Penwest Shareholders Letter 2008

Dear Fellow Shareholders,

2008 was a very active and productive year for Penwest on many fronts. We received our first royalties on sales of Opana ER® from our partner Endo Pharmaceuticals, advanced our lead drug candidate A0001 into clinical trials, entered into two drug delivery technology collaborations, completed an equity financing resulting in net proceeds of $23 million, and took steps to reduce our operating expenses, including a significant decrease in overhead costs.

These developments were reflected in our much-improved financial performance for both the fourth quarter and full year ended December 31, 2008. Compared with the fourth quarter of 2007, our revenues increased sharply, our operating expenses decreased by 30%, and our net loss was substantially reduced. In fact, we see our improved financial results in 2008 continuing into 2009, with significantly increased royalties from Opana ER and 30% lower projected operating expenses compared with 2008 levels. As a result, we expect that for 2009, our net loss will decrease to a range of $1 million to $3 million for the full year compared with a net loss of $26.7 million in 2008.

We are excited about what we can achieve in 2009, building on our 2008 accomplishments. After a thorough review by the Board of Directors of the Company’s business and strategy, we have established a highly-focused business plan for 2009, with well-defined goals and clear value milestones for our shareholders. The four goals of our plan are to:

• Maximize the value of Opana ER with our partner Endo Pharmaceuticals through additional intellectual property protection and the licensing of Opana ER in territories outside the United States.
• Advance the development of A0001, our compound for the treatment of mitochondrial diseases, to establish proof of concept.
• Monetize the value of the Company’s proven drug delivery technologies and drug formulation expertise through additional drug delivery collaborations.
• Aggressively manage the Company’s overhead and other costs to ensure that our spending is commensurate with our narrowed priorities.

We are intensely focused on implementing our plan and are excited about what we can achieve this year. At the same time, we and our Board will be monitoring our progress on each of these goals throughout this year, and are ready to revisit our strategic course and take decisive actions as appropriate.

Opana ER

We are pleased that our collaboration with Endo for Opana ER produced strong sales growth in 2008. For the year ended December 31, 2008, Endo’s net sales of Opana ER increased 69% to $143.0 million. Endo’s net sales for Opana ER for the fourth quarter of 2008 were $40.3 million, representing an increase of 76% over the fourth quarter of 2007. Endo pays us a tiered royalty based on its net sales of this product. We believe that Opana ER has strong prospects for continued growth. Managed care coverage for the product is broad and largely in place, which we believe may translate into meaningful volume increases in 2009.

Protecting the intellectual property around Opana ER is also a top priority for both Endo and Penwest, and we both are taking the steps necessary to defend it from the threat of generics. With respect to licensing opportunities for Opana ER, we have taken the business development lead on identifying partners outside the United States to develop and market the product. We own these rights jointly with Endo, and the economics of any deal will be split evenly. The licensing of this asset in territories outside the United States is a high priority for us in 2009. Our efforts are progressing well, and we expect to sign an agreement for at least one territory by the end of the first half of this year.

Progress on Internal Drug Development

We also took significant steps on our lead internal drug development program – A0001 – in 2008 and early 2009. During 2008, we completed Investigational New Drug (IND)-enabling toxicology studies, submitted an IND for A0001 to the FDA and completed a Phase 1a single ascending dose safety study of the drug in healthy volunteers. In late February 2009, we began dosing a Phase Ib multiple ascending dose safety study of A0001 in healthy volunteers, and we are in the process of designing a Phase IIa clinical trial to establish proof of concept of biological activity, which we plan to commence in the second half of this year.

Given the potential value to shareholders of A0001, and the limited time and cost it will require for us to gain a better understanding of proof of concept on both safety and efficacy through the Phase 1b and Phase IIa trials, we believe that it is important to advance A0001 through this next phase of development. If our findings do not support further development of the drug, we will discontinue this program.

Drug Delivery Collaborations

In 2008, we entered into two additional drug delivery technology collaborations, one with Cobalt Laboratories and another with Otsuka Pharmaceutical. This is our second collaboration with Otsuka.

Under these agreements, we receive up-front fees, R&D cost reimbursements, and potential milestone and royalty payments. With two new agreements per year, we believe the up-front fees and R&D reimbursements can allow us to operate this aspect of our business on a breakeven basis while providing Penwest with the upside potential in products should they advance in development and commercialization and achieve the related milestone and royalty payments.

Further Expense Reductions

We continue to significantly reduce expenses and closely manage our cash burn. Since early 2008, we have reduced our staff level by 27 employees or 36%. The responsibilities of our current staff center on activities related to supporting and maximizing the value of Opana ER, advancing the development of A0001, carrying out our responsibilities under our existing drug delivery technology collaborations as well as signing new collaborations, and performing functions related to Penwest's operation as a public company.

Having decreased our staff and taken other significant cost-reduction actions, we believe we have optimized our infrastructure and overhead to execute on our current business plan in a cost effective manner. We expect that these efforts, together with the royalties we expect from Endo, will enable us to achieve quarterly profitability by the fourth quarter of 2009, and profitability for the full year in 2010. Moreover, we do not anticipate requiring additional capital to implement our current business plan.

Closing

In closing, I want to thank my colleagues at Penwest for their tremendous efforts, and for their dedication to the Company and our mission. In the current economy, companies are scrutinizing every aspect of their business and downsizing their operations. Penwest is no exception. As a result, our employees are working very hard and doing whatever needs to be done, which often extends well beyond the job for which they were hired. Our entire team is positive, focused and highly motivated to succeed in carrying out our plan, building value for our shareholders and making a difference in the lives of patients and their families.

I look forward to keeping you informed of our progress in 2009. The Board is unanimous in its belief that we are following the right path for Penwest to build value for shareholders, both in 2009 and over the long-term. Our business plan is focused and executable, and we will continue to be accountable to you as we implement it.

Thank you for your continued support.

Sincerely,

Jennifer L. Good
President and Chief Executive Officer