CORPORATE OVERVIEW

PharmEng International Inc. (the “Company”) is a publicly listed company, trading on the TSX Venture Exchange (the “TSXV”), with a ticker symbol “PII”. Headquartered in Toronto, Canada, the Company wholly-owns PharmEng USA, Inc. (“PUSA”), PharmEng China Inc., PharmEng Taiwan Inc., and PharmEng Technology Inc. (“PTI”), which in turn wholly owns Keata Pharma Inc. (“Keata”). PharmEng is engaged in two businesses: a contract pharmaceutical manufacturing business, Keata, serving primarily North American pharmaceutical customers, and a broad-based pharmaceutical consulting business, PTI, that serves the pharmaceutical, biotechnology and medical device industries in North America and internationally.

Through Keata, the Company provides contract manufacturing services in drug formulation, manufacturing scale up, and commercial production of both solid and liquid pharmaceuticals. Keata operates through two pharmaceutical manufacturing facilities - a newly constructed facility located in Sydney, Nova Scotia (46,400 sq. ft.) and a newly acquired facility located in Arnprior, just outside of Ottawa, Ontario (85,000 sq. ft.).

In these two facilities, Keata provides high quality services under current Good Manufacturing Practices (“cGMP”) in the following areas:

• Clinical supplies production and logistics management
• Formulation and process development
• Contract manufacturing of solid and liquid finished dosage pharmaceuticals, over-the-counter and nutraceutical products
• Analytical method development, validation and contract analytical laboratory services, including full stability program management
• Advanced fluid bed granulation technology

PTI is recognized as a respected consulting practice in the pharmaceutical, biotechnology and medical device sectors, and is emerging as a leader with its complete service offerings to assist clients in the rapid commercialization of new products, from strategic planning to process scale up. PTI’s consulting services include regulatory audits and compliance, project management, engineering, quality systems development and audits, GMP (Good Manufacturing Practice) audits, SOP (Standard Operating Procedures) development, process validation, calibration, medical device investigative testing (clinical trials), medical device product licenses and establishment licenses, mandatory problem reporting and certified training in the medical device, pharmaceutical and biotechnology fields. PTI is also active in delivering the Biotechnology and Pharmaceutical Technology Certificate Program in partnership with universities in Canada and abroad by providing course materials and instructors.

STRATEGY AND OUTLOOK

PharmEng’s vision is to be a leader and preferred supplier to the pharmaceutical sector, offering a fully integrated suite of high-quality consulting services and commercial manufacturing, from strategic planning and process scale up to final production.

PharmEng’s strategy is to provide strategic benefits and advantages to its clients through access to comprehensive quality products and services. This strategy includes:

• Building the contract manufacturing business through internal growth and acquisition.
• Maximizing Keata’s competitive advantage in marketing and technical transfer capability resulting from the synergy between the consulting and manufacturing arms of PharmEng, so as to minimize costs, reduce time requirements, deal with regulatory issues, and provide a one stop shopping approach to new product location or transfer to a Keata facility.
• Continuing development and expansion of an established core consulting business providing business development synergies, engineering, validation, regulatory affairs and regulatory compliance solutions in the pharmaceutical and biotechnology sectors.
• Continuing the growth in core competencies that permit the rapid commercialization of science and research: from strategic planning and formulation development to process scale-up and contract manufacturing.
• Strengthening international operations to ensure PharmEng can provide worldwide regulatory, compliance and quality assurance to our clients wishing to export their products into global markets.
• Expanding operations in Asia to improve the sourcing of Active Pharmaceutical Ingredients (API’s) at reduced costs, both for our own manufacturing operations and for non-competing third party customers, while targeting partnership/acquisition opportunities by providing a full range of services for companies in Asia wanting to access the North American and European markets.
• Continuing to provide certification training programs in collaboration with Canada’s education institutions to pharmaceutical and biotechnology professionals.

The pursuit of this vision led the Company to a major acquisition of a Pfizer manufacturing facility located in Arnprior, Ontario. This acquisition was completed December 31, 2007

OVERVIEW OF THE PHARMACEUTICAL INDUSTRY

The global pharmaceutical industry comprises global, regional and national pharmaceutical manufactures, developers, distributors, biotechnology companies, and specialty companies in drug formulation, testing, clinical trials, engineering, and compliance.

There is a trend by major pharmaceutical companies towards outsourcing of drug development, commercial manufacturing, and consulting services to meet growing demand and bring products to market quickly. In addition, the growth of biotechnology companies, generic drug companies, and nutraceutical companies, whose principal focus is on efficient product development as opposed to incurring considerable investment for non-recurring resources and manufacturing.

PharmEng management believes that growth in pharmaceutical industry outsourcing will continue to :

• grow and will be driven by the following factors;
• Growth in the pharmaceutical industry due to the aging population;
• Global research and development are increasing;
• The number of pharmaceutical companies continues to expand;
• Consolidation in the sector, as companies focus on cost competitiveness;
• Competition from non traditional and low cost markets such as India and China
• Increasing regulatory compliance requirements to get products to market.

COMPETITORS

Pharmaceutical Consulting and Development

The pharmaceutical consulting and development market is composed of a number of small competitors who specialize in one or a few areas of the technical areas where PharmEng operates. With respect to drug development, there are small laboratories in most major centers that provide limited development services on a small scale. On the other hand there are competitors with much larger operations and geographic coverage. In most cases these larger competitors are not focused solely on the pharmaceutical sectors, and the pharmaceutical business only comprises a fraction of their overall consulting business. There are a few integrated companies that can provide the full complement of consulting services to develop and manufacture a wide range of pharmaceutical products.

Contract Manufacturing

The contract manufacturing organization (“CMO”) industry is fragmented, highly competitive with numerous private and public firms. Players range from small specialty companies to large diversified pharmaceutical manufacturers. CMO companies not only compete against one another, but also against major pharmaceutical companies, which have in-house manufacturing capabilities and seek to sell excess capacity on a contract basis.

Intellectual Properties Valuation

The Company has capitalized intellectual properties related to the development, formulation, and clinical and stability testing, for certain company owned pharmaceutical products referred to as drug identification numbers (DIN’s). The Company has received Health Canada approval for the manufacture and distribution of these products. These assets are considered to have indefinite lives and the Company tests these assets for impairment at least annually, to determine whether the carrying value exceeds its fair value. If it is determined that impairment exists, such impairment is recognized in net income at the time.

THIRD QUARTER OPERATIONAL AND FINANCIAL HIGHLIGHTS

• During the quarter ended September 30, 2008 the Company’s operational use of cash reduced significantly to $1.0 million showing substantial improvement over the previous two quarters burn of $5.9 million. For the nine month period ended September 30, 2008 the Company used $6.9 million in cash from operations. Management believes this improvement is a positive indication that its restructuring efforts implemented in the second quarter of 2008 are beginning to show results.
• For the quarter ended September 30, 2008, the Company had consolidated revenues of $8.3 million representing a 168% increase compared to consolidated revenues in third quarter of 2007 of $3.1 million. For the nine month period ended September 30, 2008 revenues were $26.9 million as compared to $9.1 million for the period ended September 30, 2007 representing an almost 200% year over year increase in turnover. This significant increase in revenues was due to the acquisition of the Arnprior plant from Pfizer Canada which closed on December 31, 2007. The acquisition has impacted the size of the Company dramatically in the areas of: mix of revenue sources, number of employees and customer base expansion of multinational pharmaceutical companies.
• Contract manufacturing revenues for the quarter ended September 30, 2008 were $5.8 million, an increase of $5.5 million over the same period last year. Contract manufacturing revenues for the nine month period ended September 30, 2008 were $20.4 million and reflect a $18.9 million increase over revenues for the nine month period ended September 30, 2007 of $1.5 million. The December 2007 acquisition of the Company’s new Arnprior facility accounts for this significant increase in year over year CMO revenues.
• The consulting division, PTI, provided $2.5 million during the quarter ended September 30, 2008, down $0.3 million or 11% from the same period last year. Consulting revenues for the nine month period ended September 30, 2008 were $6.5 million, reflecting a 16% reduction over revenues for the nine month period ended September 30, 2007 of $7.7 million. The decrease in revenues was primarily due to slow growth in both Canada and the US markets.
• Of the Company’s total consolidated revenue more than 76% is now generated from the pharmaceutical manufacturing division, Keata, compared to historic rates of 15%. The dominance of manufacturing revenues over consulting is expected to continue in the long term with senior management making the necessary adjustments in administration and supporting infrastructure.
• In the third quarter of 2008 the Company recorded a non-cash impairment provision against its manufacturing facility in Sydney of $4.2 million. The December 2007 acquisition of the Company’s Arnprior manufacturing facility has added significant additional capacity to the Company’s contract manufacturing operations. This non-cash charge is intended to reflect the impact of reduced facility utilization given that new manufacturing volumes will now be allocated between two facilities as compared to an original strategy that only entailed one facility in Sydney.
  • EBITDA (earnings before interest, taxes, depreciation and amortization) for the third quarter ending September 30, 2008 was a loss $8.2 million. For the nine month period ended September 30, 2008
  • EBITDA was a loss of $9.2 million. During the quarter the Company recorded a non-cash impairment provision against the Company’s Sydney manufacturing facility in the amount of $4.2 million. EBITDA before this provision for the three and nine month periods ending September 30, 2008 EBITDA was a loss of $4.0 million and $5.0 million respectively as compared to a loss of $0.1 million and $1.6 million for the comparable periods ended September 30, 2007. This increased loss reflects: 1) the impact of continued start-up costs as well as low manufacturing volumes at the Company’s newly commissioned Sydney facility; 2) increased provisions for bad debts and obsolete inventory at the Company’s Sydney facility; and 3) higher Administrative costs arising from below capacity volumes in both the Company’s consulting and manufacturing businesses.
• Given the continued risks associated with a need for financing as well as the need to demonstrate a consistent track record of profitability, the Company has taken a non-cash valuation reserve against previously recognized deferred tax assets in the quarter ended September 30, 2008 of $4.6 million. These assets continue to be available to the Company against future profits and will be recognized as reductions to tax liabilities and expense in future periods when profits are generated.
• The net loss for the quarter was $13.8 million ($0.18 per share) compared to a loss of $0.3 million ($0.00) for the third quarter of 2007. The consolidated loss for the nine month period ended September 30, 2008 was $15.6 million ($0.20 per share) as compared to a loss of $1.9 million ($0.03 per share) for the comparable period in 2007. Included in the 2008 losses are the impacts of the non-cash provisions for asset impairments related to the Company’s Sydney manufacturing facility ($4.2 million) and deferred tax assets ($4.6 million). Excluding these non-cash provisions the net loss for the quarter was $5.0 million for the three months ended September 30, 2008 and $6.8 million for the nine months ended September 30, 2008.

Balance Sheet

At September 30, 2008 the Company’s had drawn $8.9 million against its operating line of $10 million as compared to $4.3 million at December 31, 2007. This increase is directly associated with the financing of the Company’s Arnprior manufacturing facility that closed in December 2007, the continued gearing up for commercial production of the Company’s new Sydney manufacturing facility and the continued growth in working capital requirements as a result of overall expansion.

Accounts receivable increased during the year by $3.2 million to $5.6 million at September 30, 2008, compared to $2.4 million at December 31, 2007. This increase is a direct result of increased sales activity derived from the acquisition of Arnprior facility in December 2007.

Inventory of $4.9 million at September 30, 2008 is in line with balances at December 31, 2007. The Arnprior facility acquisition in December 2007 included the purchase of $3.9 million of inventory therefore not resulting in an incremental working capital need in 2008.

Property, plant and equipment of $8.4 million represented a decrease of $3.4 million as compared to $11.8 million at December 31, 2007. In the third quarter of 2008 the Company recorded a non-cash impairment provision against its manufacturing facility in Sydney of $4.2 million. The December 2007 acquisition of the Company’s Arnprior manufacturing facility has added significant additional capacity to the Company’s contract manufacturing operations. This non-cash charge is intended to reflect the impact of reduced facility utilization given that new manufacturing volumes will now be allocated between two facilities as compared to an original strategy that only entailed one facility in Sydney.

In the third quarter of 2008 the Company recorded a non-cash valuation reserve against previously recognized future tax attributes of $4.6 million reflecting the impact of the Company’s increased financial uncertainty on the likelihood that these assets may be realized by the Company in the future. Accordingly the Company’s deferred tax assets have been reduced to NIL as at September 30, 2008.

Accounts payable and accrued liabilities of $7.0 million at September 30, 2008 represented an increase of $1.5 million when compared to $5.5 million at December 31, 2007. This increase is directly related to new creditor obligations associated with the Arnprior facility acquisition as new inventories and creditor relationships are established that did not exist at December 31, 2007 offset by reductions in creditor obligations associated with the construction of the Sydney facility that have now been discharged.

The long-term debt amounted to $14.0 million at September 30, 2008 relatively unchanged from December 31, 2007 balance of $12.9 million.

LIQUIDITY AND CAPITAL RESOURCES

In the quarter ended September 30, 2008, cash used by operating activities amounted to $1.1 million. Financing activities provided for $0.5 million, due to additional advances from ECBC and the conversion of options. Investing activities during the quarter consisted of additions to property, plant and equipment in the amount of approximately $0.6 million.

Subsequent to the quarter the Company issued $1.0 million of convertible debentures (the “Debentures”) to a new investor (the “Investor”). Interest is payable by the Company to the Investor on the Debentures at a rate of 12% per annum (calculated on a 360-day basis) and payable monthly in arrears. The Debentures are convertible into a maximum of 4,000,000 common shares of the Company at a conversion price of $0.25 in years one and two, $0.275 in year three, $0.303 in year four, and $0.333 in year five. The Debentures are secured by a general security agreement over the certain assets of the Company in favour of the Investor. Certain consents and forbearances were entered into between the Company and its other existing secured creditors in respect of the issuance of the Debentures.

As part of the financing, the Company also issued common share purchase warrants (the “Warrants”) entitling the Investor to purchase up to 4,000,000 common shares of the Company. The Warrants are exercisable at a price of $0.25 for a period of 24 months from the closing date.

Equity and Capital

During 2007 the Company entered into a revolving credit facility (the “Revolving Credit Facility”) with Landsbanki for up to $10 million secured against eligible accounts receivable and eligible inventory. The term of the Revolving Credit Facility is three years and the rate of interest is determined by reference to the London Interbank Offered Rate (“LIBOR”) plus 3.25% per annum. At September 30, 2008 $8.9 million has been advanced against this facility.

PharmEng also entered into a term loan with Landsbanki for $5 million secured by a first charge on substantially all property, plant and equipment. The term of the loan is 3 years and the rate of interest is to be determined by reference to LIBOR plus 3.25% per annum reset quarterly. In addition, the Company entered into a senior subordinated loan with a US merchant bank for up to US$5 million. The term of this credit facility is 2 years and the rate of interest is 13% per annum. As partial consideration for the loan, the Company issued up to 2,700,000 warrants to the merchant bank. Each warrant entitles the merchant bank to purchase one common share in the capital of PharmEng exercisable for 2 years from the date of closing at an exercise price of $0.50.

At September 30, 2008 the Company is in breach of certain financial loan covenants in respect of the above credit facilities including equity coverage, EBITDA and borrowing base requirements. Presently, the lenders have provided forbearance from proceeding on this breach of covenants.

Shareholders’ equity

Common Shares Outstanding December 31 2008 : 76,530,709

Options outstanding at September 30, 2008: 4,131,500

Common share purchase warrants: 5,892,752

Fully Diluted: 86,554,961

On November 12, 2008 the Company issued a $1.0 million convertible debenture to a single investor. As part of this financing two new, experienced Board members joined the Company to assist it in its future challenges and developments.

The Company is actively negotiating term sheets from two of its existing investors for an additional financing which is expected to close before December 2008.

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