) Full scale
bioequivalence studies involve the manufacture of at least 10% of the
intended commercial lot size and the analysis of plasma concentrations of
the drug in 24 or more human subjects under fasting conditions and multiple
dose conditions and 18 or more human subjects under fed conditions to
determine whether the rate and extent of the absorption of the drug are
substantially equivalent to that of the existing drug.

ANDA Filing. An ANDA is submitted to the FDA with results of bioequivalence
studies and other data such as in vitro specifications for the formulation,
stability data, analytical data, methods validation and manufacturing
procedures and controls. See "Business -- Government Regulation."

(2) Controlled release formulations of immediate release products are subject to
the NDA regulatory process. To the extent that the controlled release
product is an extension of an FDA-approved immediate release version of the
same chemical entity, the Company's collaborators may be permitted to rely
on existing clinical data as to the safety and efficacy of the chemical
entity in filing NDAs. See "Business -- Government Regulation."

(3) Mylan has filed an ANDA for the 30 mg dosage strength of Nifedipine XL and
is conducting full scale bioequivalence studies of the 60 and 90 mg dosage
strengths of Nifedipine XL.

(4) In October 1997, Leiras received marketing approval for Cystrin CR in
Finland.

(5) The Company's collaborators typically provide research and development
support and are responsible for conducting full scale bioequivalence studies
or clinical trials, obtaining regulatory approvals and manufacturing,
marketing and selling the product. There can be no assurance that the
results obtained in bioequivalence studies or preclinical studies will be
obtained in full scale bioequivalence studies and other late stage clinical
studies or that the Company or its collaborators will receive regulatory
approvals to continue clinical studies of such products or to market any
such products. See "Business -- Collaborative Arrangements."
- --------------------------------------------------------------------------------

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<PAGE> 36

Generic Controlled Release Pharmaceuticals

Generic controlled release pharmaceuticals are therapeutic equivalents of
brand name drugs for which patents or marketing exclusivity rights have expired.
Generic controlled release pharmaceuticals are typically difficult to replicate
because of: (i) formulation complexity; (ii) analytical complexity; and/or (iii)
manufacturing complexity. The Company believes that such generic controlled
release pharmaceuticals are less likely to suffer the same price erosion as
other generic pharmaceuticals because of the difficulty in replicating
controlled release pharmaceuticals and the resulting limits on competition.

When developing generic pharmaceuticals, the drug developer is required to
demonstrate that the generic product candidate will exhibit in vivo release and
absorption characteristics equivalent to those of the branded pharmaceutical
without infringing on any unexpired patents. During the formulation of generic
pharmaceuticals, drug developers create their own version of the branded drug by
using or adapting drug delivery technologies to the product candidate.

The Company currently has development programs relating to the following
generic controlled release pharmaceuticals:

Nifedipine XL. The Company and Mylan are currently developing Nifedipine
XL, a generic version of Procardia XL incorporating TIMERx technology. Procardia
XL is a once-a-day controlled release formulation of nifedipine, a calcium
channel blocking agent indicated for hypertension, vasospastic angina and
chronic stable angina, which uses the OROS delivery system. Procardia XL is
marketed in three dosage strengths (30 mg, 60 mg and 90 mg) by the Pratt
Pharmaceuticals division of Pfizer and had sales in the United States in 1996 of
approximately $950 million.

In May 1997, Mylan's ANDA for Nifedipine XL (30 mg) was accepted by the FDA
for review. This was the first generic version of Procardia XL accepted by the
FDA for review. Mylan is currently conducting full scale bioequivalence studies
of the 60 mg and 90 mg dosage strengths of Nifedipine XL. The Company is aware
of a number of other companies that are developing generic formulations of
Procardia XL. For a description of certain litigation regarding the Mylan ANDA
filing, see "Business -- Litigation."

Nifedipine CC. The Company and Mylan are currently developing a generic
version of Adalat CC(R) incorporating TIMERx technology. Adalat CC is a
once-a-day controlled release formulation of nifedipine, a calcium channel
blocking agent indicated for hypertension. Adalat CC is marketed in three dosage
strengths (30 mg, 60 mg and 90 mg) by Bayer and had sales in the United States
in 1996 of approximately $250 million. Mylan is conducting full scale
bioequivalence studies of the 30 mg dosage strength of Nifedipine CC. Elan
recently filed an ANDA for a generic version of the 30 mg strength of Adalat CC.
The Company is also aware of a number of other companies that are developing
generic formulations of Adalat CC.

Nifedipine LA. The Company and Sanofi are currently developing a generic
version of Adalat LA(R) (a drug marketed in Europe that is equivalent to
Procardia XL) incorporating TIMERx technology. Adalat LA is a once-a-day
controlled release formulation of nifedipine, a calcium channel blocking agent
indicated for hypertension, vasospastic angina and chronic stable angina, which
uses the OROS delivery system. Adalat LA is marketed in two dosage strengths (30
mg and 60 mg) by Bayer in Europe and had sales in Europe in 1996 of
approximately $340 million. Sanofi is conducting full scale bioequivalence
studies and certain clinical trials in the United Kingdom of the 30 mg dosage
strength of Nifedipine LA.

Diltiazem CD. The Company and Kremers are currently developing a generic
version of Cardizem CD(R) incorporating TIMERx technology. Cardizem CD is a
once-a-day controlled release formulation of diltiazem hydrochloride, a calcium
channel blocking agent indicated for hypertension, vasospastic angina and
chronic stable angina, which uses a multiparticulate drug delivery system.
Cardizem CD is marketed in four dosage strengths (120 mg, 180 mg, 240 mg and 300
mg) by Hoechst Marion Roussel, Inc. and had sales in the United States in 1996
of approximately $730 million. Kremers

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<PAGE> 37

is currently conducting full scale bioequivalence studies of the 240 mg version
of Diltiazem CD. The Company is aware of three competitors which have filed
ANDAs with respect to generic formulations of Cardizem CD, one of which has been
tentatively approved by the FDA pending the outcome of patent litigation.

Glipizide XL. The Company and Mylan are currently developing a generic
version of Glucotrol XL(R) incorporating TIMERx technology. Glucotrol XL is a
once-a-day controlled release formulation of glipizide, a blood-glucose lowering
agent indicated as an adjunct to diet for the control of hyperglycemia in
diabetes patients, which uses the OROS delivery system. Glucotrol XL is marketed
in 5 mg and 10 mg dosage strengths by the Pratt Pharmaceuticals division of
Pfizer and had sales in the United States in 1996 of approximately $127 million.
Mylan is conducting full scale bioequivalence studies of the 5 mg and 10 mg
dosage strengths of Glipizide XL. The Company is aware of a number of other
companies that are developing generic formulations of Glucotrol XL.

Verapamil HS. The Company and Kremers are currently developing a generic
version of Covera HS(R) incorporating TIMERx technology. Covera HS is a
once-a-day controlled release formulation of verapamil hydrochloride, a calcium
channel blocking agent indicated for the management of hypertension and angina,
which uses the OROS delivery system. Covera HS is marketed in two dosage
strengths (180 mg and 240 mg) by G. D. Searle & Co. and had sales in the United
States in 1996 of approximately $18 million. Kremers is conducting full scale
bioequivalence studies of the 180 mg and 240 mg dosage strengths of Verapamil
HS. The Company is aware of a number of other companies that are developing
generic formulations of Covera HS.

Branded Controlled Release Pharmaceuticals

The Company is applying its TIMERx technology to the development of
controlled release formulations of immediate release pharmaceuticals. The
Company currently has development programs relating to the following:

Cystrin CR. The Company and Leiras are currently developing a controlled
release formulation of Cystrin(R) incorporating TIMERx technology. Cystrin is a
twice-a-day immediate release version of the anticholinergic drug oxybutynin
indicated for the treatment of urinary incontinence. Oxybutynin is marketed in
Europe by Leiras under the trademark Cystrin and by Hoechst Marion Roussel, Inc.
under the name Ditropan(R). These products had worldwide sales in 1996 of
approximately $160 million. In October 1997, Leiras received marketing approval
in Finland for Cystrin CR. The Company has been advised that Leiras intends to
seek distributors for Cystrin CR in other countries when and if marketing
approval is obtained in such countries.

Numorphan TRx. The Company and Endo are currently developing a controlled
release formulation of Numorphan(R) incorporating TIMERx technology. Numorphan
is a parenteral and suppository dosage form of oxymorphone, a narcotic analgesic
for the treatment of moderate to severe pain. Numorphan is marketed by Endo and
had sales in the United States in 1996 of approximately $10 million. Numorphan
TRx, if successfully developed, would represent the first oral controlled
release version of Numorphan and would compete in the severe analgesic market
with products such as MS Contin and Oxycontin, which had sales in the United
States in 1996 of approximately $170 million. The Company is currently in the
process of developing a TIMERx formulation and has not yet conducted any
clinical studies.

PHARMACEUTICAL EXCIPIENTS

The Company sells 29 excipient products which are used in the manufacture
of tablets by pharmaceutical and nutritional companies worldwide. The Company's
product line is broadly classified into three distinct categories: binders,
disintegrants and lubricants. Binders, working in conjunction with other
products, are the primary tablet-forming component of excipients. Disintegrants
function to help make a tablet fall apart when consumed by drawing water into
the dosage form, a necessary precursor to dissolution and ultimately absorption
of the drug. Lubricants help facilitate the ease of

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manufacture of drugs so that they emerge from a tabletting machine with the
desired physical characteristics.

The Company's excipients are sold to the brand prescription, generic
prescription, over-the-counter market and nutritional markets. In 1996, the
Company sold bulk excipients to more than 300 customers, including some of the
leading pharmaceutical companies in the world such as the Perrigo Company,
Bristol-Myers Squibb Company, McNeil Consumer Products Company and SmithKline
Beecham, plc ("SmithKline"), in more than 40 countries.

The Company engages in innovative product development to develop new high
performance excipients. In October 1996, the Company introduced ProSolv, which
the Company believes represents a new class of high functionality binders.
ProSolv, the first new MCC product in the pharmaceutical industry in 35 years,
is a patented product that combines MCC and colloidal silicon dioxide. MCC has
historically been one of the most popular excipients used in tabletting
operations. However, MCC has demonstrated certain disadvantages with respect to
the manufacture of tablets using the wet granulation method, a widely used
method of tablet preparation. One of the disadvantages of this method is that
when MCC is wetted or comes in contact with moisture during tablet
manufacturing, MCC loses 30-50% of its compactability. To counteract this loss,
additional MCC is required to be added to the formulation, which increases the
size and the cost of the tablet. In contrast, ProSolv's properties enable it to
be used without losing compactability when wetted or placed in contact with
moisture.

The benefits of ProSolv are maintained irrespective of the method of tablet
manufacture. ProSolv can be used by manufacturers to produce harder tablets and
can enable manufacturers to reduce the amount of binders used in the tablet,
thereby reducing the size and cost of the tablet. Additionally, ProSolv can be
used to manufacture tablets with difficult active ingredients which otherwise
may not have been manufactured.

In addition to ProSolv, the principal excipient product lines currently
marketed by Penwest include the following:

EMCOCEL(R), the Company's largest selling product, is a tabletting binder
used in pharmaceutical formulations worldwide. EMCOCEL is utilized in a number
of products including Centrum vitamins, several store brand ibuprofen products
and many prescription pharmaceuticals.

EMCOMPRESS(R), or dicalcium phosphate, is a binder marketed by the Company
under an exclusive worldwide distribution agreement with the manufacturer
Albright and Wilson Americas Inc. The distribution agreement expires on December
31, 1999, subject to automatic extension on an annual basis unless either party
gives the other party 12 months notice of its desire to terminate the agreement.
EMCOMPRESS is frequently used in vitamin formulations as it serves as an
additional source of dietary calcium.

EMDEX(R), or dextrates, is a binder that is used as a directly compressible
excipient in both chewable and non-chewable tablets. EMDEX is odorless with a
sweet taste caused by its sugar composition. EMDEX is used in, among other
things, chewable antacid tablets and vitamins. EMDEX is manufactured by Penford
and will continue to be supplied by Penford to the Company following the
completion of this offering. See "Arrangements Between the Company and Penford."

EXPLOTAB(R), or sodium starch glycolate, is the principal disintegrant
marketed by the Company. EXPLOTAB is distributed by Penwest under an exclusive
worldwide distribution agreement with the manufacturer, Roquette America, Inc.
The distribution agreement is automatically renewable on an annual basis unless
either party gives the other party 12 months notice of its desire to terminate
the agreement. EXPLOTAB is used in a number of products and is an essential
component of the Tylenol family of products.

PRUV(R), or sodium stearyl fumarate, is the principal lubricant marketed by
the Company. PRUV is marketed under an exclusive worldwide distribution
agreement with the manufacturer, Astra Pharmaceutical Production AB. The
distribution agreement is automatically renewable on an annual basis

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unless either party gives the other party 12 months notice of its desire to
terminate the agreement. PRUV is used in several prescription pharmaceuticals.

The Company had revenues from the sale of pharmaceutical excipients in
1994, 1995 and 1996 of $23.1 million, $25.0 million and $25.0 million,
respectively.

COLLABORATIVE ARRANGEMENTS

The Company has entered into collaborative arrangements with five
pharmaceutical companies to facilitate and expedite the commercialization of its
TIMERx drug delivery technology.

Mylan Pharmaceuticals Inc.

In August 1994, August 1995 and March 1996, the Company entered into
product development and supply agreements with Mylan with respect to the
development of generic versions of Procardia XL (nifedipine), Adalat CC
(nifedipine) and Glucotrol XL (glipizide), based on the Company's TIMERx
technologies (the "Mylan Products"). Mylan is one of the leading generic
pharmaceutical companies in the United States.

Under these product development and supply agreements, the Company is
responsible for the formulation, manufacture and supply of TIMERx material for
use in the Mylan Products, and Mylan is responsible for conducting all
bioequivalence studies, preparing all regulatory applications and submissions
and manufacturing and marketing the Mylan Products in the United States, Canada
and Mexico. Each product development and supply agreement is terminable by
either party upon 90 days prior written notice at any time (i) prior to the
submission of the ANDA for the product covered by such agreement if such party
reasonably determines that no further development efforts are likely to lead to
the successful development of such product and (ii) prior to approval by the FDA
of such ANDA if such party reasonably determines that such ANDA is not likely to
be approved. Following approval of the ANDA, the product development and supply
agreement will extend for a term of 20 years from the date on which the ANDA is
approved, subject to earlier termination by either party upon specified
circumstances, including termination by the Company if Mylan fails to meet
minimum sales volume requirements and termination by either party upon a
material breach by the other party of the agreement. If the Company does not
satisfy its obligations under any of these agreements, the Company will be in
breach of such agreement and Mylan will be entitled to terminate such agreement.

The Company has received milestone payments under each of the product
development and supply agreements and is entitled to additional milestone
payments under such agreements upon the continued development of the Mylan
Products. The Company is also entitled to royalties on the sale of each Mylan
Product, which royalties will be reduced with respect to such Mylan Product if
there are on the market and available for retail sale any other generic
controlled release formulations of the drug of which such Mylan Product is a
generic controlled release formulation. In addition, Mylan has agreed that
during the term of the product development and supply agreements it will
purchase formulated TIMERx material for use in the Mylan Products exclusively
from the Company at specified prices.

Penwest and Mylan also entered into a sales and distribution agreement in
January 1997 (the "Mylan Distribution Agreement") with respect to Nifedipine XL
pursuant to which Mylan agreed to manufacture and supply Nifedipine XL to
Penwest for distribution by Penwest and one or more distributors (as to which
the Company and Mylan must mutually agree) in certain specified European and
Latin American countries. This agreement expires in January 2007, subject to
automatic extension on an annual basis. Under this agreement, the Company has
agreed to purchase Nifedipine XL exclusively from Mylan at specified prices or
to pay Mylan 50% of any royalties received by the Company from its distributors
if Mylan licenses its manufacturing technology to the Company for use by the
Company's distributors instead of manufacturing the product for distribution.
Under this agreement, Mylan is entitled to 50% of any royalties or milestone
payments received by the Company under the Company's product development and
supply agreement with Sanofi described below.

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Kremers Urban Development Company

In May 1996 and August 1996, the Company entered into product development
and supply agreements with Kremers with respect to the development of generic
versions of Cardizem CD (diltiazem) and Covera HS (verapamil hydrochloride),
respectively (the "Kremers Products"), based on the Company's TIMERx
technologies. Kremers is the generics division of the research-based
pharmaceutical company, Schwarz Pharma Inc.

Under these product development and supply agreements, the Company is
responsible for formulating the Kremers Products and for manufacturing and
supplying TIMERx material to Kremers for use in the Kremers Products, and
Kremers is responsible for conducting bioequivalence studies, preparing all
regulatory applications and submissions and manufacturing and marketing the
Kremers Products in the United States, Canada and Mexico.

Each product development and supply agreement is terminable by either party
upon 30 days prior written notice at any time (i) prior to the successful
completion of specified bioequivalence studies if such party reasonably
determines that no further development efforts are likely to lead to the
successful development of the product covered by such product development and
supply agreement and (ii) prior to the approval by the FDA (or equivalent
regulatory authority) of the ANDA (or equivalent regulatory filing) for such
product if such party reasonably determines that the ANDA or equivalent filing
is not likely to be approved by the FDA (or equivalent regulatory authority). In
addition, Kremers may terminate each product development and supply agreement
if, due to changed circumstances, Kremers reasonably determines that the
potential commercial viability of the product covered by the product development
and supply agreement will not justify the use of best efforts by Kremers.
Following approval of the ANDA (or other regulatory filing), the product
development and supply agreement will extend with respect to each country
covered by such agreement for a term of 20 years from the date (the "Kremers
Approval Date") on which the Kremers Product covered by such agreement is
approved for commercial sale by the FDA (or equivalent regulatory authority)
pursuant to an ANDA (or equivalent regulatory filing) in such country, subject
to earlier termination by either party upon specified circumstances, including
upon a material breach of the agreement by a party or upon the bankruptcy of a
party. In addition, at any time following the Kremers Approval Date for
commercial sale of a Kremers Product in the United States, Kremers may terminate
the product development and supply agreement with respect to such Kremers
Product for any reason upon at least 120 days prior written notice, whereupon
the Company would have a paid-up license to Kremers's rights in such Kremers
Product and related data and regulatory filings. If the Company does not satisfy
its obligations under either of these agreements, the Company will be in breach
of such agreement and Kremers will be entitled to terminate such agreement.

The Company has received milestone payments under the product development
and supply agreements and is entitled to additional milestone payments upon the
continued development of the Kremers Products. The Company also is entitled to
royalties on the sale of the Kremers Products. However, both milestone payments
and the royalties otherwise due under the product development and supply
agreements may be reduced in the event that there are competing generic
controlled release formulations of Covera HS or Cardizem CD, as may be
applicable, on the market and available for retail sale.

In addition, Kremers has agreed that, during the term of the product
development and supply agreements, it will purchase formulated TIMERx material
for use in the Kremers Products exclusively from the Company at specified
prices. These prices will be reduced in the event that there are competing
generic versions of Covera HS and/or Cardizem CD, as may be applicable, on the
market and available for retail sale.

The Company is aware of at least three generic versions of Cardizem CD for
which ANDAs have been filed. One of these ANDAs has been tentatively approved by
the FDA, pending the outcome of patent litigation. The existence of these
generic drugs will result in the reduction of any payments to

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be received by the Company under the product development and supply agreement
covering the generic version of Cardizem CD.

Sanofi Winthrop International S.A.

In February 1997, the Company entered into a product development and supply
agreement with Sanofi with respect to the development of a generic version of
Adalat LA based on the Company's TIMERx technology (the "Sanofi Product"), a
drug that is identical to Procardia XL. Sanofi is a research-based international
pharmaceutical company, based in Paris, France, which has a European
infrastructure from which to develop, register and market prescription
pharmaceuticals.

Under the product development and supply agreement, the Company is
responsible for conducting pilot bioequivalence studies of the Sanofi Product
and for manufacturing and supplying TIMERx material to Sanofi, and Sanofi is
responsible for conducting all full scale bioequivalence studies, preparing all
regulatory applications and submissions and manufacturing and marketing the
Sanofi Product in specified countries in Europe and in South Korea.

The product development and supply agreement expires with respect to each
specified country on the 10th, 13th, 16th or 19th anniversary of the date on
which the Sanofi Product is approved by the relevant regulatory authority in
such country for commercial sale if notice is provided by either party prior to
any of such anniversary dates that the agreement will expire with respect to
such country on such anniversary date. The agreement is also subject to earlier
termination by either party under specified circumstances, including termination
by the Company if Sanofi fails to meet minimum sales volume requirements and
termination by either party upon a material breach of the agreement by the other
party. If the Company does not satisfy its obligations under the agreement, the
Company will be in breach of the agreement and Sanofi will be entitled to
terminate the agreement.

The Company is entitled to milestone payments under the product development
and supply agreement upon the continued development of the Sanofi Product. The
Company is also entitled to royalties upon the sale of the Sanofi Product. One
half of such payments will be paid to Mylan in accordance with the Mylan
Distribution Agreement. In addition, Sanofi has agreed that, during the term of
the product development and supply agreement, it will purchase formulated TIMERx
material for use in the Sanofi Product exclusively from the Company at specified
prices.

Leiras OY

In July 1992, the Company entered into an agreement with Leiras with
respect to the development and commercialization of Cystrin CR, a controlled
release formulation of Cystrin based on the Company's TIMERx technology. In May
1995, the Company entered into a second agreement with Leiras clarifying certain
matters with respect to the collaboration. Leiras is a Finnish subsidiary of
Schering AG. Leiras is developing products focused in the areas of reproductive
health care, urology, oncology and inhalation technology.

Under the agreements, the Company is responsible for the development and
formulation of Cystrin CR and for manufacturing and supplying TIMERx material to
Leiras for use in the manufacture of Cystrin CR, and Leiras is responsible for
preparing all regulatory applications and submissions and manufacturing and
marketing Cystrin CR on a worldwide basis. Leiras has the right to appoint
distributors for marketing and distribution in specified territories, subject in
certain circumstances to the approval of the Company.

The agreements terminate upon the expiration of the TIMERx patents licensed
to Leiras (which will occur in the year 2014), subject to earlier termination by
either party under specified circumstances, including upon a material breach of
the agreement by a party or upon the bankruptcy of a party. If the Company does
not satisfy its obligations under either of these agreements, the Company will
be in breach of such agreement and Leiras will be entitled to terminate such
agreement. Leiras has

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also agreed to pay the Company royalties on the sale of Cystrin CR and to
purchase formulated TIMERx material exclusively from the Company at specified
prices.

Endo Pharmaceuticals Inc.

In September 1997, the Company entered into a strategic alliance agreement
with Endo with respect to the development of controlled release formulations of
oxymorphone based on the Company's TIMERx technology (the "Endo Products"). Endo
is a research-based and generic pharmaceutical company formed from a management
buyout of a division of DuPont Merck Pharmaceuticals ("Dupont Merck"). Endo has
a broad product line including 25 drugs in the generic product division and 12
established (formerly DuPont Merck) brand products, including Percodan and
Percocet. Endo is registered with the U.S. Drug Enforcement Administration as a
developer, manufacturer and marketer of controlled narcotic substances.

Under the strategic alliance agreement, the responsibilities of the Company
and Endo with respect to any Endo Product will be determined by a committee
comprised of an equal number of members from each of the Company and Endo (the
"Alliance Committee"). However, the Company expects that it will formulate each
drug candidate and that Endo will conduct all clinical studies and prepare and
file all regulatory applications and submissions. In addition, under the
agreement, the Company has agreed to manufacture and supply TIMERx material to
Endo, and Endo has agreed to manufacture and market the Endo Products in the
United States. The manufacture and marketing of Endo Products outside of the
United States may be conducted by the Company, Endo or a third party, as
determined by the Alliance Committee.

The strategic alliance agreement is terminable with respect to an Endo
Product by either party upon 30 days prior written notice at any time (i) prior
to the completion of development activities with respect to such Endo Product if
such party determines that further development efforts are not likely to lead to
the successful development of such Endo Product and (ii) prior to obtaining
approval by the FDA (or equivalent regulatory authority) of an NDA (or
equivalent regulatory filing) with respect to such Endo Product if such party
determines that further efforts are not likely to lead to such approval,
although the non-terminating party would have the right to continue the
agreement with respect to such Endo Product for a specified period and the
royalties that might otherwise have been payable to the terminating party would
be reduced. Following regulatory approval of the marketing and sale of such Endo
Product, the term of the strategic alliance agreement will extend for up to 20
years from the date of such regulatory approval, subject to earlier termination
under specified circumstances, including failure to launch full-scale marketing
of such Endo Product when required or material breach of the agreement by a
party.

The Company and Endo have agreed to share the costs involved in the
development and commercialization of the Endo Products and that the party
marketing the Endo Products (which the Company expects will be Endo) will pay
the other party royalties equal to 50% of net marketing revenues after
fully-burdened costs (although this percentage will decrease as the total U.S.
marketing revenues from an Endo Product increase), subject to each party's right
to terminate its participation with respect to any Endo Product described above.
If the Company does not satisfy its funding and other obligations under the
agreement, the Company will be in breach of the agreement and Endo will be
entitled to terminate the agreement. Endo will purchase formulated TIMERx
material for use in the Endo Products exclusively from the Company at specified
prices. Such prices will be reflected in the determination of fully-burdened
costs.

RESEARCH AND DEVELOPMENT

The Company conducts research and development activities with respect to
additional applications of TIMERx technology, advances in the TIMERx technology
and additional novel excipients such as ProSolv. The Company is also conducting
research and development with respect to controlled release delivery of
therapeutic substances to the respiratory tract through the use of dry powder

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aerosol delivery systems and has recently received a U.S. patent relating to
such technology. The Company believes that this technology, which utilizes the
same polysaccharide materials as the Company's TIMERx technology, may be
appropriate for the delivery of peptide and protein drugs, which are often
poorly absorbed from the gastrointestinal tract. The Company expects that it
will seek to enter into collaborations to develop such new TIMERx applications
or technologies.

The Company's research and development expenses in 1994, 1995 and 1996 were
$2.3 million, $2.7 million and $3.7 million, respectively. These expenses do not
include amounts incurred by the Company's collaborators in connection with the
development of products under the collaboration agreements such as expenses for
full scale bioequivalence studies performed by the collaborators.

MANUFACTURING

The Company currently has a laboratory and pilot manufacturing facility
covering approximately 55,000 square feet contiguous to its executive offices in
Patterson, New York. However, the Company lacks commercial-scale facilities to
manufacture its TIMERx material in accordance with cGMP requirements prescribed
by the FDA. As a result, to date, the Company has relied on a large third-party
pharmaceutical company, Boehringer Ingelheim Pharmaceuticals, Inc., for the bulk
manufacture of its TIMERx material for delivery to its collaborators under an
agreement that expires in June 1998. The Company anticipates using approximately
$15.0 million from the proceeds of this offering for the construction of
manufacturing facilities in Patterson, New York for the manufacture of bulk
TIMERx, as well as expanded laboratory space. The Company is also increasing its
inventory of TIMERx material.

Although the Company intends to use a portion of the proceeds of this
offering to build a manufacturing facility for its TIMERx material, the Company
expects to continue to be dependent on third-party manufacturers until its
facility is fully operational and in compliance with cGMP. The Company believes
that there are a limited number of manufacturers that operate under cGMP
regulations capable of manufacturing the Company's products. In the event that
the Company is unable to obtain contract manufacturing, or obtain such
manufacturing on commercially reasonable terms, it may not be able to
commercialize its products as planned. There can be no assurance that third
parties depended upon by the Company will perform and any failures by third
parties may delay development or the submission of products for regulatory
approval, impair the Company's collaborators' ability to commercialize products
as planned and deliver products on a timely basis, or otherwise impair the
Company's competitive position, which could have a material adverse effect on
the Company's business, financial condition and results of operations.

The Company's TIMERx drug delivery system is a hydrophilic matrix
consisting primarily of two natural polysaccharides, xanthan and locust bean
gums, in the presence of dextrose. The Company purchases these gums from a sole
source supplier. Although the Company has qualified alternate suppliers with
respect to these gums and to date the Company has not experienced difficulty
acquiring these materials, there can be no assurance that interruptions in
supplies will not occur in the future or that the Company will not have to
obtain substitute suppliers. Any of these events could have a material adverse
effect on the Company's ability to manufacture bulk TIMERx for delivery to its
collaborators, which could have a material adverse effect on the Company's
business, financial condition and results of operations.

The Company currently has two cGMP-approved manufacturing facilities for
its MCC products, including EMCOCEL and ProSolv. These facilities are located in
Cedar Rapids, Iowa and Nastola, Finland and cover approximately 35,000 square
feet and 15,000 square feet, respectively. The Company's MCC products are
primarily made from wood pulp. Although the Company obtains wood pulp primarily
from a single supplier, wood pulp is widely available from a number of
suppliers.

All manufacturing operations of the Company are subject to federal, state
and local laws and regulations governing the use, manufacture, storage, handling
and disposal of certain materials and waste products.

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MARKETING AND DISTRIBUTION

Pursuant to the Company's collaborative agreements, the Company's
collaborators have responsibility for the marketing and distribution of any
controlled release pharmaceuticals developed based on the Company's TIMERx
technology. Because the Company does not plan on developing any of such
pharmaceuticals without a collaborator, the Company has not developed and does
not intend to develop any sales force with respect to such products. As a
result, the Company is substantially dependent on the efforts of its
collaborators to market the products. In selecting a collaborator for a drug
candidate, some of the factors the Company considers include the collaborator's
market presence in the therapeutic area targeted by the drug candidate and the
collaborator's sales force and distribution network.

The Company has an in-house sales force of nine employees who market the
Company's excipients in the United States. This sales force focuses primarily on
pharmaceutical and nutritional companies. The Company also markets its
excipients worldwide through the use of distributors located in over 40
countries. The Company typically sells its excipients to its largest customers
under three-year supply agreements.

COMPETITION

The pharmaceutical industry is highly competitive and is affected by new
technologies, governmental regulations, health care legislation, availability of
financing, litigation and other factors. Many of the Company's competitors have
longer operating histories and greater financial, marketing, legal and other
resources than the Company and certain of its collaborators. The Company expects
that it will be subject to competition from numerous other entities that
currently operate or intend to operate in the pharmaceutical industry, including
companies that engage in the development of controlled release technologies. The
Company's TIMERx business faces competition from numerous public and private
companies and their controlled release technologies, including ALZA's OROS
technology, multiparticulate systems marketed by Elan and Biovail Corporation
International, traditional matrix systems marketed by Jago Pharma AG, a
subsidiary of SkyePharma, plc, and other controlled release technologies
marketed and under development by Andrx Corporation, among others.

The Company initially is concentrating its development efforts on generic
versions of controlled release pharmaceuticals. Typically, selling prices of
immediate release drugs have declined and profit margins have narrowed after
generic equivalents of such drugs are first introduced and the number of
competitive products has increased. Similarly, the success of generic versions
of controlled release products based on the Company's TIMERx technology will
depend, in large part, on the intensity of competition from currently marketed
drugs and technologies that compete with the branded pharmaceutical, as well as
the timing of product approvals. However, the Company believes that generic
versions of controlled release pharmaceuticals based on TIMERx technology are
less likely to suffer the same degree of price erosion as other generic
pharmaceuticals because the formulation, analytical and manufacturing complexity
of the generic versions may be difficult for other companies to replicate, which
could limit competition. Competition may also arise from therapeutic products
that are functionally equivalent but produced by other methods. In addition,
under several of the Company's collaborative arrangements, the payments due to
the Company with respect to the controlled release products covered by such
collaborative arrangements will be reduced in the event that there are competing
generic controlled release versions of such products.

The generic drug industry is characterized by frequent litigation between
generic drug companies and branded drug companies. Those companies with
significant financial resources will be more able to bring and to defend any
such litigation. See "Business -- Litigation."

In its excipients business, the Company competes with a number of large
manufacturers and other distributors of excipient products, many of which have
substantially greater financial, marketing and

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other resources than the Company. The Company's principal competitor in this
market is FMC Corporation, which markets its own line of MCC excipient products.

PATENTS AND PROPRIETARY RIGHTS

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

Penwest has been issued 17 U.S. patents and 40 foreign patents relating to
its controlled release drug delivery technology. In addition, Penwest has filed
12 U.S. patent applications and various corresponding foreign patent
applications relating to its controlled release drug delivery technology. The
U.S. patents issued to the Company cover the Company's TIMERx technology,
including the combination of the xanthan and locust bean gums, the oral solid
dosage form of TIMERx and the method of preparation, as well as the application
(and combination) of TIMERx technology to various active drug substances,
including both method of treatment and methods of preparation. All these patents
expire between 2008 and 2015.

Penwest has also been issued two U.S. patents and four U.S. patent
applications have been allowed relating to its excipient technology. The U.S.
patents and the four allowed U.S. patent applications cover ProSolv and other
augmented MCC excipient products. The U.S. patents and the four allowed U.S.
patent applications, if issued, will expire no later than January 9, 2015.

The issuance of a patent is not conclusive as to its validity or as to the
enforceable scope of the claims of the patent. There is no assurance that the
Company's patents or any future patents will prevent other companies from
developing non-infringing similar or functionally equivalent products or from
successfully challenging the validity of the Company's patents. Furthermore,
there is no assurance that (i) any of the Company's future processes or products
will be patentable; (ii) any pending or additional patents will be issued in any
or all appropriate jurisdictions; (iii) the Company's processes or products will
not infringe upon the patents of third parties; or (iv) the Company will have
the resources to defend against charges of infringement by or protect its own
patent rights against third parties. The inability of the Company to protect its
patent rights or infringement by the Company of the patent or proprietary rights
of others could have a material adverse effect on the Company's business,
financial condition and results of operations.

There has been substantial litigation in the pharmaceutical, biomedical and
biotechnology industries with respect to the manufacture, use and sale of new
products that are the subject of conflicting patent rights. Most of the
controlled release products that the Company is developing with its
collaborators are generic versions of brand name controlled release products
that are covered by one or more patents. Under the Waxman-Hatch Act when an
applicant files an ANDA with the FDA for a generic version of a brand name
product covered by an unexpired patent listed with the FDA, the applicant must
certify to the FDA that such patent will not be infringed by the applicant's
product or

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that such patent is invalid or unenforceable. Notice of such certification must
be given to the patent holder and the sponsor of the NDA for the brand name
product. If a patent infringement lawsuit is filed within 45 days of the receipt
of such notice, the FDA will conduct a substantive review of the ANDA, but will
not grant final marketing approval of the generic product until a final judgment
on the patent suit is rendered in favor of the applicant or until 30 months (or
such longer or shorter period as a court may determine) have elapsed from the
date of the certification, whichever is sooner. Should a patent holder commence
a lawsuit with respect to alleged patent infringement by the Company or its
collaborators, the uncertainties inherent in patent litigation make the outcome
of such litigation difficult to predict. To date, one such action has been
commenced against one of the Company's collaborators and it is anticipated that
additional actions will be filed as the Company's collaborators file additional
ANDAs. The Company evaluates the probability of patent infringement litigation
with respect to its collaborators' ANDA submissions on a case by case basis. The
delay in obtaining FDA approval to market the Company's product candidates as a
result of litigation, as well as the expense of such litigation, whether or not
the Company is successful could have a material adverse effect on the Company's
business, financial condition and results of operations.

In May 1997, the Company's collaborator, Mylan, filed an ANDA with the FDA
for a generic version of Procardia XL, a controlled release formulation of
nifedipine. For a discussion of the litigation resulting from such filing, see
"Business -- Litigation."

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

GOVERNMENT REGULATION

FDA Regulation of Pharmaceutical Products

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

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

As an initial step in the FDA regulatory approval process for an NDA,
preclinical studies are typically conducted in animal models to assess the
drug's efficacy and to identify potential safety problems. The results of these
studies must be submitted to the FDA as part of an Investigational New Drug
("IND") application, which must be reviewed by the FDA before proposed clinical
testing can begin. Typically clinical testing involves a three-phase process.
Phase I trials are conducted with a small number of subjects and are designed to
provide information about both product safety and the expected dose of the drug.
Phase II trials are designed to provide additional information on dosing and
preliminary evidence of product efficacy. Phase III trials are large scale
studies designed to provide

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<PAGE> 47

statistical evidence of efficacy and safety in humans. The results of the
preclinical testing and clinical trials of a pharmaceutical product are then
submitted to the FDA in the form of an NDA for approval to commence commercial
sales. Preparing such applications involves considerable data collection,
verification, analysis and expense. In responding to an NDA or PLA, the FDA may
grant marketing approval, request additional information or deny the application
if it determines that the application does not satisfy its regulatory approval
criteria.

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

ANDAs may be submitted for generic versions of brand name drugs ("Listed
Drugs") where the generic drug is the "same" as the Listed Drug with respect to
active ingredient(s) and route of administration, dosage form, strength, and
conditions of use recommended in the labeling. ANDAs may also be submitted for
generic drugs that differ with regard to certain changes from a Listed Drug if
the FDA has approved a petition from a prospective applicant permitting the
submission of an ANDA for the changed product.

Rather than safety and efficacy studies, the FDA requires data
demonstrating that the ANDA drug formulation is bioequivalent to the Listed
Drug. The FDA also requires labeling, chemistry and manufacturing information.
FDA regulations define bioequivalence as the absence of a significant difference
in the rate and the extent to which the active ingredient becomes available at
the site of drug action when administered at the same molar dose under similar
conditions in an appropriately designed study. If the approved generic drug is
both bioequivalent and pharmaceutically equivalent to the Listed Drug, the
agency will assign a code to the product in an FDA publication entitled
"Approved Drug Products With Therapeutic Equivalence Evaluation." These codes
will indicate whether the FDA considers the product to be therapeutically
equivalent to the Listed Drug. The codes will be considered by third parties in
determining whether the generic drug is therapeutically equivalent and fully
substitutable for the Listed Drug and are relied upon by Medicaid and Medicare
formularies for reimbursement.

The Company's collaborator, Mylan, has filed an ANDA with the FDA for the
30 mg dosage strength of a generic version of Procardia XL, and the Company
expects that its collaborators will file additional ANDAs to obtain approval to
market other generic controlled release products. There can be no assurance that
ANDAs will be suitable or available for such products, or that such products
will receive FDA approval on a timely basis.

Certain ANDA procedures for generic versions of controlled release products
are the subject of petitions filed by brand name drug manufacturers, which seek
changes from the FDA in the approval process for generic drugs. These requested
changes include, among other things, tighter standards for certain
bioequivalence studies and disallowance of the use by a generic drug
manufacturer in its

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<PAGE> 48

ANDA of proprietary data submitted by the original manufacturer as part of an
original new drug application. The Company is unable to predict at this time
whether the FDA will make any changes to its ANDA procedures as a result of such
petitions or any future petitions filed by brand name drug manufacturers or the
effect that such changes may have on the Company. Any changes in FDA regulations
which make ANDA approvals more difficult could have a material adverse effect on
the Company's business, financial condition and results of operations.

Some products containing the Company's TIMERx formulation, such as
controlled release formulations of approved immediate release drugs, will
require the filing of an NDA. The FDA will not accept ANDAs when the delivery
system or duration of drug availability differs significantly from the Listed
Drug. However, the Company may be able to rely on existing publicly available
safety and efficacy data to support section 505(b)(2) NDAs for controlled
release products when such data exists for an approved immediate release version
of the same chemical entity. However, there can be no assurance that the FDA
will accept such section 505(b)(2) NDAs, or that the Company will be able to
obtain publicly available data that is useful. The section 505(b)(2) NDA process
is a highly uncertain avenue to approval because the FDA's policies on section
505(b)(2) NDAs have not yet been fully developed. There can be no assurance that
an application submitted under section 505(b)(2) will be approved, or will be
approved in a timely manner.

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

Under the Waxman-Hatch Act, an applicant who files the first ANDA with a
certification of patent invalidity or non-infringement with respect to a product
may be entitled to receive, if such ANDA is approved by the FDA, 180-day
marketing exclusivity (a 180-day delay in approval of other ANDAs for the same
drug) from the FDA. However, there can be no assurance that the FDA will not
approve an ANDA filed by another applicant with respect to a different dosage
strength prior to or during such 180-day marketing exclusivity period.

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

Sponsors of drug applications affected by patents may also be adversely
affected by patent term extensions provided under the FDCA to compensate for
patent protection lost due to time taken in conducting FDA required clinical
studies or during FDA review of data submissions. Patent term extensions may not
exceed five additional years nor may the total period of patent protection
following FDA marketing approval be extended beyond 14 years. In addition, by
virtue of the Uruguay Round Agreements Act of 1994 that ratified the General
Agreement on Tariffs and Trade ("GATT"), certain brand name drug patent terms
have been extended to 20 years from the date of filing of the pertinent

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<PAGE> 49

patent applications (which can be longer than the former 17-year patent term
starting from the date of patent issuance). Patent term extensions may delay the
ability of the Company and its collaborators to use the Company's proprietary
technology in the future, market new controlled release products, file section
505(b)(2) NDAs referencing approved products, or file ANDAs based on Listed
Drugs when those approved products or Listed Drugs have acquired patent term
extensions.

Most drug products of biological origin enter the market under licenses
approved by the FDA under the Public Health Service Act rather than under NDAs
or ANDAs. In general terms, the licensure process for these biological products
is comparable to the full NDA approval process for a drug product under the
FDCA. At the current time, most biological products must be approved in both a
product licensing application ("PLA") and an establishment license application
("ELA"). Effective February 9, 1998, the Public Health Service Act will require
a single biologics application rather than a PLA and an ELA. The FDA does not
have a process for licensing generic versions of biological products on the
basis of abbreviated applications such as ANDAs.

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

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

FDA Regulation of Excipients

Products sold for use as excipients in finished drug products are subject
to regulation by the FDA with regard to labeling, product integrity and
manufacturing. The FDA will not approve a drug for marketing without adequate
assurances that the excipients are safe for use in the product. The FDA presumes
certain excipients that are present in approved drug products currently marketed
for human use to be safe. These excipients are listed by the FDA in a document
known as the Inactive Ingredient Guide, or "IIG." While the FDA does not
ordinarily require applicants for NDAs or ANDAs to submit data demonstrating the
safety of excipients listed in the IIG, it may require evidence of safety in
certain circumstances, such as when evidence is required to demonstrate that
such excipients interact safely with other components of a drug product. For
excipients not listed in the IIG, the FDA will generally require data, which may
include clinical data, demonstrating the safety of the excipient for use in the
product at issue. In the case of generic drug products approved based on
bioequivalence to a reference drug, the FDA may in some cases (e.g., products
for parenteral, ophthalmic, otic or topical use) require excipients that are
identical to the excipients in the reference drug. There can be no assurance
that the FDA will not require new clinical safety data to approve an application
for a product with a Penwest excipient or that the FDA will approve such an
application even if such clinical data are submitted.

Foreign Regulatory Approval

Whether or not FDA approval has been obtained, approval of a pharmaceutical
product by comparable governmental regulatory authorities in foreign countries
must be obtained prior to the commencement of clinical trials and subsequent
marketing of such product in such countries. The approval procedure varies from
country to country, and the time required may be longer or shorter than that
required for FDA approval.

Under European Community ("EC") law, either of two approval procedures may
apply to the Company's products: a centralized procedure, administered by the
EMEA (the European Medicines Evaluation Agency); or a decentralized procedure,
which requires approval by the medicines agency

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<PAGE> 50

in each EC Member State where the Company's products will be marketed. The
centralized procedure is mandatory for certain biotechnology products and
available at the applicant's option for certain other products. Although the
decentralized procedure requires approval by the medicines agency in each EC
Member State where the products will be marketed, there is a mutual recognition
procedure under which the holder of marketing approval from one EC Member State
may submit an application to one or more other EC Member States, including a
certification to the effect that the application is identical to the application
which was originally approved or setting forth the differences between the two
applications. Within 90 days of such application, each EC Member State will be
required to determine whether to recognize the prior approval.

Whichever procedure is used, the safety, efficacy and quality of the
Company's products must be demonstrated according to demanding criteria under EC
law and extensive nonclinical tests and clinical trials are likely to be
required. In addition to premarket approval requirements, national laws in EC
Member States will govern clinical trials of the Company's products, adherence
to good manufacturing practice, advertising and promotion and other matters. In
certain EC Member States, pricing or reimbursement approval may be a legal or
practical precondition to marketing.

A procedure for abridged applications for generic products also exists in
the EC. The general effect of the abridged application procedure is to give
scope for the emergence of generic competition once patent protection has
expired and the original product has been on the market for at least six or ten
years. Independent of any patent protection, under the abridged procedure, new
products benefit in principle from a basic six or ten year period of protection
(commencing with the date of first authorization in the EC) from abridged
applications for a marketing authorization. The period of protection in respect
of products derived from certain biotechnological processes or other high-
technology medicinal products viewed by the competent authorities as
representing a significant innovation is ten years. Further, each EC Member
State has discretion to extend the basic six-year period of protection to a
ten-year period to all products marketed in its territory. Certain EC Member
States have exercised such discretion. The protection does not prevent another
company from making a full application supported by all necessary
pharmacological, toxicological and clinical data within the period of
protection. Abridged applications can be made principally for medicinal products
which are essentially similar to medicinal products which have been authorized
for either six or ten years. Under the abridged application procedure, the
applicant is not required to provide the results of pharmacological and
toxicological tests or the results of clinical trials. For such abridged
applications, all data concerning manufacturing quality and bioavailability are
required. The applicant submitting the abridged application generally must
provide evidence or information that the drug product subject to this
application is essentially similar to that of the referenced product in that it
has the same qualitative and quantitative composition with respect to the active
ingredient and the same dosage form, and is similar in bioavailability as the
referenced drug.

The Company's European excipients manufacturing operations are subject to a
variety of laws and regulations, including environmental and good manufacturing
practices regulations.

Other Regulations

The Company is governed by federal, state and local laws of general
applicability, such as laws regulating working conditions and environmental
protection. Certain drugs that the Company is developing are subject to
regulations under the Controlled Substances Act and related statutes.

PRICING AND THIRD-PARTY REIMBURSEMENT

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<PAGE> 51

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

Third-party payors are attempting to control costs by limiting the level of
reimbursement for medical products, including pharmaceuticals. Cost control
initiatives could decrease the price that the Company or any of its
collaborators receives for their drugs and have a material adverse effect on the
Company's business, financial condition and results of operations. Further, to
the extent that cost control initiatives have a material adverse effect on the
Company's collaborators, the Company's ability to commercialize its products and
to realize royalties may be adversely affected. Moreover, health care reform has
been, and may continue to be, an area of national and state focus, which could
result in the adoption of measures that adversely affect the pricing of
pharmaceuticals or the amount of reimbursement available from third party
payors. The Company's business, financial condition and results of operations
could be materially adversely affected if adequate coverage and reimbursement
levels are not provided by government and other third-party payors for the
products of the Company and its collaborators.

PRODUCT LIABILITY INSURANCE

The design, development, and manufacture of the Company's products involve
an inherent risk of product liability claims. The Company faces the risk of
product liability claims in the event that the use of its products is alleged to
have resulted in harm to a patient or subject. Such risks exist even with
respect to those products that are manufactured in licensed and regulated
facilities or that otherwise possess regulatory approval for commercial sale.
Until the Spin-off, the Company will be covered by primary product liability
insurance maintained by Penford in the amount of $1.0 million per occurrence and
$2.0 million annually in the aggregate on a claims-made basis and by umbrella
liability insurance in excess of $5.0 million which can also be used for product
liability insurance. The Company believes that its product liability insurance
is adequate for its current operations, and will seek to increase its coverage
prior to the commercial introduction of its controlled release product
candidates. There can be no assurance that the coverage limits of the Company's
insurance will be sufficient to offset potential claims or that Penwest will be
able to obtain comparable coverage following the Spin-off. Product liability
insurance is expensive and difficult to procure and may not be available in the
future on acceptable terms or in sufficient amounts, if available at all.
However, since some of the Company's collaborators require the Company to
maintain product liability insurance coverage as a condition to doing business
with the Company, the Company intends to take all reasonable steps necessary to
maintain such insurance coverage. A successful claim against the Company in
excess of its insurance coverage could have a material adverse effect upon the
Company's business, financial condition and results of operations.

LITIGATION

In May 1997, one of the Company's collaborators, Mylan, filed an ANDA with
the FDA for the 30 mg dosage strength of Nifedipine XL, a generic version of
Procardia XL, a controlled release formulation of nifedipine. Bayer and ALZA own
patents listed for Procardia XL (the last of which expires in 2010), and Pfizer
holds the NDA and markets the product. In connection with the ANDA filing, Mylan
certified to the FDA that Nifedipine XL does not infringe these Bayer or ALZA
patents and notified Bayer, ALZA and Pfizer of such certification. Bayer and
Pfizer sued Mylan in the United States District Court for the Western District
of Pennsylvania, alleging that Mylan's product infringes Bayer's patent. The
Company has been informed by Mylan that ALZA does not believe that the notice
given to it complied with the requirements of the Waxman-Hatch Act, and there
can be no assurance that ALZA will not sue Mylan for patent infringement or take
any other actions with respect to such notice. Mylan has advised the Company
that it intends to contest vigorously the allegations made in the lawsuit.
However, there can be no assurance that Mylan will prevail in this litigation or
that it will continue to contest the lawsuit. An unfavorable outcome or
protracted litigation for Mylan would

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<PAGE> 52

materially adversely affect the Company's business, financial condition and
results of operations. Delays in the commercialization of Nifedipine XL could
occur because the FDA will not grant final marketing approval of Nifedipine XL
until a final judgment on the patent suit is rendered in favor of Mylan by the
district court, or in the event of an appeal, by the court of appeals, or until
30 months (or such longer or shorter period as the court may determine) have
elapsed from the date of Mylan's certification, whichever is sooner.

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

There can be no assurance that Pfizer will not seek to protect its
marketing exclusivity with respect to Procardia XL by pursuing additional
regulatory initiatives and lawsuits.

FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES

For financial information about the Company's foreign and domestic
operations and export sales, see Note 12 of Notes to Consolidated Financial
Statements.

FACILITIES

The Company's executive, administrative, research, small-scale production
and warehouse facilities, comprising approximately 55,000 square feet, currently
are located in a single facility on a 15 acre site owned by the Company in
Patterson, New York. The Company currently plans to use approximately $15
million from the proceeds of this offering for the construction of facilities
for the manufacture of formulated TIMERx material, as well as expanded
laboratory space, at its Patterson, New York facility.

The Company owns a facility in Cedar Rapids, Iowa where it manufactures and
packages pharmaceutical excipients. The facility is a 35,000 square foot
building containing manufacturing and administrative space. The Company also
manufactures pharmaceutical excipients in a 15,000 square foot facility leased
by the Company in Nastola, Finland, which lease renews annually with a two-year
notification of termination period for either party.

The Company believes that all of its present facilities are well maintained
and in good operating condition.

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EMPLOYEES

As of September 30, 1997, the Company employed 118 persons, of which 73
were involved in research and development, administration and sales and
marketing activities in Patterson, New York, 20 were involved in manufacturing
operations at the Company's facility in Nastola, Finland, 19 were involved in
manufacturing operations at the Company's facility in Cedar Rapids, Iowa and six
were involved in sales activities in the Company's European sales offices.

Other than the Company's employees in Finland who are covered by a national
collective bargaining agreement, none of the Company's employees are covered by
collective bargaining agreements. The Company considers its employee relations
to be good.

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MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The executive officers and directors of the Company, and their ages as of
October 15, 1997, are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Tod R. Hamachek(1).................... 51 Chairman of the Board and Chief Executive Officer
John V. Talley, Jr.................... 41 President, Chief Operating Officer and Director
Anand R. Baichwal, Ph.D............... 42 Senior Vice President, Research and Development
Edmund O. Belsheim, Jr................ 45 Senior Vice President, Corporate Development,
General Counsel and Secretary
Stephen J. Berte, Jr.................. 42 Vice President, Marketing and Sales
Jennifer L. Good...................... 32 Vice President, Finance and Chief Financial
Officer
Paul K. Wotton, Ph.D.................. 37 Vice President, Business Development
Paul E. Freiman(1)(3)................. 63 Director
Jere E. Goyan, Ph.D.(2)............... 67 Director
Rolf H. Henel(2)...................... 60 Director
Robert J. Hennessey(1)(3)............. 55 Director
N. Stewart Rogers(2)(3)............... 67 Director
W. Leigh Thompson, M.D., Ph.D.(2)..... 59 Director
</TABLE>

- ---------------
(1) Member of Executive Committee.

(2) Member of Audit Committee.

(3) Member of Compensation Committee.

Tod R. Hamachek was named Chairman of the Board of Directors and Chief
Executive Officer of the Company on October 8, 1997. Mr. Hamachek has served as
President and Chief Executive Officer of Penford since 1985, but will resign
from these positions effective upon the closing of this offering. He has also
served as a director of Penford since 1983 but will resign from this position
effective upon the date of the Spin-off. Mr. Hamachek is a director of DEKALB
Genetics Corporation and Northwest Natural Gas Company.

John V. Talley, Jr. has served as President of the Company since December
1993 and was named Chief Operating Officer and a director of the Company on
October 8, 1997. Mr. Talley has served as a Vice President of Penford since 1993
but will resign from that position effective upon the closing of this offering.
Prior to joining the Company, Mr. Talley served in a variety of positions at
Sterling Drug from 1979 to 1993, including Vice President of Marketing from 1992
to 1993 and Vice President, Marketing of the Hospital Products Division from
1989 to 1992. From 1979 to 1989, Mr. Talley served in the New Product
Development and Marketing Department of Sanofi where he was responsible for the
marketing of prescription drugs in the United States.

Dr. Anand R. Baichwal has served as Senior Vice President, Research and
Development of the Company since January 1997, after serving in a variety of
positions for the Company since 1987, including Vice President, Technology from
1994 to 1997, Vice President, Research and Development from 1993 to 1994,
Director of Commercial Development from 1991 to 1993 and Director of Research
and Development and Technical Affairs from 1987 to 1991. Dr. Baichwal is a
co-inventor of the TIMERx technology. See "Certain Transactions."

Edmund O. Belsheim, Jr. was named Senior Vice President, Corporate
Development, General Counsel and Secretary of the Company on October 8, 1997.
Mr. Belsheim has served as Vice President, Corporate Development and General
Counsel of Penford since September 1996 and as Secretary of

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<PAGE> 55

Penford since March 1997, but will resign from these positions effective upon
the closing of this offering. Prior to joining Penford, Mr. Belsheim was a
member of the law firm Bogle & Gates P.L.L.C. from 1986 to 1996.

Stephen J. Berte, Jr. has served as Vice President, Marketing and Sales of
the Company since January 1995. Prior to joining the Company, Mr. Berte served
in a variety of positions at Sanofi, including Senior Director of New Product
Development from 1992 to 1995, Director of Marketing from 1990 to 1992, Senior
Product Manager from 1989 to 1990, Product Manager from 1988 to 1989 and
Assistant Project Manager for injectable drugs from 1987 to 1988.

Jennifer L. Good has served as Vice President, Finance of the Company since
March 1997 and was named Chief Financial Officer of the Company on October 8,
1997. Prior to joining the Company, Ms. Good served as Corporate Director of
Finance and Secretary of Penford from 1996 to March 1997 and as Corporate
Controller of Penford from 1993 to 1996. From 1987 to 1993, Ms. Good was
employed by Ernst & Young LLP as an audit manager.

Dr. Paul K. Wotton has served as Vice President, Business Development of
the Company, since November 1994, after serving in a variety of positions for
the Company since 1989, including Director of Business Development from 1993 to
1994 and Product Manager (Europe) from 1991 to 1993. Prior to joining the
Company, Dr. Wotton served as a Project Manager at Abbott Laboratories, a
pharmaceutical company ("Abbott"), from 1987 to 1989 and as a Research
Pharmacist at Merck and Co., Inc. ("Merck"), a pharmaceutical company, from 1985
to 1987.

Paul E. Freiman became a director of the Company on October 8, 1997. Mr.
Freiman has served as a director of Penford since April 1996 but will resign
from this position effective upon the date of the Spin-off. Mr. Freiman has
served as President of Neurobiological Technologies, Inc., a biotechnology
company, since May 1997 and as Chairman of the Board of Digital Gene
Technologies, a biotechnology company, since February 1995. From 1990 to 1995,
Mr. Freiman served as Chairman and Chief Executive Officer of Syntex
Corporation, a pharmaceutical company.

Dr. Jere E. Goyan became a director of the Company on October 8, 1997. Dr.
Goyan has been the President and Chief Operating Officer of Alteon Corporation
("Alteon"), a biopharmaceutical company, since April 1993. Dr. Goyan also served
as the Acting Chief Executive Officer of Alteon from June 1993 to February 1994
and as Senior Vice President, Research and Development of Alteon from January
1993 through April 1993. Dr. Goyan is Professor Emeritus of Pharmacy and
Pharmaceutical Chemistry and Dean Emeritus of the School of Pharmacy, University
of California, San Francisco ("UCSF"). He has been on the faculty of the School
of Pharmacy at UCSF since 1963. He took a leave of absence from 1979 to 1981 to
serve as Commissioner of Food and Drugs of the FDA. Dr. Goyan is a director of
ATRIX Laboratories, Inc., Emisphere Technologies, Inc. and SciClone
Pharmaceuticals, Inc., each a biopharmaceutical firm, and Boehringer Ingelheim
Pharmaceuticals, Inc., a pharmaceutical company.

Rolf H. Henel became a director of the Company on October 8, 1997. Mr.
Henel has served as Executive Director of Performance Effectiveness Corp., a
consulting firm for the pharmaceutical industry, since June 1995 and as a
partner of Naimark & Associates P.C., a consulting firm for the healthcare
industry, since September 1990. From 1978 to 1993, Mr. Henel served in a variety
of positions at American Cyanamid Co., a pharmaceutical company, most recently
as President of Lederle International, a division of American Cyanamid Co. Mr.
Henel is a director of SciClone Pharmaceuticals, Inc.

Robert J. Hennessey became a director of the Company on October 8, 1997.
Mr. Hennessey has served as Chairman of the Board and Chief Executive Officer of
Genome Therapeutics Corp., a biotechnology company, since March 1993. From 1990
to 1993, Mr. Hennessey served as the President of Hennessey & Associates Ltd., a
strategic consulting firm to biotechnology and healthcare companies. Prior to
1990, Mr. Hennessey held a variety of management positions at Merck, SmithKline,

54
<PAGE> 56

Abbott and Sterling Drug. Mr. Hennessey is also a director of Virus Research
Institute, Inc., a biotechnology company.

N. Stewart Rogers became a director of the Company on October 8, 1997. Mr.
Rogers has served as Chairman of the Board of Directors of Penford since 1990
and as a director of Penford since 1983. Mr. Rogers is also a director of Fluke
Corporation, an electronic test instrument manufacturer, Royal Pakhoed N.V. (The
Netherlands), a chemical logistics and distribution company, U.S. Bancorp, a
bank holding company and VWR Scientific Products Corporation, a laboratory
supply company.

Dr. W. Leigh Thompson became a director of the Company on October 8, 1997.
Dr. Thompson has served as Chief Executive Officer of Profound Quality
Resources, Ltd., a consulting firm for the pharmaceutical industry, since 1995.
From 1993 to 1994, Dr. Thompson served as Chief Scientific Officer of Eli Lilly
and Company, a pharmaceutical company, and prior to that in a variety of
positions at Eli Lilly and Company since 1982, including Executive Vice
President of Lilly Research Laboratories.

BOARD OF DIRECTORS' COMMITTEES AND OTHER INFORMATION

Each officer of the Company is elected by the Board of Directors on an
annual basis and serves until his or her successor has been duly elected and
qualified. There are no family relationships among any of the executive officers
or directors of the Company.

The Board of Directors is divided into three classes, each of whose members
serves for a staggered three-year term. The Board consists of three Class I
directors (Mr. Freiman, Mr. Henel and Mr. Rogers), three Class II directors (Dr.
Goyan, Mr. Talley and Dr. Thompson) and two Class III directors (Mr. Hamachek
and Mr. Hennessey). At each annual meeting of shareholders, a class of directors
is elected for a three-year term to succeed the directors of the same class
whose term is then expiring. The terms of the Class I directors, Class II
directors and Class III directors expire at the annual meeting of shareholders
to be held in 1998, 1999 and 2000, respectively. It is Penwest's policy that
when the Chairman of the Board and the Chief Executive Officer is the same
person, the Board of Directors will appoint one of its members as a Lead
Director to chair meetings of the Board and for certain other purposes. Mr.
Freiman has been appointed Lead Director.

The Board of Directors has established a Compensation Committee, an Audit
Committee and an Executive Committee. The Compensation Committee makes
recommendations to the Board with respect to the compensation of directors and
executive officers of the Company. The Compensation Committee also supervises
the Company's employee benefit plans. The Compensation Committee consists of
Messrs. Freiman, Hennessey and Rogers.

The Audit Committee recommends to the Board the selection of the
independent auditors, reviews the proposed scope of the independent audit,
reviews the annual financial statements and the independent auditor's report,
reviews the independent auditor's recommendations relating to accounting,
internal controls and other matters, and reviews internal controls and
accounting procedures with management. The Audit Committee consists of Messrs.
Henel and Rogers and Drs. Goyan and Thompson.

The Executive Committee exercises all powers and authority of the Board
with certain exceptions as provided under Washington law. The Executive
Committee consists of Messrs. Freiman, Hamachek and Hennessey.

DIRECTOR COMPENSATION

In connection with this offering, options to purchase 10,000 shares of
Common Stock (11,000 shares in the case of the Lead Director) will be granted to
each non-employee director under the Company's 1997 Equity Incentive Plan (the
"1997 Plan") upon the date on which the initial public offering price is
determined (the "Pricing Date") at the initial public offering price. It is
contemplated that each non-employee director will also receive an annual grant
of stock options under the

55
<PAGE> 57

Company's 1997 Plan to purchase 7,000 shares of Common Stock (8,000 shares in
the case of the Lead Director) at an exercise price equal to the closing price
of the Common Stock on the date of grant. All options granted to non-employee
directors will first become exercisable six months after their grant date. These
options will become exercisable in full upon a change in control of Penwest (as
defined).

Each non-employee director will be reimbursed for his expenses incurred in
connection with his attendance at Board and committee meetings.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The current members of the Company's Compensation Committee are Messrs.
Freiman, Hennessey and Rogers, none of whom are employees of the Company.

56
<PAGE> 58

EXECUTIVE COMPENSATION

The following table sets forth the compensation paid by the Company or
Penford in the year ended December 31, 1996 to the Company's Chief Executive
Officer and to the Company's other executive officers whose annual salary and
bonus exceeded $100,000 (collectively, the "Named Executive Officers").

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
------------
SECURITIES
ANNUAL COMPENSATION OF PENFORD
--------------------- UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION(1) SALARY BONUS OPTIONS(5) COMPENSATION(6)
- ------------------------------ -------- -------- ------------ ---------------
<S> <C> <C> <C> <C>
Tod R. Hamachek(2)...................... $340,000(4) $123,636 96,000 $19,702
Chairman of the Board and Chief
Executive Officer
John V. Talley, Jr. .................... 180,000(4) 58,183 19,000 8,403
President and Chief Operating Officer
Stephen J. Berte, Jr. .................. 119,000 17,927 10,000 4,745
Vice President, Marketing and Sales
Paul K. Wotton, Ph.D. .................. 107,000 25,000 6,000 6,298
Vice President, Business Development
Anand R. Baichwal, Ph.D.(3)............. 96,000 19,000 6,000 6,101
Senior Vice President, Research and
Development
</TABLE>

- ---------------
(1) In accordance with the rules of the Commission, this table and the stock
option grant table and the stock option exercise table which follow present
information concerning the Company's Chief Executive Officer and its four
other most highly compensated executive officers whose total annual salary
and bonus exceeded $100,000 (determined by reference to total annual salary
and bonus earned by such officers) for the year ended December 31, 1996.
Edmund O. Belsheim, Jr., who joined Penford as Vice President, Corporate
Development and General Counsel in September 1996, currently receives an
annual salary of $190,000 per year. During the year ended December 31, 1996,
pursuant to Penford's 1994 Stock Option Plan, Mr. Belsheim was granted stock
options to purchase an aggregate of 53,000 shares of common stock of Penford
at a weighted average exercise price of $18.33 per share.

(2) Mr. Hamachek earned the compensation set forth above for services rendered
to Penford in his capacity as President and Chief Executive Officer of
Penford.

(3) For a discussion of certain other amounts payable to Dr. Baichwal, see
"Certain Transactions."

(4) Includes $20,000 and $4,638 as to which Messrs. Hamachek and Talley,
respectively, elected to defer payment.

(5) Represents options to purchase common stock of Penford granted to the Named
Executive Officers in 1996.

(6) Represents Penford's matching and profit sharing contributions under the
Penford Savings and Stock Ownership Plan and premiums paid on behalf of the
Named Executive Officers for supplemental life and disability insurance
plans.

57
<PAGE> 59

Option Grants

The following table sets forth certain information concerning grants of
stock options to purchase shares of common stock of Penford made during the year
ended December 31, 1996 by Penford to the Named Executive Officers. No options
to purchase shares of Penwest's Common Stock were issued during the year ended
December 31, 1996.

OPTION GRANTS IN YEAR ENDED DECEMBER 31, 1996

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
--------------------------------------------------
PERCENT OF POTENTIAL REALIZABLE
NUMBER OF TOTAL VALUE AT ASSUMED
SECURITIES OPTIONS ANNUAL RATES OF STOCK
OF PENFORD GRANTED TO EXERCISE PRICE APPRECIATION
UNDERLYING EMPLOYEES OR BASE FOR OPTION TERM(4)
OPTIONS BY PENFORD PRICE PER EXPIRATION ---------------------
NAME GRANTED(1) IN 1996 SHARE DATE(3) 5% 10%
- ---- ---------- ------------ --------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Tod R. Hamachek............... 46,000 12.57% $ 18.50 10/23/06 $535,194 $1,356,239
50,000(2) 13.66 17.50 12/12/06 550,288 1,394,488
John V. Talley, Jr. .......... 19,000 5.19 18.50 10/23/06 221,058 560,186
Steven J. Berte, Jr. ......... 5,000 1.37 18.25 06/25/06 57,387 145,425
5,000 1.37 17.00 12/20/06 53,457 135,465
Paul K. Wotton................ 1,000 0.27 18.25 06/25/06 11,477 29,085
5,000 1.37 17.00 12/20/06 53,457 135,465
Anand R. Baichwal............. 1,000 0.27 18.25 06/25/06 11,477 29,085
5,000 1.37 17.00 12/20/06 53,457 135,465
</TABLE>

- ---------------
(1) Except as noted in note (2) below, these stock options are either
exercisable in four or five equal annual installments commencing on the
first anniversary of the date of grant of the options.

(2) These stock options are exercisable with respect to 20,000 of such shares
and become exercisable with respect to 10,000 of such shares in four equal
annual installments commencing on the first anniversary of the date of grant
of the options, and with respect to 20,000 of such shares on the date on
which the closing price of the common stock of Penford has equaled or
exceeded $38.00 for each of the 20 consecutive trading days immediately
preceding such date.

(3) The expiration date of an option is the tenth anniversary of the date on
which the option was originally granted.

(4) The amounts shown on this table represent hypothetical gains that could be
achieved for the respective options if exercised at the end of the option
term. These gains are based on assumed rates of stock appreciation of 5% and
10%, compounded annually from the date the respective options were granted
to their expiration date. The gains shown are net of the option exercise
price, but do not include deductions for taxes or other expenses associated
with the exercise and do not represent the Company's estimate or projection
of the future price of the common stock of Penford. Actual gains, if any, on
stock option exercises will depend on the future performance of the common
stock of Penford, the optionholders' continued employment through the option
period with either Penford or the Company, and the date on which the options
are exercised.

The Company has approved the grant of stock options to purchase an
aggregate of 654,000 shares of Common Stock to its employees and officers,
effective upon the Pricing Date, at an exercise price equal to the initial
public offering price, of which options to purchase 180,000 shares, 105,000
shares, 30,000 shares, 51,000 shares, 78,000 shares and 75,000 shares were
granted to Mr. Hamachek, Mr. Talley, Mr. Berte, Dr. Wotton, Dr. Baichwal and Mr.
Belsheim, respectively. These options will be exercisable in four equal annual
installments commencing on the first anniversary of the Pricing Date and will
become exercisable in full upon a change in control of Penwest (as defined).

58
<PAGE> 60

Stock Options Held as of Year-End

The following table sets forth certain information concerning each exercise
of a stock option to purchase common stock of Penford during the year ended
December 31, 1996 by a Named Executive Officer, and the number and value of
unexercised stock options to purchase shares of common stock of Penford held by
each of the Named Executive Officers as of December 31, 1996. No Named Executive
Officer held any stock options to purchase shares of Penwest's Common Stock as
of December 31, 1996.

AGGREGATE OPTION EXERCISES IN 1996
AND YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
NUMBER NUMBER OF SECURITIES OF
OF SHARES PENFORD UNDERLYING VALUE OF UNEXERCISED
OF PENFORD UNEXERCISED OPTIONS AS OF IN-THE-MONEY OPTIONS AS OF
ACQUIRED DECEMBER 31, 1996(#) DECEMBER 31, 1996($)(1)
ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ---------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Tod R. Hamachek............ 32,242 $376,264 225,000 96,000 $ 1,950,075 $ --
John V. Talley, Jr......... -- -- 6,000 63,000 -- --
Stephen J. Berte, Jr....... -- -- -- 10,000 -- 2,500
Paul K. Wotton............. -- -- 2,000 14,000 -- 2,500
Anand R. Baichwal.......... -- -- 2,000 14,000 -- 2,500
</TABLE>

- ---------------
(1) Value is based on the difference between the option exercise price and the
fair market value of shares of common stock of Penford as of December 31,
1996 ($17.50 per share as quoted on the Nasdaq National Market).

Penford Retirement Plan

Penford has a defined benefit retirement plan (the "Retirement Plan"). The
table below shows the estimated annual benefits payable on retirement under the
Retirement Plan to persons in the specified compensation and years of service
classifications. The retirement benefits shown are based upon retirement at age
65 and the payments of a single-life annuity to the employee using current
average Social Security wage base amounts and are not subject to any deduction
for Social Security or other offset amounts. With certain exceptions, the Code
restricts to an aggregate amount of $120,000 (subject to cost of living
adjustments) the annual pension that may be paid by an employer from a plan
which is qualified under the Code. The Code also limits the covered compensation
which may be used to determine benefits to $150,000. The Board of Directors of
Penford has established supplemental benefits for certain highly compensated
employees to whom this limit applies or will apply in the future, so that these
employees will obtain the benefit of the formula that would have applied in the
absence of the limitation. Named Executive Officers entitled to receive
supplemental benefits as of December 31, 1996 were Messrs. Hamachek and Talley.

RETIREMENT BENEFITS

<TABLE>
<CAPTION>
YEARS OF SERVICE
-----------------------------------------------------
COVERED COMPENSATION(1) 20 25 30 35
- ----------------------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
$200,000.................................. $ 57,070 $ 71,337 $ 85,604 $ 99,872
300,000.................................. 87,070 108,837 130,604 152,372
400,000.................................. 117,070 146,337 175,604 204,872
500,000.................................. 147,070 183,837 220,604 257,372
600,000.................................. 177,070 221,337 265,604 309,872
700,000.................................. 207,070 258,837 310,604 362,372
800,000.................................. 237,070 296,337 355,604 414,872
900,000.................................. 267,070 333,837 400,604 467,372
</TABLE>

- ---------------
(1) Represents the highest average annual earnings during five consecutive
calendar years of service.

Compensation of Named Executive Officers covered by the Retirement Plan
includes salaries and bonuses as shown in the salary and bonus columns of the
Summary Compensation Table.

59
<PAGE> 61

As of December 31, 1996, the approximate years of credited service (rounded
to the nearest year) under the Retirement Plan of the Named Executive Officers
were: Mr. Hamachek, 12, Mr. Talley, 3, Mr. Berte, 3, Dr. Wotton, 7, and Dr.
Baichwal, 9.

Under the Employee Benefits Agreement between Penford and Penwest, Penford
will freeze all benefits of employees of Penwest under this plan as of the
closing of this offering and will distribute to each employee on the date of the
Spin-off his or her fully vested interest in the form of a lump sum payment or
an annuity. See "Arrangements Between the Company and Penford."

EMPLOYEE BENEFIT PLANS

1997 Equity Incentive Plan

The Company's 1997 Plan was adopted by the Company in October 1997. The
1997 Plan provides for the grant of incentive stock options, nonstatutory stock
options, restricted stock awards and other stock-based awards, including the
grant of securities convertible into Common Stock and the grant of stock
appreciation rights (collectively "Awards"). A total of 3,500,000 shares of
Common Stock may be issued pursuant to Awards granted under the 1997 Plan.

Optionees receive the right to purchase a specified number of shares of
Common Stock at a specified option price and subject to such other terms and
conditions as are specified in connection with the option grant. Awards may be
granted at an exercise price which may be less than, equal to or greater than
the fair market value of the Common Stock on the date of grant subject to the
limitations described below. Incentive stock options may not be granted at an
exercise price less than the fair market value of the Common Stock on the date
of grant (or less than 110% of the fair market value in the case of incentive
stock options granted to optionees holding more than 10% of the voting power of
the Company). Options may not be granted for a term in excess of ten years. The
1997 Plan permits the Board to determine the manner of payment of the exercise
price of options, including through payment by cash, check or in connection with
a "cashless exercise" through a broker, by surrender to the Company of shares of
Common Stock, by delivery to the Company of a promissory note, or any
combination of the foregoing.

Restricted stock Awards entitle recipients to acquire shares of Common
Stock, subject to the right of the Company to repurchase all or part of such
shares from the recipient in the event that the conditions specified in the
applicable Award are not satisfied prior to the end of the applicable
restriction period established for such Award.

Under the 1997 Plan, the Board has the right to grant other Awards based
upon the Common Stock having such terms and conditions as the Board may
determine, including the grant of securities convertible into Common Stock and
the grant of stock appreciation rights.

Officers, employees, directors, consultants and advisors of the Company and
its subsidiaries are eligible to be granted Awards under the 1997 Plan. However,
incentive stock options may only be granted to employees. The maximum number of
shares with respect to which an Award may be granted to any participant under
the 1997 Plan may not exceed 500,000 shares per calendar year.

As of the date of adoption of the 1997 Plan, all the Company's employees
were eligible to receive Awards under the 1997 Plan. The granting of Awards
under the 1997 Plan is discretionary, and the Company cannot now determine the
number or type of Awards to be granted in the future to any particular person or
group.

The 1997 Plan is administered by the Board of Directors. The Board has the
authority to adopt, amend and repeal the administrative rules, guidelines and
practices relating to the 1997 Plan and to interpret the provisions of the 1997
Plan. Pursuant to the terms of the 1997 Plan, the Board of Directors may
delegate authority under the 1997 Plan to one or more committees of the Board,
and subject to certain limitations, to one or more executive officers of the
Company. The Board has authorized the Compensation Committee to administer
certain aspects of the 1997 Plan, including the granting of

60
<PAGE> 62

options to executive officers. Subject to any applicable limitations contained
in the 1997 Plan, the Board of Directors, the Compensation Committee or any
other committee or executive officer to whom the Board delegates authority, as
the case may be, selects the recipients of Awards and determines (i) the number
of shares of Common Stock covered by options and the dates upon which such
options become exercisable, (ii) the exercise price of options, (iii) the
duration of options, and (iv) the number of shares of Common Stock subject to
any restricted stock or other stock-based Awards and the terms and conditions of
such Awards, including conditions for repurchase, issue price and repurchase
price.

The Board of Directors is required to make appropriate adjustments in
connection with the 1997 Plan and any outstanding Awards to reflect stock
dividends, stock splits and certain other events. In the event of a merger,
liquidation or other Acquisition Event (as defined in the 1997 Plan), the Board
of Directors is authorized to provide for outstanding options or other
stock-based Awards to be assumed or substituted for, to accelerate the Awards to
make them fully exercisable prior to consummation of the Acquisition Event or to
provide for a cash out of the value of any outstanding options. If any Award
expires or is terminated, surrendered, canceled or forfeited, the unused shares
of Common Stock covered by such Award will again be available for grant under
the 1997 Plan.

The Company has approved the grant of stock options to purchase an
aggregate of 715,000 shares of Common Stock to its employees, officers and
directors, effective upon the Pricing Date, at an exercise price equal to the
public offering price. See "Management -- Director Compensation" and
"-- Executive Compensation -- Option Grants."

1997 Employee Stock Purchase Plan

The Company's 1997 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Company in October 1997. The Purchase Plan authorizes the
issuance of up to a total of 300,000 shares of Common Stock to participating
employees at a discount from fair market value. The Purchase Plan is intended to
qualify as an employee stock purchase plan within Section 423 of the Code.

All employees of the Company, including directors of the Company who are
employees and all employees of any designated subsidiaries, whose customary
employment is more than 20 hours per week and for more than five months in any
calendar year, are eligible to participate in the Purchase Plan. Employees who
would immediately after the grant own 5% or more of the total combined voting
power or value of the stock of the Company or any subsidiary are not eligible to
participate. Following this offering, all the Company's full-time employees as
of the date of adoption of the Purchase Plan will be eligible to participate in
the Purchase Plan.

On the first day of a designated payroll deduction period (the "Offering
Period"), the Company will grant to each eligible employee who has elected to
participate in the Purchase Plan an option to purchase shares of Common Stock as
follows: the employee may authorize an amount (a whole percentage from 1% to 10%
of such employee's regular pay) to be deducted by the Company from such pay
during an Offering Period. On the last day of such Offering Period, the employee
is deemed to have exercised the option, at the option exercise price, to the
extent of accumulated payroll deductions. Under the terms of the Purchase Plan,
the option price is an amount equal to 85% of the fair market value per share of
the Common Stock on either the first day or the last day of each Offering
Period, whichever is lower. In no event may an employee purchase in any one
Offering Period a number of shares which is more than the number determined by
dividing $12,500 by the closing price of a share of Common Stock on the
commencement date of each Offering Period. The Compensation Committee may, at
its discretion, choose an Offering Period of 12 months or less for each of the
offerings and choose a different Offering Period for each offering.

If an employee is not a participant on the last day of an Offering Period,
such employee is not entitled to exercise any option, and the amount of such
employee's accumulated payroll deductions will be refunded without interest. An
employee's rights under the Purchase Plan terminate upon voluntary withdrawal
from the Purchase Plan at any time, or when such employee ceases employment for
any reason.

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<PAGE> 63

CERTAIN TRANSACTIONS

Since January 1, 1994, the Company has not engaged in any transactions with
the directors or officers of the Company or Penford except as described below.

Under a Recognition and Incentive Agreement (as amended, the "Baichwal
Agreement") with Anand Baichwal, the Company's Senior Vice President, Research
and Development, the Company is obligated to pay to Dr. Baichwal on an annual
basis in arrears (i) one-half of one percent of the Company's Net Sales (as
defined in the Baichwal Agreement) of TIMERx Material (as defined in the
Baichwal Agreement) to third parties, (ii) one-half of one percent of royalties
received by the Company under licenses, collaborations or other exploitation
agreements with third parties with respect to the sale, license, use or
exploitation by such third parties of products based on or incorporating the
TIMERx Material, and (iii) one-half of one percent of payments made in lieu of
such Net Sales or royalties and received by the Company. Such payments cease in
the event that Dr. Baichwal's employment is terminated for cause. The Baichwal
Agreement also contains non-competition and non-solicitation provisions which
expire two years after the termination of his employment.

For a description of the stock options granted to the directors and
officers of the Company, see "Management -- Director Compensation" and
"Management -- Executive Compensation."

For a description of the Company's arrangements with Penford, see
"Arrangements between the Company and Penford."

62
<PAGE> 64

PRINCIPAL SHAREHOLDER

Prior to this offering, all outstanding shares of Common Stock will be
owned by Penford. Penford's address is 777 108th Avenue N.E., Suite 2390,
Bellevue, WA 98004. Upon completion of this offering, Penford will own
approximately 85.3% (approximately 83.5% if the Underwriters over-allotment
option is exercised in full) of the outstanding Common Stock. See "Risk
Factors -- Control by Penford Pending the Spin-off; Uncertainty of the
Spin-off," "Risk Factors -- Relationship with Penford; Conflicts of Interest"
and "Arrangements between the Company and Penford."

Penford has announced its intent, subject to the satisfaction of certain
conditions, to divest its ownership interest in the Company through the
Spin-off, which is anticipated to occur in the second quarter of 1998. See
"Background of the Planned Spin-off" and "Risk Factors -- Control by Penford
Pending the Spin-off; Uncertainty of the Spin-off."

The Company has approved the grant of stock options to purchase an
aggregate of 654,000 shares of Common Stock to its employees and officers,
effective upon the Pricing Date, at an exercise price equal to the initial
public offering price, of which options to purchase 180,000 shares, 105,000
shares, 30,000 shares, 51,000 shares, 78,000 shares and 75,000 shares were
granted to Mr. Hamachek, Mr. Talley, Mr. Berte, Dr. Wotton, Dr. Baichwal and Mr.
Belsheim, respectively. Options to purchase 10,000 shares of Common Stock
(11,000 shares in the case of the Lead Director) will also be granted to each
non-employee director upon the Pricing Date at an exercise price equal to the
initial public offering price. No director or executive officer of the Company
beneficially owned any shares of Common Stock as of September 30, 1997. See
"Management -- Director Compensation" and "-- Executive Compensation -- Option
Grants."

The following table sets forth certain information regarding the beneficial
ownership of the common stock of Penford as of September 30, 1997, with respect
to (i) each director and Named Executive Officer of the Company and (ii) all
directors and executive officers of the Company as a group.

<TABLE>
<CAPTION>
PENFORD
---------------------------------------
PERCENTAGE OF
OUTSTANDING SHARES
NAME (1) NUMBER OF SHARES BENEFICIALLY OWNED
- -------- ---------------- ------------------
<S> <C> <C>
Directors
Tod R. Hamachek.......................................... 367,421(2) 5.03%
Paul E. Freiman.......................................... 3,178(3) *
Jere E. Goyan............................................ -- --
Rolf H. Henel............................................ 1,000 *
Robert J. Hennessey...................................... -- --
N. Stewart Rogers........................................ 153,005(4) 2.10
John V. Talley, Jr....................................... 13,001(5) *
W. Leigh Thompson........................................ -- --

Other Named Executive Officers
Anand R. Baichwal........................................ 6,480(6) *
Steven J. Berte, Jr...................................... 1,888(7) *
Paul K. Wotton........................................... 5,933(8) *
All directors and executive officers as a group
(13 persons)........................................... 579,948(9) 7.88%
</TABLE>

- ---------------
* Less than 1%

(1) Except as reflected in the footnotes to this table, shares of Common Stock
of Penwest and Penford beneficially owned consist of shares owned by the
indicated person, and all share ownership involves sole voting and
investment power. Amounts shown in the above table and the following

63
<PAGE> 65

notes include shares issuable within the 60-day period following September
30, 1997 pursuant to the exercise of options.

(2) Includes 31,500 shares subject to outstanding options held by Mr. Hamachek,
which are exercisable within the 60-day period following September 30, 1997.

(3) Includes 2,192 shares subject to outstanding options held by Mr. Freiman,
which are exercisable within the 60-day period following September 30, 1997.

(4) Includes 11,538 shares held in irrevocable trusts for which Mr. Rogers has
sole voting power, as well as 19,521 shares subject to outstanding options
held by Mr. Rogers, which are exercisable within the 60-day period following
September 30, 1997.

(5) Includes 10,750 shares subject to outstanding stock options held by Mr.
Talley, which are exercisable within the 60-day period following September
30, 1997.

(6) Includes 4,200 shares subject to outstanding stock options held by Dr.
Baichwal, which are exercisable within the 60-day period following September
30, 1997.

(7) Includes 1,000 shares subject to outstanding stock options held by Mr.
Berte, which are exercisable within the 60-day period following September
30, 1997.

(8) Includes 4,200 shares subject to outstanding stock options held by Dr.
Wotton, which are exercisable within the 60-day period following September
30, 1997.

(9) Includes an aggregate of 91,943 shares subject to outstanding stock options
which are exercisable within the 60-day period following September 30, 1997.

64
<PAGE> 66

ARRANGEMENTS BETWEEN THE COMPANY AND PENFORD

The Company is currently a wholly-owned subsidiary of Penford. Upon
completion of this offering, Penford will own approximately 85.3% (approximately
83.5% if the Underwriters' over-allotment option is exercised in full) of the
outstanding Common Stock. Penford has announced its intent, subject to the
satisfaction of certain conditions, including receipt of either a favorable tax
ruling from the IRS or a written opinion from Ernst & Young LLP, to divest its
ownership interest in the Company through the Spin-off, which is anticipated to
occur in the second quarter of 1998. See "Background of the Planned Spin-off "
and "Risk Factors -- Control by Penford Pending the Spin-off; Uncertainty of the
Spin-off."

The following discussion of agreements between the Company and Penford
summarizes the material items of the agreements and is qualified in its entirety
by reference to the forms of such agreements, which have been filed as exhibits
to the Registration Statement of which this Prospectus is a part.

Separation Agreement

The Company and Penford have entered into a separation agreement (the
"Separation Agreement") setting forth the agreement of the parties with respect
to the principal corporate transactions required to effect the separation of
Penford's pharmaceutical business from its food and paper businesses, this
offering and the Spin-off, and certain other agreements governing the
relationship of the parties both prior to and after the Spin-off.

Asset Transfer. In connection with the separation of the pharmaceutical
business, Penford has agreed to assign to the Company, to the extent not
previously assigned, its rights, title and interest in any assets related to the
pharmaceutical business, and Penwest has agreed to assume, to the extent not
previously assumed, all Penford's liabilities relating to the pharmaceutical
business. As part of this assignment, Penford will assign to Penwest its rights
in the agreements entered into with the Company's collaborators, as well as
certain trademarks of Penford. Penford also has agreed to contribute to the
capital of Penwest all existing remaining intercompany indebtedness of Penwest
($37.5 million as of September 30, 1997).

Offering. Penford has agreed to undertake certain obligations with respect
to this offering, subject to specified conditions precedent. One of these
conditions is that, immediately following this offering, Penford shall "control"
Penwest within the meaning of Sections 355 and 368 of the Code in order to
permit the Spin-off to qualify as a tax-free distribution for federal income tax
purposes under Section 355 of the Code.

Spin-off. Penwest and Penford have agreed that the Board of Directors of
Penford will have the sole discretion to determine the date of consummation of
the Spin-off at any time on or after April 1, 1998 and prior to the date six
months after the closing of this offering. Following the date six months after
the closing of this offering, Penford will be obligated to consummate the
Spin-off as promptly as practicable following the date on which the conditions
described below are either satisfied or waived. In addition, in the event that
Penford obtains and relies upon a private letter ruling from the IRS and the
other conditions described below are either satisfied or waived, Penford will
effect the Spin-off prior to the later of (i) six months from the closing of
this offering and (ii) three months from the date of the private letter ruling.

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Penford and Penwest have agreed to use their reasonable best efforts to
cause all conditions to be satisfied and to effect the Spin-off including: (i) a
private letter ruling from the IRS shall have been obtained, and shall continue
in effect, or a written opinion from Ernst & Young LLP shall have been received,
to the effect that, among other things, the Spin-off will qualify as tax-free
for federal income tax purposes under Sections 355 and 368 of the Code, and such
ruling or opinion shall be in form and substance satisfactory to Penford; (ii)
any material governmental approvals and consents necessary to consummate the
Spin-off shall have been obtained and shall be in full force and effect; (iii)
no order, injunction or decree issued by any court or agency of competent
jurisdiction or other legal restraint or prohibition preventing the consummation
of the Spin-off shall be in effect, and no other event outside the control of
Penford shall have occurred or failed to occur that prevents the consummation of
the Spin-off; and (iv) no material adverse change shall have occurred with
respect to the business or financial condition of Penford or Penwest which
would, in the reasonable judgment of the Penford Board, make the approval of the
Spin-off inadvisable.

Treatment of Options. Penford and Penwest have also agreed that at the
time of the Spin-off the stock options to purchase the common stock of Penford
will be adjusted to reflect the Spin-off. In this regard, Penford has agreed to
(i) amend its stock plans to provide that, for purposes of such stock plans, the
term employee shall include employees of Penwest, (ii) amend each stock option
held by a Penwest employee to provide that the option will continue to vest for
so long as the Penwest employee remains an employee of Penwest, (iii) adjust the
exercise price of each stock option then outstanding by multiplying the exercise
price of the stock option by a fraction, the numerator of which shall equal the
amount determined by multiplying (a) Penford's fully diluted shares outstanding
(including shares issuable upon exercise of outstanding stock options) by (b)
the fair market value of the Penford common stock as of the Spin-off (as
determined in the manner specified in the Separation Agreement) (the "Penford
Market Capitalization"), and the denominator of which shall equal the sum of (x)
the Penford Market Capitalization and (y) the amount determined by multiplying
Penwest's fully diluted shares outstanding (including shares issuable upon
exercise of outstanding stock options), by the fair market value of the Common
Stock of Penwest as of the Spin-off (as determined in the manner specified in
the Separation Agreement) (the "Penwest Market Capitalization"), and (iv) adjust
the number of shares of common stock of Penford issuable upon exercise of each
stock option then outstanding by multiplying the number of shares of common
stock of Penford issuable under the stock option by a fraction, the numerator of
which shall equal the sum of the Penford Market Capitalization and the Penwest
Market Capitalization, and the denominator of which shall equal the Penford
Market Capitalization.

Registration Rights. Penwest has agreed that if Penford has not received a
favorable private letter ruling from the IRS or a written opinion from Ernst &
Young LLP with respect to the Spin-off by September 30, 1998, Penford will have
the right, exercisable at any time after September 30, 1998, to cause Penwest to
use its reasonable best efforts to register the shares of Penwest Common Stock
held by Penford for resale under the Securities Act, subject to certain
conditions and limitations. Penwest has also agreed that if it files a
registration statement for the sale of securities on a form in which the Common
Stock held by Penford may be included, it will include shares of Common Stock
held by Penford in such registration statement.

Indemnification. Penwest has agreed to indemnify Penford from and against
any liabilities arising out of (i) the employment of individuals by Penwest,
(ii) the pharmaceutical business and the use of the assets transferred to
Penwest, (iii) purchase orders, accounts payable, accrued compensation and other
liabilities which relate to the pharmaceutical business and the assets
transferred to Penwest, and (iv) any misstatement or omission of a material fact
in any documents or filings prepared by Penwest for purposes of compliance or
qualification under applicable securities laws in connection with this offering
or the Spin-off, including this Prospectus (the "SEC filings"). Penford has
agreed to indemnify Penwest from and against all liabilities arising out of (i)
the business of Penford and the liabilities not assumed by Penwest and (ii) any
misstatement or omission of a material fact with respect to Penford based on
information supplied by Penford in the SEC filings.

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Sharing of Utilities. Penford has agreed that Penwest will be entitled to
use and consume at Penwest's Cedar Rapids facility certain utilities consisting
of natural gas, electricity and steam from Penford's Cedar Rapids facility.
Penwest will reimburse Penford for such consumption based on Penford's total
cost for such utilities and Penwest's fraction of the total consumption.

Non-Competition and Non-Solicitation. Penford has agreed that, during the
period ending upon the later of (a) five years from the date of the Separation
Agreement and (b) the expiration or termination of the Excipient Supply
Agreement to be entered into between Penford and Penwest, it shall not (i)
manufacture, market, sell or distribute for inclusion in any pharmaceutical or
nutritional product (excluding any food product) any product having the same or
substantially the same form, composition or application as EMDEX or CANDEX or
any similar sugar-based product or (ii) recruit or solicit any employee of
Penwest, without the consent of Penwest. Penwest has agreed that during the same
period, it will not (i) manufacture, market, sell or distribute for inclusion in
any foods product any product having the same or substantially the same form,
composition or applications as EMDEX or CANDEX or any similar sugar-based
product or (ii) recruit or solicit any employee of Penford, without the consent
of Penford.

Services Agreement

The Company and Penford have entered into a services agreement (the
"Services Agreement") pursuant to which Penford will continue on an interim
basis to provide or otherwise make available to the Company, upon the Company's
reasonable request, certain accounting and audit, finance and treasury, tax,
financial and human resources services, provide for certain insurance coverage
and arrange for administration of insurance and risk management and employee
benefit programs. Prior to the Spin-off, the Company will pay the direct costs
of these services. On or after the Spin-off, the Company will pay the direct
costs of these services, plus a percentage negotiated by and mutually agreeable
to Penwest and Penford. To the extent that such direct costs cannot be
separately measured, the Company will pay a portion of the total cost determined
on a reasonable basis selected by Penford and approved by the Company. The
initial term of the Services Agreement will expire on the date of the Spin-off
and will be extended automatically for successive one-year terms unless either
party provides written notice of its election not to renew the Services
Agreement at least 90 days prior to the expiration of the initial or any renewal
term.

Tax Allocation Agreement

The Company and Penford have entered into a tax allocation agreement (the
"Tax Allocation Agreement") providing for (i) the allocation of payments of
taxes for periods during which the Company and Penford (or any of its affiliates
other than the Company and its subsidiaries) are included in the same
consolidated group for federal income tax purposes or the same consolidated,
combined or unitary returns for state, local or foreign tax purposes, (ii) the
allocation of any taxes payable if the Spin-off fails to qualify as tax-free
under Sections 355 and 368 of the Code, (iii) the allocation of responsibility
for the filing of tax returns, (iv) the conduct of tax audits and the handling
of tax controversies and (v) various related matters. Under the Tax Allocation
Agreement, Penwest will be responsible for any tax liabilities (including
interest and penalties) imposed on it and will indemnify Penford for any tax
liabilities (including interest and penalties) imposed on Penford that are
directly related to the failure of the Spin-off to qualify as tax-free under
Sections 355 and 368 of the Code as a result of (i) the inaccuracy of certain
representations and covenants made by Penwest in the Tax Allocation Agreement or
(ii) the participation by Penwest in certain acts set forth in the Tax
Allocation Agreement that occur after the Spin-off. For periods during which the
Company is included in Penford's consolidated federal income tax returns or
state consolidated, combined or unitary tax returns (which periods are expected
to include the period between this offering and the Spin-off), the Company will
be required to pay to or entitled to receive from Penford its allocable portion
of the consolidated federal income and state tax liability or credits, other
than credits related to net operating losses. The Company will be directly
responsible for separate state, local and foreign tax returns and related
liabilities for itself and its subsidiaries for all periods.

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<PAGE> 69

Excipient Supply Agreement

The Company and Penford have entered into a supply agreement (the "Supply
Agreement") pursuant to which Penford will manufacture and supply exclusively to
Penwest, and Penwest will purchase exclusively from Penford, subject to certain
exceptions, all Penwest's requirements for EMDEX and CANDEX, two sugar-based
excipients marketed by the Company. Penwest will purchase such excipients at
specified prices, which will be subject to adjustment on a semi-annual basis.
The initial term of the Supply Agreement will expire on December 31, 2003,
unless earlier terminated by Penwest or Penford upon one year's prior written
notice, and will be extended automatically for successive one-year terms unless
either party provides written notice of its election not to renew the Supply
Agreement at least 90 days prior to the expiration of the initial or any renewal
term. Revenues from the sale of EMDEX and CANDEX represented less than 10% of
the Company's total revenues for the nine months ended September 30, 1997 and
each of the three years ended December 31, 1996.

Employee Benefits Agreement

The Company and Penford have entered into an employee benefits agreement
(the "Benefits Agreement") setting forth the parties' agreements as to the
continuation of certain Penford pension and benefits arrangements for the
employees of Penwest following this offering. Under the Benefits Agreement,
Penford has agreed that the employees of Penwest will continue to be covered by
Penford's Savings and Stock Ownership Plan, health plan (medical, dental and
vision) and flexible benefits plan (pretax payment of health plan premiums,
medical reimbursement account and dependent care account) until December 31,
1997. In connection with the continuation of these plans, Penwest will reimburse
Penford for any costs and expenses paid by Penford with respect to continued
participation in such plans by employees of Penwest following this offering. The
Benefits Agreement also provides for the termination, as of the closing of this
offering, of participation of Penwest employees under certain of Penford's other
welfare and retirement plans and sets forth the manner in which the assets and
liabilities under certain of such plans will be transferred to Penwest. Finally,
under the Benefits Agreement, Penwest has agreed to establish for its employees
a set of benefit plans similar to those provided by Penford with the exception
of Penford's defined benefit plan.

Conflicts of interest may arise between the Company and Penford in a number
of areas relating to their past and ongoing relationships, including tax and
employee benefit matters, indemnity arrangements, registration rights, sales or
distributions by Penford of its remaining shares of Common Stock and the
exercise by Penford of its ability to control the management and affairs of the
Company.

The Company and Penford may enter into amendments to the terms of the
foregoing agreements or new material transactions and agreements in the future.
The Company has been advised by Penford that it intends that the terms of any
future amendments, transactions and agreements between the Company and Penford
or its affiliates will approximate fair market value. The Board of Directors of
Penwest will utilize such procedures in evaluating the terms and provisions of
any material transactions between the Company and Penford or its affiliates as
the Board may deem appropriate in light of its fiduciary duties under state law.
Depending on the nature and size of the particular transaction, in any such
evaluation, the Board of Directors of Penwest may rely on management's
statements and opinions and may or may not utilize outside experts or
consultants or obtain independent appraisals or opinions.

Directors of the Company who are also directors of Penford may have
conflicts of interest with respect to matters potentially or actually involving
or affecting the Company and Penford, such as acquisitions, financings and other
corporate opportunities that may be suitable for the Company and Penford. To the
extent that such opportunities arise, such directors may consult with their
legal advisors and make a determination after consideration of a number of
factors, including whether such opportunity is presented to any such director in
his or her capacity as a director of the Company, whether such opportunity is
within the Company's line of business or consistent with its strategic
objectives and whether the Company will be able to undertake or benefit from
such opportunity. In addition, determinations may be made by the Board, when
appropriate, by the vote of the disinterested

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<PAGE> 70

directors only. Notwithstanding the foregoing, there can be no assurance that
conflicts will be resolved in favor of the Company. See "Risk
Factors -- Relationship with Penford; Conflicts of Interest."

So long as the Company remains a subsidiary of Penford, the directors and
officers of the Company will, subject to certain limitations, be indemnified by
Penford and insured under insurance policies maintained by Penford against
liability for actions taken or omitted to be taken in their capacities as
directors and officers of the Company, including actions or omissions that may
be alleged to constitute breaches of the fiduciary duties owed by such persons
to the Company and its shareholders. It is contemplated that, prior to the
Spin-off, the Company will obtain insurance coverage for its directors and
officers in respect of such matters. See "Risk Factors -- Relationship with
Penford; Conflicts of Interest."

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<PAGE> 71

DESCRIPTION OF CAPITAL STOCK

The authorized capital stock of the Company consists of 39,000,000 shares
of Common Stock, $0.001 par value per share, and 1,000,000 shares of Preferred
Stock, $0.001 par value per share ("Preferred Stock"). Prior to this offering,
there was outstanding 14,538,282 shares of Common Stock which were held of
record by one stockholder, Penford. Immediately after this offering, 17,038,282
shares of Common Stock will be outstanding.

The following summary of certain provisions of the Common Stock and
Preferred Stock does not purport to be complete and is subject to, and qualified
in its entirety by, the provisions of the Company's Amended and Restated
Articles of Incorporation (the "Restated Articles"), which are included as an
exhibit to the Registration Statement of which this Prospectus is a part, and by
the provisions of applicable law.

COMMON STOCK

Holders of Common Stock are entitled to receive dividends as may from time
to time be declared by the Board of Directors out of funds legally available
therefor, subject to any preferential dividend rights of any outstanding class
or series of Preferred Stock, and to one vote per share on all matters on which
the holders of Common Stock are entitled to vote. Such holders do not have any
cumulative voting rights or preemptive, conversion, redemption or sinking fund
rights. In the event of a liquidation, dissolution or winding up of the Company,
holders of Common Stock are entitled to share equally and ratably in the
Company's assets, if any, remaining after the payment of all liabilities of the
Company and the liquidation preference of any outstanding class or series of
Preferred Stock. The outstanding shares of Common Stock are, and the shares of
Common Stock offered hereby will be, when issued and paid for, fully paid and
nonassessable. The rights, preferences and privileges of holders of Common Stock
are subject to, and may be adversely affected by, the rights of the holders of
shares of any series of Preferred Stock that the Company may issue in the
future.

PREFERRED STOCK

The Company's Board of Directors has the authority to issue up to 1,000,000
shares of Preferred Stock in one or more series and to fix the number of shares
constituting any such series and the preferences, limitations and relative
rights, including dividend rights, dividend rate, voting rights, terms of
redemption, redemption price or prices, conversion rights and liquidation
preferences of the shares constituting any series, without any further vote or
action by the Company's shareholders. The issuance of Preferred Stock by the
Board of Directors could adversely affect the rights of holders of Common Stock.
The potential issuance of Preferred Stock may have the effect of delaying,
deferring or preventing a change in control of the Company, may discourage bids
for the Common Stock at a premium over the market price of the Common Stock and
may adversely affect the market price of, and the voting and other rights of the
holders of, the Common Stock. The Company has no current plans to issue any
shares of Preferred Stock.

WASHINGTON LAW AND CERTAIN CHARTER AND BYLAW PROVISIONS

The laws of Washington, where the Company is incorporated, restrict certain
transactions between Washington corporations and certain significant
shareholders. Chapter 23B.19 of the Washington Business Corporation Act
prohibits a "target corporation," with certain exceptions, from engaging in any
"significant business transaction" with a person or group of persons which has
acquired 10% or more of the voting securities of the target corporation (an
"acquiring person") for five years after such acquisition unless the transaction
or such acquisition is approved by a majority of the members of the target
corporation's board of directors prior to acquisition. Significant business
transactions include, among others, a merger, share exchange or consolidation
with, disposition of assets to, or issuance or redemption of stock to or from,
the acquiring person, or a reclassification of securities that has the effect of
increasing the proportionate share of the outstanding securities held by

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the acquiring person. After the five-year period, a significant business
transaction may take place if it complies with certain fair price provisions of
the statute. A target corporation includes every Washington corporation that has
a class of voting stock registered pursuant to Section 12 or 15 of the
Securities Exchange Act of 1934, as amended.

The Restated Articles provide for the division of the Board of Directors
into three classes as nearly equal in size as possible with staggered three-year
terms. In addition, the Restated Articles provide that directors may be removed
only for cause by the affirmative vote of the holders of two-thirds of the
shares of capital stock of the Company entitled to vote. Under the Restated
Articles, any vacancy on the Board of Directors, however occurring, including a
vacancy resulting from an enlargement of the Board, may only be filled by vote
of a majority of the directors then in office. The classification of the Board
of Directors and the limitations on the removal of directors and filling of
vacancies could have the effect of making it more difficult for a third party to
acquire, or of discouraging a third party from acquiring, control of the
Company.

The Company's Amended and Restated Bylaws (the "Restated Bylaws") provide
that any action required or permitted to be taken by the stockholders of the
Company at an annual meeting or special meeting of shareholders may only be
taken if it is properly brought before such meeting and that any such action may
also be taken without a meeting by written consent if all the shareholders
entitled to vote with respect to such action so consent. The Restated Articles
provide that special meetings of the shareholders may be called by the President
of the Company, the Chairman of the Board or the Board of Directors. Under the
Restated Bylaws, in order for any matter to be considered "properly brought"
before a meeting, a shareholder must comply with certain requirements regarding
advance notice to the Company. The foregoing provisions could have the effect of
delaying until the next shareholders meeting shareholder actions which are
favored by the holders of a majority of the outstanding voting securities of the
Company. These provisions may also discourage another person or entity from
making a tender offer for the Company's Common Stock, because such person or
entity, even if it acquired a majority of the outstanding voting securities of
the Company, would be able to take action as a shareholder (such as electing new
directors or approving a merger) only at a duly called shareholders meeting, and
not by written consent.

The laws of Washington provide generally that the affirmative vote of a
majority of the shares entitled to vote on any matter is required to amend a
corporation's articles of incorporation or bylaws, unless a corporation's
articles of incorporation or bylaws, as the case may be, require a greater
percentage. The Restated Articles and the Restated Bylaws require the
affirmative vote of the holders of at least two-thirds of the shares of capital
stock of the Company issued and outstanding and entitled to vote to amend or
repeal any of the provisions described in the prior two paragraphs.

The Restated Articles contain certain provisions relating to the
elimination of personal liability of directors to the Company or its
shareholders for monetary damages to the full extent permitted by Washington
law. In addition, the Restated Bylaws contain provisions to indemnify the
Company's directors and officers to the fullest extent permitted by Washington
law.

TRANSFER AGENT AND REGISTRAR

The transfer agent and registrar for the Common Stock is ChaseMellon
Shareholder Services.

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SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this offering, the Company will have outstanding
17,038,282 shares of Common Stock. Of these shares, the 2,500,000 shares sold in
this offering (plus any shares issued upon exercise of the Underwriters'
over-allotment option) will be freely tradeable without restriction under the
Securities Act, unless purchased or held by "affiliates" of the Company as that
term is defined under the Securities Act. The remaining 14,538,282 shares of
Common Stock outstanding upon the consummation of this offering will be shares
of Common Stock held by Penford and will be "restricted securities," as that
term is defined in Rule 144, that may be sold only if registered under the
Securities Act or in accordance with an applicable exemption from registration,
such as Rule 144.

Although the shares held by Penford may not be sold by Penford absent
registration under the Securities Act or an exemption from such registration,
Penford has advised the Company that it contemplates effecting the Spin-off
without registration under the Securities Act and that the shares distributed
pursuant thereto would thereafter be freely tradeable by persons other than
"affiliates" of the Company without restriction or registration under the
Securities Act.

Pursuant to the Underwriting Agreement, the Company has agreed, subject to
limited exceptions, not to offer, sell or otherwise dispose of any shares of
Common Stock for a period of 180 days after the date of this Prospectus without
the prior written consent of BancAmerica Robertson Stephens. Similarly, Penford
and the officers and directors of the Company have agreed, subject to limited
exceptions (including, with respect to Penford, the Spin-off), not to sell,
offer, contract to sell, pledge, grant an option to purchase or otherwise
dispose of any shares of Common Stock (or any securities convertible into, or
exchangeable for, or any rights to purchase or acquire, shares of Common Stock)
held by such holders, acquired by such holder after the date hereof or which may
be deemed to be beneficially owned by such holder for a period of 180 days after
the date of this Prospectus without the prior written consent of BancAmerica
Robertson Stephens. None of the shares of Common Stock distributed pursuant to
the Spin-off (other than shares distributed to the Company's "affiliates") will
be subject to any contractual restriction on sale or disposition pursuant to the
Underwriting Agreement or otherwise.

In general, under Rule 144, as currently in effect, beginning 90 days after
the effective date of the registration statement of which this Prospectus is a
part (the "Effective Date"), a person (or persons whose shares are aggregated)
who has beneficially owned "restricted securities" for at least one year would
be entitled to sell within any three-month period a number of shares that does
not exceed the greater of: (i) one percent of the number of shares of Common
Stock then outstanding (which will equal approximately 170,383 shares
immediately after this offering); or (ii) the average weekly trading volume of
the Common Stock during the four calendar weeks preceding the filing of a Form
144 with respect to such sale. Sales under Rule 144 are also subject to certain
manner of sale provisions and notice requirements and to the availability of
current public information about the Company. Under Rule 144(k), a person who is
not deemed to have been an affiliate of the Company at any time during the 90
days preceding a sale, and who has beneficially owned the shares proposed to be
sold for at least two years, is entitled to sell such shares without complying
with the manner of sale, public information, volume limitation or notice
provisions of Rule 144.

In the event any person who is deemed to be an "affiliate" of the Company
for purposes of Rule 144 purchases Common Stock pursuant to this offering,
receives shares of Common Stock in the Spin-off or purchases shares of Common
Stock in a registered offering effected by Penford, the shares held by such
person will not be subject to any holding period requirement and may be sold in
the open market in reliance upon Rule 144, subject to the volume limitations and
lockup arrangements described above. Shares properly sold in reliance upon Rule
144 to persons who are not "affiliates" of the Company are thereafter freely
tradeable without restriction or registration under the Securities Act.

Penford has not determined what action, if any, it would take if it did not
receive a favorable tax ruling or written opinion from Ernst & Young LLP with
respect to the Spin-off. If the Spin-off does not

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<PAGE> 74

occur, Penford may sell all or a portion of its ownership interest in the
Company through a public offering or a private sale. In order to enable Penford
to sell its ownership interest in a public offering in such event, the Company
has agreed to give Penford the right to cause the Company to register the Common
Stock owned by it under the Securities Act, in which event Penford would be able
to sell or otherwise distribute such shares upon the effectiveness of any such
registration and such shares would thereafter be freely tradeable by the
purchasers thereof, other than "affiliates" of the Company, without restriction
or registration under the Securities Act.

The Company intends to file registration statements on Form S-8 under the
Securities Act at least 90 days after the Effective Date to register shares of
Common Stock reserved for issuance under the 1997 Plan and the Purchase Plan.
Such registration statements will become effective immediately upon filing.

Prior to this offering, there has been no public market for the Common
Stock of the Company and no predictions can be made as to the effect, if any,
that market sales of shares of Common Stock prevailing from time to time may
have on the market price of the Common Stock. Nevertheless, the Spin-off and
future sales of significant numbers of shares of the Common Stock in the public
market or the perception that such future sales could occur, could adversely
affect the market price of the Common Stock offered hereby and could impair the
Company's future ability to raise capital through an offering of its equity
securities.

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UNDERWRITING

The Underwriters named below, acting through their representatives,
BancAmerica Robertson Stephens and SBC Warburg Dillon Read Inc. (the
"Representatives"), have severally agreed, subject to the terms and conditions
of the Underwriting Agreement, to purchase from the Company the number of shares
of Common Stock set forth opposite their respective names below. The
Underwriters are committed to purchase and pay for all such shares, if any are
purchased.

<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
----------- ----------------
<S> <C>
BancAmerica Robertson Stephens.......................................
SBC Warburg Dillon Read Inc..........................................

-------
Total......................................................
=======
</TABLE>

The Company has been advised by the Representatives that the Underwriters
propose to offer the shares of Common Stock to the public at the initial public
offering price set forth on the cover page of this Prospectus and to certain
dealers at such price, less a concession of not more than $ per share,
of which $ per share may be reallowed to other dealers. After the
initial public offering, the public offering price, concession and reallowances
to dealers may be reduced by the Representatives.

The Company has granted to the Underwriters an option, exercisable during
the 30-day period after the date of this Prospectus, to purchase up to an
additional 375,000 shares of Common Stock at the same price per share as the
Company will receive for the 2,500,000 shares that the Underwriters have agreed
to purchase. To the extent that the Underwriters exercise such option, each of
the Underwriters will have a firm commitment to purchase approximately the same
percentage of such additional shares that the number of shares of Common Stock
to be purchased by it shown in the above table represents as a percentage of the
2,500,000 shares offered hereby. If purchased, such additional shares will be
sold by the Underwriters on the same terms as those on which the 2,500,000
shares are being sold. The Company will be obligated, pursuant to such option,
to sell shares to the Underwriters to the extent such option is exercised. The
Underwriters may exercise such option only to cover over-allotments made in
connection with the sale of shares of Common Stock offered hereby.

The Underwriting Agreement contains covenants of indemnity between the
Underwriters and the Company and Penford against certain civil liabilities,
including liabilities under the Securities Act and liability arising from
breaches of representations and warranties contained in the Underwriting
Agreement.

Each officer, director and the sole shareholder of the Company, together
holding approximately 14,538,282 shares of Common Stock, have agreed with the
Representatives that, until 180 days from the date of this Prospectus, subject
to certain limited exceptions (including, with respect to Penford, the
Spin-off), they will not, directly or indirectly, sell, offer, contract to sell,
pledge, grant any option to purchase or otherwise dispose of any shares of
Common Stock (or any securities convertible into, or exchangeable for, or any
rights to purchase or acquire, shares of Common Stock), held by such holders,
acquired by such holder after the date hereof or which may be deemed to be
beneficially owned by such holder, without the prior written consent of
BancAmerica Robertson Stephens.

74
<PAGE> 76

BancAmerica Robertson Stephens may, in its sole discretion without notice,
release all or any portion of the securities subject to the lock-up agreements.
In addition, the Company has agreed that, until 180 days from the date of this
Prospectus, the Company will not, without the prior written consent of
BancAmerica Robertson Stephens, subject to certain limited exceptions, sell or
otherwise dispose of, any shares of Common Stock, any options or warrants to
purchase any shares of Common Stock (or any securities convertible into,
exercisable for or exchangeable for shares of Common Stock) other than the
Company's sale of shares in this offering, the issuance of Common Stock upon the
exercise of outstanding options, or the Company's grant of options and issuance
of stock under existing employee stock option or stock purchase plans. See
"Shares Eligible for Future Sale."

The Representatives have advised the Company that the Underwriters do not
intend to confirm sales to accounts over which they exercise discretionary
authority.

The Representatives have advised the Company that, pursuant to Regulation M
under the Securities Act, certain persons participating in this offering may
engage in transactions, including stabilizing bids, syndicate covering
transactions or the imposition of penalty bids, which may have the effect of
stabilizing or maintaining the market price of the Common Stock at a level above
that which might otherwise prevail in the open market. A "stabilizing bid" is a
bid for or the purchase of the Common Stock on behalf of the Underwriters for
the purpose of fixing or maintaining the price of the Common Stock. A "syndicate
covering transaction" is the bid for or the purchase of the Common Stock on
behalf of the Underwriters to reduce a short position incurred by the
Underwriters in connection with this offering. A "penalty bid" is an arrangement
permitting the Representatives to reclaim the selling concession otherwise
accruing to an Underwriter or syndicate member in connection with this offering
if the Common Stock originally sold by such Underwriter or syndicate member is
purchased by the Representatives in a syndicate covering transaction and has
therefore not been effectively placed by such Underwriter or syndicate member.
The Representatives have advised the Company that such transactions may be
effected on the Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.

Prior to this offering, there has been no public market for the Common
Stock of the Company. Consequently, the initial public offering price for the
Common Stock will be determined through negotiations between the Company and the
Representatives. The material factors to be considered in such negotiations are
prevailing market conditions, certain financial information of the Company in
recent periods, market valuations of other companies that the Company and the
Representatives believe to be comparable to the Company, estimates of the
business potential of the Company, the present state of the Company's
development, the Company's management and other factors deemed relevant. The
estimated initial public offering price range set forth on the cover of this
preliminary prospectus is subject to change as a result of market conditions and
other factors. There can be no assurance that an active or orderly trading
market will develop for the Common Stock or that the Common Stock will trade in
the public market subsequent to this offering at or above the initial trading
price. See "Risk Factors -- Possibility of Substantial Sales of Common Stock,"
"Risk Factors -- No Prior Public Market; Determination of Public Offering Price;
Potential Volatility of Stock Price" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations."

McFarland Dewey & Co. ("McFarland Dewey") has been retained by Penford
since 1996 to identify and evaluate strategic options available to it. As part
of McFarland Dewey's compensation in respect of such services, Penwest has
agreed to pay McFarland Dewey $300,000 upon the closing of this offering.

75
<PAGE> 77

LEGAL MATTERS

The validity of the shares of Common Stock offered hereby will be passed
upon for the Company by Edmund O. Belsheim, Jr., its general counsel. Certain
legal matters in connection with this offering will be passed upon for the
Company by Hale and Dorr LLP, Boston, Massachusetts. Certain legal matters in
connection with this offering will be passed upon for the Underwriters by Testa,
Hurwitz & Thibeault, LLP, Boston, Massachusetts.

EXPERTS

The financial statements and related schedule of the Company at September
30, 1997, and for the nine-month period ended September 30, 1997 as well as at
December 31, 1996 and 1995, and for each of the three years in the period ended
December 31, 1996, appearing in this Prospectus and Registration Statement have
been audited by Ernst & Young LLP, independent auditors, as set forth in their
report thereon appearing elsewhere herein, and are included in reliance upon
such report given upon the authority of such firm as experts in accounting and
auditing.

76
<PAGE> 78

PENWEST PHARMACEUTICALS CO.

CONSOLIDATED FINANCIAL STATEMENTS

CONTENTS

<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Ernst & Young LLP........................................................... F-2
Financial Statements
Consolidated Balance Sheets......................................................... F-3
Consolidated Statements of Operations............................................... F-4
Consolidated Statements of Shareholder's Equity (Deficit)........................... F-5
Consolidated Statements of Cash Flows............................................... F-6
Notes to Consolidated Financial Statements............................................ F-7
</TABLE>

F-1
<PAGE> 79

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors
Penwest Pharmaceuticals Co.

We have audited the accompanying consolidated balance sheets of Penwest
Pharmaceuticals Co., (formerly known as Edward Mendell Co., Inc.), as of
September 30, 1997 and December 31, 1996 and 1995, and the related consolidated
statements of operations, shareholder's equity (deficit) and cash flows for the
nine-month period ended September 30, 1997, and each of the three years in the
period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Penwest
Pharmaceuticals Co. at September 30, 1997 and December 31, 1996 and 1995, and
the consolidated results of its operations and its cash flows for the nine-month
period ended September 30, 1997, and each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.

ERNST & YOUNG LLP
Stamford, Connecticut
October 11, 1997

F-2
<PAGE> 80

PENWEST PHARMACEUTICALS CO.

CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)

<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER
-------------------- 30,
1995 1996 1997
------- -------- ------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................... $ 290 $ 695 $ 1,088
Trade accounts receivable, net of allowance for doubtful
accounts of $200, $237 and $237...................... 5,157 4,680 4,813
Inventories............................................. 4,337 7,555 7,661
Prepaid expenses and other current assets............... 295 72 204
------- -------- --------
Total current assets............................... 10,079 13,002 13,766
Fixed assets, net......................................... 20,203 20,336 21,575
Other assets.............................................. 1,389 1,745 2,039
------- -------- --------
Total assets....................................... $31,671 $ 35,083 $ 37,380
======= ======== ========
LIABILITIES AND SHAREHOLDER'S DEFICIT
Current liabilities:
Accounts payable and accrued expenses................... $ 3,455 $ 3,810 $ 3,865
Taxes payable........................................... 374 454 283
Payable to Penford...................................... 25,711 32,100 37,503
------- -------- --------
Total current liabilities.......................... 29,540 36,364 41,651
Deferred taxes............................................ 2,525 3,071 3,470
Other long-term liabilities............................... 83 60 337
------- -------- --------
Total liabilities.................................. 32,148 39,495 45,458
Shareholder's deficit
Common stock, par value $.001, authorized 39,000,000
shares, issued and outstanding 14,538,282 shares
(Note 13)............................................ 15 15 15
Additional paid in capital.............................. 8,075 8,075 8,075
Accumulated deficit..................................... (8,469) (12,333) (15,508)
Cumulative translation adjustment....................... (98) (169) (660)
------- -------- --------
Total shareholder's deficit........................ (477) (4,412) (8,078)
------- -------- --------
Total liabilities and shareholder's deficit........ $31,671 $ 35,083 $ 37,380
======= ======== ========
</TABLE>

See accompanying notes.

F-3
<PAGE> 81

PENWEST PHARMACEUTICALS CO.

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------- -------------------
1994 1995 1996 1997
------- ------- ------- 1996 -------
-------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Revenues
Product sales.......................... $23,146 $24,989 $25,007 $19,108 $19,876
Royalties and licensing fees........... 100 1,082 850 911
------- ------- ------- ------- -------
Total revenues...................... 23,146 25,089 26,089 19,958 20,787
Cost of product sales.................... 15,910 17,267 18,690 14,033 14,660
------- ------- ------- ------- -------
Gross profit........................ 7,236 7,822 7,399 5,925 6,127
Operating expenses
Selling, general and administrative.... 7,021 7,676 6,776 5,264 5,747
Research and product development....... 2,322 2,719 3,723 2,636 2,994
------- ------- ------- ------- -------
Total operating expenses............ 9,343 10,395 10,499 7,900 8,741
------- ------- ------- ------- -------
Loss before income taxes................. (2,107) (2,573) (3,100) (1,975) (2,614)
Income tax expense (Note 8).............. 522 679 764 486 561
------- ------- ------- ------- -------
Net loss................................. $(2,629) $(3,252) $(3,864) $(2,461) $(3,175)
======= ======= ======= ======= =======
Net loss per share....................... $ (0.18) $ (0.22) $ (0.27) $ (0.17) $ (0.22)
======= ======= ======= ======= =======
Weighted average shares of common stock
outstanding............................ 14,538 14,538 14,538 14,538 14,538
</TABLE>

See accompanying notes.

F-4
<PAGE> 82

PENWEST PHARMACEUTICALS CO.

CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY (DEFICIT)
(in thousands)

<TABLE>
<CAPTION>
COMMON STOCK CUMULATIVE
---------------- PAID-IN ACCUMULATED TRANSLATION
SHARES AMOUNT CAPITAL DEFICIT ADJUSTMENT TOTAL
------ ------ ------- ----------- ----------- ------
<S> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1994 before stock
split.................................... 5 $ 5 $8,085 $ (2,588) $(491) $ 5,011
Stock split (Note 13)...................... 14,533 10 (10)
------ --- ------ -------- ----- -------
Balances, January 1, 1994 after stock
split.................................... 14,538 15 8,075 (2,588) (491) 5,011
Net loss................................... (2,629) (2,629)
Translation adjustment..................... 259 259
------ --- ------ -------- ----- -------
Balances, December 31, 1994................ 14,538 15 8,075 (5,217) (232) 2,641
Net loss................................... (3,252) (3,252)
Translation adjustment..................... 134 134
------ --- ------ -------- ----- -------
Balances, December 31, 1995................ 14,538 15 8,075 (8,469) (98) (477)
Net loss................................... (3,864) (3,864)
Translation adjustment..................... (71) (71)
------ --- ------ -------- ----- -------
Balances, December 31, 1996................ 14,538 15 8,075 (12,333) (169) (4,412)
Net loss................................... (3,175) (3,175)
Translation adjustment..................... (491) (491)
------ --- ------ -------- ----- -------
Balances, September 30, 1997............... 14,538 $15 $8,075 $(15,508) $(660) $(8,078)
====== === ====== ======== ===== =======
</TABLE>

See accompanying notes.

F-5
<PAGE> 83

PENWEST PHARMACEUTICALS CO.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------ ---------------------
1994 1995 1996 1996 1997
------- ------------ ------- ----------- -------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Cash used in operating activities:
Net loss............................... $(2,629) $ (3,252) $(3,864) $(2,461) $(3,175)
Adjustments to reconcile net loss to
net cash used in operating
activities:
Depreciation......................... 1,408 1,724 2,190 1,601 1,713
Amortization......................... 337 282 207 156 115
Deferred income taxes................ 470 455 546 341 428
Changes in operating assets:
Accounts receivables................. (236) (1,647) 470 518 (22)
Inventories.......................... (622) (1,079) (3,218) (3,212) (105)
Prepaid expenses and other current
assets............................ (58) (123) 193 152 (295)
Accounts payable and accrued
expenses.......................... 383 519 464 248 19
------- ------- ------- ------- -------
Net cash used in operating
activities........................... (947) (3,121) (3,012) (2,657) (1,322)
Net cash (used in) provided by
investing activities:
Acquisitions of fixed assets, net.... (1,926) (3,990) (2,322) (1,857) (2,953)
Other................................ 68 (87) (657) (605) (625)
------- ------- ------- ------- -------
Net cash used in investing
activities........................... (1,858) (4,077) (2,979) (2,462) (3,578)
Cash provided by financing activities:
Increase in payable to Penford....... 3,073 6,787 6,390 5,562 5,403
Effect of exchange rate changes on
cash................................. 53 33 6 (4) (110)
------- ------- ------- ------- -------
Net increase (decrease) in cash and
cash equivalents..................... 321 (378) 405 439 393
Cash and cash equivalents at beginning
of year.............................. 347 668 290 290 695
------- ------- ------- ------- -------
Cash and cash equivalents at end of
year................................. $ 668 $ 290 $ 695 $ 729 $ 1,088
======= ======= ======= ======= =======
</TABLE>

See accompanying notes.

F-6
<PAGE> 84

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information for the nine-month period ended September 30, 1996 is unaudited

1. BUSINESS

Penwest Pharmaceuticals Co. and subsidiaries ("Penwest" or the "Company"),
formerly known as Edward Mendell Co., Inc. is a wholly-owned subsidiary of
Penford Corporation ("Penford"). The Company is engaged in the research,
development, and commercialization of novel drug delivery products and
technologies. The Company has developed TIMERx proprietary controlled release
drug delivery technology. The Company also manufactures and distributes
pharmaceutical excipients, the inactive ingredients in tablets and capsules. The
Company has manufacturing facilities in Iowa and Finland and has customers
primarily throughout North America and Europe.

The Company is subject to the risks and uncertainties associated with an
early-stage drug delivery company. These risks and uncertainties include, but
are not limited to, a history of net losses, technological changes, dependence
on collaborators and key personnel, no assurance of regulatory approval,
compliance with government regulations, patent infringement litigation and
competition from current and potential competitors, some with greater resources
than the Company.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements include the accounts of
Penwest and its wholly owned subsidiaries. Material intercompany balances and
transactions have been eliminated. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates. In addition, the consolidated financial statements include various
costs allocated by Penford (see Notes 6 and 9). Although management believes the
amounts allocated are reasonable and approximate the cost of obtaining the
service from an unrelated third party, the actual costs could differ.

Cash and Cash Equivalents

All highly liquid investments with a maturity of three months or less when
purchased are considered cash equivalents.

Credit Risk and Fair Value of Financial Instruments

The Company performs ongoing credit evaluations of its customers and
generally does not require collateral. The Company's excipient revenues and its
royalties and licensing fees are derived from major pharmaceutical companies
that have significant cash resources. The Company maintains an allowance for
doubtful accounts which management believes is sufficient to cover potential
credit losses.

The carrying value of financial instruments, which includes cash,
receivables, and payables, approximates market value.

F-7
<PAGE> 85

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

Fixed Assets

Property and equipment are recorded at cost and depreciated by the
straight-line method over their estimated useful lives. Estimated useful lives
by class of assets are as follows:

<TABLE>
<S> <C>
Buildings...................................... 20-25 years
Machinery and equipment........................ 10-12 years
Office furniture and equipment................. 5-10 years
</TABLE>

Property and equipment of the Company are reviewed for impairment whenever
events or circumstances indicate that the asset's undiscounted expected cash
flows are not sufficient to recover its carrying amount. The Company measures an
impairment loss by comparing the fair value of the asset to its carrying amount.
Fair value of an asset is calculated as the present value of expected future
cash flows.

Foreign Currencies

Monetary assets and liabilities of the Company's foreign operations are
translated into U.S. dollars at year-end exchange rates and revenue and expenses
are translated at average exchange rates. For each of the foreign operations,
the functional currency is the local currency. Translation adjustments are
disclosed and accumulated in a separate component of consolidated shareholder's
deficit. Realized gains and losses from foreign currency transactions are
reflected in the consolidated statement of operations. The change in the
cumulative translation adjustment from December 31, 1995 to September 30, 1996
was $21,000. Foreign transaction gains and losses were not significant in each
of the years in the three year period ended December 31, 1996 or the nine month
periods ended September 30, 1996 and 1997.

Income Taxes

The Company's results of operations are included in the tax returns of
Penford. Deferred income tax expense and related income tax assets and
liabilities are reflected as if the Company were an independent entity, in
accordance with FAS 109, except that the Company is not compensated for tax
losses that are utilized by Penford. See Note 8.

Revenue Recognition

Royalties and licensing fees include royalty revenues and milestone fees
related to licensing agreements for TIMERx with various collaborators. To date
there have been no royalties recognized as there are no products currently
commercialized using the TIMERx technology. Milestone payments are derived from
reaching development milestones with collaborators and are recognized as
achieved in accordance with the contract terms. These milestones payments are
not subject to forfeiture.

Product sales revenues are recognized when goods are shipped.

Advertising Costs

Advertising costs are accounted for as expenses in the period in which they
are incurred.

F-8
<PAGE> 86

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

Research and Development

Research and development expenses consist of costs related to products
being developed internally as well as costs related to products subject to
licensing agreements. Research and development costs are charged to expense as
incurred.

Per Share Data

Earnings per common share are computed based on the weighted average number
of common shares and dilutive common stock equivalents outstanding during the
period after giving effect to the October 8, 1997 2,907.66-for-1 stock split
(see Note 13).

In February 1997, the FASB issued Statement No. 128, "Earnings Per Share."
The statement is effective for fiscal years ending after December 15, 1997,
including interim periods, and requires public companies to present basic
earnings per share and, if applicable, diluted earnings per share. The Company
will adopt Statement No. 128 in 1997. The statement will not impact the
Company's earnings per share as disclosed.

Long-Lived Assets

In March 1995, the Financial Accounting Standards Board ("FASB") issued
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," which requires impairment losses to be
recorded on long-lived assets used in operations when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets' carrying amount. Statement 121 also addresses
the accounting for long-lived assets that are expected to be disposed. The
Company adopted Statement 121 in the first quarter of 1996 with no impact on
financial position or results of operations.

Interim Consolidated Financial Statements

The unaudited interim consolidated statements of operations and cash flows
for the nine month period ended September 30, 1996 have been prepared on the
same basis as the annual audited consolidated financial statements included
herein. In the opinion of management, such interim financial statements include
all adjustments (consisting only of normal recurring adjustments) necessary to
present fairly the results for such periods.

The operating results for the nine month period ended September 30, 1997
are not necessarily indicative of the operating results to be expected for the
full year ending December 31, 1997 or for any future period.

3. INVENTORIES

Inventories, which consist of raw materials, pharmaceutical excipients
manufactured by the Company, pharmaceutical excipients held for distribution,
and manufactured bulk TIMERx, are stated at the lower of cost (first-in,
first-out) or market. Cost includes material, labor and manufacturing overhead
costs.

F-9
<PAGE> 87

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

Inventories are summarized as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------- SEPTEMBER 30,
1995 1996 1997
------ ------ -------------
(in thousands)
<S> <C> <C> <C>
Raw materials............................... $1,150 $1,745 $ 1,561
Finished products........................... 3,187 5,810 6,100
------- ------- -------
Total inventories...................... $4,337 $7,555 $ 7,661
======= ======= =======
</TABLE>

Included in inventories are approximately $1,220,000, $1,742,000 and
$2,671,000 of TIMERx raw materials and bulk TIMERx as of December 31, 1995 and
1996 and September 30, 1997, respectively. The ability to continue to sell
TIMERx related inventory is dependent, in part, upon the commercialization of
products by third parties utilizing bulk TIMERx and the continued use by the
Company and third parties of the TIMERx related inventory in existing and new
research efforts. Although third parties have products in various stages of
development, none of these products have been commercialized and the period
required to achieve commercialization is uncertain if achieved at all. The
manufactured bulk TIMERx does not have a predetermined shelf life.

The Company has relied on a large third-party pharmaceutical company for
the manufacture of its TIMERx products. There are a limited number of third
party manufacturers capable of producing the Company's TIMERx products.

The Company's TIMERx drug delivery system is a hydrophilic matrix
consisting primarily of two natural polysaccharides, xanthan and locust bean
gums, in the presence of dextrose. The Company purchases these gums from a sole
source supplier. Most of the Company's excipients are manufactured from wood
pulp, which the Company also purchases from a sole source supplier. Although the
Company has qualified alternate suppliers with respect to these materials, there
can be no assurance that interruptions in supplies will not occur in the future
or that the Company will not have to obtain substitute suppliers. Any of these
events could have a material adverse effect on the Company's ability to
manufacture bulk TIMERx for delivery to its collaborators or manufacture its
excipients, which could have a material adverse effect on the Company's results
of operations, cash flows and financial position.

4. FIXED ASSETS

Fixed assets, at cost, summarized by major categories, consist of the
following:

<TABLE>
<CAPTION>
DECEMBER 31,
------------------- SEPTEMBER 30,
1995 1996 1997
------- ------- -------------
(in thousands)
<S> <C> <C> <C>
Buildings and equipment................... $24,682 $26,513 $27,718
Land...................................... 675 696 696
Construction in progress.................. 873 1,160 2,597
------- ------- -------
26,230 28,369 31,011
Less: accumulated depreciation............ 6,027 8,033 9,436
------- ------- -------
$20,203 $20,336 $21,575
======= ======= =======
</TABLE>

F-10
<PAGE> 88

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

5. OTHER ASSETS

Other assets, net of accumulated amortization, consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------- SEPTEMBER 30,
1995 1996 1997
------ ------ -------------
(in thousands)
<S> <C> <C> <C>
Patents, net of accumulated amortization of
$96, $162 and $225........................ $1,030 $1,443 $1,780
Goodwill, net of accumulated amortization of
$181, $238 and $281....................... 359 302 259
------ ------ ------
$1,389 $1,745 $2,039
====== ====== ======
</TABLE>

Goodwill is being amortized over ten years and was recorded upon the
acquisition of the Company by Penford. Amortization expense approximated $57,000
for each of the years ended December 31, 1994, 1995 and 1996, and $43,000 for
each of the nine month periods ended September 30, 1996 and 1997.

Patents include costs to secure patents and trademarks on technology
developed by the Company. Patents are amortized over their useful lives of 17 to
20 years. Amortization expense of $20,000, $48,000 and $66,000 was recorded in
the years ended December 31, 1994, 1995 and 1996, respectively, and $49,000 and
$63,000 for the nine month periods ended September 30, 1996 and 1997,
respectively.

Recorded intangibles are evaluated for potential impairment whenever events
or circumstances indicate that the undiscounted cash flows are not sufficient to
recover their carrying amounts. An impairment loss is recorded to the extent the
assets carrying value is in excess of related discounted cash flows.

6. PAYABLE TO PENFORD

The Payable to Penford consists solely of advances. These advances were
generated primarily from the initial acquisition of the Company, the addition of
a microcrystalline cellulose plant and the funding of operations. The Payable to
Penford is a non-interest-bearing obligation. Average balances for the years
ended December 31, 1994, 1995 and 1996 and for the nine months ended September
30, 1996 and 1997 were $17,500,000, $22,100,000, $27,300,000, $26,700,000 and
$33,200,000, respectively. Penford has indicated that it intends to continue to
provide advances until the offering is completed (see Note 13). The Company also
participates in pension and other employee benefit plans sponsored by Penford
and purchases inventory from a wholly-owned subsidiary of Penford. The inventory
purchases amounted to approximately $771,000, $609,000, and $634,000 for the
years ended December 31, 1994, 1995 and 1996, respectively and $462,000 and
$311,000 for the nine month periods ended September 30, 1996 and 1997,
respectively. The Company believes the terms of its employee benefit and
inventory purchase transactions approximate those that would be reached with a
third party in an arms length transaction and represent the approximate costs
the Company would have incurred on a stand-alone basis.

Penford allocates executive office salaries, bonuses and legal fees to the
Company in the form of a management fee. The costs making up the management fee
are allocated to the Company based upon its pro-rata portion of Penford's
consolidated revenue. The Company believes the management fee approximates the
actual costs of services provided and represents the approximate costs the
Company would have incurred on a stand-alone basis. Included in selling, general
and administrative expenses is a management fee of $438,000, $404,000 and
$391,000 for the years ended December 31, 1994, 1995 and

F-11
<PAGE> 89

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

1996, respectively and $295,000 and $433,000 for the nine month periods ended
September 30, 1996 and 1997, respectively.

7. COMMITMENTS

Leases

The Company's manufacturing facility in Finland is leased under a two-year
operating lease with annual rental expense of $188,000 and renewal options.
Rental expense under this operating lease, including additional charges
determined on a month-to-month basis for equipment and warehouse usage, was
$186,000, $210,000 and $216,000 for the years ended December 31, 1994, 1995, and
1996, respectively and $162,000, and $162,000 for the nine month periods ended
September 30, 1996 and 1997.

8. INCOME TAXES

The provision for federal, state and foreign income taxes consists of the
following (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
---------------------- --------------------
1994 1995 1996 1996 1997
---- ---- ---- ----------- ----
(Unaudited)
<S> <C> <C> <C> <C> <C>
Federal:
Deferred....................................... $364 $386 $423 $266 $338
Foreign:
Current........................................ 51 223 217 144 132
State:
Current........................................ 1 1 1 1 1
Deferred....................................... 106 69 123 75 90
---- ---- ---- ---- ----
$522 $679 $764 $486 $561
==== ==== ==== ==== ====
</TABLE>

The reconciliation between the statutory tax rate and those reflected in
the Company's income tax provision is as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- SEPTEMBER 30,
1994 1995 1996 1997
---- ---- ---- -------------
<S> <C> <C> <C> <C>
Statutory tax rate........................................ (34)% (34)% (34)% (34)%
Tax benefit utilized by Penford........................... 55 56 55 53
Foreign taxes............................................. -- 1 2 --
State taxes, net of federal benefit....................... 3 2 2 2
Other..................................................... 1 1 -- 1
--- --- --- ---
25% 26% 25% 22%
=== === === ===
</TABLE>

The provision for income takes for the nine month period ended September
30, 1996 is based on the effective rate for the year ended December 31, 1996.

F-12
<PAGE> 90

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

The components of deferred federal and state income tax assets and
liabilities are as follows (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31,
----------------- SEPTEMBER 30,
1995 1996 1997
------ ------ -------------
<S> <C> <C> <C>
Receivable allowance................................ $ (95) $ (107) $ (92)
Inventory reserves.................................. (74) (115) (126)
------ ------ -------
(169) (222) (218)
Accelerated depreciation and amortization........... 2,694 3,293 3,688
------ ------ ------
Deferred tax liability.............................. $2,525 $3,071 $ 3,470
====== ====== =======
</TABLE>

The Company has made payments for foreign income taxes of approximately
$51,000, $223,000 and $217,000 for the years ended December 31, 1994, 1995 and
1996, respectively, and $144,000 and $132,000 for the nine month periods ended
September 30, 1996 and 1997, respectively.

The Company is included in the consolidated federal and state tax returns
of Penford. In accordance with the Company's tax sharing agreement, the Company
is not compensated for tax losses that are utilized by Penford. As a result of
Penford fully utilizing all of the Company's tax losses, the Company does not
possess any net operating loss carryforwards. Although the Company is not
compensated for tax losses that are utilized by Penford, if such tax losses
remained with the Company they would have been fully offset by a valuation
allowance due to the Company's history of operating losses. As a result, the
provision as calculated approximates that which would have been recorded if
calculated on a stand-alone basis. Through September 30, 1997, Penford has
utilized approximately $17,350,000 of federal net operating loss carryforwards
that the Company would have had outstanding were it a stand-alone entity. In
addition, Penford is liable for any federal, state or foreign tax adjustments
assessed against the Company for periods through the date of the distribution.

The Company's policy is to permanently reinvest foreign earnings.
Accumulated foreign earnings, for which no deferred taxes have been provided,
amounted to $1,499,000, $1,793,000 and $2,088,000 as of December 31, 1995 and
1996 and September 30, 1997, respectively. If such earnings were to be
repatriated, the income tax effect would not be significant.

Included in the loss before income taxes is foreign income of $125,000,
$606,000 and $801,000 for the years ended December 31, 1994, 1995 and 1996,
respectively, and $387,000 for the nine-month period ended September 30, 1997.

9. PENSION AND OTHER EMPLOYEE BENEFITS

Pension Plan

Penwest participates in a noncontributory defined benefit pension plan (the
Plan) that covers substantially all employees. The Plan is sponsored by its
Parent and costs are allocated based upon actual costs incurred for the
Company's employees. In addition to the employees of the Company, employees of
Penford and its other subsidiaries participate in the Plan. The Company has
accounted for its involvement in the overall Plan as a participant in a
multiemployer pension plan. Under this method, the Company recognizes as net
periodic pension cost its allocated contribution for the period. The Company
recognizes a liability for any contributions due and unpaid.

Under the terms of the Employee Benefits Agreement between Penford and
Penwest, Penford will freeze all benefits of employees of Penwest under the Plan
as of the closing of this offering and will distribute to each employee on the
date of the Spin-off his or her fully vested interest in the form of a lump sum
payment or an annuity (see Note 13). Based upon the terms of the agreement there
will be

F-13
<PAGE> 91

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

no termination gains or losses as a result of the freezing of Plan benefits, the
termination of the right of employees of the Company to participate in the Plan
or the subsequent distribution. Subsequent to the distribution, the Company
plans to adopt a defined contribution plan and employees of Penwest will be
eligible to participate in such defined contribution plan.

Benefits for employees are primarily related to years of credited service
and final average five-year earnings. Employees generally become eligible to
participate in the plans after attaining age 21 and benefits become vested after
five years of credited service.

Pension expense of $70,000, $73,000 and $74,000 was recorded for the years
ended December 31, 1994, 1995 and 1996, respectively. Pension expense of $55,000
and $43,000 was recorded for the nine month periods ended September 30, 1996 and
1997, respectively.

Savings and Stock Ownership Plan

The Company's employees participate in Penford's Savings and Stock
Ownership Plan and costs are charged to the Company based upon actual costs
incurred for the Company's employees. Seventy-five percent (75%) of employee's
contributions are matched up to 6% of the employee's pay, in the form of Penford
common stock. The Company's expense under the plan was $89,000, $110,000 and
$147,000 for 1994, 1995, and 1996, respectively and $112,000 and $118,000 for
the nine month periods ended September 30, 1996 and 1997, respectively.

The Plan also includes an annual profit-sharing component that is awarded
by Penford's Board of Directors based on achievement of predetermined corporate
goals. This feature of the plan is available to all employees who meet the
eligibility requirements of the plan. The profit sharing expense related to the
Company's employees was $37,000, $80,000 and $38,000 for 1994, 1995 and 1996,
respectively, and $28,000 and $44,000 for the nine month periods ended September
30, 1996 and 1997, respectively.

Supplemental Executive Retirement Plan

Penford sponsors a Supplemental Executive Retirement Plan (SERP), a
nonqualified plan, which covers certain key employees including certain
employees of Penwest. For 1994, 1995, and 1996, the net expense for the SERP
incurred by Penwest was $9,000, $32,000 and $35,000, respectively, and $30,000
and $15,000 for the nine month periods ended September 30, 1996 and 1997,
respectively. The allocated costs represent the costs attributable to the
Company's employees.

Health Care and Life Insurance Benefits

The Company offers health care and life insurance benefits to most active
employees. Costs incurred to provide these benefits are charged to expense when
incurred. Health care and life insurance expense was $262,000, $244,000 and
$212,000 in 1994, 1995, and 1996, respectively, and $133,000 and $229,000 for
the nine month periods ended September 30, 1996 and 1997, respectively.

10. LICENSING AGREEMENTS

The Company has entered into collaborative arrangements with five
pharmaceutical companies to facilitate and expedite the commercialization of its
TIMERx drug delivery technology.

In August 1994, August 1995 and March 1996, the Company entered into
product development and supply agreements with Mylan Pharmaceuticals, Inc.
("Mylan") with respect to the development of generic versions of Procardia XL
(nifedipine), Adalat CC (nifedipine) and Glucotrol XL (glipizide), based on the
Company's TIMERx technologies (the "Mylan Products"). Under these product

F-14
<PAGE> 92

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

development and supply agreements, the Company is responsible for the
formulation, manufacture and supply of TIMERx material for use in the Mylan
Products, and Mylan is responsible for conducting all bioequivalence studies,
preparing all regulatory applications and submissions and manufacturing and
marketing the Mylan Products in the United States, Canada and Mexico. The
Company has received non-refundable milestone payments under each of the product
development and supply agreements and is entitled to additional milestone
payments under such agreements upon the continued development of the Mylan
Products. The Company is also entitled to royalties on the sale of each Mylan
Product, which royalties will be reduced with respect to such Mylan Product if
there are on the market and available for retail sale any other generic
controlled release formulations of the drug of which such Mylan Product is a
generic controlled release formulation. In addition, Mylan has agreed that
during the term of the product development and supply agreements it will
purchase formulated TIMERx material for use in the Mylan Products exclusively
from the Company at specified prices.

Penwest and Mylan also entered into a sales and distribution agreement in
January 1997 (the "Mylan Distribution Agreement") with respect to Nifedipine XL
pursuant to which Mylan agreed to manufacture and supply Nifedipine XL to
Penwest for distribution by Penwest and one or more distributors (as to which
the Company and Mylan must mutually agree) in certain specified European and
Latin American countries. Under this agreement, the Company has agreed to
purchase Nifedipine XL exclusively from Mylan at specified prices or to pay
Mylan 50% of any royalties received by the Company from its distributors if
Mylan licenses its manufacturing technology to the Company for use by the
Company's distributors instead of manufacturing the product for distribution.
Under this agreement, Mylan is entitled to 50% of any royalties or milestone
payments received by the Company under the Company's product development and
supply agreement with Sanofi described below.

In May 1996 and August 1996, the Company entered into product development
and supply agreements with Kremers Urban Development Company ("Kremers") with
respect to the development of generic versions of Cardizem CD (diltiazem) and
Covera HS (verapamil hydrochloride), respectively (the "Kremers Products"),
based on the Company's TIMERx technology. Under these product development and
supply agreements, the Company is responsible for formulating the Kremers
Products and for manufacturing and supplying TIMERx material to Kremers for use
in the Kremers Products, and Kremers is responsible for conducting
bioequivalence studies, preparing all regulatory applications and submissions
and manufacturing and marketing the Kremers Products in the United States,
Canada and Mexico. The Company has received non-refundable milestone payments
under the product development and supply agreements and is entitled to
additional milestone payments upon the continued development of the Kremers
Products. The Company also is entitled to royalties on the sale of the Kremers
Products. However, both milestone payments and the royalties otherwise due under
the product development and supply agreements may be reduced in the event that
there are competing generic controlled release formulations of Covera HS or
Cardizem CD, as may be applicable, on the market and available for retail sale.
In addition, Kremers has agreed that, during the term of the product development
and supply agreements, it will purchase formulated TIMERx material for use in
the Kremers Products exclusively from the Company at specified prices. These
prices will be reduced in the event that there are competing generic versions of
Covera HS and/or Cardizem CD, as may be applicable, on the market and available
for retail sale.

In February 1997, the Company entered into a product development and supply
agreement with Sanofi Winthrop International S.A. ("Sanofi") with respect to the
development of a generic version of Adalat LA based on the Company's TIMERx
technology (the "Sanofi Product"), a drug that is identical to Procardia XL.
Under the product development and supply agreement, the Company is responsible
for conducting pilot bioequivalence studies of the Sanofi Product and for
manufacturing and supplying TIMERx material to Sanofi, and Sanofi is responsible
for conducting all full scale bioequivalence

F-15
<PAGE> 93

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

studies, preparing all regulatory applications and submissions and manufacturing
and marketing the Sanofi Product in specified countries in Europe and in South
Korea. The Company is entitled to non-refundable milestone payments under the
product development and supply agreement upon the continued development of the
Sanofi Product. The Company is also entitled to royalties upon the sale of the
Sanofi Product. One half of such payments will be paid to Mylan in accordance
with the Mylan Distribution Agreement. In addition, Sanofi has agreed that,
during the term of the product development and supply agreement, it will
purchase formulated TIMERx material for use in the Sanofi Product exclusively
from the Company at specified prices.

In July 1992, the Company entered into an agreement with Leiras or
("Leiras") with respect to the development and commercialization of Cystrin CR,
a controlled release formulation of Cystrin based on the Company's TIMERx
technology. In May 1995, the Company entered into a second agreement with Leiras
clarifying certain matters with respect to the collaboration. Leiras is a
Finnish subsidiary of Schering AG. Leiras is developing products focused in the
areas of reproductive health care, urology, oncology and inhalation technology.
Under the agreements, the Company is responsible for the development and
formulation of Cystrin CR and for manufacturing and supplying TIMERx material to
Leiras for use in the manufacture of Cystrin CR, and Leiras is responsible for
preparing all regulatory applications and submissions and manufacturing and
marketing Cystrin CR on a worldwide basis. Leiras has the right to appoint
distributors for marketing and distribution in specified territories, subject in
certain circumstances to the approval of the Company. Leiras has also agreed to
pay the Company royalties on the sale of Cystrin CR and to purchase formulated
TIMERx material exclusively from the Company at specified prices.

In September 1997, the Company entered into a strategic alliance agreement
with Endo Pharmaceuticals, Inc. ("Endo") with respect to the development of
controlled release formulations of oxymorphone based on the Company's TIMERx
technology (the "Endo Products"). Under the agreement, the Company has agreed to
manufacture and supply TIMERx material to Endo, and Endo has agreed to
manufacture and market the Endo Products in the United States. The manufacture
and marketing of Endo Products outside of the United States may be conducted by
the Company, Endo or a third party, as determined by a committee comprised of an
equal number of members from each of the Company and Endo. The Company and Endo
have agreed to share the costs involved in the development and commercialization
of the Endo Products and that the party marketing the Endo Products (which the
Company expects will be Endo) will pay the other party royalties equal to 50% of
their respective net marketing revenues after fully-burdened costs (although
this percentage will decrease as the total U.S. marketing revenues from an Endo
Product increase), subject to each party's right to terminate its participation
with respect to any Endo Product described above. Endo will purchase formulated
TIMERx material for use in the Endo Products exclusively from the Company at
specified prices. Such prices will be reflected in the determination of
fully-burdened costs.

Royalties and licensing fees revenue consist solely of milestone payments
received from TIMERx collaborative agreements. Approximately $1,590,000,
$1,844,000 and $2,819,000 for the years ended December 31, 1994, 1995 and 1996,
respectively, and $1,976,000 and $2,264,000 for the nine month periods ended
September 30, 1996 and 1997, respectively, of research and development expense
principally related to applications of TIMERx technology to products covered by
the Company's collaborative agreements. Since the collaborative agreements can
be terminated by either party, the costs associated with such agreements could
be discontinued by the Company. Such costs are typically incurred prior to the
receipt of milestones, royalties and other payments.

F-16
<PAGE> 94

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

11. CONTINGENCIES

In May 1997, one of the Company's collaborators, Mylan, filed an
Abbreviated New Drug Application ("ANDA") with the U.S. Food and Drug
Administration ("FDA") for the 30 mg dosage strength of Nifedipine XL, a generic
version of Procardia XL, a controlled release formulation of nifedipine. See
Note 10 for a description of the Company's collaborative agreements with Mylan.
Bayer AG ("Bayer") and ALZA Corporation ("ALZA") hold patents relating to
Procardia XL, and Pfizer Inc. ("Pfizer") holds the New Drug Application ("NDA")
and markets the product. In connection with the ANDA filing, Mylan certified in
May 1997 to the FDA that Nifedipine XL does not infringe the Bayer or ALZA
patents and notified Bayer, ALZA and Pfizer of such certification. Bayer and
Pfizer sued Mylan in the United States District Court for the Western District
of Pennsylvania, alleging that Nifedipine XL infringes Bayer's patent. ALZA has
informed Mylan that ALZA does not believe that the notice given to it complied
with the requirements of the Waxman-Hatch Act, and there can be no assurance
that ALZA will not sue Mylan for patent infringement or take any other actions
with respect to such notice. Mylan has advised the Company that it intends to
contest vigorously the allegations made in the lawsuit. However, there can be no
assurance that Mylan will prevail in this litigation or that it will continue to
contest the lawsuit. An unfavorable outcome or protracted litigation for Mylan
would materially adversely affect the Company's business, financial condition,
cash flows and results of operations. Delays in the commercialization of
Nifedipine XL could also occur because the FDA will not grant final marketing
approval of Nifedipine XL until a final judgment on the patent suit is rendered
in favor of Mylan by the district court, or in the event of an appeal, by the
court of appeals, or until 30 months (or such longer or shorter period as the
court may determine) have elapsed from the date of Mylan's certification,
whichever is sooner.

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

F-17
<PAGE> 95

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

through the ANDA process. Reformulation of a product would likely require new
bioequivalence studies. If reformulation were not possible, then new clinical
studies and an NDA filing for such product would likely be required for FDA
approval of such product. Any of such events could materially adversely affect
the Company's collaborative arrangements where ANDA filings had been made or
were contemplated, which would have a material adverse effect on the Company's
business, financial condition and results of operations.

12. GEOGRAPHIC INFORMATION

The Company, which operates in one business segment as a drug delivery
company, conducts its business primarily in North America and Europe. The
European operations consist of a manufacturing facility in Nastola, Finland and
sales offices in Reigate, England and Uetersen, Germany. None of the European
locations, other than Finland, is individually significant. Intercompany sales
include a profit component for the selling company. Intercompany sales and
profits are eliminated in consolidation. Corporate operating expenses are not
allocated to the European operations. Operating profit repre-

F-18
<PAGE> 96

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

sents gross profit less selling, general and administrative expenses and, for
North America, research and development expense.

<TABLE>
<CAPTION>
NORTH
AMERICA EUROPE ELIMINATIONS TOTAL
-------- ------- ------------ -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
SEPTEMBER 30, 1997
Total Revenues..................................... $ 19,718 $ 4,525 $ (3,456) $20,787
Operating Profit (Loss)............................ (2,652) 38 -- (2,614)
Identifiable Assets................................ 32,359 6,336 (1,315) 37,380
Export Sales....................................... 1,212

DECEMBER 31, 1996
Total Revenues..................................... 25,400 6,917 (6,228) 26,089
Operating Profit (Loss)............................ (2,985) 488 (603) (3,100)
Identifiable Assets................................ 30,014 6,611 (1,542) 35,083
Export Sales....................................... 1,756

DECEMBER 31, 1995
Total Revenues..................................... 22,253 7,509 (4,673) 25,089
Operating Profit (Loss)............................ (2,695) 180 (58) (2,573)
Identifiable Assets................................ 29,420 4,108 (1,857) 31,671
Export Sales....................................... 1,865

DECEMBER 31, 1994
Total Revenues..................................... 21,813 5,897 (4,564) 23,146
Operating Profit (Loss)............................ (1,746) (361) -- (2,107)
Identifiable Assets................................ 24,514 2,865 (1,949) 25,430
Export Sales....................................... 1,947
</TABLE>

Segment information for operations in Finland, Germany and the United
Kingdom are included under the caption "Europe." Total revenues, operating
profit (loss) and identifiable assets in Europe are principally from the Finnish
operations. None of the revenues, operating profit (loss) or identifiable assets
of the operations in Germany or the United Kingdom, individually or in the
aggregate, exceed 10% of total revenues, operating profit (loss) or identifiable
assets of the Company. North American export sales consist principally of sales
to Western Europe. European export sales consist principally of sales from
Finland to Western European countries.

13. SUBSEQUENT EVENTS

Registration Statement

On October 8, 1997, the Board of Directors of Penford authorized the sale
of up to 20% of Penwest, through an initial public offering of Penwest's stock.

In contemplation of the Company's initial public offering, a 2907.66-for-1
stock split occurred on October 8, 1997, transforming the Company's capital
structure from 50,000 shares, $1.00 par value per share, of common stock
authorized and 5,000 shares of common stock outstanding to 39,000,000 shares,
$.001 par value per share, of common stock authorized and 14,538,282 shares of
common stock outstanding and 1,000,000 shares of preferred stock, $.001 par
value per share, authorized, that may be issued by the Board in one or more
series. Accordingly, all share and per share data have been retroactively
adjusted to give effect to the stock split.

F-19
<PAGE> 97

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

The Company expects to file a Registration Statement with the Securities
and Exchange Commission to permit the Company to sell shares of its common stock
to the public. In connection with the proposed public offering, the Board
authorized the issuance and sale by the Company of up to 2,500,000 shares of
common stock, plus up to an additional 375,000 shares to cover over-allotments.

The Parent has announced its intent, subject to the satisfaction of certain
conditions, including receipt of a favorable tax ruling from the Internal
Revenue Service or a written opinion from Ernst & Young LLP, to divest its
ownership interest in the Company (the Spin-off) by means of a tax-free
distribution to its shareholders, which is anticipated to occur for the second
quarter of 1998.

In anticipation of the offering and Penford's announced intention to divest
its ownership interest in the Company, the Company and Penford have entered into
a number of agreements which will become effective upon the closing of the
offering. Those agreements include: a service agreement under which Penford will
continue to provide on an interim basis, certain general corporate services
(including accounting, audit, treasury, financial and human resources, insurance
and tax) which will be charged to the Company on an actual or allocated basis
prior to the Spin-off and on an actual or allocated basis, plus specified
percentage negotiated by and mutually agreeable to Penford and Penwest; a tax
allocation agreement wherein for as long as the Company participates in the
consolidated tax returns, calculated on a separate return basis, of Penford, the
Company will be required to pay to or be entitled to receive from Penford its
allocable portion of consolidated federal or state income tax liability or
credits, other than credits related to net operating losses; an excipients
supply agreement under which Penford will manufacture and supply exclusively to
Penwest all of the Company's EMDEX and CANDEX requirements under pricing and
quantity terms that the Company believes approximate fair market value; and an
employee benefits agreement under which Penford will enable employees of the
Company to continue to be covered under Penford's long-term disability insurance
and group life insurance policies until Penford's divestiture of the Company's
stock and under Penford's Savings and Stock Ownership plan and medical, dental,
vision and flexible benefits plans until December 31, 1997, under all of which
the Company will be charged actual costs incurred by Penford for the Company's
employees. Subsequent to the closing of the Offering no terminating liabilities
will be incurred by Penwest related to employee benefits, including the Penford
defined benefit plan.

Stock Plans

In contemplation of the initial public offering of the Company's stock, the
Company adopted the 1997 Equity Incentive Plan (the "Plan") under which the
Board of Directors or its compensation committee is authorized to grant stock
options, stock appreciation rights, restricted stock, deferred stock,
performance units, or any combination thereof, to directors, employees,
directors, officers, consultants or advisors of the Company. There are 3,500,000
shares are available for grant under the terms of the Plan. These options are to
be granted at prices equal to the fair market value of common stock at the date
of grant and vest over a period not to exceed four years. Options granted under
the Plan must be exercised within ten years of grant, unless a shorter period is
designated at the time of grant. No options can be awarded under the Plan after
ten years. In connection with the offering, options to purchase 715,000 shares
of common stock at the initial public offering price were granted. In addition,
the Company adopted the 1997 Employee Stock Purchase Plan which will enable
employees of the Company to purchase stock at 85% of market value as defined in
the plan. There are 300,000 shares available under the Plan.

At the time of the Spin-off the outstanding stock options to purchase the
common stock of Penford will be adjusted. Penford has agreed to (i) amend its
stock plans to provide that, for purposes of such stock plans, the term employee
shall include employees of Penwest, (ii) amend each stock option held

F-20
<PAGE> 98

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

by a Penwest employee to provide that the option will continue to vest for so
long as the Penwest employee remains an employee of Penwest while maintaining
the vesting provisions and option period of the original grant, (iii) adjust the
exercise price of each stock option then outstanding, and (iv) adjust the number
of shares of common stock of Penford issuable upon exercise of each stock option
then outstanding. The adjustment of the exercise price and the number of shares
of Penford issuable upon exercise of each stock option outstanding are designed
to ensure the ratio of exercise price per option to the market value per share
is not reduced and to ensure the aggregate intrinsic value of options
immediately after the change is not greater than the aggregate intrinsic value
of the options immediately before the change. The changes in the stock options
to purchase the common stock of Penford will not result in additional
compensation expense.

Penford Stock Option Plan

Certain of the Company's employees participate in Penford's 1994 Stock
Option Plan (the "1994 Plan") for which 1,000,000 shares of common stock have
been authorized for grants of options by Penford. The 1994 Plan provides for the
granting of stock options at the fair market value of the common stock on the
date of grant. Either incentive stock options or non-qualified stock options
have been granted under the 1994 Plan. The incentive stock options generally
vest over five years at the rate of 20% each year and expire 10 years from the
date of grant. The non-qualified stock options generally vest over four years at
the rate of 25% each year and expire 10 years and 10 days from the date of
grant.

The Company has elected to follow Accounting Principals Board Opinion (APB)
No. 25 "Accounting for Stock Issued to Employees" and related Interpretations in
accounting for its employee stock options. Under APB No. 25, the Company does
not recognize compensation expense for Penford options granted to employees of
Penwest, since the exercise price of the options granted is equal to the market
value of the Parent's common stock at the date of grant. Statement of Financial
Accounting Standard No. 123 "Accounting for Stock Based Compensation" (SFAS 123)
requires the Company to disclose the pro forma impact on net loss and loss per
share as if compensation expense associated with employee stock options granted
to employees of Penwest had been calculated under the fair value method of SFAS
123 for employee stock options granted to employees of Penwest subsequent to
December 31, 1994.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31, NINE MONTHS ENDED
------------------- ------------------
1995 1996 SEPTEMBER 30, 1997
------- ------- ------------------
IN THOUSANDS, EXCEPT PER SHARE DATA
<S> <C> <C> <C>
Net loss -- as reported............................... $(3,252) $(3,864) $ (3,175)
Net loss -- pro forma................................. (3,396) (4,123) (3,526)

Net loss per share, primary -- as reported............ (0.22) (0.27) (0.22)
Net loss per share, primary -- pro forma.............. $ (0.23) $ (0.28) $ (0.24)
</TABLE>

The fair value of each option grant was estimated using the Black-Scholes
option-pricing model with the following weighted average assumptions: risk-free
interest rates of 5.6% to 6.1%; expected option life of each vesting increment
of 2.8 years; expected volatility of 49%; and expected dividends of $0.20 per
share. The weighted average fair value of options granted under the 1994 Plan
during the years ended December 31, 1995 and 1996 and nine months ended
September 30, 1997 was $13.02, $9.30, and $9.67 respectively. The effect of
applying Statement No. 123 for providing pro forma disclosures for the years
ended December 31, 1995, 1996 and nine months ended September 30, 1997 is not
likely to be representative of the effects in future years because the amounts
above reflect only the options granted in 1995, 1996 and during the nine months
ended September 30, 1997 that vest over four to five years. No additional Parent
shares will be available to the Company upon closing of the Offering.

F-21
<PAGE> 99

PENWEST PHARMACEUTICALS CO.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information for the nine-month period ended September 30, 1996 is unaudited

Changes in Penford stock options granted to employees of Penwest for the
three years ended December 31, 1994, 1995, and 1996 and nine months ended
September 30, 1997 are as follows:

<TABLE>
<CAPTION>
OPTION PRICE RANGE WTD. AVERAGE
SHARES EXERCISE PRICE
------- ------------------- --------------
<S> <C> <C> <C> <C> <C>
1994
Balance, January 1, 1994....................... 14,000 $20.13 - $22.75 $22.00
Granted........................................ --
Exercised...................................... --
Cancelled...................................... --
Balance, December 31, 1994..................... 14,000 20.13 - 22.75 22.00
=======
Options Exercisable............................ 2,800 20.13 - 22.75 22.00

1995
Granted........................................ 71,000 21.00 - 24.50 21.30
Exercised...................................... --
Cancelled...................................... --
Balance, December 31, 1995..................... 85,000 20.13 - 24.50 21.41
=======
Options Exercisable............................ 5,000 20.13 - 24.50 22.00

1996
Granted........................................ 80,500 17.00 - 18.25 17.71
Exercised...................................... --
Cancelled...................................... --
Balance, December 31, 1996..................... 165,000 17.00 - 24.50 19.61
=======
Option Exercisable............................. 14,600 20.13 - 24.50 21.86

Nine Months ended Sept. 30, 1997
Granted........................................ 1,000 18.25 18.25
Exercised...................................... (200) 18.25 18.25
Cancelled...................................... (1,800) 18.25 18.25
-------
Balance, September 30, 1997.................... 164,500 17.00 - 24.50 19.62
Options Exercisable............................ 24,600 $18.25 - $24.50 $21.26
</TABLE>

At September 30, 1997, the weighted average remaining contractual life of
options outstanding approximates 8.2 years.

F-22
<PAGE> 100

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.

The following table sets forth the Registrant's expenses in connection with
the issuance and distribution of the securities being registered. Except for the
SEC Registration Fee, the NASD Filing Fee and the Nasdaq National Market Listing
Fee, the amounts listed below are estimates:

<TABLE>
<S> <C>
Registration fee......................................................... $ 10,455
NASD filing fee.......................................................... 3,950
Nasdaq National Market listing fee....................................... 50,000
Printing and engraving expenses.......................................... 105,000
Legal fees and expenses.................................................. 200,000
Accounting fees and expenses............................................. 300,000
Blue Sky fees and expenses (including legal fees)........................ 10,000
Transfer agent and registrar fees and expenses........................... 2,500
Financial adviser fee.................................................... 300,000
Miscellaneous............................................................ 18,095
----------
Total.......................................................... $1,000,000
==========
</TABLE>

The Company will bear all expenses shown above.

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.

The Washington Business Corporation Act and the Registrant's Amended and
Restated Bylaws provide for indemnification of the Registrant's directors and
officers for liabilities and expenses that they may incur in such capacities. In
general, directors and officers are indemnified with respect to actions taken in
good faith in a manner reasonably believed to be in, or not opposed to, the best
interests of the Registrant, and with respect to any criminal action or
proceeding, actions that the indemnitee had no reasonable cause to believe were
unlawful. Reference is made to the Registrant's Amended and Restated Bylaws
filed as Exhibits 3.2 hereto. The officers and directors of the Registrant are
currently covered under director and officer liability insurance maintained by
Penford Corporation, the parent of the Registrant. The Registrant expects to
obtain its own director and officer liability insurance prior to or effective on
the Spin-off.

In addition, the Underwriting Agreement, the form of which is filed as
Exhibit 1.1 hereto, contains provisions for indemnification by the Underwriters
of the Registrant and its officers, directors and controlling stockholders
against certain liabilities under the Securities Act.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.

No securities of the Registrant have been issued during the three years
preceding the date of this Registration Statement.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

(A) Exhibits:

<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------
<S> <C> <C>
1.1* -- Form of Underwriting Agreement.
3.1* -- Amended and Restated Articles of Incorporation.
3.2* -- Amended and Restated Bylaws of the Company.
4.1** -- Specimen certificate representing the Common Stock.
</TABLE>

II-1
<PAGE> 101

<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- --------------------------------------------------------------------------------
<S> <C> <C>
5.1 -- Opinion of Edmund O. Belsheim, Jr.
+10.1* -- Product Development and Supply Agreement dated August 17, 1994 by and between
the Registrant and Mylan Pharmaceuticals Inc. ("Mylan").
+10.2* -- Product Development and Supply Agreement dated August 3, 1995 by and between the
Registrant and Mylan.
+10.3* -- Product Development and Supply Agreement dated March 22, 1996 by and between the
Registrant and Mylan.
+10.4* -- Sales and Distribution Agreement dated January 3, 1997 by and between the
Registrant and Mylan.
+10.5* -- Product Development and Supply Agreement dated May 31, 1996 by and between the
Registrant and Kremers Urban Development Company.
+10.6* -- Product Development and Supply Agreement dated August 30, 1996 by and between
the Registrant and Kremers Urban Development Company.
+10.7* -- Product Development, License and Supply Agreement dated February 28, 1997 by and
between the Registrant and Sanofi Winthrop International S.A., as amended.
+10.8* -- Agreement dated May 26, 1995 by and between the Registrant and Leiras OY.
+10.9* -- Agreement dated July 27, 1992 by and between the Registrant and Leiras OY.
+10.10* -- Strategic Alliance Agreement dated as of September 17, 1997 by and between the
Registrant and Endo Pharmaceuticals Inc.
10.11* -- 1997 Equity Incentive Plan.
10.12* -- 1997 Employee Stock Purchase Plan.
10.13* -- Form of Separation Agreement to be entered into between the Registrant and
Penford Corporation ("Penford").
10.14* -- Form of Excipient Supply Agreement to be entered into between the Registrant and
Penford.
10.15* -- Form of Services Agreement to be entered into between the Registrant and
Penford.
10.16* -- Form of Tax Allocation Agreement to be entered into between the Registrant and
Penford.
10.17* -- Form of Employee Benefits Agreement to be entered into between the Registrant
and Penford.
10.18* -- Recognition and Incentive Agreement dated as of May 14, 1990 between the
Registrant and Anand Baichwal, as amended.
21.1* -- Subsidiaries.
23.1 -- Consent of Ernst & Young LLP.
23.2 -- Consent of Edmund O. Belsheim, Jr. (included in Exhibit 5.1).
24.1* -- Power of Attorney.
27.1* -- Financial Data Schedule.
</TABLE>

- ---------------
* Previously filed.

** To be filed by amendment.

+ Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the Commissioner.

(B) Financial Statements Schedules:

Schedule II -- Valuation and Qualifying Accounts

All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore have
been omitted.

II-2
<PAGE> 102

ITEM 17. UNDERTAKINGS.

Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to provisions described in Item 14 above, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
Securities Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.

The undersigned registrant hereby undertakes (1) to provide to the
underwriters at the closing specified in the underwriting agreement certificates
in such denominations and registered in such names as required by the
underwriters to permit prompt delivery to each purchaser; (2) that for purposes
of determining any liability under the Securities Act, the information omitted
from the form of prospectus filed as part of a registration statement in
reliance upon Rule 430A and contained in the form of prospectus filed by the
registrant pursuant to Rule 424(b)(2) or (3) or (4) or 497(h) under the
Securities Act shall be deemed to be part of this registration statement as of
the time it was declared effective; and (3) that for the purpose of determining
any liability under the Securities Act, each post-effective amendment that
contains a form of prospectus shall be deemed to be a new registration statement
relating to the securities offered therein, and this offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.

II-3
<PAGE> 103

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in Patterson, New York, on December 4,
1997.

PENWEST PHARMACEUTICALS CO.

By: /s/ JOHN V. TALLEY, JR.
------------------------------------
John V. Talley, Jr.
President and Chief Operating
Officer

POWER OF ATTORNEY AND SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.

<TABLE>
<CAPTION>
SIGNATURE TITLE(S) DATE
- ------------------------------------------ ------------------------------ -----------------
<C> <S> <C>

* Chairman, Chief Executive December 4, 1997
- ------------------------------------------ Officer and Director
Tod R. Hamachek (Principal Executive
Officer)

* Vice President, Finance and December 4, 1997
- ------------------------------------------ Chief Financial Officer
Jennifer L. Good (Principal Financial and
Accounting Officer)

* Director December 4, 1997
- ------------------------------------------
Paul E. Freiman

* Director December 4, 1997
- ------------------------------------------
Jere E. Goyan, Ph.D.

* Director December 4, 1997
- ------------------------------------------
Rolf H. Henel

* Director December 4, 1997
- ------------------------------------------
Robert J. Hennessey

* Director December 4, 1997
- ------------------------------------------
N. Stewart Rogers

/s/ JOHN V. TALLEY, JR. Director December 4, 1997
- ------------------------------------------
John V. Talley, Jr.

* Director December 4, 1997
- ------------------------------------------
W. Leigh Thompson, Ph.D., M.D.
</TABLE>

*By: /s/ JOHN V. TALLEY, JR.
---------------------------------

John V. Talley, Jr.
Attorney-in-fact

II-4
<PAGE> 104

REPORT OF INDEPENDENT AUDITORS ON SCHEDULE

We have audited the consolidated financial statements of Penwest
Pharmaceuticals Co. as of September 30, 1997 and December 31, 1996 and 1995, and
for the nine-month period ended September 30, 1997, and each of the three years
in the period ended December 31, 1996, and have issued our report thereon dated
October 11, 1997, included elsewhere in this Registration Statement. Our audits
also included the financial statement schedule listed in Item 16(b) of this
Registration Statement. This schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits.

In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.

ERNST & YOUNG LLP
Stamford, Connecticut
October 11, 1997

S-1
<PAGE> 105

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
PENWEST PHARMACEUTICALS CO.
SEPTEMBER 30, 1997
(IN THOUSANDS)

<TABLE>
<CAPTION>
BALANCE AT CHARGED TO
BEGINNING OF COSTS AND CHARGED TO OTHER DEDUCTIONS BALANCE AT
PERIOD EXPENSES ACCOUNTS DESCRIBE DESCRIBE END OF PERIOD
------------ ---------- ----------------- ------------------- -----------------
<S> <C> <C> <C> <C> <C>
Nine month period ended September
30, 1997
Allowance for Doubtful Accounts.... $237 $ 0 -- -- $237
==== === === ==== ====
Year ended December 31, 1996
Allowance for Doubtful Accounts.... $200 $37 -- -- $237
==== === === ==== ====
Year ended December 31, 1995
Allowance for Doubtful Accounts.... $187 $28 -- (15)(1) $200
==== === === ==== ====
Year ended December 31, 1994
Allowance for Doubtful Accounts.... $198 $55 -- (66)(1) $187
==== === === ==== ====
</TABLE>

- ---------------
(1) Write-off of bad debts

S-2
<PAGE> 106

EXHIBITS

<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NO. DESCRIPTION PAGE
- ------- --------------------------------------------------------------------- ------------
<S> <C> <C> <C>
1.1* -- Form of Underwriting Agreement.
3.1* -- Amended and Restated Articles of Incorporation.
3.2* -- Amended and Restated Bylaws of the Company.
4.1** -- Specimen certificate representing the Common Stock.
5.1 -- Opinion of Edmund O. Belsheim, Jr.
+10.1* -- Product Development and Supply Agreement dated August 17, 1994 by and
between the Registrant and Mylan Pharmaceuticals Inc. ("Mylan").
+10.2* -- Product Development and Supply Agreement dated August 3, 1995 by and
between the Registrant and Mylan.
+10.3* -- Product Development and Supply Agreement dated March 22, 1996 by and
between the Registrant and Mylan.
+10.4* -- Sales and Distribution Agreement dated January 3, 1997 by and between
the Registrant and Mylan.
+10.5* -- Product Development and Supply Agreement dated May 31, 1996 by and
between the Registrant and Kremers Urban Development Company.
+10.6* -- Product Development and Supply Agreement dated August 30, 1996 by and
between the Registrant and Kremers Urban Development Company.
+10.7* -- Product Development, License and Supply Agreement dated February 28,
1997 by and between the Registrant and Sanofi Winthrop International
S.A., as amended.
+10.8* -- Agreement dated May 26, 1995 by and between the Registrant and Leiras
OY.
+10.9* -- Agreement dated July 27, 1992 by and between the Registrant and
Leiras OY.
+10.10* -- Strategic Alliance Agreement dated as of September 17, 1997 by and
between the Registrant and Endo Pharmaceuticals Inc.
10.11* -- 1997 Equity Incentive Plan.
10.12* -- 1997 Employee Stock Purchase Plan.
10.13* -- Form of Separation Agreement to be entered into between the
Registrant and Penford Corporation ("Penford").
10.14* -- Form of Excipient Supply Agreement to be entered into between the
Registrant and Penford.
10.15* -- Form of Services Agreement to be entered into between the Registrant
and Penford.
10.16* -- Form of Tax Allocation Agreement to be entered into between the
Registrant and Penford.
10.17* -- Form of Employee Benefits Agreement to be entered into between the
Registrant and Penford.
10.18* -- Recognition and Incentive Agreement dated as of May 14, 1990 between
the Registrant and Anand Baichwal, as amended.
</TABLE>

<PAGE> 107

<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NO. DESCRIPTION PAGE
- ------- --------------------------------------------------------------------- ------------
<S> <C> <C> <C>
21.1* -- Subsidiaries.
23.1 -- Consent of Ernst & Young LLP.
23.2 -- Consent of Edmund O. Belsheim, Jr. (included in Exhibit 5.1).
24.1* -- Power of Attorney.
27.1* -- Financial Data Schedule.
</TABLE>

- ---------------
* Previously filed.

** To be filed by amendment.

+ Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the Commissioner.

<PAGE> 1
[LOGO] Penwest

Post Office Box 1688
Bellevue, WA
98009-1688

(206) 462-6000
Fax (206) 462-2819

December 5, 1997

Penwest Pharmaceuticals Co.
2981 Route 22
Patterson, NY 12563

Ladies and Gentlemen:

I am General Counsel of Penwest Pharmaceuticals Co., a Washington
corporation (the "Company"), and am issuing this opinion in connection with the
Registration Statement on Form S-1 (Registration No. 333-38389) (together with
Amendment No. 1 and Amendment No. 2 thereto, the "Registration Statement") filed
with the Securities and Exchange Commission under the Securities Act of 1933, as
amended. The Registration Statement relates to the proposed sale by the Company
of an aggregate of 2,875,000 shares (the "Shares") of the Company's common
stock, $.001 par value per share (the "Common Stock"), including 375,000 Shares
subject to an option granted by the Company to the Underwriters (as defined
herein) to cover any over allotments. The Shares are to be sold by the Company
pursuant to an Underwriting Agreement (the "Underwriting Agreement") among the
Company and BancAmerica Robertson Stephens and SBC Warburg Dillon Read Inc., as
representatives of the several underwriters named in the Underwriting Agreement
(the "Underwriters").

I have examined the Registration Statement and such other documents and
records as I have deemed necessary as a basis for the opinion set forth herein.

Based upon the foregoing, I am of the opinion that the Shares will, when
sold by the Company in accordance with the terms of the Underwriting Agreement,
be validly issued, fully paid and nonassessable.

I consent to the filing of this opinion as an exhibit to the Registration
Statement. I also consent to the reference to my name under the caption "Legal
Matters" in the prospectus filed as part of the Registration Statement.

Very truly yours,

/s/ Edmund O. Belsheim, Jr.
-------------------------------
Edmund O. Belsheim, Jr.
General Counsel

<PAGE> 1
EXHIBIT 23.1

CONSENT OF INDEPENDENT AUDITORS

We consent to the reference to our firm under the captions "Experts" and
"Selected Financial Data" and to the use of our reports dated October 11, 1997,
in the Registration Statement (Form S-1 No. 333-38389 Amendment No. 2) and
related Prospectus of Penwest Pharmaceuticals Co. for the registration of
2,875,000 shares of its common stock.

/s/ Ernst & Young LLP

Stamford, Connecticut
December 4, 1997