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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934
 For the quarterly period ended February 28, 2005 OR o
    
    TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934
 For the transition period from ___to ___
 Commission File No. 0-11488 PENFORD CORPORATION  Washington
    
    91-1221360(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification No.)7094 South Revere Parkway,Englewood, Colorado
    
    80112-3932(Address of Principal Executive Offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (303) 649-1900 Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ    No o Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). 
Yes þ    No o The net number of shares of the Registrants common stock (the Registrants only outstanding class
of stock) outstanding as of April 5, 2005 was 8,825,133.




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PENFORD CORPORATION AND SUBSIDIARIES INDEX  
 PagePART IFINANCIAL INFORMATIONItem 1. Financial StatementsCondensed Consolidated Balance Sheets  February 28, 2005 and August 31, 2004
    
    
    3Condensed Consolidated Statements of Operations  Three and Six Months ended February 28, 2005
and February 29, 2004
    
    
    4Condensed Consolidated Statements of Cash Flow  Six Months ended February 28, 2005 and
February 29, 2004
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    17Item 4. Controls and Procedures
    
    
    17PART IIOTHER INFORMATIONItem 1. Legal Proceedings
    
    
    18Item 4. Submission of Matters to a Vote of Security Holders
    
    
    18Item 6. Exhibits
    
    
    18Signatures
    
    
    19Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certifications of CEO & CFO Pursuant to Section 906




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PART I  FINANCIAL INFORMATION 
 Item 1: Financial Statements PENFORD CORPORATION AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 February 28,
    
    
    August 31,(In thousands, except per share data)
    
    2005
    
    
    2004(Unaudited)ASSETSCurrent assets:Cash
    
    $
    4,459
    
    
    $
    5,915Trade accounts receivable, net
    
    
    37,970
    
    
    
    38,703Inventories
    
    
    33,154
    
    
    
    31,807Prepaid expenses
    
    
    3,431
    
    
    
    4,124Other
    
    
    3,408
    
    
    
    3,031Total current assets
    
    
    82,422
    
    
    
    83,580Property, plant and equipment, net
    
    
    131,206
    
    
    
    130,392Deferred income taxes
    
    
    13,477
    
    
    
    13,462Restricted cash value of life insurance
    
    
    12,764
    
    
    
    12,623Goodwill, net
    
    
    22,568
    
    
    
    20,171Other intangible assets, net
    
    
    2,248
    
    
    
    2,299Other assets
    
    
    3,187
    
    
    
    3,269Total assets
    
    $
    267,872
    
    
    $
    265,796LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    25,916
    
    
    $
    25,169Accrued pension liability
    
    
    1,842
    
    
    
    3,151Accrued liabilities
    
    
    8,949
    
    
    
    10,200Current portion of long-term debt
    
    
    5,406
    
    
    
    4,775Total current liabilities
    
    
    42,113
    
    
    
    43,295Long-term debt
    
    
    78,212
    
    
    
    75,551Other post-retirement benefits
    
    
    12,920
    
    
    
    12,598Deferred income taxes
    
    
    19,951
    
    
    
    20,809Other liabilities
    
    
    18,022
    
    
    
    17,824Total liabilities
    
    
    171,218
    
    
    
    170,077Shareholders equity:Preferred stock, par value $1.00 per share, authorized 1,000 shares,
none issued
    
    
    
    
    
    
    Common stock, par value $1.00 per share, authorized 29,000 shares,
issued 10,806 and 10,784 shares, respectively
    
    
    10,806
    
    
    
    10,784Additional paid-in capital
    
    
    37,232
    
    
    
    36,911Retained earnings
    
    
    69,709
    
    
    
    75,585Treasury stock, at cost, 1,981 shares
    
    
    (32,757
    )
    
    
    (32,757
    )Accumulated other comprehensive income
    
    
    11,664
    
    
    
    5,196Total shareholders equity
    
    
    96,654
    
    
    
    95,719Total liabilities and shareholders equity
    
    $
    267,872
    
    
    $
    265,796
 The accompanying notes are an integral part of these statements. 3




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PENFORD CORPORATION AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited) Three months ended
    
    
    Six months endedFebruary 28,
    
    
    February 29,
    
    
    February 28,
    
    
    February 29,(In thousands, except per share data)
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004Sales
    
    $
    69,219
    
    
    $
    68,482
    
    
    $
    141,284
    
    
    $
    134,652Cost of sales
    
    
    62,059
    
    
    
    58,574
    
    
    
    130,895
    
    
    
    114,932Gross margin
    
    
    7,160
    
    
    
    9,908
    
    
    
    10,389
    
    
    
    19,720Operating expenses
    
    
    5,986
    
    
    
    5,483
    
    
    
    11,794
    
    
    
    11,175Research and development expenses
    
    
    1,431
    
    
    
    1,454
    
    
    
    2,843
    
    
    
    2,956Restructure costs, net
    
    
    
    
    
    
    487
    
    
    
    
    
    
    
    740Income (loss) from operations
    
    
    (257
    )
    
    
    2,484
    
    
    
    (4,248
    )
    
    
    4,849Non-operating income, net
    
    
    370
    
    
    
    530
    
    
    
    452
    
    
    
    505Interest expense
    
    
    1,358
    
    
    
    1,185
    
    
    
    2,620
    
    
    
    2,292Income (loss) before income taxes
    
    
    (1,245
    )
    
    
    1,829
    
    
    
    (6,416
    )
    
    
    3,062Income tax expense (benefit)
    
    
    (253
    )
    
    
    794
    
    
    
    (1,598
    )
    
    
    1,182Net income (loss)
    
    $
    (992
    )
    
    $
    1,035
    
    
    $
    (4,818
    )
    
    $
    1,880Weighted average common shares and
equivalents outstanding:Basic
    
    
    8,825
    
    
    
    8,731
    
    
    
    8,821
    
    
    
    8,684Diluted
    
    
    8,825
    
    
    
    8,831
    
    
    
    8,821
    
    
    
    8,780Earnings (loss) per share:Basic
    
    $
    (0.11
    )
    
    $
    0.12
    
    
    $
    (0.55
    )
    
    $
    0.22Diluted
    
    $
    (0.11
    )
    
    $
    0.12
    
    
    $
    (0.55
    )
    
    $
    0.21Dividends declared per common share
    
    $
    0.06
    
    
    $
    0.06
    
    
    $
    0.12
    
    
    $
    0.12
 The accompanying notes are an integral part of these statements. 4




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PENFORD CORPORATION AND SUBSIDIARIES 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
 (Unaudited) Six Months EndedFebruary 28,
    
    
    February 29,(In thousands)
    
    2005
    
    
    2004Cash flows from operating activities:Net income (loss)
    
    $
    (4,818
    )
    
    $
    1,880Adjustments to reconcile net income (loss) to net cash provided by
operations:Depreciation and amortization
    
    
    8,632
    
    
    
    8,927Deferred income taxes
    
    
    (1,048
    )
    
    
    (222
    )Loss on early extinguishment of debt
    
    
    
    
    
    
    665Other
    
    
    84
    
    
    
    1,001Change in assets and liabilities:Trade accounts receivable
    
    
    2,244
    
    
    
    (257
    )Prepaid expenses
    
    
    765
    
    
    
    620Inventories
    
    
    736
    
    
    
    2,685Accounts payable and accrued liabilities
    
    
    (2,051
    )
    
    
    (6,846
    )Taxes payable
    
    
    (1,133
    )
    
    
    (1,046
    )Other
    
    
    (171
    )
    
    
    1,429Net cash provided by operating activities
    
    
    3,240
    
    
    
    8,836Cash flows from investing activities:Investment in property, plant and equipment, net
    
    
    (4,309
    )
    
    
    (4,735
    )Other
    
    
    (113
    )
    
    
    (159
    )Net cash used in investing activities
    
    
    (4,422
    )
    
    
    (4,894
    )Cash flows from financing activities:Proceeds from revolving line of credit
    
    
    3,000
    
    
    
    35,975Payments on revolving line of credit
    
    
    
    
    
    
    (63,579
    )Proceeds from long-term debt
    
    
    
    
    
    
    50,039Payments of long-term debt
    
    
    (2,291
    )
    
    
    (24,134
    )Exercise of stock options
    
    
    215
    
    
    
    1,685Payment of loan fees
    
    
    (146
    )
    
    
    (1,571
    )Payment of dividends
    
    
    (1,058
    )
    
    
    (1,038
    )Net cash used in financing activities
    
    
    (280
    )
    
    
    (2,623
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    6
    
    
    
    (538
    )Net increase (decrease) in cash and cash equivalents
    
    
    (1,456
    )
    
    
    781Cash and cash equivalents, beginning of period
    
    
    5,915
    
    
    
    5,697Cash and cash equivalents, end of period
    
    $
    4,459
    
    
    $
    6,478
 The accompanying notes are an integral part of these statements. 5




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PENFORD CORPORATION AND SUBSIDIARIES 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 1BUSINESS Penford Corporation (Penford or the Company) is in the business of developing,
manufacturing and marketing specialty natural-based ingredient systems for various applications,
including papermaking, textiles and food products. The Company operates manufacturing facilities
in the United States, Australia, and New Zealand. Penfords products provide excellent binding and
film-forming characteristics that make customers products better through natural, convenient and
cost effective solutions. Sales of the Companys products are generated using a combination of
direct sales and distributor agreements. The Company has extensive research and development capabilities, which are used in
understanding the complex chemistry of carbohydrate-based materials and their application. In
addition, the Company has specialty processing capabilities for a variety of modified starches. 2BASIS OF PRESENTATION Consolidation The accompanying condensed consolidated financial statements include the accounts of Penford
and its wholly owned subsidiaries. All material intercompany transactions and balances have been
eliminated. The condensed consolidated balance sheet at February 28, 2005 and the condensed
consolidated statements of operations and cash flows for the interim periods ended February 28,
2005 and February 29, 2004 have been prepared by the Company without audit. In the opinion of
management, all adjustments, consisting only of normal recurring adjustments, that are necessary to
present fairly the financial information have been made. Certain information and footnote
disclosures normally included in financial statements prepared in accordance with generally
accepted accounting principles, have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC). The results of operations for
interim periods are not necessarily indicative of the operating results of a full year or of future
operations. The accompanying condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements included in the Companys Annual Report on
Form 10-K for the year ended August 31, 2004. Recent Accounting Pronouncements In November 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 151,
Inventory Costsan Amendment of ARB No. 43, Chapter 4 (SFAS No. 151). SFAS No. 151, which is
effective for inventory costs incurred during years beginning after June 15, 2005, clarifies the
accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted
material, requiring that those items be recognized as current-period charges. In addition, SFAS
No. 151 requires that allocation of fixed production overheads be based on the normal capacity of
the production facilities. The adoption of SFAS No. 151 beginning September 1, 2005 is not
expected to have a material effect on the Companys results of operation, financial position or
liquidity. In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment
(SFAS No. 123R). SFAS No. 123R, which is effective for the first interim or annual period
beginning after June 15, 2005, requires all share-based payments to employees, including grants of
stock options, to be recognized in the financial statements based on their fair values. In
addition, two transition alternatives are permitted at the time of adoption
of this statement, restating prior year financial statements or recognizing adjustments to
share-based liabilities as the cumulative effect of a change in accounting principle. The adoption
of SFAS No. 123R will increase the Companys compensation costs and share-based liabilities. The
Company is studying the requirements of this standard and, at this time, cannot reasonably estimate
the impact of SFAS No. 123R on its financial statements. 6




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Stock-based Compensation The Company accounts for its stock-based employee compensation related to stock options under
the intrinsic value recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees and its various interpretations. Accordingly, no compensation expense
has been recognized for the stock-based compensation plans other than for the Directors Plan and
restricted stock awards. The following table illustrates the effect on net income and earnings per share if the Company
had elected to recognize compensation expense consistent with the provisions prescribed in FASB
Statement No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), as amended. Under
SFAS No. 123, compensation expense is measured at the grant date based on the value of the award
and is recognized over the vesting period. Three months ended
    
    
    Six months endedFebruary
    
    
    February
    
    
    February
    
    
    February(In thousands, except per share data)
    
    28, 2005
    
    
    29, 2004
    
    
    28, 2005
    
    
    29, 2004Net income (loss), as reported
    
    $
    (992
    )
    
    $
    1,035
    
    
    $
    (4,818
    )
    
    $
    1,880Add: Stock-based employee compensation expense
included in reported net income, net of tax
    
    
    25
    
    
    
    19
    
    
    
    42
    
    
    
    37Less: Stock-based employee compensation expense
determined under the fair value method for all
awards, net of tax
    
    
    (332
    )
    
    
    (338
    )
    
    
    (607
    )
    
    
    (691
    )Pro forma net income (loss)
    
    $
    (1,299
    )
    
    $
    716
    
    
    $
    (5,383
    )
    
    $
    1,226Earnings (loss) per share:Reported basic earnings (loss) per common share
    
    $
    (0.11
    )
    
    $
    0.12
    
    
    $
    (0.55
    )
    
    $
    0.22Reported diluted earnings (loss) per common share
    
    $
    (0.11
    )
    
    $
    0.12
    
    
    $
    (0.55
    )
    
    $
    0.21Pro forma basic earnings (loss) per common share
    
    $
    (0.15
    )
    
    $
    0.08
    
    
    $
    (0.61
    )
    
    $
    0.14Pro forma diluted earnings (loss) per common share
    
    $
    (0.15
    )
    
    $
    0.08
    
    
    $
    (0.61
    )
    
    $
    0.14
 3INVENTORIES The components of inventory are as follows: February 28,
    
    
    August 31,2005
    
    
    2004(In thousands)Raw materials and other
    
    $
    12,852
    
    
    $
    13,996Work in progress
    
    
    781
    
    
    
    687Finished goods
    
    
    19,521
    
    
    
    17,124Total inventories
    
    $
    33,154
    
    
    $
    31,807
 7




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4PROPERTY, PLANT AND EQUIPMENT February 28,
    
    
    August 31,2005
    
    
    2004(In thousands)Land
    
    $
    17,116
    
    
    $
    15,952Plant and equipment
    
    
    299,983
    
    
    
    293,721Construction in progress
    
    
    14,014
    
    
    
    10,526331,113
    
    
    
    320,199Accumulated depreciation
    
    
    (199,907
    )
    
    
    (189,807
    )Net property, plant and equipment
    
    $
    131,206
    
    
    $
    130,392
 Changes in Australian and New Zealand currency exchange rates have increased net property,
plant and equipment in the first six months of fiscal 2005 by approximately $4.9 million. 5DEBT At February 28, 2005, the Company had $37.5 million outstanding under its revolving credit
facilities and $46.1 million in term loans. Effective November 2004, Penford obtained an amendment
to the funded debt ratio covenant, a ratio of earnings before interest, depreciation and taxes, as
defined, to total debt, in its credit facility agreement. The Companys lenders agreed to exclude
$8.4 million, a majority of the nonrecurring strike-related costs, from the calculation of the
funded debt ratio. The agreement was also amended to increase the funded debt ratio threshold to
3.5 for the first half of fiscal 2005, to 3.25 for the third quarter of fiscal 2005, and to 3.0
thereafter. The maximum capital expenditure level was reduced from $20 million to $15 million for
fiscal 2005. Pursuant to the terms of the credit agreement, Penfords borrowing ability was $8.1
million at February 28, 2005. The Company was in compliance as of February 28, 2005 and expects to
be in compliance with these revised covenants for the remainder of fiscal 2005. 6TAXES The Companys effective tax rate for the three and six months ended February 28, 2005 and the
three and six months ended February 29, 2004 varied from the U.S. federal statutory rate primarily
due to U.S. tax credits related to research and development and the favorable tax effect of export
sales from the U.S. The second quarter 2005 tax benefit recorded included an adjustment increasing
the tax benefit in Australia by $0.1 million after reconciling the fiscal 2004 tax return filed to
the tax provision recorded in fiscal 2004. 7OTHER COMPREHENSIVE INCOME The components of total comprehensive income (loss) are as follows: Three months ended
    
    
    Six months endedFebruary
    
    
    February
    
    
    February
    
    
    February28, 2005
    
    

29, 2004
    
    
    28, 2005
    
    

29, 2004(In thousands)Net income (loss)
    
    $
    (992
    )
    
    $
    1,035
    
    
    $
    (4,818
    )
    
    $
    1,880Foreign currency translation adjustments
    
    
    751
    
    
    
    2,839
    
    
    
    6,452
    
    
    
    8,405Change in unrealized gains on derivative
instruments that qualify as cash flow
hedges
    
    
    73
    
    
    
    718
    
    
    
    16
    
    
    
    742Total comprehensive income (loss)
    
    $
    (168
    )
    
    $
    4,592
    
    
    $
    1,650
    
    
    $
    11,027
 8




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8NON-OPERATING INCOME, NET Non-operating income, net consists of the following: Three months ended
    
    
    Six months endedFebruary
    
    
    February
    
    
    February
    
    
    February28, 2005
    
    
    28, 2005
    
    
    28, 2005
    
    
    29, 2004(In thousands)Loss on early extinguishment of debt
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (665
    )Gain on sale of investment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    150Royalty and licensing income
    
    
    440
    
    
    
    396
    
    
    
    527
    
    
    
    763Other
    
    
    (70
    )
    
    
    134
    
    
    
    (75
    )
    
    
    257Total
    
    $
    370
    
    
    $
    530
    
    
    $
    452
    
    
    $
    505
 In October 2003, Penford refinanced its existing secured credit and inventory financing credit
agreements and wrote off the unamortized deferred transaction costs related to these credit
agreements. In November 2002, the Company licensed the rights to its resistant starch intellectual
property portfolio for applications in human nutrition. The initial licensing fee of $2.25 million
received in November 2002 is being amortized over the life of the licensing agreement. In
addition, the Company receives royalty income as a percentage of its licensees sales of resistant
starch for a period of seven years or until a maximum of $11 million in royalties has been received
by Penford. The royalty payments are subject to a minimum of $7 million over the first five years
of the licensing agreement. 9  PENSION AND POST-RETIREMENT BENEFIT PLANS The following represents the net periodic pension and post-retirement benefit costs and
related components in accordance with SFAS No. 132(R) for the three and six months ended February
28, 2005 and February 29, 2004. Defined benefit pension plans
    
    Three months ended
    
    
    Six months endedFebruary 28,
    
    
    February 29,
    
    
    February 28,
    
    
    February 29,2005
    
    
    2004
    
    
    2005
    
    
    2004(In thousands)Service cost
    
    $
    283
    
    
    $
    229
    
    
    $
    533
    
    
    $
    458Interest cost
    
    
    533
    
    
    
    473
    
    
    
    1,032
    
    
    
    945Expected return on plan assets
    
    
    (467
    )
    
    
    (434
    )
    
    
    (934
    )
    
    
    (868
    )Amortization of transition
obligation
    
    
    
    
    
    
    30
    
    
    
    
    
    
    
    60Amortization of prior service cost
    
    
    67
    
    
    
    27
    
    
    
    97
    
    
    
    55Amortization of actuarial losses
    
    
    118
    
    
    
    109
    
    
    
    240
    
    
    
    218Net periodic benefit cost
    
    $
    534
    
    
    $
    434
    
    
    $
    968
    
    
    $
    868
 Post-retirement health care plans
    
    Three months ended
    
    
    Six months endedFebruary 28,
    
    
    February 29,
    
    
    February 28,
    
    
    February 29,2005
    
    
    2004
    
    
    2005
    
    
    2004(In thousands)Service cost
    
    $
    28
    
    
    $
    126
    
    
    $
    176
    
    
    $
    252Interest cost
    
    
    138
    
    
    
    213
    
    
    
    388
    
    
    
    426Amortization of prior service cost
    
    
    (76
    )
    
    
    
    
    
    
    (76
    )
    
    
    Amortization of actuarial losses
    
    
    4
    
    
    
    15
    
    
    
    19
    
    
    
    30Net periodic benefit cost
    
    $
    94
    
    
    $
    354
    
    
    $
    507
    
    
    $
    708
 The net post-retirement benefit costs for the second quarter and first half of fiscal 2005
declined compared to the same periods last year due to plan changes retroactive to September 1,
2004 pursuant to a new union contract at the Companys Iowa manufacturing facility. 9




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10SEGMENT REPORTING Financial information for the Companys three segments is presented below. The first two
segments, Industrial IngredientsNorth America and Food IngredientsNorth America, are broad
categories of end-market users, primarily served by the Companys U.S. operations. The third
segment is the Companys geographically separate operations in Australia and New Zealand, which are
engaged primarily in the food ingredients business. A fourth item for corporate and other
activity is presented to provide reconciliation to amounts reported in the condensed consolidated
financial statements. Corporate and other represents the activities related to the corporate
headquarters such as public company reporting, personnel costs of the executive management team,
corporate-wide professional services and elimination and consolidation entries. The elimination of
intercompany sales between Australia/New Zealand operations and Food IngredientsNorth America of
$172,000 and $718,000 for the three and six month periods ended February 28, 2005, respectively,
and $74,000 and $267,000 in the three and six month periods ended February 29, 2004, respectively,
is presented separately since the chief operating decision maker views segment results prior to
intercompany eliminations. Three months ended
    
    
    Six months endedFebruary 28,
    
    
    February
    
    
    February
    
    
    February2005
    
    
    29, 2004
    
    
    28, 2005
    
    
    29, 2004(In thousands)Sales:Industrial IngredientsNorth America
    
    $
    35,634
    
    
    $
    35,801
    
    
    $
    70,769
    
    
    $
    68,327Food IngredientsNorth America
    
    
    11,852
    
    
    
    10,973
    
    
    
    24,124
    
    
    
    22,866Australia/New Zealand operations
    
    
    21,905
    
    
    
    21,782
    
    
    
    47,109
    
    
    
    43,726Intercompany sales
    
    
    (172
    )
    
    
    (74
    )
    
    
    (718
    )
    
    
    (267
    )$
    69,219
    
    
    $
    68,482
    
    
    $
    141,284
    
    
    $
    134,652Income (loss) from operations:Industrial IngredientsNorth America (1)
    
    $
    604
    
    
    $
    1,567
    
    
    $
    (3,786
    )
    
    $
    3,115Food IngredientsNorth America
    
    
    1,103
    
    
    
    719
    
    
    
    2,495
    
    
    
    2,618Australia/New Zealand operations (2)
    
    
    (327
    )
    
    
    1,537
    
    
    
    248
    
    
    
    1,808Corporate and other
    
    
    (1,637
    )
    
    
    (1,339
    )
    
    
    (3,205
    )
    
    
    (2,692
    )$
    (257
    )
    
    $
    2,484
    
    
    $
    (4,248
    )
    
    $
    4,849
   (1)
    
    Restructuring costs of $487,000 have been included in income from operations in the
three and six month periods ended February 29, 2004.(2)
    
    Restructuring costs of $253,000 have been included in income from operations in the six
months ended February 29, 2004. February 28,
    
    
    August 31,2005
    
    
    2004(In thousands)Total assets:Industrial IngredientsNorth America
    
    $
    100,038
    
    
    $
    101,620Food IngredientsNorth America
    
    
    32,345
    
    
    
    32,323Australia/New Zealand operations
    
    
    104,554
    
    
    
    99,344Corporate and other
    
    
    30,935
    
    
    
    32,509$
    267,872
    
    
    $
    265,796
 10




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##### Table of Contents



11EARNINGS (LOSS) PER SHARE Basic earnings (loss) per share reflects only the weighted average common shares outstanding
during the period. Diluted earnings (loss) per share reflects weighted average common shares
outstanding and the effect of any dilutive common stock equivalent shares.The following table
presents the computation of diluted weighted average shares outstanding for the three and six
months ended February 28, 2005 and February 29, 2004. Three months ended
    
    
    Six months endedFebruary
    
    
    February
    
    
    February
    
    
    February28, 2005
    
    
    29, 2004
    
    
    28, 2005
    
    
    29, 2004(In thousands)Weighted average common shares
outstanding
    
    
    8,825
    
    
    
    8,731
    
    
    
    8,821
    
    
    
    8,684Net effect of dilutive stock options
    
    
    
    
    
    
    100
    
    
    
    
    
    
    
    96Weighted average common shares,
outstanding, assuming dilution
    
    
    8,825
    
    
    
    8,831
    
    
    
    8,821
    
    
    
    8,780
 Diluted earnings per share is calculated by dividing net income by the average common shares
outstanding plus additional common shares that would have been outstanding assuming the exercise
of in-the-money stock options, using the treasury stock method. Weighted-average stock options
to purchase 1,134,991 and 1,081,958 common stock for the three and six months ended February 28,
2005 and 267,000 and 300,000 common stock for the three and six months ended February 29, 2004
were excluded from the calculation of diluted earnings per share because they were antidilutive. 12LITIGATION In October 2004, Penford Products Co. (Penford Products), a wholly-owned subsidiary of the
Company, was served with a lawsuit filed by Graphic Packaging International, Inc. (Graphic) in
the Fourth Judicial District, Ouachita Parish, State of Louisiana. The petition seeks monetary
damages for alleged breach of contract, negligence and tortious misrepresentation. These claims
arise out of an alleged agreement obligating Penford Products to supply goods to Graphic and
Penford Products alleged breach of such agreement together with conduct related to such alleged
breach. Penford has filed its answer generally denying all liability and has countersued for
damages. Discovery is proceeding in this case. The Company cannot determine the likelihood of the
plaintiff prevailing or an estimate of damages, if any. 11




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##### Table of Contents



Item 2: Managements Discussion and Analysis of Financial Condition and Results of
Operations Forward-looking Statements The statements contained in this Quarterly Report onForm 10-Q(Quarterly Report) that are
not historical facts, including, but not limited to statements found in the Notes to Condensed
Consolidated Financial Statements and in Item 2  Managements Discussion and Analysis of Financial
Condition and Results of Operations, are forward-looking statements that represent managements
beliefs and assumptions based on currently available information. Forward-looking statements can
be identified by the use of words such as believes, may, will, looks, should, could,
anticipates, expects, or comparable terminology or by discussions of strategies or trends. Although the Company believes that the expectations reflected in such forward-looking
statements are reasonable, it cannot give any assurances that these expectations will prove to be
correct. Such statements by their nature involve substantial risks and uncertainties that could
significantly affect expected results. Actual future results could differ materially from those
described in such forward-looking statements, and the Company disclaims any intention or obligation
to update or revise any forward-looking statements, whether as a result of new information, future
events or otherwise. Among the factors that could cause actual results to differ materially are
the risks and uncertainties discussed in this Quarterly Report, including those referenced above,
and those described from time to time in other filings with the Securities and Exchange Commission
which include, but are not limited to, competition; the possibility of interruption of business
activities due to equipment problems, accidents, strikes, weather or other factors; product
development risk; changes in corn and other raw material prices and availability; changes in
general economic conditions or developments with respect to specific industries or customers
affecting demand for the Companys products including unfavorable shifts in product mix;
unanticipated costs, including labor costs, expenses or third party claims; the risk that results
may be affected by construction delays, cost overruns, technical difficulties, nonperformance by
contractors or changes in capital improvement project requirements or specifications; interest rate
and energy cost volatility; foreign currency exchange rate fluctuations; changes in assumptions
used for determining employee benefit expense and obligations; or other unforeseen developments in
the industries in which Penford operates. Results of Operations Executive Overview Penford generates revenues, income and cash flows by developing, manufacturing and marketing
specialty natural-based ingredient systems for industrial and food applications. The Company
develops and manufactures ingredients with starch as a base which provide value-added applications
to its customers. Penfords starch products are manufactured primarily from corn, potatoes, and
wheat, and are used as binders and coatings in paper and food production. In analyzing business trends, management considers a variety of performance and financial
measures, including sales revenue growth, sales volume growth, gross margins and operating income
of the Companys business segments. Penford manages its business in three segments. The first
two, Industrial IngredientsNorth America and Food IngredientsNorth America, are broad categories
of end-market users, served by operations in the United States. The third segment is the Companys
operations in Australia and New Zealand, which operations are engaged primarily in the food
ingredients business. 12




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##### Table of Contents



Consolidated sales for the three months ended February 28, 2005 increased 1% to $69.2 million
from $68.5 million in the second quarter of fiscal 2004. Improved pricing in the North American
operations and strong foreign exchange rates were offset by declines in Australian exports and
lower volumes in the Industrial Ingredients segment. Gross margin as a percent of sales declined
to 10.3% in the second quarter of fiscal 2005 from 14.5% in the same quarter last year due to
higher energy and chemical costs and the incremental costs of reconfiguring manufacturing processes
in Australia to streamline production and change the product mix. Sales for the first half of fiscal 2005 rose 5% to $141.3 million over the first half of
fiscal 2004, reflecting favorable foreign exchange rates, which contributed 2% of the consolidated
sales growth, sales volume improvement in the Australia/New Zealand business segment, and improved
pricing and mix in North America. Operating income for the six months ended February 28, 2005 was
a loss of $4.2 million compared to income of $4.8 million for the same six-month period last year.
Gross margin as a percent of sales declined to 7.4% from 14.6% last year on $4 million of
incremental operating costs related to the Cedar Rapids strike which was settled on October 17,
2004, and the higher energy and chemical costs and Australian manufacturing issues which impacted
the second quarter of fiscal 2005. Fiscal 2005 second quarter and first half operating expenses increased by $0.5 million and
$0.6 million, respectively, primarily due to increases in professional fees associated with the
initial attestation on internal controls as required by the Sarbanes-Oxley Act of 2002. A
discussion of segment results of operations follows. Sales Sales at the Companys Industrial IngredientsNorth America business unit of $35.6 million
were comparable to sales in the second quarter of last year. Sales volumes declined 7% reflecting
a softness in sales orders related to the labor strike in this business which ended mid-first
quarter. The volume decrease was offset by improved unit pricing in core product categories and a
43% increase in sales of specialty starches. Sales of $70.8 million for the six-month period ended
February 28, 2005 increased $2.4 million, or 3.6%, over the same period last year due to improved
pricing and a 48% increase in specialty starch sales offset by a 2% volume decline. Sales of $21.9 million for the second quarter of fiscal 2005 at the Australia/New Zealand
operations rose slightly over the second quarter of fiscal 2004. Stronger foreign currency
exchange rates and a sales volume increase of 4% were offset by the impact of competitive pricing
from imported products and unfavorable product mix. Fiscal 2005 year-to-date sales of $47.1
million grew 8% over the same period last year. Stronger Australian and New Zealand exchange rates
contributed 5% of the revenue increase. The remainder of the increase is due to a 9% volume growth
offset by unfavorable product mix and continued competition from imports. Second quarter fiscal 2005 sales for the Food IngredientsNorth America business of $11.9
million rose $0.9 million, or 8%, compared to the second quarter of last year on volume increases
and favorable product mix. Volume expansion contributed 6% to the quarters sales increase, with
growth in sales of applications used in the dairy, meat and nutrition, or low carbohydrate
markets. Sales for the first six months of fiscal 2005 increased $1.3 million, or 6%, over the
prior year due to a 2% increase in sales volumes and favorable product mix. Income from operations Income from operations for the second quarter of 2005 at Penfords Industrial
IngredientsNorth America business unit declined to $0.6 million from $1.6 million for the prior
year quarter. Gross margin as a percent of sales was 9.6% in the quarter ended February 28, 2005
compared to 13.1% for the same period last year. The margin decline was due to continued high
energy and chemical costs, which increased by $1.3 million over the prior year quarter, lower
overall sales volumes and increases in unit manufacturing costs, partially offset by improved unit
pricing and expanded sales of higher margin specialty starches. Income from operations for the
first half of fiscal 2005 was a loss of $3.8 million compared to income of $3.1 million in fiscal
2004. The primary factors contributing to this decrease were the incremental costs of
approximately $4 million related to the labor strike at the Companys Iowa manufacturing facility
which ended October 17, 2004, and increased energy and chemical costs of $2.3 million. The Company
believes that the new union contract will bring labor costs, particularly the cost of benefits, in
this business segment more in line with its industry peers over the next few
years. Included in operating income for the 13




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##### Table of Contents



second quarter and year-to-date fiscal 2004 was a
$0.5 million pre-tax charge related to a workforce reduction in this business segment. Income from operations at the Companys Australia/New Zealand operations was a loss of $0.3
million for the quarter ended February 28, 2005 compared to income of $1.5 million last year.
Quarterly gross margin as a percent of sales decreased from 12.8% last year to 4.2% in the current
year quarter. Fiscal 2005 year-to-date operating income decreased by $1.6 million to $0.2 million
compared to the prior year period and gross margin as a percent of sales was 6.3% compared to 10.4%
last year. The declines in gross margin and operating income for the three- and six-month periods
ended February 28, 2005 are due to pricing pressures on domestic products from imports as the
Australian and New Zealand currencies continue to strengthen, manufacturing problems as plant
operations were reconfiguring processes and installing new equipment to improve product mix, and a
decrease in higher margin low carbohydrate product applications. Included in operating income
for the quarter and six months ended February 29, 2004 was $0.3 million of severance costs related
to a workforce reduction. Second quarter income from operations at the Food IngredientsNorth American business unit
grew $0.4 million to $1.1 million from the comparable quarter last year and gross margin as a
percent of sales improved to 23.8% from 21.9% last year on a quarterly sales volume increase of 6%,
higher margins generated by low carbohydrate product applications, and higher plant utilization
in the Companys dextrose production facility. Fiscal 2005 year-to-date operating income and gross
margin as a percent of sales both decreased slightly to $2.5 million and 24.1%, respectively, from
$2.6 million and 25.8%, respectively, in the first half of fiscal 2004. Improvements in sales,
product mix and costs in the second quarter only partially offset higher first quarter costs to
manufacture dextrose and corn products during the strike in Iowa. Corporate operating expenses Corporate operating expenses for the second quarter and first six months of fiscal 2005
increased $0.3 million and $0.5 million, respectively, over the prior year periods due to increases
in professional fees associated with the initial attestation on internal controls required by the
Sarbanes-Oxley Act of 2002. Interest and taxes Fiscal 2005 interest expense rose $0.2 million in the second quarter and $0.3 million for the
first six months compared to the same periods last year on slightly higher average floating
interest rates in the U.S. and Australia. The Companys effective tax rate for the three and six months ended February 28, 2005 and the
three and six months ended February 29, 2004 varied from the U.S. federal statutory rate primarily
due to U.S. tax credits related to research and development and the favorable tax effect of export
sales from the U.S. The second quarter 2005 tax benefit recorded included an adjustment increasing
the tax benefit in Australia by $0.1 million after reconciling the fiscal 2004 tax return filed to
the tax provision recorded in fiscal 2004. Non-operating income, net Non-operating income, net consists of the following: Three months ended
    
    
    Six months endedFebruary
    
    
    February
    
    
    February
    
    
    February28, 2005
    
    
    29, 2004
    
    
    28, 2005
    
    
    29, 2004(In thousands)Loss on early extinguishment of debt
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (665
    )Gain on sale of investment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    150Royalty and licensing income
    
    
    440
    
    
    
    396
    
    
    
    527
    
    
    
    763Other
    
    
    (70
    )
    
    
    134
    
    
    
    (75
    )
    
    
    257Total
    
    $
    370
    
    
    $
    530
    
    
    $
    452
    
    
    $
    505
 14




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##### Table of Contents



In October 2003, Penford refinanced its existing secured credit and inventory financing credit
agreements and wrote off the unamortized deferred transaction costs related to these credit
agreements. In November 2002, the Company licensed the rights to its resistant starch intellectual
property portfolio for applications in human nutrition. The initial licensing fee of $2.25 million
received in November 2002 is being amortized over the life of the licensing agreement. In
addition, the Company receives royalty income as a percentage of its licensees sales of resistant
starch for a period of seven years or until a maximum of $11 million in royalties has been received
by Penford. The royalty payments are subject to a minimum of $7 million over the first five years
of the licensing agreement. Liquidity and Capital Resources Penford had working capital of $40.3 million at February 28, 2005 and August 31, 2004. Cash
flow from operations was $3.2 million and $8.8 million for the six months ended February 28, 2005
and February 29, 2004, respectively. The decrease in cash flow from operations is primarily due to
the decline in earnings in fiscal 2005. At February 28, 2005, the Company had $37.5 million outstanding under its revolving credit
facilities and $46.1 million in term loans. Effective November 2004, Penford obtained an amendment
to the funded debt ratio covenant, a ratio of earnings before interest, depreciation and taxes, as
defined, to total debt, in its credit facility agreement. The Companys lenders agreed to exclude
$8.4 million, a majority of the nonrecurring strike-related costs, from the calculation of the
funded debt ratio. The agreement was also amended to increase the funded debt ratio threshold to
3.5 for the first half of fiscal 2005, to 3.25 for the third quarter of fiscal 2005, and to 3.0
thereafter. The maximum capital expenditure level was reduced from $20 million to $15 million for
fiscal 2005. Pursuant to the terms of the credit agreement, Penfords borrowing ability was $8.1
million at February 28, 2005. The Company was in compliance as of February 28, 2005 and expects to
be in compliance with these revised covenants for the remainder of fiscal 2005. The Company paid dividends of $1.1 million during the six months ended February 28, 2005,
which represents a quarterly rate of $0.06 per share, the same per share dividend rate as the six
months ended February 29, 2004. On January 28, 2005, the Board of Directors declared a dividend of
$0.06 per common share payable on March 4, 2005 to shareholders of record as of February 11, 2005.
Any future dividends will be paid at the discretion of the Companys board of directors and will
depend upon, among other things, earnings, financial condition, cash requirements and availability,
and contractual requirements. Recent Accounting Pronouncements In November 2004, the FASB issued Statement No. 151, Inventory Costsan Amendment of ARB No.
43, Chapter 4 (SFAS No. 151). SFAS No. 151, which is effective for inventory costs incurred
during years beginning after June 15, 2005, clarifies the accounting for abnormal amounts of idle
facility expense, freight, handling costs, and wasted material, requiring that those items be
recognized as current-period charges. In addition, SFAS No. 151 requires that allocation of fixed
production overheads be based on the normal capacity of the production facilities. The adoption of
SFAS No. 151 beginning September 1, 2005 is not expected to have a material effect on the Companys
results of operation, financial position or liquidity. In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment
(SFAS No. 123R). SFAS No. 123R, which is effective for the first interim or annual period
beginning after June 15, 2005, requires all share-based payments to employees, including grants of
stock options, to be recognized in the financial statements based on their fair values. In
addition, two transition alternatives are permitted at the time of adoption of this statement,
restating prior year financial statements or recognizing adjustments to share-based liabilities as
the cumulative effect of a change in accounting principle. The adoption of SFAS No. 123R will
increase the Companys compensation costs and share-based liabilities. The Company is studying the
requirements of this standard and, at this time, cannot reasonably estimate the impact of SFAS No.
123R on its financial statements. 15




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##### Table of Contents



Risks and Uncertainties The availability and cost of the agricultural products and agricultural by-products Penford
purchases are vulnerable to weather and other factors beyond its control. Approximately 30% of Penfords manufacturing costs are the costs of agricultural raw materials
and agricultural by-products: corn, wheat flour, and potato starch. Weather conditions, plantings
and global supply, among other things, have historically caused volatility in the supply and prices
of these agricultural products. The Company may not be able to pass through any increases in the
cost of agricultural raw materials to its customers. To manage the price volatility in the
commodity markets, the Company may purchase inventory in advance or enter into exchange traded
futures or options contracts. Despite these hedging activities, Penford may not be successful in
limiting its exposure to market fluctuations in the cost of agricultural raw materials. Increases
in the cost of corn, wheat flour, and potato starch due to weather conditions or other factors
beyond Penfords control and that cannot be passed through to customers will reduce Penfords
future profitability. Increases in energy costs will reduce the Companys profitability. Electricity and natural gas comprise approximately 15% of the cost of manufacturing the
Companys products in North America. Natural gas is used extensively in the Industrial Ingredients
 North America business to dry the starch products. The prices of these inputs to the
manufacturing process fluctuate based on anticipated changes in supply and demand, weather and the
prices of alternative fuels. Penford may use short-term purchase contracts or exchange traded
futures or option contracts to reduce the price volatility of natural gas. Penford may not be able
to pass on increases in energy costs to its customers and margins and profitability would be
adversely affected. The loss of a major customer could have an adverse effect on Penfords results of operations. None of the Companys customers constituted 10% of sales in the last three fiscal years.
However, in the six months of fiscal 2005, sales to the top ten customers and sales to the largest
customer represented 46% and 8.8%, respectively, of total consolidated net sales. Customers place
orders on an as-needed basis and generally can change their suppliers without penalty. If the
Company lost one or more of its major customers, or if one or more of its customers significantly
reduced its orders, sales and results of operations would be adversely affected. In order to be successful, Penford must retain and motivate key employees. In order to be successful, the Company must retain and motivate executives and other key
employees. In particular, hiring and retaining qualified personnel in management, research and
development, sales and marketing, manufacturing and finance is critical to Penfords future.
Penford faces intense competition for its personnel needs. The loss of key employees could have a
significant impact on the Companys results of operations and stock price. Changes in interest rates will affect Penfords profitability. At February 28, 2005, approximately $73.3 million of the Companys outstanding debt is subject
to variable interest rates which move in direct proportion to the London InterBank Offered Rate
(LIBOR) or the Australian Bank Bill Buying Rate (BBSY). Significant changes in these interest
rates would materially affect Penfords profitability. Unanticipated changes in tax rates or exposure to additional income tax liabilities could affect
Penfords profitability. Penford is subject to income taxes in the United States, Australia and New Zealand. The
effective tax rates could be adversely affected by changes in the mix of earnings in countries with
differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities or
changes in tax laws. The carrying value of deferred tax assets, which are predominantly in the
United States, is dependent on Penfords ability to generate future taxable income in the United
States. 16




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##### Table of Contents



Profitability is subject to risks associated with changes in foreign exchange currency rates. In the ordinary course of business, Penford is subject to risks associated with changing
foreign exchange rates. For the six months ended February 28, 2005, approximately 33% of the
Companys revenue is denominated in currencies other than the U.S. dollar. Penfords revenues and
results of operations are affected by fluctuations in exchange rates between the U.S. dollar and
the Australian and New Zealand dollars. Provisions of Washington law could discourage or prevent a potential takeover. Penford is incorporated in the State of Washington and subject to the anti-takeover provisions
of the Washington Business Corporation Act (the 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 the anti-takeover provisions of
the Act could have the effect of delaying or preventing a change of control in the ownership of the
Company. 
 Item 3: Quantitative and Qualitative Disclosures About Market Risk. The Company is exposed to market risks from adverse changes in interest rates, foreign
currency exchange rates and commodity prices. Since August 31, 2004, there have been no
significant changes in the Companys exposure to market risks. 
 Item 4: Controls and Procedures. Under the supervision and with the participation of management, including the Chief Executive
Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and
operation of its disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this
report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that these disclosure controls and procedures are effective such that information related
to the Company required to be disclosed in the Securities and Exchange Commission (SEC) reports
(i) is recorded, processed, summarized and reported within the time periods specified in SEC rules
and forms, and (ii) is accumulated and communicated to the Companys management, including the
Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure. 17




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##### Table of Contents



PART II  OTHER INFORMATION 
 Item 1: Legal Proceedings See Note 12 to the Condensed Consolidated Financial Statements for a discussion of legal
proceedings. 
 Item 4: Submission of Matters to a Vote of Security Holders The Company held its Annual Meeting of Shareholders on January 28, 2005. The only item voted
upon at the meeting was the election of directors. The results of the election are shown below.
Directors not elected at this meeting and whose term of office continued after the meeting are
Jeffrey T. Cook, R. Randolph Devening, Paul H. Hatfield, Thomas D. Malkoski and Sally G. Narodick. Percent of
    
    
    
    
    
    
    Percent ofDirector
    
    Votes For
    
    
    Total Shares
    
    
    Votes Withheld
    
    
    Total SharesWilliam E. Buchholz
    
    
    6,687,554
    
    
    
    75.8
    %
    
    
    283,675
    
    
    
    3.2
    %John C. Hunter III
    
    
    6,796,652
    
    
    
    73.0
    %
    
    
    174,577
    
    
    
    2.0
    %James E. Warjone
    
    
    6,861,495
    
    
    
    77.8
    %
    
    
    109,734
    
    
    
    1.2
    %
 
 Item 6: Exhibits. Exhibits
 31.1
    
    Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 200232
    
    Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 18




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. Penford Corporation(Registrant)April 8, 2005
    
    /s/ Steven O. CordierSteven O. CordierSenior Vice President, Chief Financial Officer
and Corporate Secretary
 19




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##### Table of Contents



EXHIBIT INDEX Exhibit No.
    
    Description31.1
    
    Certifications of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200231.2
    
    Certifications of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200232
    
    Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 20