• Advancing the development of A0001 drug candidate. Through the completed Phase Ib trial and the planned Phase IIa trials, we are seeking to establish proof of concept with respect to both the safety and efficacy of A0001.

• Monetizing the value of our proven drug delivery technologies and drug formulation expertise by executing additional deals. Our goal is to enter into at least two new collaborations in 2009. We believe that with two agreements, this aspect of our business can operate on a breakeven basis, fund a

portion of our overhead and provide us with a financial stake in products, should the collaborations advance into development and commercialization. In June 2009, we entered into a new collaboration with Otsuka Pharmaceuticals Co., Ltd., or Otsuka. In September 2009, we achieved a development milestone for achieving proof of principal in a Phase I pharmacokinetic study on the first collaboration signed with Otsuka. Achieving this milestone triggered a financial payment to us, which we expect to receive in the fourth quarter of 2009.

• Managing overhead and other costs to ensure that our infrastructure is sized appropriately to our priorities. In the nine months ended September 30, 2009, we continued to reduce expenses and closely managed our cash expenditures, including staff reductions implemented in January 2009. We have reduced our selling, general and administrative, or SG&A, and research and product development, or R&D, expenses by 36% in total for the nine months ended September 30, 2009 as compared to the prior year's nine month period. In addition, in November 2009, we announced additional cost reduction measures as discussed below.

In January 2009, we implemented staff reductions of approximately 18% of our workforce as part of our efforts to aggressively manage our overhead cost structure. The terms of the severance arrangements we entered into with terminated employees include severance pay and continuation of certain benefits, including medical insurance, over the respective severance periods. In connection with these severance arrangements, we recorded a severance charge in our statement of operations for the first quarter of 2009 of $550,000, of which $21,000 was unpaid as of September 30, 2009 but will be paid over the remainder of 2009. Of such severance charge, $464,000 and $86,000 were recorded as SG&A expense and R&D expense, respectively, in the first quarter of 2009. In addition, as a result of these terminations, in the first quarter of 2009, we recorded a non-cash credit of $885,000 associated with the forfeiture of stock options held by these former employees. Of such amount, $844,000 and $41,000 were recorded as credits to SG&A expense and R&D expense, respectively, in the first quarter of 2009.
In November 2009, we announced that we would be reducing our staff from 48 to 39 and consolidating our Danbury, Connecticut headquarters into our Patterson, New York facility as of January 1, 2010. We expect an annualized cost reduction of approximately $2 million from the staff reduction and facilities consolidation, including a reduction in SG&A expense of approximately $1.2 million and a reduction in R&D expense of approximately $800,000, all on an annualized basis. In addition, we announced our decision to defer any new development work on A0001, other than the two Phase IIa studies, pending review and analysis of the results of those studies. We anticipate recording a restructuring charge in the fourth quarter of 2009 of approximately $250,000, which amount is net of a non-cash credit associated with the expected forfeiture of stock options held by affected employees. This charge relates primarily to anticipated severance arrangements and facility relocation costs, and will be recorded primarily to selling, general and administrative expense.
Products
Opana ER. Opana ER is an oral extended release opioid analgesic, which we developed with Endo, using our proprietary TIMERx technology. In June 2006, the FDA approved for marketing Opana ER, for twice-a-day dosing in patients with moderate to severe pain requiring continuous, around-the-clock opioid treatment for an extended period of time. Under the terms of our collaboration with Endo, Endo launched Opana ER in the United States in July 2006 in 5 mg, 10 mg, 20 mg and 40 mg tablets, and in March 2008 in 7.5 mg, 15 mg and 30 mg tablets.
Under the terms of our collaboration with Endo, Endo pays us royalties based on U.S. net sales of Opana ER. No payments were due to us for the first $41 million of royalties otherwise payable to us beginning from the time of the product launch in July 2006, a period we refer to as the "royalty holiday". In the third quarter of 2008, the royalty holiday ended and we began earning royalties from Endo on sales of Opana ER. Endo has the right under our agreement to recoup the $28 million in development costs that Endo funded on our behalf prior to the approval of Opana ER, through a temporary 50% reduction in royalties. For the three and nine month periods ended September 30, 2009, we recognized $4.9 million and $13.7 million, respectively, in royalties from Endo on sales of Opana ER. These royalty amounts reflect this temporary reduction. As of September 30, 2009, $9.3 million of the $28 million remains to be recouped by Endo.
In March 2009, Endo and we entered into a Third Amendment to the Amended and Restated Strategic Alliance Agreement with respect to Opana ER, effective January 1, 2009, the Third Amendment. Under the terms of the

Third Amendment, Endo agreed to directly reimburse us for costs and expenses incurred by us in connection with patent applications and patent maintenance costs related to Opana ER. If any of such costs and expenses are not reimbursed to us by Endo, we may bill Endo for these costs and expenses through adjustments to the pricing of TIMERx material that we supply to Endo for use in Opana ER. In connection with the Third Amendment, Endo reimbursed us for such costs and expenses incurred prior to December 31, 2008, which we had capitalized as patent assets, in the amount of $206,000. We received such payment, as well as reimbursement by Endo of an additional $23,000 in patent costs incurred prior to the Third Amendment, in the second quarter of 2009, at which time we credited such reimbursements to our patent assets. Patent-related costs and expenses that we incurred subsequent to the Third Amendment have either been reimbursed or are expected to be reimbursed to us by Endo, with these reimbursements recorded by us as offsets to our costs.
On May 7, 2009, we received notice from Draxis Specialty Pharmaceuticals Inc., or Draxis, our contract manufacturer of TIMERx material, that as a result of Draxis' decision to cease manufacturing of solid dosage form products in the facility in which TIMERx is currently manufactured, it will not renew its manufacturing agreement with us upon the expiration of the current term in November 2009. As a result, we intend to increase our current inventory levels of TIMERx material and are working with Endo on the qualification of another manufacturer. Draxis has agreed to honor outstanding purchase orders we have with them for our present requirements of TIMERx material. We expect that these purchase orders will be fulfilled by approximately the end of the first quarter of 2010 and will provide us with a sufficient amount of TIMERx material to satisfy our current forecasted requirements until we have completed the qualification of another manufacturer.
On June 8, 2009, Endo and Valeant signed an exclusive license, the Valeant Agreement, granting Valeant the right to develop and commercialize Opana ER in Canada, Australia and New Zealand. Under the terms of the Valeant Agreement, Valeant paid Endo an upfront fee of C$2 million, and agreed to make payments totaling up to C$1.0 million when certain sales milestones are achieved in Canada and AUS$1.1 million when certain regulatory and sales milestones are achieved in Australia. In addition, Valeant has agreed to pay tiered royalties ranging from 10% to 20% of annual net sales of Opana ER in each of the three countries, subject to royalty reductions upon patent expiry or generic entry. The Valeant Agreement also includes rights to Opana®, the immediate release formulation of oxymorphone developed by Endo. In connection with the Valeant Agreement, we signed a supply agreement with Valeant, agreeing to supply bulk TIMERx material to Valeant for its use in manufacturing Opana ER under the Valeant Agreement. The selling price to Valeant will approximate Penwest's costs, as defined in the agreement, and may be adjusted annually.
In connection with the Valeant Agreement and our supply agreement with Valeant, on June 8, 2009, Endo and we signed a consent agreement consenting to these arrangements and confirming the share of the payments to be made by Valeant that would be due to us. In July 2009, we received payment from Endo in the amount of $764,000 for our share of the upfront payment received by Endo under the Valeant Agreement, which amount we recorded as deferred revenue. We began to recognize revenue from this upfront payment in the three month period ended September 30, 2009, and expect to recognize revenue on the remainder of this payment ratably over the remaining estimated marketing period. Endo and we will share equally in the royalties and sales milestones received from Valeant for Opana ER under the terms of the Valeant Agreement.
Opana ER is not approved for marketing outside the United States. Endo and we continue to seek additional collaborations to develop and commercialize Opana ER in territories outside the United States. Under the terms of our agreement with Endo, any fees, royalties, payments or other revenues received by the parties in connection with any collaborator outside the United States will be divided equally between Endo and us. A description of our agreement with Endo is included under the caption "Collaborative and Licensing Agreements" in "Part I. Item 1- Notes to Condensed Financial Statements." IMPAX Laboratories, Inc., or IMPAX, Actavis South Atlantic LLC, or Actavis, Sandoz, Inc., or Sandoz, and Barr Laboratories, Inc., or Barr, have each filed abbreviated new drug applications, or ANDA's, that, together with their respective amendments, cover all seven strengths of Opana ER. These ANDA filings each contained paragraph IV certifications under 21 U.S.C. Section 355(j). Endo and we have filed patent infringement lawsuits against each of IMPAX, Actavis, Sandoz and Barr in connection with their respective ANDA's.

We intend to pursue all available legal and regulatory avenues to defend Opana ER. We believe that we are entitled to a 30-month stay under the Hatch Waxman Act against IMPAX's ANDA, Actavis' ANDA, Sandoz's ANDA and Barr's ANDA. IMPAX has announced that it is seeking to reinstate an earlier filing date of its ANDA covering Opana ER 5mg, 10 mg, 20 mg and 40 mg. If this occurs, or if Endo and we are unsuccessful in these legal proceedings, Opana ER could be subject to generic competition earlier than the end of the 30-month stay.
On February 20, 2009, Endo and we settled all of the Actavis litigation. Both sides agreed to dismiss their respective claims and counterclaims with prejudice. Under the terms of the settlement, Actavis agreed not to challenge the validity or enforceability of our four Orange Book-listed patents. Endo and we agreed to grant Actavis a license under US Patent No. 5,958,456 and a covenant not to sue for Actavis's generic formulation of Opana ER under our four Orange Book-listed patents. The license and covenant not to sue will take effect on July 15, 2011, or earlier under certain circumstances.
The settlement is subject to the review of the U.S. Federal Trade Commission and Department of Justice.
A description of the legal proceedings related to Opana ER and the settlement with Actavis are included in "Part II. Item 1 - Legal Proceedings." A0001. A0001, or alpha tocopherol quinone, is a coenzyme Q analog that we are developing under our collaboration and licensing agreement with Edison. Coenzyme Q is a molecule intrinsic to mitochondria and its production of energy in the body. We are developing A0001 for the treatment of inherited mitochondrial respiratory chain diseases. We believe that impairment of mitochondrial function is a significant factor in a number of inherited mitochondrial respiratory chain diseases. As such, we believe that enhancing mitochondrial function may provide substantial clinical benefit to patients suffering from mitochondrial respiratory chain disease. A0001 has shown strong biological activity in cell assays developed by Edison to test the ability of compounds to rescue cells from death caused by inherited mitochondrial diseases.
In May 2008, we submitted an Investigational New Drug application, or IND, for A0001 for the treatment of symptoms associated with inherited mitochondrial respiratory chain diseases. In July 2008, we initiated a Phase Ia placebo-controlled, single ascending dose trial designed to evaluate the safety and tolerability of A0001 in healthy subjects, and to collect pharmacokinetic data. A0001 was well tolerated by all subjects across all dose groups and there were no drug-related serious adverse events. In June 2009, we completed a Phase Ib multiple ascending dose safety study of A0001 in healthy subjects. In the Phase Ib trial, the drug was well tolerated by subjects and no serious adverse events were reported. In addition, we observed a dose-dependent increase in exposure following repeat dosing and were able to establish a maximum tolerated dose. Based on these results, we plan to advance A0001 into Phase IIa studies in patients with mitochondrial diseases in the fourth quarter of 2009. We intend to commence two Phase IIa trials - one trial focused on patients with Friedreich's Ataxia and another trial focused on patients with the A3243G mitochondrial DNA point mutation associated with MELAS syndrome. The goal of these trials will be to determine if A0001 has biological activity. We expect data from both of these trials by the third quarter of 2010. In parallel with the Phase Ib trial, we also conducted long-term animal toxicology studies to support longer dosing in the clinical program, which we expect to complete by the end of the fourth quarter of 2009.
Under the terms of the Edison Agreement, we have exclusive, worldwide rights to develop and commercialize A0001 and one additional compound of Edison's, which we selected in September 2009, for all indications, subject to the terms and conditions in the Edison Agreement. Upon our selection of this additional compound, we became obligated to make a milestone payment to Edison, which we recorded as R&D expense in the third quarter of 2009 and paid to Edison in October 2009.
On May 5, 2009, we and Edison entered into an agreement under which Edison agreed that we could offset $550,000, and following that, the loan amount of $1.0 million plus accrued interest, against 50% of any future milestone and royalty payments, which may be due to Edison under the terms of the Edison Agreement. The loan amount is otherwise due and payable by Edison according to the original loan terms under the loan agreement. In addition, the agreement provides that we have no further contractual payment obligations in connection with the research period. Following the milestone payment we made to Edison in the fourth quarter of 2009, as noted above, $300,000 remains of the $550,000 offset provided for under the May 5, 2009 agreement.

A description of the Edison Agreement is included under the caption "Collaborative and Licensing Agreements" in "Part I. Item 1. - Notes to Condensed Financial Statements."
Nifedipine XL. Under a collaboration agreement with Mylan Pharmaceuticals Inc., or Mylan, we developed Nifedipine XL, a generic version of Procardia XL based on our TIMERx technology, which was approved by the FDA in December 1999. In March 2000, Mylan signed a supply and distribution agreement with Pfizer Inc., or Pfizer, to market Pfizer's generic versions of all three strengths (30 mg, 60 mg, and 90 mg) of Procardia XL. In connection with that agreement, Mylan decided not to market Nifedipine XL, and as a result, Mylan entered into a letter agreement with us and agreed to pay us a royalty on all future net sales of the 30 mg strength of Pfizer's generic Procardia XL. The term of the letter agreement continues until such time that Mylan permanently ceases to market Pfizer's generic version of Procardia XL 30 mg. In October 2009, Mylan notified us that Mylan had informed Pfizer of Mylan's intent not to extend its supply and distribution agreement with Pfizer, which expires in March 2010. As a result, we do not expect to receive royalties from Mylan on sales of Pfizer's generic version of Procardia XL 30 mg after the first half of 2010.
Net Loss and Profitability
We have incurred net losses since 1994 including net losses of $26.7 million, $34.5 million and $31.3 million during 2008, 2007 and 2006, respectively. For the nine month period ended September 30, 2009, our net loss was $2.7 million. As of September 30, 2009, our accumulated deficit was approximately $236 million. We currently generate revenues primarily from royalties received from Endo on Endo's net sales of Opana ER and from Mylan on Mylan's net sales of Pfizer's generic version of Procardia XL 30 mg, revenues from our drug delivery technology collaborations and, to a lesser extent, from bulk sales of TIMERx material to Endo for use in Opana ER. For the third quarter of 2009, we reported net income of $383,000, our first quarterly net profit from continuing operations. We anticipate that, based upon our current operating plan, which includes expected royalties from third parties, we will achieve profitability in the fourth quarter of 2009 and annual profitability in 2010. If we do not receive royalties from Endo for Opana ER in such amounts as forecasted and provided to us by Endo, or if we are unable to maintain our current operating expense level, which was reduced, compared with our 2008 level, we may not be able to achieve profitability in the fourth quarter of 2009 or in the full year of 2010. However, even if we are profitable in the fourth quarter of 2009 or the full year 2010, we may not be able to sustain profitability on a quarterly or annual basis. Our future profitability will depend on numerous factors, including:
• the commercial success of Opana ER, and the amount of royalties from Endo's sales of Opana ER, which may be adversely affected by any potential generic competition;

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

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

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

• the level of our general and administrative expenses;

• the successful development and commercialization of product candidates in our portfolio and products being developed for collaborations; and

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

Our results of operations may fluctuate from quarter to quarter depending on the amount and timing of royalties on Endo's sales of Opana ER, Mylan's sales of Pfizer's generic version of Procardia XL 30 mg, the volume and timing of shipments of formulated bulk TIMERx material, including to Endo, the variations in payments under our collaborative agreements, and the amount and timing of our investment in research and development activities.

Critical Accounting Policies and Estimates The discussion and analysis of our financial condition and results of operations are based upon our condensed financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. We base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances. We regard an accounting estimate underlying our financial statements as a "critical accounting estimate" if the nature of the estimate or assumption is material due to the level of subjectivity and judgment involved, or the susceptibility of such matter to change, and if the impact of the estimate or assumption on our financial condition or performance may be material. We evaluate these estimates and judgments on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions. Areas where significant judgments are made include, but are not limited to: revenue recognition, research and development expenses, deferred taxes-valuation allowance, impairment of long-lived assets and share-based compensation. For a more detailed explanation of the judgments we make in these areas, refer to Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2008.
Recent Accounting Pronouncements
A detailed description of recent accounting pronouncements is included under the caption "Recent Accounting Pronouncements" in "Part I. Item 1. - Notes to Condensed Financial Statements."
Results of Operations for the Three and Nine month periods ended September 30,

2009 and 2008
Revenues

                                     Three months                                  Three months              Nine months                                 Nine months
                                        ended               Percentage                ended                     ended               Percentage              ended
                                    September 30,            increase             September 30,             September 30,            increase           September 30,
                                         2009               (decrease)                 2008                      2009               (decrease)               2008
                                                                                    (In thousands, except percentages)
Royalties                           $        5,286                  409 %       $            1,039          $       14,859                  644 %       $        1,998
Product sales                                  134                  158                         52                     472                  (19 )                  581
Collaborative licensing and
development revenue                            874                  224                        270                   1,492                   78                    837

Total revenues                      $        6,294                  362 %       $            1,361          $       16,823                  392 %       $        3,416

Our royalties increased in the three and nine month periods ended September 30, 2009, as compared to the three and nine month periods ended September 30, 2008, reflecting increased royalties received from Endo on its net sales of Opana ER. We began to recognize royalties from Endo on sales of Opana ER following the completion of the royalty holiday in the third quarter of 2008. For the three and nine month periods ended September 30, 2009, we recognized . . .